THE ARBITRAGE FUND
A SERIES OF THE ARBITRAGE FUNDS
350 Park Avenue
New York, New York 10022
PROSPECTUS
AUGUST 31, 2000
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THE SECURITIES AND EXCHANGE COMMISSION HAS NOT APPROVED OR DISAPPROVED OF THESE
SECURITIES OR PASSED UPON THE ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO
THE CONTRARY IS A CRIMINAL OFFENSE.
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THE ARBITRAGE FUND
The Arbitrage Funds currently offers one fund series to
investors--The Arbitrage Fund. The Fund is non-diversified and
its investment objective is to achieve capital growth by
engaging in merger arbitrage.
This prospectus has information you should know before
investing. Please read it carefully and keep it with your
investment records.
ADVISER
Water Island Capital, LLC
TABLE OF CONTENTS
RISK/RETURN SUMMARY............................................................3
PERFORMANCE....................................................................4
FEES AND EXPENSES..............................................................4
INVESTMENT OBJECTIVE, POLICIES AND RISKS.......................................5
ADVISER........................................................................7
DISTRIBUTION ARRANGEMENTS......................................................8
NET ASSET VALUE................................................................8
HOW TO PURCHASE SHARES.........................................................9
REDEMPTIONS...................................................................10
TAX STATUS, DIVIDENDS AND DISTRIBUTIONS.......................................12
FINANCIAL HIGHLIGHTS..........................................................12
RISK/RETURN SUMMARY
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INVESTMENT OBJECTIVE
The Fund seeks to achieve capital growth by engaging in merger
arbitrage.
PRINCIPAL INVESTMENT STRATEGY
In attempt to achieve its objective, the Fund plans to invest at least
65% of its assets in equity securities of companies that are involved in
publicly announced mergers, takeovers, tender offers, leveraged buyouts,
spin-offs, liquidations and other corporate reorganizations. Equity securities
include common and preferred stock. Merger arbitrage is a highly specialized
investment approach designed to profit from the successful completion of
corporate reorganizations. The Adviser uses investment strategies designed to
minimize market exposure including short selling and purchasing and selling
options. The most common arbitrage activity, and the approach the Fund generally
will use, involves purchasing the shares of an announced acquisition target
company at a discount to their expected value upon completion of the
acquisition. The Adviser may engage in selling securities short when the terms
of a proposed acquisition call for the exchange of common stock and/or other
securities. In such a case, the common stock of the company to be acquired may
be purchased and, at approximately the same time, an equivalent amount of the
acquiring company's common stock and/or other securities may be sold short.
PRINCIPAL INVESTMENT RISKS
As with all mutual funds, investing in the Fund entails risks that
could cause the Fund and you to lose money. The principal risks of investing in
the Fund are as follows:
o MERGER ARBITRAGE RISKS: The principal risk associated with the Fund's
merger arbitrage investment strategy is that the proposed
reorganizations in which the Fund invests may be renegotiated or
terminated, in which case the Fund may realize losses.
o HIGH PORTFOLIO TURNOVER RATE: The Fund's investment strategy may
result in high turnover rates. This may increase the Fund's
short-term capital appreciation and increase brokerage commission
costs. Rapid portfolio turnover also exposes shareholders to a
higher current realization of capital gains and this could cause
you to pay higher taxes.
o NON-DIVERSIFICATION RISKS: The Fund is not a "diversified" fund,
which means the Fund may invest in a relatively small number of
issuers making it more susceptible to adverse developments of a
single issuer. As a result, investing in the Fund is potentially
more risky than an investing in a diversified fund that is
otherwise similar to the Fund.
o BORROWING RISKS: Because the Fund may borrow money from banks to
purchase securities of companies involved in reorganizations, the
Fund's exposure to fluctuations in the prices of these securities
is increased in relation to the Fund's capital. This can cause the
price of shares to be more volatile than if the Fund did not
borrow money. Borrowing also increases the Fund's expenses because
of the interest the Fund must pay on borrowed money, together with
any additional fees to maintain a line of credit or any minimum
average balances required to be maintained.
o SHORT SALE/PUT AND CALL OPTIONS RISKS: The Fund may engage in various
hedging practices, which by definition entail substantial risks. As
stated above, the approach the Fund generally will use involves
purchasing the shares of an announced acquisition target company at a
discount to their expected value upon completion of the acquisition.
But if an acquisition is called off or otherwise not completed, the
Fund may realize losses on the shares of the target company it acquired
and on its short position in the acquirer's securities. Also, options
transactions involve special risks that may make it difficult or
impossible to unwind a position when the Fund desires.
PERFORMANCE
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Because the Fund has no operating history, there is no performance
information available at this time.
FEES AND EXPENSES
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This table describes the fees and expenses that you may pay if you buy
and hold shares of the Fund.
SHAREHOLDER FEES(1)
(FEES PAID DIRECTLY FROM YOUR ACCOUNT)
Maximum Sales Charge (Load) Imposed on Purchases None(2)
(AS A PERCENTAGE OF OFFERING PRICE)
Maximum Deferred Sales Charge (Load) None
(AS A PERCENTAGE OF OFFERING PRICE)
Maximum Sale Charge (Load) Imposed on
Reinvested Dividends and Other None
Distributions
Redemption Fee None
(AS A PERCENTAGE OF AMOUNT REDEEMED)
Exchange Fee None
ANNUAL FUND OPERATING EXPENSES
(EXPENSES THAT ARE DEDUCTED FROM FUND ASSETS)
Management Fees 1.50%
Distribution and/or Service (12b-1) Fees 0.25%
Other Operating Expenses 2.25%
Total Annual Fund Operating Expenses 4.00%
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Less Expense Reimbursement(3) -2.05%
Net Annual Fund Operating Expenses 1.95%
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(1) Although no sales loads or transaction fees are charged, you will be
assessed fees for outgoing wire transfers, returned checks and stop payment
orders at prevailing rates charged by Firstar Mutual Fund Services, LLC, the
Fund's transfer agent.
(2) IRA accounts will be charged a $12.50 annual maintenance fee as well as
fees for certain transactions.
(3) The Adviser has entered into an Expense Waiver and Reimbursement contract
dated ______, 2000 with the Fund under which the Adviser has agreed to waive its
fees and absorb expenses, excluding taxes, interest and dividends on short
positions, to the extent that Annual Fund Operating Expenses exceed 1.95% of
average daily net assets. The Advisor can recapture any expenses or fees it has
waived or reimbursed within a three-year period subject to the applicable cap of
1.95%. The contract is in effect for one year and expires ______, 2001.
EXAMPLE
This example is intended to help you compare the cost of investing in
the Fund with the cost of investing in other mutual funds.
THE EXAMPLE ASSUMES THAT YOU INVEST $10,000 IN THE FUND FOR THE TIME
PERIODS INDICATED AND THEN REDEEM ALL OF YOUR SHARES AT THE END OF THOSE
PERIODS. THE EXAMPLE ALSO ASSUMES THAT YOUR INVESTMENT HAS A 5% RETURN EACH
YEAR, YOU REINVEST ALL DIVIDENDS AND CAPITAL GAINS DISTRIBUTIONS AND THAT THE
FUND'S OPERATING EXPENSES REMAIN THE SAME. ALTHOUGH YOUR ACTUAL COSTS MAY BE
HIGHER OR LOWER, BASED ON THESE ASSUMPTIONS, YOUR COSTS WOULD BE:
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1 YEAR 3 YEARS
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$196 $1,012
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INVESTMENT OBJECTIVE, POLICIES AND RISKS
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INVESTMENT OBJECTIVE
The Fund seeks to achieve capital growth by engaging in merger
arbitrage.
PRINCIPAL INVESTMENT STRATEGIES AND POLICIES
To achieve its investment objective, the Fund, under normal market
conditions, will invest at least 65% of its total assets in equity securities of
companies involved in publicly announced mergers, takeovers, tender offers,
leveraged buyouts, spin-offs, liquidations and other types of corporate
reorganizations (all referred to as "corporate reorganizations"). Equity
securities include common and preferred stock.
Merger arbitrage refers to the investment practice of capturing the
difference between the end value of a corporate reorganization and the
prevailing market prices of the securities of the companies involved prior to
the consummation of the reorganization. It is a highly specialized investment
approach designed to profit from the successful completion of such
reorganizations. The discrepancy in value is attributable to risks that are
inherent in corporate reorganizations, which include the possibility the
transaction will not be completed and the time it takes for corporate
reorganizations to be completed.
The Fund continuously monitors not only the investment positions owned
by the Fund, but also other potential mergers and corporate reorganizations.
This enables the Fund to make timely and informed investment decisions if market
prices of other securities adjust enough for the Fund to make new investments
for its own portfolio. The Adviser expects the Fund's assets to be diversified
in various industries; however if a large percentage (i.e., at least 50%) of
mergers taking place within the U.S. are within one industry (e.g. banking or
telecommunications) over a given period of time, a large portion of the Fund's
assets could be concentrated in that industry for that period of time.
The most common arbitrage activity, and the approach the Fund generally
will use, involves purchasing the shares of an announced acquisition target at a
discount to their expected value upon completion of the acquisition. The Adviser
will carefully evaluate all potential arbitrage investment opportunities
examining each situation's return characteristics together with its risk
profile. As an important part of this investment process, the Fund
systematically reduces market exposure by employing various hedging strategies.
HEDGING STRATEGIES:
The Fund may employ various hedging techniques, such as short selling
or engaging in put and call options.
SHORT SALES: The Adviser may engage in selling securities short when
the terms of a proposed acquisition call for the exchange of common stock and/or
other securities. In such a case, the common stock of the company to be acquired
may be purchased and, at approximately the same time, an equivalent amount of
the acquiring company's common stock and/or other securities may be sold short.
The Fund will make these short sales with the intention of later closing out (or
covering) the short position with the securities of the acquiring company
received when the acquisition is consummated. The purpose of the short sale is
to protect against a decline in the market value of the acquiring company's
securities prior to the acquisition's completion. At all times when the Fund
does not own securities which are sold short, the Fund will maintain collateral
consisting of cash, cash equivalents and liquid securities equal in value on a
daily marked-to-market basis to the securities sold short.
PUT AND CALL OPTIONS: The Adviser may engage in purchasing and/or
selling put and call options in an effort to reduce the risks associated with
some of its investments. A put option is a short-term contract which gives the
purchaser of the option, in return for a premium paid, the right to sell the
underlying security at a specified price upon exercise of the option at any time
prior to the expiration of the option. The market price of a put option will
normally vary inversely with the market price of the underlying security.
Consequently, by purchasing put options on securities the Fund has purchased, it
may be possible for the Fund to partially offset any decline in the market value
of these securities. A call option, on the other hand, is a short-term contract
entitling the purchaser, in return for a premium paid, the right to buy the
underlying security at a specified price upon exercise of the option, at any
time prior to its expiration. The market price of the call will, in most
instances, move in conjunction with the price of the underlying security.
The premium received by the Fund for the sale of options may be used by
the Fund to reduce the risks associated with individual investments and to
increase total investment return. Currently, the Adviser does not intend to
commit greater than 25% of the Fund's net assets to option strategies.
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PUT AND CALL OPTIONS (DEFINITION)
A SHORT-TERM CONTRACT THAT GIVES THE PURCHASER OF THE OPTION THE RIGHT TO SEE
(PUT) OR BUY (CALL) THE UNDERLYING SECURITY AT ANY TIME BEFORE THE OPTION
EXPIRES IN RETURN FOR A PREMIUM.
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LEVERAGE THROUGH BORROWING: The Fund may borrow from banks to increase
its portfolio holdings of securities on a secured or unsecured basis at fixed or
variable interest rates. When borrowing money, the Fund must follow specific
guidelines under the Investment Company Act of 1940, which allow the Fund to
borrow an amount equal to as much as 50% of the value of its net assets (not
including the amount borrowed). The Fund also may borrow money for temporary or
emergency purposes, but these borrowings, together with all other borrowings,
may not exceed 33% of the value of the Fund's gross assets at the time the loan
is made.
When determining whether to sell or cover a security, the Adviser
continuously reviews and rationalizes each investment's risk versus its reward
relative to its predetermined exit strategy. The Fund will sell or cover a
security when the securities of the companies involved in the transaction do not
meet the Fund's expected return criteria when gauged by prevailing market prices
and the relative risks of the situation.
TEMPORARY INVESTMENTS: The Fund may adopt temporary defensive positions
that are inconsistent with the Fund's principal investment strategies in
attempting to respond to adverse market, economic, political, or other
conditions. Depending upon the level of merger activity and other economic and
market conditions, the Fund may invest temporarily a substantial portion of its
assets in cash or cash equivalents, including money market instruments such as
Treasury bills and other short-term obligations of the United States Government,
its agencies or instrumentalities, prime commercial paper, and repurchase
agreements for the above securities. To the extent the Fund invests in these
temporary investments, the Fund will not achieve its investment objective of
growth of capital since these instruments bear interest but do not appreciate in
value.
INVESTMENT RISKS
The Fund's investment program involves investment techniques and
securities holdings that entail risks, in some cases different from the risks
ordinarily associated with investments in equity securities. Some of these risks
include:
MERGER ARBITRAGE RISKS: The principal risk associated with the Fund's
arbitrage investments is that certain of the proposed reorganizations in which
the Fund invests may be renegotiated, terminated, or involve a longer time frame
than originally contemplated, in which case the Fund may lose money. If a
transaction takes a longer time to close than the Fund originally anticipated,
the Fund may not realize the level of returns desired.
NON-DIVERSIFICATION RISKS: Because the Fund's assets are invested in a
smaller number of companies or companies, there is a somewhat greater risk
associated with investment in the Fund than there would be if investing in a
diversified investment company. Non-diversification makes the value of the
Fund's shares more susceptible to adverse developments affecting any single
issuer and more susceptible to greater losses.
HIGH PORTFOLIO TURNOVER RISKS: The Fund invests a portion of its assets
to seek short-term capital appreciation, which increases portfolio turnover and
causes increased brokerage commission costs. A high turnover rate exposes you to
a higher current realization of capital gains, and thus a higher current tax
liability, than may be associated with investments in other investment companies
that emphasize long-term investment strategies and thus have a lower turnover
rate.
SHORT SALE/PUT AND CALL OPTIONS RISKS: A substantial percentage of the
investments made by the Fund will not lend themselves to hedging strategies and,
even when available, these strategies may not be successful. For instance, if an
acquisition is called off or otherwise not completed, the Fund may realize
losses on the shares of the target company it acquired and on its short position
in the acquirer's securities. Also, options transactions involve special risks
that may make it difficult or impossible to close a position when the Fund
desires. These risks include:
o possible imperfect correlation between the price movements of the option and
the underlying security,
o the potential lack of a liquid secondary market at any particular time, and
o possible price fluctuation limits.
BORROWING RISKS: The Fund's borrowing activities will exaggerate any
increase or decrease in the net asset value of the Fund. In addition, the
interest which the Fund must pay on borrowed money, together with any additional
fees to maintain a line of credit or any minimum average balances required to be
maintained, are additional costs which will reduce or eliminate any net
investment profits. Unless profits on assets acquired with borrowed funds exceed
the costs of borrowing, the use of borrowing will diminish the investment
performance of the Fund compared with what it would have been without borrowing.
ADVISER
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Water Island Capital, LLC, 350 Park Avenue, New York, New York 10022, a
registered investment adviser, is the Fund's Adviser. Subject to the authority
of the Fund's Board of Trustees, the Adviser is responsible for the overall
management of the Fund's business affairs. The fee the Adviser charges the Fund
is higher than fees typically paid by other mutual funds. This higher fee is
attributable in part to the higher expenses and the specialized skills
associated with managing a portfolio of merger arbitrage investments. The Fund
pays the Adviser an annual advisory fee of 1.5% of the Fund's average daily net
assets.
John S. Orrico, CFA, is portfolio manager for the Fund. Mr. Orrico
serves as President of the Adviser and also serves as the President and a
Trustee of the Fund. Prior to organizing the Adviser, Mr. Orrico managed private
hedge funds with Lindemann Capital Partners, L.P. during 1999. From 1994 to
1998, Mr. Orrico engaged in mergers and acquisition arbitrage while managing the
Gruss Family Trust for Gruss & Co. Mr. Orrico received two Bachelors degrees
from Georgetown University in 1982--one in Finance and the other in
International Management. He became a Chartered Financial Analyst in 1988.
DISTRIBUTION ARRANGEMENTS
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DISTRIBUTOR
Quasar Distributors, LLC serves as principal underwriter for the Fund
and as such, is the exclusive agent for the distribution of shares of the Fund.
DISTRIBUTION PLAN
The Fund has adopted a Rule 12b-1 plan, which allows the Fund to pay
distribution fees for the sale and distribution of its shares. The maximum level
of distribution expenses is 0.25% per year of the Fund's average daily net asset
value. As these fees are paid out of the Fund's assets on an on-going basis,
over time these fees will increase the cost of your investment and may cost you
more than paying other types of sales charges.
NET ASSET VALUE
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The net asset value per share of the Fund will be determined on each
day the New York Stock Exchange ("NYSE") is open for business and will be
computed by determining the aggregate market value of all assets of the Fund
less its liabilities, and then dividing by the total number of shares
outstanding. The NYSE is closed on weekends and most national holidays. The
determination of net asset value for a particular day is applicable to all
applications for the purchase of shares, as well as all requests for the
redemption of shares, received before the close of trading on the NYSE on that
day.
HOW TO PURCHASE SHARES
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You may purchase shares of the Fund at net asset value without any
sales or other charge by sending a completed application form to one of the
following addresses:
REGULAR MAIL EXPRESS/OVERNIGHT MAIL
The Arbitrage Fund The Arbitrage Fund
c/o Firstar Mutual Fund Services, LLC c/o Firstar Mutual Fund Services, LLC
P.O. Box 701 615 East Michigan Street
Milwaukee, Wisconsin 53201-0701 Milwaukee, Wisconsin 53202
MINIMUM AND ADDITIONAL INVESTMENT AMOUNTS
The minimum initial investment for individuals, IRAs, corporations,
partnerships and trusts is $2,000. There is no minimum for subsequent
investments. Shares of the Fund are offered on a continuous basis. The Fund,
however, reserves the right, in its sole discretion, to reject any application
to purchase shares. Applications will not be accepted unless they are
accompanied by a check drawn on a U.S. bank, savings and loan, or credit union
in U.S. funds for the full amount of the shares to be purchased. After you open
an account, you may purchase additional shares by sending a check TOGETHER WITH
A NOTE STATING the name(s) on the account and the account number, to the above
address. You should make all checks payable to "THE ARBITRAGE FUNDS."
NOTE: The custodian, Firstar Bank, N.A., will charge a $25.00 fee
against your account, in addition to any loss sustained by the Fund, for any
payment check returned to the custodian for insufficient funds.
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GOOD ORDER: WHEN MAKING A PURCHASE REQUEST, MAKE SURE YOUR REQUEST IS IN GOOD
ORDER. "GOOD ORDER" MEANS YOUR PURCHASE REQUEST INCLUDES:
O THE NAME OF THE FUND
O THE DOLLAR AMOUNT OF SHARES TO BE PURCHASED
O A COMPLETED PURCHASE APPLICATION OR INVESTMENT STUB
O CHECK PAYABLE TO THE ARBITRAGE FUNDS
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WHEN ORDER IS PROCESSED
All shares will be purchased at the net asset value per share next
determined after the Fund receives your application or request in good order.
All requests received in good order by the Fund before 4:00. (Eastern time) will
be executed on that same day. Requests received after 4:00 p.m. will be
processed on the next business day.
PURCHASE THROUGH BROKERS
You may use your broker, dealer, financial institution or other
servicing agent to purchase shares of the Fund if the servicing agent has an
agreement with the Fund's distributor. Please note that such agents may charge
additional fees for their services. You should also note that your servicing
agent may become record shareholders of the Fund requiring all purchase and
redemption requests to be sent through them. Finally, various servicing agents
use procedures and impose restrictions that may be in addition to, or different
from those applicable to investors purchasing shares directly from the Fund. You
should carefully read the program materials provided to you by your servicing
agent.
PURCHASE BY WIRE
If you wish to wire money to invest in the Fund, please call the Fund
at 1-800-295-4485 to notify the Fund that a wire transfer is coming. You may use
the following instructions:
Firstar Bank, N.A.
Milwaukee, WI 53202
ABA #: 042000013
Credit: Firstar Mutual Fund Services, LLC
Account #: 112-952-137
Further Credit: The Arbitrage Fund
(your name/title on the account)
(account #)
AUTOMATIC INVESTMENT PLAN
You may participate in the Fund's Automatic Investment Plan, an
investment plan that automatically debits money from your bank account and
invests it in the Fund through the use of electronic funds transfers or
automatic bank drafts. After making an initial investment of at least $2,000,
you may elect to make subsequent investments by transfers of a minimum of $100
on specified days of each month into your established Fund account. Please
contact the Fund at 1-800-295-4485 for more information about the Fund's
Automatic Investment Plan.
RETIREMENT PLANS
You may purchase shares of the Fund for your individual retirement
plans. Please call the Fund at 1-800-295-4485 for the most current listing and
appropriate disclosure documentation on how to open a retirement account.
REDEMPTIONS
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WRITTEN REDEMPTION REQUESTS
You will be entitled to redeem all or any portion of the shares
credited to your accounts by submitting a written request for redemption to:
REGULAR MAIL EXPRESS/OVERNIGHT MAIL
The Arbitrage Fund The Arbitrage Fund
c/o Firstar Mutual Fund Services, LLC c/o Firstar Mutual Fund Services, LLC
P.O. Box 701 615 East Michigan Street
Milwaukee, Wisconsin 53201-0701 Milwaukee, Wisconsin 53202
REDEEMING BY TELEPHONE
You may redeem shares having a value of less than $25,000 by telephone.
The proceeds will be sent by mail to the address designated on your account or
wired directly to your existing account in any commercial bank or brokerage firm
in the United States as designated on your application. To redeem by telephone,
call 1-800-295-4485. The redemption proceeds normally will be sent by mail or by
wire within three business days after receipt of your telephone instructions.
IRA accounts are not redeemable by telephone.
The telephone redemption privilege is automatically available to all
new accounts. If you do not want the telephone redemption privilege, you must
indicate this in the appropriate area on your account application or you must
write to the Fund and instruct it to remove this privilege from your account.
The Fund reserves the right to suspend the telephone redemption
privileges with respect to your account if the name(s) or the address on the
account has been changed within the previous 30 days. Neither the Fund, Firstar
Mutual Fund Services, LLC, nor their respective affiliates will be liable for
complying with telephone instructions they reasonably believe to be genuine or
for any loss, damage, cost or expenses in acting on such telephone instructions
and you will be required to bear the risk of any such loss. The Fund or Firstar
Bank, or both, will employ reasonable procedures to determine that telephone
instructions are genuine. If the Fund and/or Firstar Mutual Fund Services, LLC,
do not employ these procedures, they may be liable to you for losses due to
unauthorized or fraudulent instructions. These procedures may include, among
others, requiring forms of personal identification prior to acting upon
telephone instructions, providing written confirmation of the transactions
and/or tape recording telephone instructions.
WIRE REDEMPTIONS
If you request your redemption by wire transfer, you will be required
to pay a $12.00 wire transfer fee to Firstar Bank to cover costs associated with
the transfer. In addition, your bank may impose a charge for receiving wires.
SYSTEMATIC WITHDRAWAL PLAN
If your individual accounts, IRA or other qualified plan account have a
current account value of at least $10,000, you may adopt a Systematic Withdrawal
Plan to provide for monthly, quarterly or other periodic checks for any
designated amount of $500 or more. Firstar Bank will charge you an annual fee of
$15.00 per plan to participate. If you wish to open a Systematic Withdrawal
Plan, please indicate on your application or contact the Fund at 1-800-295-4485.
WHEN REDEMPTIONS ARE SENT
Once the Fund receives your redemption request in "good order" as
described below, it will issue a check based on the next determined net asset
value following your redemption request. If you purchase shares using a check
and soon after request a redemption, the Fund will honor the redemption request,
but will not mail the proceeds until your purchase check has cleared (usually
within 12 days).
GOOD ORDER
Your redemption request will be processed if it is in "good order." To
be in good order, the following conditions must be satisfied:
o The request should be in writing, indicating the number of shares or dollar
amount to be redeemed;
o The request must identify your account number;
o The request should be signed by you and any other person listed on the
account, exactly as the shares are registered; and
o If you request the redemption proceeds to be sent to an address other than
that of record, or if the proceeds of a requested redemption exceed $25,000,
the signature(s) on the request must be guaranteed by an eligible signature
guarantor.
WHEN YOU NEED SIGNATURE GUARANTEES
If you wish to change the bank or brokerage account that you have
designated on your account, you may do so at any time by writing to the Fund
with your signature guaranteed. A signature guarantee assures that a signature
is genuine and protects you from unauthorized account transfers. You will need
your signature guaranteed if:
o you request a redemption to be made payable to a person not on record with the
Fund; or
o you request that a redemption be mailed to an address other than that
on record with the Fund.
Signatures may be guaranteed by any eligible guarantor institution
(including banks, brokers and dealers, credit unions, national securities
exchanges, registered securities associations, clearing agencies and savings
associations) or by completing a supplemental telephone redemption authorization
form. Contact the Fund to obtain this form. Further documentation will be
required to change the designated account if shares are held by a corporation,
fiduciary or other organization. A NOTARY PUBLIC CANNOT GUARANTEE SIGNATURES.
RETIREMENT PLANS
If you own an IRA or other retirement plan, you must indicate on your
redemption request whether the Fund should withhold federal income tax. Unless
you elect in your redemption request that you do not want to have federal tax
withheld, the redemption will be subject to withholding.
REDEEMING THROUGH BROKER
If shares of the Fund are held by a broker-dealer, financial
institution or other servicing agent, you must contact that servicing agent to
redeem shares of the Fund. The servicing agent may charge a fee for this
service.
LOW BALANCES
If at any time your account balance falls below $1,000, the Fund may
notify you that, unless the account is brought up to at least $1,000, your
account could be closed. The Fund may, within 30 days, redeem all of your shares
and close your account by sending you a check to the address of record.
TAX STATUS, DIVIDENDS AND DISTRIBUTIONS
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The Fund intends to distribute substantially all of its net investment
income and net capital gain in December. Both distributions will be reinvested
in shares of the Fund unless you elect to receive cash. Dividends from net
investment income (including any excess of net short-term capital gain over net
long-term capital loss) are taxable to investors as ordinary income, while
distributions of net capital gain (the excess of net long-term capital gain over
net short-term capital loss) are taxable as long-term capital gain, regardless
of your holding period for the shares. The Fund expects that, as a result of its
investment objectives and strategies, its distributions will consist primarily
of short-term capital gains, which are taxable as ordinary income. Certain
dividends or distributions declared in October, November or December will be
taxed to shareholders as if received in December if they are paid during the
following January. Each year the Fund will inform you of the amount and type of
your distributions. IRAs and other qualified retirement plans are exempt from
federal income taxation.
On the account application, you will be asked to certify that your
social security number or tax payer identification number is correct and that
you are not subject to backup withholding for failing to report income to the
IRS. If you are subject to backup withholding or you did not certify your
taxpayer identification number, the IRS requires the Fund to withhold 31% of any
dividend and redemption or exchange proceeds. The Fund reserves the right to
reject any application that does not include a certified social security or
taxpayer identification number. If you do not have a social security number, you
should indicate on the purchase form that your application to obtain a number is
pending. The Fund is required to withhold taxes if a number is not delivered to
the Fund within seven days.
This summary is not intended to be and should not be construed to be
legal or tax advice to any current holder of the Fund's shares. You should
consult your own tax advisors to determine the tax consequences of owning Fund
shares.
FINANCIAL HIGHLIGHTS
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Because the Fund has recently been formed, there are no financial
highlights to report.
THE ARBITRAGE FUND
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Adviser WATER ISLAND CAPITAL, LLC
350 Park Avenue
New York, NY 10011
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Distributor QUASAR DISTRIBUTORS, LLC
615 East Michigan Street
Milwaukee, Wisconsin 53202
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Transfer Agent FIRSTAR MUTUAL FUND SERVICES, LLC
615 East Michigan Street, 3rd Floor
Milwaukee, WI 53202
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Custodian FIRSTAR BANK, N.A.
425 Walnut Street
Cincinnati, OH 45202
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Additional information about the Fund is included in the Statement of Additional
Information dated August 31, 2000. The Statement of Additional Information is
incorporated into this prospectus by reference (i.e., legally made a part of
this prospectus). The Statement of Additional Information provides more details
about the Fund's policies and management. Additional information about the
Fund's investments is available in the Fund's annual and semiannual reports to
shareholders. In the Fund's annual report, you will find a discussion of the
market conditions and strategies that significantly affected the Fund's
performance during its last fiscal year.
To obtain a free copy of the SAI, the annual and semiannual reports or other
information about the Fund, or to make shareholder inquires about the Fund,
please call 1-800-295-4485. You may also write to:
THE ARBITRAGE FUNDS
c/o Firstar Mutual Fund Services, LLC
P.O. Box 701
Milwaukee, Wisconsin 53201-0701
You may review and obtain copies of Fund information at the SEC Public Reference
Room in Washington, D.C. Please call 1-202-942-8090 for information relating to
the operation of the Public Reference Room. Reports and other information about
the Fund are available on the EDGAR Database on the SEC's Internet site at
HTTP://WWW.SEC.GOV. Copies of the information may be obtained, after paying a
duplicating fee, by electronic request at the following E-mail address:
[email protected], or by writing the Public Reference Section, Securities and
Exchange Commission, Washington, D.C. 20549-0102.
Investment Company Act File # 811-09815
THE ARBITRAGE FUND
A SERIES OF THE ARBITRAGE FUNDS
A no-load, open-end, non-diversified investment company which
seeks capital growth by engaging in merger arbitrage.
STATEMENT OF ADDITIONAL INFORMATION
August 31, 2000
This Statement of Additional Information is not a prospectus
and should be read in conjunction with the prospectus of The Arbitrage Fund, a
copy of which may be obtained without charge by contacting the Fund's Transfer
Agent, Firstar Mutual Fund Services, LLC, P.O. Box 701, Milwaukee, Wisconsin
53201-0701 or 1-800-295-4485.
TABLE OF CONTENTS
THE TRUST......................................................................3
INVESTMENT RESTRICTIONS........................................................3
INVESTMENT OBJECTIVES AND POLICIES.............................................5
MANAGEMENT....................................................................13
INVESTMENT ADVISER............................................................15
THE DISTRIBUTOR...............................................................16
DISTRIBUTION PLAN.............................................................16
ALLOCATION OF PORTFOLIO BROKERAGE.............................................17
PORTFOLIO TURNOVER............................................................17
FUND ADMINISTRATION...........................................................18
FUND ACCOUNTING AND TRANSFER AGENT............................................18
CUSTODIAN.....................................................................18
PURCHASE, REDEMPTION AND PRICING OF SHARES....................................19
TAX STATUS....................................................................20
PERFORMANCE INFORMATION.......................................................23
INDEPENDENT ACCOUNTANTS.......................................................24
COUNSEL.......................................................................24
FINANCIAL STATEMENTS..........................................................25
THE TRUST
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The Arbitrage Funds (the "Trust"), an open-end management investment
company, was organized as a Delaware business trust on December 22, 1999. The
Trust currently offers one series of shares to investors, The Arbitrage Fund.
The Fund is a non-diversified series and has its own investment objective and
policies. The Trust may start another series and offer shares of a new fund
under the Trust at any time.
Shares of the Fund have equal voting rights and liquidation rights, and
are voted in the aggregate and not by Fund except in matters where a separate
vote is required by the Investment Company Act of 1940 (the "1940 Act") or when
the matter affects only the interest of a particular Fund. When matters are
submitted to shareholders for a vote, each shareholder is entitled to one vote
for each full share owned and fractional votes for fractional shares owned. The
Trust does not normally hold annual meetings of shareholders. The Trustees shall
promptly call and give notice of a meeting of shareholders for the purpose of
voting upon removal of any Trustee when requested to do so in writing by
shareholders holding 10% or more of the Trust's outstanding shares. The Trust
will comply with the provisions of Section 16(c) of the 1940 Act in order to
facilitate communications among shareholders.
Each share of the Fund represents an equal proportionate interest in
the assets and liabilities belonging to that Fund with each other share of that
Fund and is entitled to such dividends and distributions out of the income
belonging to the Fund as are declared by the Trustees. The shares do not have
cumulative voting rights or any preemptive or conversion rights, and the
Trustees have the authority from time to time to divide or combine the shares of
any Fund into a greater or lesser number of shares of that Fund so long as the
proportionate beneficial interests in the assets belonging to that Fund and the
rights of shares of any other Fund are in no way affected. In case of any
liquidation of a Fund, the holders of shares of the Fund being liquidated will
be entitled to receive as a class a distribution out of the assets, net of the
liabilities, belonging to that Fund. Expenses attributable to any Fund are borne
by that Fund. Any general expenses of the Trust not readily identifiable as
belonging to a particular Fund are allocated by or under the direction of the
Trustees in such manner as the Trustees allocate such expenses on the basis of
relative net assets or number of shareholders. No shareholder is liable to
further calls or to assessment by the Trust without his or her express consent.
The assets of the Fund received for the issue or sale of its shares,
and all income, earnings, profits and proceeds thereof, subject only to the
rights of creditors, shall constitute the underlying assets of the Fund. In the
event of the dissolution or liquidation of the Fund, the holders of shares of
the Fund are entitled to share pro rata in the net assets of the Fund available
for distribution to shareholders.
INVESTMENT RESTRICTIONS
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The following investment restrictions have been adopted by the Fund as
fundamental policies and may be changed only by the affirmative vote of a
majority of the outstanding shares of the Fund. As used in this Statement of
Additional Information and in the Fund's prospectus, the term "majority of the
outstanding shares of the Fund" means the vote of whichever is less:
(1) 67% or more of the Fund's shares present at a meeting, if the holders of
more than 50% of the outstanding shares of the Fund are present or represented
by proxy, or (2) more than 50% of the Fund's outstanding shares.
These investment restrictions provide that:
(1) The Fund may not issue senior securities other than to evidence borrowings
or short sales as permitted.
(2) The Fund may not borrow money except that it may borrow:
(a) from banks to purchase or carry securities or other investments,
(b) from banks for temporary or emergency purposes, or
(c) by entering into reverse repurchase agreements,
if, immediately after any such borrowing, the value of the Fund's assets,
including all borrowings then outstanding less its liabilities, is equal to at
least 300% of the aggregate amount of borrowings then outstanding (for the
purpose of determining the 300% asset coverage, the Fund's liabilities will
not include amounts borrowed). Any such borrowings may be secured or unsecured.
The Fund may issue securities (including senior securities) appropriate to
evidence the indebtedness, including reverse repurchase agreements, which the
Fund is permitted to incur.
(3) The Fund may not underwrite or participate in the marketing of securities
issued by other persons except to the extent that the Fund may be deemed to be
an underwriter under federal securities laws in connection with the disposition
of portfolio securities.
(4) The Fund may not concentrate its investments in any industry, with the
exception of securities issued or guaranteed by the U.S. Government, its
agencies, and instrumentalities. Not withstanding the foregoing, if a large
percentage (i.e., at least 50%) of mergers taking place within the U.S. are
within one industry (e.g. banking or telecommunications) over a given period of
time, a large portion of the Fund's assets could be concentrated in that
industry for that period of time.
(5) The Fund may not purchase or sell real estate or real estate mortgage loans
as such, but this restriction shall not prevent the Fund from investing in
readily marketable interests in real estate investment trusts, readily
marketable securities of companies which invest in real estate, or obligations
secured by real estate or interests therein.
(6) The Fund may not purchase or sell commodities or commodity contracts.
(7) The Fund will not lend any of its assets, except that it may lend up to 1/3
of its portfolio securities.
(8) The Fund may not purchase securities on margin, except that the Fund may
obtain such short-term credits as may be necessary for the clearance of
purchases and sales of securities.
(9) The Fund may not pledge, mortgage or hypothecate its assets, except that to
secure borrowings.
(10) The Fund may not invest in companies for the purpose of exercising control
or management.
Non-fundamental restrictions may be amended by a majority vote of the
Trustees of the Fund. Under the non-fundamental investment restrictions, the
Fund may not:
(11) The Fund will not invest or knowingly purchase or otherwise acquire
securities more than 15% of the value of its net assets in illiquid securities
and restricted securities. Restricted securities are those that are subject to
legal or contractual restrictions on resale. Illiquid securities are those
securities without readily available market quotations, including repurchase
agreements having a maturity of more than seven days.
(12) The Fund may not purchase warrants, valued at the lower of cost or market,
in excess of 5% of the net assets of the Fund (taken at current value); provided
that this shall not prevent the purchase, ownership, holding or sale of warrants
of which the grantor is the issuer of the underlying securities. Included within
that amount, but not to exceed 2% of the value of the Fund's net assets, may be
warrants that are not listed on the New York or American Stock Exchange.
Warrants acquired by the Fund at any time in units or attached to securities are
not subject to this restriction.
(13) The Fund may not make short sales of securities (unless by virtue of its
ownership of other securities at the time of such sale, it owns or has a
prospective right to receive, without the payment of additional compensation,
securities equivalent in kind and amount to the securities sold). The total
market value of all securities sold short may not exceed 50% of the value of the
net assets of the Fund, and the value of securities of any one issuer in which
the Fund is short may not exceed the lesser of 10% of the value of the Fund's
net assets or 10% of the securities of any class of any issuer.
(14) The Fund may not (a) sell covered call options the underlying securities of
which have an aggregate value (determined as of the date the calls are sold)
exceeding 50% of the value of the net assets of the Fund; or (b) invest in put
options to the extent that the premiums on protective put options exceed 25% of
the value of its net assets; provided that the provisions of this paragraph
shall not prevent the purchase, ownership, holding or sale of forward contracts
with respect to foreign securities or currencies.
(15) The Fund may not purchase securities of other investment companies, except
in accordance with the 1940 Act.
If a particular percentage restriction as set forth above is adhered to
at the time of investment, a later increase or decrease in percentage resulting
from a change in values or assets will not constitute a violation of that
restriction.
INVESTMENT OBJECTIVES AND POLICIES
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A more detailed discussion of some of the investment strategies and
policies described in the Prospectus (see "Investment Objectives, Policies and
Risks") appears below:
MERGER ARBITRAGE
Although a variety of strategies may be employed depending upon the
nature of the reorganizations selected for investment, the most common merger
arbitrage activity involves purchasing the shares of an announced acquisition
target at a discount from the expected value of such shares upon completion of
the acquisition. The size of the discount, or spread, and whether the potential
reward justifies the potential risk, are functions of numerous factors affecting
the riskiness and timing of the acquisition. Such factors include the status of
the negotiations between the two companies (for example, spreads typically
narrow as the parties advance from an agreement in principle to a definitive
agreement), the complexity of the transaction, the number of regulatory
approvals required, the likelihood of government intervention on antitrust or
other grounds, the type of consideration to be received and the possibility of
competing offers for the target company.
Because the expected gain on an individual arbitrage investment is
normally considerably smaller than the possible loss should the transaction be
unexpectedly terminated, Fund assets will not be committed unless the proposed
acquisition or other reorganization plan appears to the Adviser to have a
substantial probability of success. The expected timing of each transaction is
also extremely important since the length of time that the Fund's capital must
be committed to any given reorganization will affect the rate of return realized
by the Fund, and delays can substantially reduce such returns. See "Portfolio
Turnover."
Trading to seek short-term capital appreciation can be expected to
cause the Fund's portfolio turnover rate to be substantially higher than that of
the average equity-oriented investment company and, as a result, may involve
increased brokerage commission costs which will be borne directly by the Fund
and ultimately by its investors. See "Allocation of Portfolio Brokerage" and
"Portfolio Turnover." Certain investments of the Fund may, under certain
circumstances, be subject to rapid and sizable losses, and there are additional
risks associated with the Fund's overall investment strategy, which may be
considered speculative.
SPECIAL RISKS OF OVER-THE-COUNTER OPTIONS TRANSACTIONS
As part of its merger arbitrage strategy, the Fund may engage in
transactions in options that are traded over-the-counter ("OTC transactions").
OTC transactions differ from exchange-traded transactions in several respects.
OTC transactions are transacted directly with dealers and not with a clearing
corporation. Without the availability of a clearing corporation, OTC transaction
pricing is normally done by reference to information from market makers, which
information is carefully monitored by the Investment Adviser and verified in
appropriate cases.
As the OTC transactions are transacted directly with dealers, there is
a risk of nonperformance by the dealer as a result of the insolvency of such
dealer or otherwise, in which event the Fund may experience a loss. An OTC
transaction may only be terminated voluntarily by entering into a closing
transaction with the dealer with whom the Fund originally dealt. Any such
cancellation, if agreed to, may require the Fund to pay a premium to that
dealer. In those cases in which the Fund has entered into a covered transaction
and cannot voluntarily terminate the transaction, the Fund will not be able to
sell the underlying security until the investment instrument expires or is
exercised or different cover is substituted. In such cases, the Fund may not be
able to sell an underlying security even though it might otherwise be
advantageous to do so.
It is the Fund's intention to enter into OTC transactions only with
dealers which agree to, and which are expected to be capable of, entering into
closing transactions with the Fund, although there is no assurance that a dealer
will voluntarily agree to terminate the transaction. There is also no assurance
that the Fund will be able to liquidate an OTC transaction at any time prior to
expiration. OTC transactions for which there is no adequate secondary market
will be considered illiquid.
ADDITIONAL INFORMATION ON INVESTMENT SECURITIES
The Fund may invest in the following types of securities including
those discussed in the Prospectus:
COMMERCIAL PAPER. Commercial paper consists of short-term (usually from
one to 270 days) unsecured promissory notes issued by corporations in order to
finance their current operations. The Fund will only invest in commercial paper
rated A-1 by Standard & Poor's Ratings Group ("Standard & Poor's") or Prime-1 by
Moody's Investors Service, Inc. ("Moody's") or unrated paper of issuers who have
outstanding unsecured debt rated AA or better by Standard & Poor's or Aa or
better by Moody's. Certain notes may have floating or variable rates. Variable
and floating rate notes with a demand notice period exceeding seven days will be
subject to each Fund's policy with respect to illiquid investments unless, in
the judgment of the Investment Adviser, such note is liquid.
The rating of Prime-1 is the highest commercial paper rating assigned
by Moody's. Among the factors considered by Moody's in assigning ratings are the
following: valuation of the management of the issuer; economic evaluation of the
issuer's industry or industries and an appraisal of speculative-type risks which
may be inherent in certain areas; evaluation of the issuer's products in
relation to competition and customer acceptance; liquidity; amount and quality
of long-term debt; trend of earnings over a period of 10 years; financial
strength of the issuer's parent company and the relationships which exist with
the issuer; and recognition by the management of obligations which may be
present or may arise as a result of public interest questions and preparations
to meet such obligations. These factors are all considered in determining
whether the commercial paper is rated Prime-1. Issuers of commercial paper rated
A (highest quality) by Standard & Poor's have the following characteristics:
liquidity ratios are adequate to meet cash requirements; long-term senior debt
is rated "A" or better, although in some cases "BBB" credits may be allowed; the
issuer has access to at least two additional channels of borrowing; basic
earnings and cash flow have an upward trend with allowance made for unusual
circumstances; typically, the issuer's industry is well established and the
issuer has a strong position within the industry; and the reliability and
quality of management are unquestioned. The relative strength or weakness of the
above factors determines whether the issuer's commercial paper is rated A-1.
REPURCHASE AGREEMENTS. Repurchase agreements are agreements by which a
person purchases a security and simultaneously commits to resell that security
to the seller (a member bank of the Federal Reserve System or recognized
securities dealer) at an agreed upon price on an agreed upon date within a
number of days (usually not more than seven) from the date of purchase. The
resale price reflects the purchase price plus an agreed upon market rate of
interest which is unrelated to the coupon rate or maturity of the purchased
security. A repurchase agreement involves the obligation of the seller to
repurchase the securities at the agreed upon price, which obligation is in
effect secured by the value of the underlying security. The Fund may enter into
repurchase agreements with respect to obligations in which the Fund is
authorized to invest.
WARRANTS. The Fund may invest a portion of its assets in warrants, but
only to the extent that such investments do not exceed 5% of the Fund's net
assets at the time of purchase. A warrant gives the holder a right to purchase
at any time during a specified period a predetermined number of shares of common
stock at a fixed price. Unlike convertible debt securities or preferred stock,
warrants do not pay a fixed coupon or dividend. Investments in warrants involve
certain risks, including the possible lack of a liquid market for resale of the
warrants, potential price fluctuations as a result of speculation or other
factors, and failure of the price of the underlying security to reach or have
reasonable prospects of reaching a level at which the warrant can be prudently
exercised (in which event the warrant may expire without being exercised,
resulting in a loss of the Fund's entire investment therein).
INITIAL PUBLIC OFFERINGS. The Fund may purchase shares in initial
public offerings (IPOs). Because IPO shares frequently are volatile in price,
the Fund may hold IPO shares for a very short period of time. This may increase
the turnover of the Fund's portfolio and may lead to increased expenses to the
Fund, such as commissions and transaction costs. By selling shares, the Fund may
realize taxable capital gains that it will subsequently distribute to
shareholders. Investing in IPOs have added risks because their shares are
frequently volatile in price. As a result, their performance can be more
volatile and they face greater risk of business failure, which could increase
the volatility of the Fund's portfolio
FOREIGN SECURITIES. Subject to the Fund's investment policies and
quality standards, the Fund may invest in the securities of foreign issuers
listed on foreign securities exchanges or over-the-counter markets, or which are
represented by American Depository Receipts and listed on domestic securities
exchange or traded in the United States on over-the-counter markets.
Because the Fund may invest in foreign securities, an investment in the
Fund involves risks that are different in some respects from an investment in a
fund that invests only in securities of U.S. domestic issuers. Foreign
investments may be affected favorably or unfavorably by changes in currency
rates and exchange control regulations. There may be less publicly available
information about a foreign company than about a U.S. company, and foreign
companies may not be subject to accounting, auditing and financial reporting
standards and requirements comparable to those applicable to U.S. companies.
There may be less governmental supervision of securities markets, brokers and
issuers of securities. Securities of some foreign companies are less liquid or
more volatile than securities of U.S. companies, and foreign brokerage
commissions and custodian fees are generally higher than in the United States.
Settlement practices may include delays and may differ from those customary in
United States markets. Investments in foreign securities may also be subject to
other risks different from those affecting U.S. investments, including local
political or economic developments, expropriation or nationalization of assets,
restrictions on foreign investment and repatriation of capital, imposition of
withholding taxes on dividend or interest payments, currency blockage (which
would prevent cash from being brought back to the United States), and difficulty
in enforcing legal rights outside the United States. Finally, there are many
differences in government regulation and supervision of foreign securities
exchanges, brokers, listed companies and banks compared to the United States.
These differences could negatively impact foreign securities in which the Fund
invests.
NON-DIVERSIFICATION OF INVESTMENTS. The Fund is non-diversified under
the 1940 Act, which means that there is no restriction under the 1940 Act on how
much the Fund may invest in the securities of any one issuer. However, to
qualify for tax treatment as a regulated investment company under the Internal
Revenue Code ("Code"), the Fund intends to comply, as of the end of each taxable
quarter, with certain diversification requirements imposed by the Code. Pursuant
to these requirements, the Fund will, among other things, limit its investments
in the securities of any one issuer (other than U. S. Government securities or
securities of other regulated investment companies) to no more than 25% of the
value of the Fund's total assets. In addition, the Fund, with respect to 50% of
its total assets, will limit its investments in the securities of any issuer to
5% of the Fund's total assets, and will not purchase more than 10% of the
outstanding voting securities of any one issuer. As a non-diversified investment
company, the Fund may be subject to greater risks than diversified companies
because of the possible fluctuation in the values of securities of fewer
issuers.
WRITING COVERED CALL OPTIONS. The Fund may write covered call options
on equity securities to earn premium income, to assure a definite price for a
security that the Fund has considered selling, or to close out options
previously purchased. A call option gives the holder (buyer) the right to
purchase a security at a specified price (the exercise price) at any time until
a certain date (the expiration date). A call option is "covered" if the Fund
owns the underlying security subject to the call option at all times during the
option period.
When writing call options on securities, the Fund may cover its
position by owning the underlying security on which the option is written.
Alternatively, the Fund may cover its position by owning a call option on the
underlying security, on a share for share basis, which is deliverable under the
option contract at a price no higher than the exercise price of the call option
written by the Fund or, if higher, by owning such call option and depositing and
maintaining cash or liquid securities equal in value to the difference between
the two exercise prices. In addition, a Fund may cover its position by
depositing and maintaining cash or liquid securities equal in value to the
exercise price of the call option written by the Fund. The principal reason for
the Fund to write call options on securities held by the Fund is to attempt to
realize, through the receipt of premiums, a greater return than would be
realized on the underlying securities alone.
There is no assurance that a closing transaction can be effected at a
favorable price. During the option period, the covered call writer has, in
return for the premium received, given up the opportunity for capital
appreciation above the exercise price should the market price of the underlying
security increase, but has retained the risk of loss should the price of the
underlying security decline.
WRITING COVERED PUT OPTIONS. The Fund may write covered put options on
equity securities to assure a definite price for a security if they are
considering acquiring the security at a lower price than the current market
price or to close out options previously purchased. A put option gives the
holder of the option the right to sell, and the writer has the obligation to
buy, the underlying security at the exercise price at any time during the option
period. The operation of put options in other respects is substantially
identical to that of call options.
When writing put options on securities, the Fund may cover its position
by owning a put option on the underlying security, on a share for share basis,
which is deliverable under the option contract at a price no lower than the
exercise price of the put option written by the Fund or, if lower, by owning
such put option and depositing and maintaining cash or liquid securities equal
in value between the two exercise prices. In addition a Fund may cover its
position by depositing and maintaining cash or liquid securities equal in value
to the exercise price of the put option written by the Fund.
The risks involved in writing put options include the risk that a
closing transaction cannot be effected at a favorable price and the possibility
that the price of the underlying security may fall below the exercise price, in
which case a Fund may be required to purchase the underlying security at a
higher price than the market price of the security at the time the option is
exercised.
OPTIONS TRANSACTIONS GENERALLY. The Fund may write both covered and
uncovered options. Option transactions in which the Fund may engage involve the
specific risks described above as well as the following risks:
o the writer of an option may be assigned an exercise at any time during the
option period;
o disruptions in the markets for underlying instruments could result in losses
for options investors;
o imperfect or no correlation between the option and the securities being
hedged;
o the insolvency of a broker could present risks for the broker's customers; and
o market imposed restrictions may prohibit the exercise of certain options.
In addition, the option activities of the Fund may affect its portfolio
turnover rate and the amount of brokerage commissions paid by the Fund. The
success of the Fund in using the option strategies described above depends,
among other things, on the Investment Adviser's ability to predict the direction
and volatility of price movements in the options and securities markets and the
Investment Adviser's ability to select the proper time, type and duration of the
options.
By writing call options, the Fund forgoes the opportunity to profit
from an increase in the market price of the underlying security above the
exercise price except insofar as the premium represents such a profit. The Fund
may also seek to earn additional income through receipt of premiums by writing
covered put options. The risk involved in writing such options is that there
could be a decrease in the market value of the underlying security. If this
occurred, the option could be exercised and the underlying security would then
be sold to the Fund at a higher price than its then current market value.
The Fund may purchase put and call options to attempt to provide
protection against adverse price effects from anticipated changes in prevailing
prices of securities. The purchase of a put option generally protects the value
of portfolio holdings in a falling market, while the purchase of a call option
generally protects cash reserves from a failure to participate in a rising
market. In purchasing a call option, the Fund would be in a position to realize
a gain if, during the option period, the price of the security or increased by
an amount greater than the premium paid. The Fund would realize a loss if the
price of the security decreased or remained the same or did not increase during
the period by more than the amount of the premium. If a put or call option
purchased by the Fund were permitted to expire without being sold or exercised,
its premium would represent a realized loss to the Fund.
The imperfect correlation in price movement between an option and the
underlying financial instrument and/or the costs of implementing such an option
may limit the effectiveness of the strategy. The Fund's ability to establish and
close out options positions will be subject to the existence of a liquid
secondary market. Although the Fund generally will purchase or sell only those
options for which there appears to be an active secondary market, there is no
assurance that a liquid secondary market on an exchange will exist for any
particular option or at any particular time. If an option purchased by the Fund
expires unexercised, the Fund will lose the premium it paid. In addition, the
Fund could suffer a loss if the premium paid by the Fund in a closing
transaction exceeds the premium income it received. When the Fund writes a call
option, its ability to participate in the capital appreciation of the underlying
obligation is limited.
It is the present intention of the Adviser not to commit greater than
25% of the Fund's net assets to option strategies.
BORROWING. The Fund may borrow from banks to increase its portfolio
holdings of securities. Such borrowings may be on a secured or unsecured basis
at fixed or variable rates of interest. The Investment Company Act of 1940
requires the Fund to maintain continuous asset coverage of not less than 300%
with respect to all borrowings. This allows the Fund to borrow for such purposes
an amount (when taken together with any borrowings for temporary or emergency
purposes as described below) equal to as much as 50% of the value of its net
assets (not including such borrowings). If such asset coverage should decline to
less than 300% due to market fluctuations or other reasons, the Fund may be
required to dispose of some of its portfolio holdings within three days in order
to reduce the Fund's debt and restore the 300% asset coverage, even though it
may be disadvantageous from an investment standpoint to dispose of assets at
that time.
The use of borrowing by the Fund involves special risk considerations
that may not be associated with other funds having similar policies. Since
substantially all of the Fund's assets fluctuate in value, whereas the interest
obligation resulting from a borrowing will be fixed by the terms of the Fund's
agreement with their lender, the asset value per share of the Fund will tend to
increase more when its portfolio securities increase in value and decrease more
when its portfolio securities decrease in value than would otherwise be the case
if the Fund did not borrow funds. In addition, interest costs on borrowings may
fluctuate with changing market rates of interest and may partially offset or
exceed the return earned on borrowed funds. Under adverse market conditions, the
Fund might have to sell portfolio securities to meet interest or principal
payments at a time when fundamental investment considerations would not favor
such sales. The interest which the Fund must pay on borrowed money, together
with any additional fees to maintain a line of credit or any minimum average
balances required to be maintained, are additional costs which will reduce or
eliminate any net investment income and may also offset any potential capital
gains. Unless the appreciation and income, if any, on assets acquired with
borrowed funds exceed the costs of borrowing, the use of leverage will diminish
the investment performance of the Fund compared with what it would have been
without leverage.
ILLIQUID SECURITIES. Historically, illiquid securities have included
securities subject to contractual or legal restrictions on resale because they
have not been registered under the Securities Act of 1933 (the "Securities
Act"), securities which are otherwise not readily marketable and securities such
as repurchase agreements having a maturity of longer than seven days. Securities
which have not been registered under the Securities Act are referred to as
private placements or restricted securities and are purchased directly from the
issuer or in the secondary market. Mutual funds do not typically hold a
significant amount of these restricted or other illiquid securities because of
the potential for delays on resale and uncertainty in valuation. Limitations on
resale may have an adverse effect on the marketability of portfolio securities
and a mutual fund might be unable to dispose of restricted securities promptly
or at reasonable prices and might thereby experience difficulty satisfying
redemption requirements. A mutual fund might also have to register such
restricted securities in order to dispose of them, resulting in additional
expense and delay. Adverse market conditions could impede such a public offering
of securities.
In recent years, however, a large institutional market has developed
for certain securities that are not registered under the Securities Act
including repurchase agreements, commercial paper, foreign securities, municipal
securities and corporate bonds and notes. Institutional investors depend on an
efficient institutional market in which the unregistered security can be readily
resold or on an issuer's ability to honor a demand for repayment. The fact that
there are contractual or legal restrictions on resale to the general public or
to certain institutions may not be indicative of the liquidity of such
investments. The Board of Trustees may determine that such securities are not
illiquid securities notwithstanding their legal or contractual restrictions on
resale. In all other cases, however, securities subject to restrictions on
resale will be deemed illiquid. The Fund will not invest more than 15% of the
value of its net assets in illiquid securities, including repurchase agreements
providing for settlement in more than seven days after notice, non negotiable
fixed time deposits with maturates over seven days, over-the-counter options and
certain restricted securities not determined by the Trustee to be liquid.
SHORT SALES: The Fund may employ various hedging techniques, such as
short selling in an effort to reduce the risks associated with certain of its
investments. For example, when the terms of a proposed acquisition call for the
exchange of common stock and/or other securities, the common stock of the
company to be acquired may be purchased and, at approximately the same time, the
amount of the acquiring company's common stock and/or other securities to be
received may be sold short. The Investment Adviser will make any such short sale
with the intention of later closing out (or covering) the short position with
the securities of the acquiring company received once the acquisition was
consummated. The purpose of the short sale is to protect against a decline in
the market value of the acquiring company's securities prior to the
acquisition's completion. However, should the acquisition be called off or
otherwise not completed, the Fund may realize losses on both its long position
in the target company's shares and its short position in the acquirer's
securities. At all times when the Fund does not own securities which are sold
short, the Fund will maintain long securities available for collateral
consisting of cash, cash equivalents and liquid securities equal in value on a
daily marked-to-market basis to the securities sold short.
EQUITY SWAP AGREEMENTS: The Fund may also enter into equity swap
agreements for the purpose of attempting to obtain a desired return or exposure
to certain equity securities or equity indices in an expedited manner or at a
lower cost to the Fund than if the Fund had invested directly in such
securities.
Swap agreements are two party contracts entered into primarily by
institutional investors for periods ranging from a few weeks to more than one
year. In a standard swap transaction, two parties agree to exchange the returns
(or differentials in return) earned or realized on particular predetermined
investments or instruments. The gross returns to be exchanged or "swapped"
between the parties are generally calculated with respect to a "notional
amount," I.E., the return on, or increase in value of a particular dollar amount
invested in a "basket" of particular securities or securities representing a
particular index.
Forms of swap agreements include:
(1) equity or index caps, under which, in return for a premium, one
party agrees to make payment to the other to the extent that the
return on securities exceeds a specified rate, or "cap";
(2) equity or index floors, under which, in return for a premium, one
party agrees to make payments to the other to the extent that the
return on securities fall below a specified level, or "floor"; and
(3) equity or index collars, under which a party sells a cap and
purchases a floor or vice versa in an attempt to protect itself
against movements exceeding given minimum or maximum levels.
Parties may also enter into bilateral swap agreements, which obligate
one party to pay the amount of any net appreciation in a basket or index of
securities while the counterparty is obligated to pay the amount of any net
depreciation.
The "notional amount" of the swap agreement is only a fictive basis on
which to calculate the obligations that the parties to a swap agreement have
agreed to exchange. Most swap agreements entered into by the Fund would
calculate the obligations of the parties to the agreement on a "net basis."
Consequently, the Fund's current obligations (or rights) under a swap agreement
will generally be equal only to the net amount to be paid or received under the
agreement based on the relative values of the positions held by each party to
the agreement (the "net amount"). The Fund's current obligations under a swap
agreement will be accrued daily (offset against amounts owed to the Fund) and
any accrued but unpaid net amounts owed to a swap counterparty will be covered
by the maintenance of a segregated account consisting of liquid assets. The Fund
will not enter into a swap agreement with any single party if the net amount
owed or to be received under existing contracts with that party would exceed 10%
of the Fund's net assets.
Whether the Fund's use of swap agreements will be successful in
furthering its investment objective will depend on the Investment Adviser's
ability to predict correctly whether certain types of investments are likely to
produce greater returns than other investments. Moreover, the Fund bears the
risk of loss of the amount expected to be received under a swap agreement in the
event of the default or bankruptcy of a swap agreement counterparty. The
Investment Adviser will cause the Fund to enter into swap agreements only with
counterparties that would be eligible for consideration as repurchase agreement
counterparties under the Fund's repurchase agreement guidelines. Certain
restrictions imposed on the Fund by the Internal Revenue Code may limit the
Fund's ability to use swap agreements. The swaps market is a relatively new
market and is largely unregulated. It is possible that developments in the swaps
market, including potential government regulation, could adversely affect the
Fund's ability to terminate existing swap agreements or to realize amounts to be
received under such agreements.
TEMPORARY INVESTMENTS: The Fund may adopt temporary defensive positions
that are inconsistent with the Fund's principal investment strategies in
attempting to respond to adverse market, economic, political, or other
conditions. Depending upon the level of merger activity and other economic and
market conditions, the Fund may invest temporarily a substantial portion of its
assets in:
|X| cash or cash equivalents, including money market instruments such
as Treasury bills and other short-term obligations of the United
States Government, its agencies or instrumentalities;
|X| commercial paper rated A-1 or A-2 by S&P, Prime-1 or Prime-2 by
Moody's, or F-1 or F-2 by Fitch. In the case where commercial
paper has received different ratings from different rating
services, such commercial paper is acceptable so long as at least
one rating is in the two highest categories of the nationally
recognized rating organizations described above; obligations of
the U.S. government or its agencies or instrumentalities; and
|X| repurchase agreements;
To the extent the Fund invests in these temporary investments, the Fund
may not reach its investment objective.
MANAGEMENT
--------------------------------------------------------------------------------
The business of the Trust is managed under the direction of the Board
of Trustees in accordance with the Declaration of Trust of the Trust, which
Declaration of Trust has been filed with the Securities and Exchange Commission
and is available upon request. Pursuant to the Declaration of Trust, the
Trustees shall elect officers including a president, secretary and treasurer.
The Board of Trustees retains the power to conduct, operate and carry on the
business of the Trust and has the power to incur and pay any expenses which, in
the opinion of the Board of Trustees, are necessary or incidental to carry out
any of the Trust's purposes. The Trustees, officers, employees and agents of the
Trust, when acting in such capacities, shall not be subject to any personal
liability except for his or her own bad faith, willful misfeasance, gross
negligence or reckless disregard of his or her duties. Following is a list of
the Trustees and executive officers of the Trust and their principal occupation
over the last five years.
<TABLE>
<CAPTION>
-------------------------------- -------- ---------------------- -----------------------------------------------------
PRINCIPAL OCCUPATION
NAME AND ADDRESS AGE POSITION DURING THE PAST FIVE YEARS
-------------------------------- -------- ---------------------- -----------------------------------------------------
<S> <C> <C> <C>
John S. Orrico, CFA* 40 President, General Partner, Water Island Capital, LLC, the
350 Park Avenue Secretary, Treasurer Fund's Advisor, from January 1, 2000 to present.
New York, NY 10022 and Trustee Previously, Portfolio Manager & Advisor to private
trusts and entities at Lindemann Capital Partners,
L.P., (financial management firm) 1-99 to 12-99;
Portfolio Manager to private trusts and entities at
Gruss & Co., (financial management firm)1994 - 1998.
-------------------------------- -------- ---------------------- -----------------------------------------------------
Joel Charles Ackerman 55 Disinterested Trustee Partner, Ardsley Partners (hedge fund), 10-98 to
Ardsley Partners Present; Trader, Odyssey Partners (hedge fund),
646 Steamboat Road 1-97 to 12-97; Trader, Steinhart Partners (hedge
Greenwich, CT 06830 fund), 1-96 to 12-96; Partner, Gross Partners
(private investment partnership), 1-92 to 12-95.
-------------------------------- -------- ---------------------- -----------------------------------------------------
Jay Neil Goldberg 59 Disinterested Trustee CEO, Opcenter, LLC (computer services), 9-96 to
Hudson Venture Partners Present; Partner, Hudson Ventures (venture
660 Madison Avenue capital), 1-97 to Present, CEO, Zeitech, Inc.
New York, NY 10021 (computer services), 9-89 to 12-95.
-------------------------------- -------- ---------------------- -----------------------------------------------------
Michael Neumark 57 Disinterested Trustee Senior Vice President, I.T.G. Inc. (institutional
380 Madison Avenue electronic brokerage), 1992-Present.
New York, , NY 10017
-------------------------------- -------- ---------------------- -----------------------------------------------------
</TABLE>
*John S. Orrico, as an affiliated person of Water Island Capital, LLC, the
Fund's investment adviser, is an "interested person" of the Trust within the
meaning of Section 2(a)(19) of the 1940 Act.
COMPENSATION
For their service as Trustees, the independent Trustees will receive an
annual retainer of $2,000 plus a fee of $500 per meeting attended, as well as
reimbursement for expenses incurred in connection with attendance at such
meetings. The interested Trustees of the Trust receive no compensation for their
service as Trustees. The table below details the ESTIMATED amount of
compensation the Trustees may receive from the Trust for the next fiscal year.
Presently, none of the executive officers receive compensation from the Trust.
The aggregate compensation is provided for the Trust.
<TABLE>
<CAPTION>
---------------------------- ----------------- ----------------------- ---------------------- ------------------------
NAME AND POSITION ESTIMATED PENSION OR RETIREMENT ESTIMATED ANNUAL ESTIMATED TOTAL
AGGREGATE BENEFITS ACCRUED AS BENEFITS UPON COMPENSATION FROM
COMPENSATION PART OF TRUST EXPENSES RETIREMENT TRUST AND FUND COMPLEX
FROM TRUST PAID TO TRUSTEES
---------------------------- ----------------- ----------------------- ---------------------- ------------------------
<S> <C> <C> <C> <C>
John S. Orrico* None None None None
Joel Charles Ackerman $4,000 None None $4,000
Jay Neil Goldberg $4,000 None None $4,000
Michael Neumark $4,000 None None $4,000
---------------------------- ----------------- ----------------------- ---------------------- ------------------------
</TABLE>
*This trustee is deemed to be an interested person as defined in the 1940 Act.
MANAGEMENT OWNERSHIP
As of August 1, 2000 for organizational purposes only, Water Island Capital, LLC
owned 100% of the outstanding shares of the Fund. John S. Orrico is the sole
shareholder of Water Island Capital, LLC.
INVESTMENT ADVISER
--------------------------------------------------------------------------------
INVESTMENT ADVISER AND ADVISORY CONTRACT
Water Island Capital, LLC (the "Investment Adviser"), is registered as
an investment adviser with the Securities and Exchange Commission under the
Investment Advisers Act of 1940. John S. Orrico is the President of the
Investment Adviser and the only portfolio manager of the Fund. Mr. Orrico is the
sole shareholder of the Investment Adviser and there are no other affiliates to
the Fund.
Under the terms of the Investment Advisory Contract (the "Advisory
Contract") between the Trust and the Investment Adviser, the Investment Adviser
(1) manages the investment operations of the Fund and the composition of its
portfolio, including the purchase, retention and disposition of securities in
accordance with the Fund's investment objective,
(2) provides all statistical, economic and financial information reasonably
required by the Fund and reasonably available to the Investment Adviser,
(3) provides the Custodian of the Fund's securities on each business day with a
list of trades for that day, and
(4) provides persons satisfactory to the Trust's Board of Trustees to act as
officers and employees of the Trust.
The Advisory Contract provides that the Fund pay all of the Fund's
expenses, including, without limitation,
(1) the costs incurred in connection with registration and maintenance of its
registration under the Securities Act of 1933, as amended, the Investment
Company Act of 1940, as amended, and state securities laws and regulations,
(2) preparation of and printing and mailing reports, notices and prospectuses to
current shareholders,
(3) transfer taxes on the sales of the Fund's shares and on the sales of
portfolio securities,
(4) brokerage commissions,
(5) custodial and shareholder transfer charges,
(6) legal, auditing and accounting expenses,
(7) expenses of servicing shareholder accounts,
(8) insurance expenses for fidelity and other coverage,
(9) fees and expenses of Trustees who are not "interested persons" within the
meaning of the Investment Company Act of 1940,
(10) expenses of Trustee and shareholder meetings and
(11) any expenses of distributing the Fund's shares which may be payable
pursuant to a Plan of Distribution adopted pursuant to Rule 12b-1 under the
Investment Company Act of 1940.
The Fund is also liable for such nonrecurring expenses as may arise,
including litigation to which the Fund may be a party. The Fund has an
obligation to indemnify each of its officers and Trustees with respect to such
litigation but not against any liability to which he would otherwise be subject
by reason of willful misfeasance, bad faith, gross negligence, or reckless
disregard of the duties involved in the conduct of his office.
The Investment Adviser receives an advisory fee, payable monthly, for
the performance of its services at an annual rate of 1.5% of the average daily
net assets of the Fund. The fee will be accrued daily for the purpose of
determining the offering and redemption price of the Fund's shares.
The Advisory Contract will continue in effect from year to year
provided such continuance is approved at least annually by (a) a vote of the
majority of the Fund's Trustees who are not parties thereto or "interested
persons" (as defined in the Investment Company Act of 1940) of the Fund or the
Adviser, cast in person at a meeting specifically called for the purpose of
voting on such approval and by (b) the majority vote of either all of the Fund's
Trustees or the vote of a majority of the outstanding shares of the Fund. The
Advisory Contract may be terminated without penalty on 60 days' written notice
by a vote of a majority of the Fund's Trustees or by the Adviser, or by holders
of a majority of the Fund's outstanding shares. The Advisory Contract shall
terminate automatically in the event of its assignment.
The Fund, the Investment Adviser and the Distributor each have adopted
codes of ethics under Rule 17j-1 under the 1940 Act that governs the personal
securities transactions of their board members, officers and employees who may
have access to current trading information of the Trust. Under the code of
ethics, the Trustees are permitted to invest in securities that may also be
purchased by the Fund.
THE DISTRIBUTOR
--------------------------------------------------------------------------------
Quasar Distributors, LLC (the "Distributor") serves as the principal
underwriter and national distributor for the shares of the Fund pursuant to a
Distribution Agreement with the Trust dated as of ____________, 2000 (the
"Distribution Agreement"). The Distributor is registered as a broker-dealer
under the Securities Exchange Act of 1934 and each state's securities laws and
is a member of the NASD. The offering of the Fund's shares is continuous. The
Distribution Agreement provides that the Distributor, as agent in connection
with the distribution of Fund shares, will use its best efforts to distribute
the Fund's shares. No affiliated persons of the Fund are affiliated persons of
the Distributor.
The Distributor Agreement provides that, unless sooner terminated, it
will continue in effect from year to year, subject to annual approval by (a) the
Board of Trustees or a vote of a majority of the outstanding shares, and (b) by
a majority of the Trustees who are not interested persons of the Trust or of the
Distributor by vote cast in person at a meeting called for the purpose of voting
on such approval.
The Distributor Agreement may be terminated by the Trust at any time,
without the payment of any penalty, by vote of a majority of the entire Board of
Trustees of the Trust or by vote of a majority of the outstanding shares of the
Fund on 60 days' written notice to the Distributor, or by the Distributor at any
time, without the payment of any penalty, on 60 days' written notice to the
Trust. The Distributor Agreement will automatically terminate in the event of
its assignment.
DISTRIBUTION PLAN
--------------------------------------------------------------------------------
The Fund has adopted a plan of distribution dated ______ (the "Plan")
pursuant to Rule 12b-1 under the Investment Company Act of 1940. Under the Plan,
the Fund may pay to Quasar Distributors, LLC, to any broker-dealer with whom
Quasar Distributors, LLC or the Fund has entered into a contract to distribute
Fund shares, or to any other qualified financial services firm, compensation for
distribution and/or shareholder-related services with respect to shares held or
purchased by their respective customers or in connection with the purchase of
shares attributable to their efforts. The amount of such compensation paid in
any one year shall not exceed 0.25% annually of the average daily net assets of
the Fund.
The Plan provides that the Trustees will review, at least quarterly, a
report of distribution expenses incurred under the Plan and the purposes for
which such expenses were incurred. The Plan will remain in effect from year to
year provided such continuance is approved at least annually by the vote of a
majority of the Fund's Trustees who are not "interested persons" (as defined in
the Investment Company Act of 1940) of the Fund or the Adviser and who have no
direct or indirect interest in the operation of the Plan or any related
agreement (the "Rule 12b-1 Trustees"), cast in person at a meeting called for
the purpose of voting on such approval, and additionally by a vote of either a
majority of the Fund's Trustees or a majority of the outstanding shares of the
Fund.
The Plan may be terminated at any time by vote of a majority of the
Rule 12b-1 Trustees or by vote of a majority of the Fund's outstanding shares.
The Plan may not be amended to increase materially the amount of distribution
expenses payable under the Plan without approval of the Fund's shareholders. In
addition, all material amendments to the Plan must be approved by the Trustees
in the manner described above.
ALLOCATION OF PORTFOLIO BROKERAGE
--------------------------------------------------------------------------------
Subject to the supervision of the Trustees, decisions to buy and sell
securities for the Fund are made by the Adviser. The Adviser is authorized by
the Trustees to allocate the orders placed by it on behalf of the Fund to
brokers or dealers who may, but need not, provide research or statistical
material or other services to the Fund or the Adviser for the Fund's use. Such
allocation is to be in such amounts and proportions as the Adviser may
determine.
In selecting a broker or dealer to execute each particular transaction,
the Adviser will take the following into consideration:
o the best net price available;
o the reliability, integrity and financial condition of the broker or dealer;
o the size of and difficulty in executing the order; and
o the value of the expected contribution of the broker or dealer to the
investment performance of the Fund on a continuing basis.
Brokers or dealers executing a portfolio transaction on behalf of the
Fund may receive a commission in excess of the amount of commission another
broker or dealer would have charged for executing the transaction if the Adviser
determines in good faith that such commission is reasonable in relation to the
value of brokerage, research and other services provided to the Fund.
In allocating portfolio brokerage, the Adviser may select brokers or
dealers who also provide brokerage, research and other services to other
accounts over which the Adviser exercises investment discretion. Some of the
services received as the result of Fund transactions may primarily benefit
accounts other than the Fund, while services received as the result of portfolio
transactions effected on behalf of those other accounts may primarily benefit
the Fund.
PORTFOLIO TURNOVER
--------------------------------------------------------------------------------
The Fund's portfolio turnover rate is calculated by dividing the lesser
of purchases or sales of portfolio securities for the fiscal year by the monthly
average of the value of the portfolio securities owned by the Fund during the
fiscal year. The calculation excludes from both the numerator and the
denominator (1) securities with maturities at the time of acquisition of one
year or less and (2) short positions. High portfolio turnover involves
correspondingly greater brokerage commissions and other transaction costs, which
will be borne directly by the Fund. A 100% turnover rate would occur if all of
the Fund's portfolio securities were replaced once within a one-year period.
The Fund will invest portions of its assets to seek short-term capital
appreciation. The Fund's investment objective and corresponding investment
policies can be expected to cause the portfolio turnover rate to be
substantially higher than that of the average equity-oriented investment
company.
Merger arbitrage investments are characterized by a high turnover rate
because, in general, a relatively short period of time elapses between the
announcement of a reorganization and its completion or termination. The majority
of mergers and acquisitions are consummated in less than six months, while
tender offers are normally completed in less than two months. Liquidations and
certain other types of corporate reorganizations usually require more than six
months to complete. The Fund will generally benefit from the timely completion
of the proposed reorganizations in which it has invested, and a correspondingly
high portfolio turnover rate would be consistent with, although it would not
necessarily ensure, the achievement of the Fund's investment objective.
Short-term trading involves increased brokerage commissions, which expense is
ultimately borne by the shareholders.
FUND ADMINISTRATION
--------------------------------------------------------------------------------
Firstar Mutual Fund Services, LLC ("Firstar") serves as Fund
Administrator pursuant to a Fund Administration Servicing Agreement with the
Company. As such, Firstar provides all necessary bookkeeping, shareholder
recordkeeping services and share transfer services to the Fund.
Under the Fund Administration Servicing Agreement, Firstar receives an
administration fee for the Fund, at an annual rate of 7 basis points on the
first $200 million, 6 basis points on the next $500 million and 4 basis points
on the balance of the daily average net assets of the Fund. Fees are billed to
the Fund on a monthly basis.
FUND ACCOUNTING AND TRANSFER AGENT
--------------------------------------------------------------------------------
Firstar Mutual Fund Services, LLC, serves as Fund Accountant and
Transfer Agent to the Fund pursuant to a Fund Accounting Servicing Agreement and
a Transfer Agent Servicing Agreement. Under the Fund Accounting Servicing
Agreement, Firstar will provide portfolio accounting services, expense accrual
and payment services, fund valuation and financial reporting services, tax
accounting services and compliance control services. Firstar will receive a fund
accountant fee for the Fund, which will be billed on a monthly basis.
Under the Transfer Agent Servicing Agreement, Firstar will provide all
of the customary services of a transfer agent and dividend disbursing agent
including, but not limited to: (1) receiving and processing orders to purchase
or redeem shares; (2) mailing shareholder reports and prospectuses to current
shareholders; and (3) providing blue sky services to monitor the number of Fund
shares sold in each state. Firstar will receive a transfer agent fee, which will
be billed on a monthly basis.
CUSTODIAN
--------------------------------------------------------------------------------
The Custodian for the Trust and the Fund is Firstar Bank, N.A., 425
Walnut Street, Cincinnati, Ohio 45202, an affiliate of Firstar Mutual Fund
Services, LLC. As Custodian, Firstar Bank, N.A. holds all of securities and
cash owned by the Fund.
PURCHASE, REDEMPTION AND PRICING OF SHARES
--------------------------------------------------------------------------------
CALCULATION OF SHARE PRICE
The net asset value per share of the Fund will be determined on each
day when the New York Stock Exchange ("NYSE") is open for business and will be
computed by taking the aggregate market value of all assets of the Fund less its
liabilities, and dividing by the total number of shares outstanding. Each
determination will be made:
(1) by valuing portfolio securities, including open short positions, which are
traded on the New York Stock Exchange, American Stock Exchange and on the NASDAQ
National Market System at the last reported sales price on that exchange;
(2) by valuing put and call options which are listed on an exchange, but which
are not traded on the valuation date are valued at the average of the current
bid and asked prices.;
(3) by valuing listed securities and put and call options for which no sale was
reported on a particular day and securities traded on the over-the-counter
market at the mean between the last bid and asked prices; and
(4) by valuing any securities or other assets for which market quotations are
not readily available at fair value in good faith and under the supervision of
the Trustees, although others may do the actual calculation.
The Adviser reserves the right to valueoptions at prices other than
last sale prices when such last sale prices are believed unrepresentative of
fair market value as determined in good faith by the Adviser.
The share price (net asset value) of the shares of the Fund is
determined as of the close of the regular session of trading on the NYSE
(currently 4:00 p.m., Eastern Time), on each day the NYSE is open for business.
The NYSE is open for business on every day except Saturdays, Sundays and the
following holidays: New Year's Day, Martin Luther King, Jr. Day, President's
Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving and
Christmas.
TRADING IN FOREIGN SECURITIES
Trading in foreign securities may be completed at times that vary from
the closing of the New York Stock Exchange. In computing the net asset value,
the Fund values foreign securities at the latest closing price on the exchange
on which they are traded immediately prior to the closing of the New York Stock
Exchange. Some foreign currency exchange rates may also be determined at the
latest rate prior to the closing of the New York Stock Exchange. Foreign
securities quoted in foreign currencies are translated into U.S. dollars at
current rates. Occasionally, events that affect these values and exchange rates
may occur between the times at which they are determined and the closing of the
New York Stock Exchange. If these events materially affect the value of
portfolio securities, these securities may be valued at their fair value as
determined in good faith by the Fund's Board of Trustees.
PURCHASE OF SHARES
Orders for shares received by the Trust in good order prior to the
close of business on the New York Stock Exchange (the "Exchange") on each day
during such periods that the Exchange is open for trading are priced at net
asset value per share computed as of the close of the regular session of trading
on the Exchange. Orders received in good order after the close of the Exchange,
or on a day it is not open for trading, are priced at the close of such Exchange
on the next day on which it is open for trading at the next determined net asset
value per share.
REDEMPTION OF SHARES
The Trust will redeem all or any portion of a shareholder's shares of
the Fund when requested in accordance with the procedures set forth in the
"Redemptions" section of the Prospectus. Under the Investment Company Act of
1940, a shareholder's right to redeem shares and to receive payment therefore
may be suspended at times:
(a) when the New York Stock Exchange is closed, other than customary weekend and
holiday closings;
(b) when trading on that exchange is restricted for any reason;
(c) when an emergency exists as a result of which disposal by the Fund
of securities owned by it is not reasonably practicable or it is not reasonably
practicable for the Fund fairly to determine the value of its net assets,
provided that applicable rules and regulations of the Securities and Exchange
Commission (or any succeeding governmental authority) will govern as to whether
the conditions prescribed in (b) or (c) exist; or
(d) when the Securities and Exchange Commission by order permits a suspension of
the right to redemption or a postponement of the date of payment on redemption.
In case of suspension of the right of redemption, payment of a
redemption request will be made based on the net asset value next determined
after the termination of the suspension.
Supporting documents in addition to those listed under "Redemptions" in
the Fund's prospectus will be required from executors, administrators, trustees,
or if redemption is requested by one other than the shareholder of record. Such
documents include, but are not restricted to, stock powers, trust instruments,
certificates of death, appointments as executor, certificates of corporate
authority and waiver of tax required in some states when settling estates.
REDEMPTION IN KIND
Payment of the net redemption proceeds may be made either in cash or in
portfolio securities (selected in the discretion of the Investment Adviser under
supervision of the Board of Trustees and taken at their value used in
determining the net asset value), or partly in cash and partly in portfolio
securities. However, payments will be made wholly in cash unless the Board of
Trustees believes that economic conditions exist which would make such a
practice detrimental to the best interests of the Fund. If payment for shares
redeemed is made wholly or partly in portfolio securities, brokerage costs may
be incurred by the investor in converting the securities to cash. The Trust has
filed an election with the Securities and Exchange Commission pursuant to which
the Fund will effect a redemption in portfolio securities only if the particular
shareholder of record is redeeming more than $250,000 or 1% of net assets,
whichever is less, during any 90-day period. The Trust expects, however, that
the amount of a redemption request would have to be significantly greater than
$250,000 or 1% of net assets before a redemption wholly or partly in portfolio
securities would be made.
TAX STATUS
--------------------------------------------------------------------------------
The Fund has qualified and elected to be treated as a regulated
investment company under the Internal Revenue Code of 1986, as amended (the
"Code"), and intends to continue to so qualify, which requires compliance with
certain requirements concerning the sources of its income, diversification of
its assets, and the amount and timing of its distributions to shareholders. Such
qualification does not involve supervision of management or investment practices
or policies by any government agency or bureau. By so qualifying, the Fund will
not be subject to federal income or excise tax on its net investment income or
net capital gain which are distributed to shareholders in accordance with the
applicable timing requirements. Net investment income and net capital gain of
the Fund will be computed in accordance with Section 852 of the Code.
The Fund intends to distribute all of its net investment income, any
excess of net short-term capital gains over net long-term capital losses, and
any excess of net long-term capital gains over net short-term capital losses in
accordance with the timing requirements imposed by the Code and therefore will
not be required to pay any federal income or excise taxes. Distributions of net
investment income and net capital gain will be made after June 30, the end of
each fiscal year, and no later than December 31 of each year. Both types of
distributions will be in shares of the Fund unless a shareholder elects to
receive cash.
If the Fund fails to qualify as a regulated investment company under
Subchapter M in any fiscal year, it will be treated as a corporation for federal
income tax purposes. As such the Fund would be required to pay income taxes on
its net investment income and net realized capital gains, if any, at the rates
generally applicable to corporations. Shareholders of the a Fund would not be
liable for income tax on the Fund's net investment income or net realized
capital gains in their individual capacities. Distributions to shareholders,
whether from the Fund's net investment income or net realized capital gains,
would be treated as taxable dividends to the extent of current or accumulated
earnings and profits of the Fund.
The Fund is subject to a 4% nondeductible excise tax on certain
undistributed amounts of ordinary income and capital gain under a prescribed
formula contained in Section 4982 of the Code. The formula requires payment to
shareholders during a calendar year of distributions representing at least 98%
of the Fund's ordinary income for the calendar year and at least 98% of its
capital gain net income (i.e., the excess of its capital gains over capital
losses) realized during the one-year period ending October 31 during such year
plus 100% of any income that was neither distributed nor taxed to the Fund
during the preceding calendar year. Under ordinary circumstances, the Fund
expects to time its distributions so as to avoid liability for this tax.
Net investment income is made up of dividends and interest less
expenses. Net capital gain for a fiscal year is computed by taking into account
any capital loss carryforward of the Fund.
The following discussion of tax consequences is for the general
information of shareholders that are subject to tax. Shareholders that are IRAs
or other qualified retirement plans are exempt from income taxation under the
Code.
Distributions of taxable net investment income and the excess of net
short-term capital gain over net long-term capital loss are taxable to
shareholders as ordinary income.
Distributions of net capital gain ("capital gain dividends") are
taxable to shareholders as long-term capital gain, regardless of the length of
time the shares of the Fund have been held by such shareholders.
A redemption of Fund shares by a shareholder will result in the
recognition of taxable gain or loss depending upon the difference between the
amount realized and his tax basis in his Fund shares. Such gain or loss is
treated as a capital gain or loss if the shares are held as capital assets
However, any loss realized upon the redemption of shares within six months from
the date of their purchase will be treated as a long-term capital loss to the
extent of any amounts treated as capital gain dividends during such six-month
period. All or a portion of any loss realized upon the redemption of shares may
be disallowed to the extent shares are purchased (including shares acquired by
means of reinvested dividends) within 30 days before or after such redemption.
Distributions of taxable net investment income and net capital gain
will be taxable as described above, whether received in shares or in cash.
Shareholders electing to receive distributions in the form of additional shares
will have a cost basis for federal income tax purposes in each share so received
equal to the net asset value of a share on the reinvestment date.
All distributions of taxable net investment income and net capital
gain, whether received in shares or in cash, must be reported by each taxable
shareholder on his or her federal income tax return. Dividends or distributions
declared in October, November or December as of a record date in such a month,
if any, will be deemed to have been received by shareholders on December 31, if
paid during January of the following year. Redemptions of shares may result in
tax consequences (gain or loss) to the shareholder and are also subject to these
reporting requirements.
Under the Code, the Fund will be required to report to the Internal
Revenue Service all distributions of taxable income and capital gains as well as
gross proceeds from the redemption or exchange of Fund shares, except in the
case of certain exempt shareholders. Under the backup withholding provisions of
Section 3406 of the Code, distributions of taxable net investment income and net
capital gain and proceeds from the redemption or exchange of the shares of a
regulated investment company may be subject to withholding of federal income tax
at the rate of 31% in the case of non-exempt shareholders who fail to furnish
the investment company with their taxpayer identification numbers and with
required certifications regarding their status under the federal income tax law,
or if the Fund is notified by the IRS or a broker that withholding is required
due to an incorrect TIN or a previous failure to report taxable interest or
dividends. If the withholding provisions are applicable, any such distributions
and proceeds, whether taken in cash or reinvested in additional shares, will be
reduced by the amounts required to be withheld.
Shareholders of the Fund may be subject to state and local taxes on
distributions received from the Fund and on redemptions of the Fund's shares.
A brief explanation of the form and character of the distribution
accompany each distribution. In January of each year the Fund issues to each
shareholder a statement of the federal income tax status of all distributions.
The Fund is organized as a Delaware business trust and generally will
not be liable for any income or franchise tax in the State of Delaware. If the
Fund qualifies as a regulated investment company for federal income tax purposes
and pays no federal income tax, it generally will also not be liable for New
York State income taxes, other than a nominal corporation franchise tax (as
adjusted by the applicable New York State surtaxes).
PERFORMANCE INFORMATION
--------------------------------------------------------------------------------
TOTAL RETURN
Average annual total return quotations that may be used in the Fund's
advertising and promotional materials are calculated according to the following
formula:
P(1+T)n = ERV
Where: P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical
$1,000 payment made at the beginning of the
period.
Under the foregoing formula, the time periods used in any 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. Average
annual total return, or "T" in the above formula, is computed by finding the
average annual compounded rates of return over the period that would equate the
initial amount invested to the ending redeemable value. Average annual total
return assumes the reinvestment of all dividends and distributions.
The calculation assumes an initial $1,000 payment and assumes all
dividends and distributions by the Fund are reinvested at the price stated in
the Prospectus on the reinvestment dates during the period, and includes all
recurring fees that are charged to all shareholder accounts.
The Fund may also calculate total return on a cumulative basis that
reflects the cumulative percentage change in value over the measuring period.
The formula for calculating cumulative total return can be expressed as follows:
Cumulative Total Return = [ (ERV) - 1 ]
-----
P
OTHER INFORMATION
The Fund's performance data quoted in any advertising and other
promotional materials represents past performance and is not intended to predict
or indicate future results. The return and principal value of an investment in
the Fund will fluctuate, and an investor's redemption proceeds may be more or
less than the original investment amount.
COMPARISON OF FUND PERFORMANCE
The performance of the Fund may be compared to data prepared by Lipper
Analytical Services, Inc., Morningstar, Inc. or other independent services which
monitor the performance of investment companies, and may be quoted in
advertising in terms of its ranking in each applicable universe. In addition,
the Fund may use performance data reported in financial and industry
publications, including Barron's, Business Week, Forbes, Fortune, Investor's
Daily, IBC/Donoghue's Money Fund Report, Money Magazine, The Wall Street Journal
and USA Today.
The Fund may from time to time use the following unmanaged index for
performance comparison purposes:
S&P 500 Index -- the S&P 500 is an index of 500 stocks
designed to mirror the overall equity market's industry weighting. Most, but not
all, large capitalization stocks are in the Index. There are also some small
capitalization names in the Index. Standard & Poor's Corporation maintain the
Index. It is market capitalization weighted. There are always 500 issuers in the
S&P 500. Standard & Poor's makes changes as needed.
INDEPENDENT ACCOUNTANTS
--------------------------------------------------------------------------------
The Fund has selected KPMG, 303 East Wacker Drive, Chicago, Illinois,
60601, as its independent accountants.
COUNSEL
--------------------------------------------------------------------------------
Foley & Lardner, 777 East Wisconsin Avenue, Milwaukee, Wisconsin 53202,
serves as the Trust's legal counsel.
FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
KPMG
303 East Wacker Drive
Chicago, IL 60601-5212
INDEPENDENT ACCOUNTANTS' REPORT
The Shareholder and Board of Directors of
The Arbitrage Fund:
We have audited the accompanying statement of assets and liabilities of The
Arbitrage Fund (the "Fund"), a series of The Arbitrage Funds, Inc., as of July
13, 2000, and the related statement of operations for the period then ended.
These financial statements are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit of financial statements includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of The Arbitrage Fund as of July
13, 2000, and the results of its operations for the period then ended, in
conformity with generally accepted accounting principles.
/s/ KPMG LLP
KPMG LLP
Chicago, Illinois
July 14, 2000
The Arbitrage Fund
Statement of Assets and Liabilities
As of July 13, 2000
ASSETS:
Cash $100,000.00
Receivable from Manager 35,392.32
Prepaid Blue Sky 1,485.00
Prepaid Insurance 24,000.00
---------
Total Assets $160,877.32
-----------
LIABILITIES:
Payable to Manager $60,877.32
----------
Total Liabilities $60,877.32
----------
NET ASSETS $100,000.00
===========
Capital shares, no par value; unlimited
shares authorized 10,000
======
Net Asset Value, offering and redemption
price per share (net assets/shares outstanding) $10.00
======
See accompanying notes to the financial statements.
The Arbitrage Fund
Statement of Operations
For the Period December 17, 1999 through July 13, 2000
EXPENSES:
Organization expenses $35,392.32
Less: Expenses to be paid by Manager ($35,392.32)
------------
Net income/(loss) $0.00
=====
See accompanying notes to the financial statements.
The Arbitrage Funds
Notes to the Financial Statements
1. ORGANIZATION
The Arbitrage Funds (the "Trust") was organized as a Delaware business trust
on December 22, 1999, 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 is the Arbitrage Fund (the "Fund"). The Fund will be
non-diversified. The Fund has had no operations other than those related to
organizational matters, including the sale of 10,000 shares for cash in the
amount of $100,000 of the Fund to Water Island Capital, LLC. ("Water Island"
also referred to as the "Manager") on July 13, 2000.
2. SIGNIFICANT ACCOUNTING POLICIES
(a) Organization and Prepaid Initial Registration Expense
Expenses incurred by the Trust in connection with the organization are
expensed as incurred. These expenses were advanced by the Manager, and
the Manager has contractually agreed to bear these expenses, subject to
potential recovery (see Note 3). Prepaid initial state registration and
prepaid insurance expenses are deferred and amortized over the period
of benefit.
(b) Federal Income Taxes
The 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
shareholders sufficient to relieve it from all or substantially all
Federal income taxes.
(c) Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and use assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenue
and expenses during the reporting period. Actual results could differ
from those estimates.
3. INVESTMENT MANAGER
The Trust has entered into an Investment Management Agreement (the
"Agreement") with the Manager, with whom certain Officers and Trustees of
the Trust are affiliated, to furnish investment and business management
services to the Fund. Under the terms of the Agreement, the Trust, on behalf
of the Fund, compensates the Manager for its management services at the
annual rate of 1.50% of the Fund's average daily assets.
The Manager has contractually agreed to waive, through 6/30/2001, its
management fee and/or to make payments to limit the Fund's other expenses,
including potential recovery of organizational expenses, to the extent
necessary to ensure that the Fund's annual operating expenses, do not exceed
1.95% of its average daily net assets starting with the commencement of
operations. Any such waiver or payment is subject to later adjustment to
allow the Manager to recoup amounts waived or paid to the extent actual fees
and expenses for a period are less than the expense limitation cap of 1.95%,
provided, however, that the Manager shall only be entitled to recoup such
amounts for a period of three (3) years from the date such amount was waived
or paid.
4. DISTRIBUTION PLAN
The Trust, on behalf of the Fund, has adopted a Distribution and
Shareholder Servicing Plan pursuant to Rule 12b-1 under the 1940 Act (the
"12b-1 Plan"), which authorizes the Fund to reimburse the Manager, the
Fund's distributor, or others for amounts expended for distribution or
shareholder servicing activities in amounts not to exceed an annual rate of
0.25% of the average daily net assets of the Fund. Payments made under the
12b-1 Plan are limited to actual expenses incurred.
