<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON SEPTEMBER 18, 1996
Registration Nos. 33-18934 and 811-5412
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------
FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 [ ]
Pre-Effective Amendment No. ___ [ ]
Post-Effective Amendment No. 11 [X]
AND/OR
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 [ ]
Amendment No. 11 [X]
STATE BOND TAX-FREE INCOME FUNDS, INC.
(Exact Name of Registrant as Specified in Charter)
100 North Minnesota Street
P.O. Box 69
New Ulm, Minnesota 56073-0069
(Address of Registrant's Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, including Area Code: (507) 354-2144
Copies to:
Kevin L. Howard, Esq. Joel H. Goldberg, Esq.
515 W. Market 8th floor Shereff, Friedman, Hoffman & Goodman,
Louisville, KY 40202-3319 LLP
(Name and Address of Agent for Service) 919 Third Avenue
New York, New York 10022
---------------------------------------
It is proposed that this filing will become effective (check appropriate box):
[ ] immediately upon filing pursuant to paragraph (b)
[ ] on (date) pursuant to paragraph (b)
[ ] 60 days after filing pursuant to paragraph (a)(1)
[X] on November 1, 1996 pursuant to paragraph (a)(1)
[ ] 75 days after filing pursuant to paragraph (a)(2)
[ ] on (date) pursuant to paragraph (a)(2) of rule 485
If appropriate, check the following box:
[ ] this post-effective amendment designates a new effective date for a
previously filed post-effective amendment
Pursuant to Rule 24f-2(a)(1) under the Investment Company Act of 1940, the
Registrant has registered an indefinite number or amount of its securities under
the Securities Act of 1933. The Registrant has filed a notice under such rule
for its fiscal year ended June 30, 1996 within 60 days of such date.
<PAGE>
CROSS-REFERENCE SHEET PURSUANT TO RULE 481(A) UNDER THE SECURITIES ACT OF 1933
N-1A Item No.
- -------------
Part A
Item 1. Cover Page............................................. COVER PAGE
Item 2. Synopsis.................................. SHAREHOLDER TRANSACTION
AND OPERATING EXPENSE TABLE
Item 3. Condensed Financial Information.............. FINANCIAL HIGHLIGHTS
Item 4. General Description of Registrant............. GENERAL INFORMATION
ABOUT STATE BOND
MINNESOTA TAX-EXEMPT FUND
WHAT ARE THE FUND'S
INVESTMENT OBJECTIVES AND
POLICIES?
Item 5. Management of the Fund................... HOW IS THE FUND MANAGED?
Item 5A. Management's Discussion of Fund
Performance.......................................... MANAGEMENT'S
DISCUSSION OF FUND
PERFORMANCE
Item 6. Capital Stock and other Securities............ GENERAL INFORMATION
ABOUT STATE BOND
MINNESOTA TAX-FREE FUND
WHAT IS THE TAX STATUS OF THE
DIVIDENDS AND DISTRIBUTIONS
YOU RECEIVE?
INVESTMENT PERFORMANCE
Item 7. Purchase of Securities Being Offered........... HOW CAN YOU INVEST
IN THE FUND?
HOW IS THE OFFERING PRICE
OF THE FUND'S SHARES DETERMINED?
WHAT IS THE FUND'S PLAN OF DISTRIBUTION?
HOW DOES THE FUND'S EXCHANGE PRIVILEGE
WORK?
WHAT SERVICES DOES THE FUND OFFER?
Item 8. Redemption of Repurchase....................... HOW CAN YOU "SELL"
YOUR SHARES?
WHAT SERVICES DOES THE FUND OFFER?
Item 9. Legal Proceedings.................................. NOT APPLICABLE
Part B
Item 10. Cover Page............................................. COVER PAGE
Item 11. Table of Contents...................................... COVER PAGE
Item 12. General Information and History............... GENERAL INFORMATION
Item 13. Investment Objectives and Policies............ WHAT ARE THE FUND'S
INVESTMENT OBJECTIVES,
POLICIES AND RISKS?
WHAT ARE THE FUND'S INVESTMENT
LIMITATIONS?
Item 14. Management of the Registrant.......................... WHO MANAGES
THE FUND?
THE MANAGER
Item 15. Control Persons and Principal Holders of Securities... WHO MANAGES
THE FUND?
<PAGE>
THE MANAGER
Item 16. Investment Advisory and Other Services............... WHO MANAGES
THE FUND?; MANAGEMENT AGREEMENT
AND EXPENSES; PLAN OF DISTRIBUTION;
TRANSFER AGENT; CUSTODIAN
Item 17. Brokerage Allocation...................... PORTFOLIO TRANSACTIONS
AND BROKERAGE
Item 18. Capital Stock and Other Securities............ PURCHASE OF SHARES
Item 19. Purchase, Redemption and Pricing of Securities
Being Offered................................ PURCHASE OF SHARES;
OFFERING PRICE; HOW CAN YOU
SELL YOUR SHARES?
HOW IS THE NET ASSET VALUE PER
SHARE DETERMINED?
Item 20. Tax Status............................... TAX STATUS OF THE FUND;
ADDITIONAL TAX INFORMATION;
WILL THE FUND WITHHOLD TAXES
ON DISTRIBUTIONS?
Item 21. Underwriters............................... PLAN OF DISTRIBUTION;
HOW ARE SHARES DISTRIBUTED?
Item 22. Calculation of Performance Data................... CALCULATION OF
PERFORMANCE DATA
Item 23. Financial Statements........................ FINANCIAL STATEMENTS
Part C
Information required to be included in Part C is set forth under the
appropriate Item, so numbered, in Part C to this Post-Effective Amendment to the
Registration Statement.
<PAGE>
PROSPECTUS
STATE BOND MINNESOTA TAX-FREE INCOME FUND
100 NORTH MINNESOTA STREET
P.O. BOX 69
NEW ULM, MINNESOTA 56073-0069
PHONE: (507) 354-2144
NOVEMBER 1, 1996
State Bond Minnesota Tax-Free Income Fund (the "Fund") is a mutual fund which
seeks to maximize current income exempt from both federal income tax and
Minnesota personal income tax to the extent consistent with preservation of
capital. The Fund is the only investment portfolio of State Bond Tax-Free
Income Funds, Inc.
This Prospectus concisely sets forth information about the Fund which investors
should know before investing. Please read it carefully before you invest and
keep it for future reference.
Additional information about the Fund is contained in a Statement of Additional
Information filed with the Securities and Exchange Commission and is available
upon request and without charge by calling or writing the Fund at (800) 328-
4735, 100 NORTH MINNESOTA STREET, P.O. BOX 69, NEW ULM, MINNESOTA 56073-0069.
The Statement of Additional Information is dated the same date as this
Prospectus and is incorporated herein by reference in its entirety.
AN INVESTMENT IN THE FUND IS NOT A DEPOSIT OR OBLIGATION OF, OR GUARANTEED OR
ENDORSED BY, ANY BANK AND IS NOT INSURED OR GUARANTEED BY THE U.S. GOVERNMENT,
THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD, OR ANY
OTHER FEDERAL AGENCY. AN INVESTMENT IN THE FUND INVOLVES INVESTMENT RISK,
INCLUDING THE POSSIBLE LOSS OF PRINCIPAL.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
<PAGE>
TABLE OF CONTENTS
-----------------
Page
----
SHAREHOLDER TRANSACTION AND OPERATING EXPENSE TABLE 3
FINANCIAL HIGHLIGHTS 4
WHAT ARE THE FUND'S INVESTMENT OBJECTIVES, POLICIES, AND RISKS? 5
HOW IS THE FUND MANAGED? 13
WHAT ARE THE FUND'S BROKERAGE COMMISSIONS? 14
HOW CAN YOU INVEST IN THE FUND? 15
HOW IS THE OFFERING PRICE OF THE FUND'S SHARES DETERMINED? 16
HOW ARE THE FUND'S SALES CHARGES DETERMINED? 16
HOW CAN YOU "SELL" YOUR SHARES? 17
HOW DOES THE FUND'S EXCHANGE PRIVILEGE WORK? 19
HOW DOES THE FUND PAY DIVIDENDS AND DISTRIBUTIONS? 20
WHAT IS THE TAX STATUS OF DIVIDENDS AND DISTRIBUTIONS YOU RECEIVE? 20
WHAT IS THE FUND'S PLAN OF DISTRIBUTION? 22
WHO ARE THE FUND'S ACCOUNTING AGENT AND ITS CUSTODIAN? 23
WHAT SERVICES DOES THE FUND OFFER? 23
GENERAL INFORMATION ABOUT STATE BOND MINNESOTA TAX-FREE INCOME FUND 24
INVESTMENT PERFORMANCE 24
MANAGEMENT'S DISCUSSION OF FUND PERFORMANCE 26
<PAGE>
SHAREHOLDER TRANSACTION AND OPERATING EXPENSE TABLE
SHAREHOLDER TRANSACTION EXPENSES
<TABLE>
<CAPTION>
<S> <C>
Maximum Sales Load Imposed on Purchases (as a percentage of offering price) 4.50%
ANNUAL FUND OPERATING EXPENSES
(As a percentage of average daily net assets)
Management Fee (After Expense Reimbursement) .43%
12b-1 Fee .25%
Other Expenses .32%
-----
Total Fund Operating Expenses (After Expense Reimbursements) 1.00%
-----
</TABLE>
A fee of $10 will be charged for certain redemptions by wire transfer. See "How
------
Can You 'Sell' Your Shares?"
EXAMPLE:
You would pay the following aggregate expenses on a $1,000 investment, assuming:
(1) 5% annual return and (2) redemption at the end of each time period:
1 Year 3 Years 5 Years 10 Years
[S] [C] [C] [C]
$55 $75 $98 $162
Note: This Example is not a representation of past or future expenses and actual
expenses may be more or less than those shown above.
The Fund's shares have an asset-based sales fee which may result in long-term
shareholders paying more than the economic equivalent of the maximum front-end
sales charge permitted by NASD regulations.
The purpose of the above table is to assist you in understanding the various
costs and expenses that you will bear directly or indirectly as an investor in
the Fund. The expense information in the above table is based upon expenses
incurred by the Fund during its fiscal year ended June 30, 1996. The above
operating expenses are net of expense reimbursements. Without such
reimbursements, the management fee would have been .60%, for total operating
expenses of 1.17% of average daily net assets. For more information concerning
fees and expenses, see "What Is The Fund's Plan Of Distribution?" and "How Is
The Fund Managed?" For information on additional sales charges that may be
payable upon exchange into a fund in the State Bond Group which has a higher
sales charge, see "How Does The Exchange Privilege Work?".
3
<PAGE>
FINANCIAL HIGHLIGHTS
The information presented below for the fiscal years ended June 30, 1995 and
1996 has been audited by Ernst & Young LLP, independent auditors for the Fund,
and the financial statements of the Fund, along with the report of Ernst & Young
LLP thereon, are set forth in the Statement of Additional Information. The
information presented below for each fiscal year in the three-year period
ended June 30, 1994 has been audited by the previous auditors for the Fund.
Further information about the performance of the Fund is contained in the Fund's
most recent annual report to shareholders which may be obtained, without charge,
by calling or writing the Fund at the telephone number or address on the front
cover of this Prospectus.
PER SHARE INVESTMENT INCOME AND CAPITAL CHANGES
(For a share outstanding throughout the year)
YEAR ENDED JUNE 30
<TABLE>
<CAPTION>
January 6, l988
(COMMENCEMENT
of Operations)
through
June 30,
1996 1995# 1994 1993 1992 1991 1990 1989 1988
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net asset value, beginning of year $10.61 $10.45 $10.94 $10.49 $10.18 $10.11 $10.23 $ 9.65 $10.00
Income from investment operations:
Net investment income .53 .56 .56 .59 .61 .62 .64 .65 .29
Net realized and unrealized gain
(loss) on investment (.03) .16 (.47) .45 .33 .07 (.12) .58 (.35)
---- --- ---- --- --- --- ---- --- ----
Total from investment operations .50 .72 .09 1.04 .94 .69 .52 1.23 (.06)
Less distributions:
From net investment income (.53) (.56) (.56) (.59) (.61) (.62) (.64) (.65) (.29)
From net realized gain (.02) - (.02) - (.02) - - - -
---- ---- ---- ---- ---- ---- ---- ---- ----
Total distributions (.55) (.56) (.58) (.59) (.63) (.62) (.64) (.65) (.29)
---- ---- ---- ---- ---- ---- ---- ---- ----
Net asset value, end of year $10.56 $10.61 $10.45 $10.94 $10.49 $10.18 $10.11 $10.23 $ 9.65
====== ====== ====== ====== ====== ====== ====== ====== ======
Total Return** 4.78% 7.10% .79% 10.06% 9.47% 6.87% 5.48% 13.18% (1.03%)*
Ratios and Supplemental Data:
Net assets, end of year (in $19,197 $18,178 $16,486 $15,318 $12,244 $9,238 $6,189 $4,997 $3,196
thousands)
Ratio of expenses to average
net assets*** 1.00% 1.00% 1.00% 1.00% 1.00% 1.00% 1.00% 1.00% 1.00%*
Ratio of net investment income to
average net assets*** 5.02% 5.37% 5.14% 5.41% 5.86% 6.17% 6.34% 6.56% 6.47%*
Portfolio turnover rate
13% 6% 2% 15% 1% 8% 2% - -
</TABLE>
_______________________________________________
# ARM Capital Advisors, Inc. began managing the investment
operations of the Fund on June 14, 1995.
* Annualized
** Total return does not consider the effects of the one time
sales charge.
*** The Fund's investment adviser voluntarily reimbursed the Fund on
a monthly basis for expenses incurred in excess of 1% of average
daily net assets. Without such voluntary reimbursement, the ratio
of expenses to average net assets in each of the respective
fiscal years would have been as follows: 1996--1.17%; 1995--
1.24%; 1994--1.29%; 1993--1.38%; 1992--1.54%; 1991--1.65%; 1990--
1.87%; 1989--2.19%; and 1988--3.10% (annualized). Without such
voluntary reimbursement, the ratio of net investment income to
average net assets in each of the respective fiscal years would
have been as follows: 1996--4.85%; 1995--5.13%; 1994--4.85%;
1993--5.03%; 1992--5.32%; 1991--5.52%; 1990--5.47%; 1989--
5.37%; 1988--4.37% (annualized)
4
<PAGE>
WHAT ARE THE FUND'S INVESTMENT OBJECTIVES, POLICIES AND RISKS?
The Fund seeks to maximize current income exempt from both Federal income tax
and Minnesota personal income tax to the extent consistent with preservation of
capital. In pursuing these goals, under normal circumstances the Fund invests
at least 80% of the value of its assets in debt obligations issued by or on
behalf of the State of Minnesota and its political subdivisions, the income from
which is exempt from federal income tax and Minnesota personal income tax
(referred to in this prospectus as "Minnesota Tax-Exempt Securities"). The Fund
intends to invest its assets such that at least 95% of its tax-exempt interest
income is derived from Minnesota Tax-Exempt Securities. Generally, the values
of the securities in which the Fund will invest, and accordingly the value of
the Fund's shares, will fall as interest rates rise and rise as interest rates
fall. There is no assurance that the Fund's goals will be achieved.
The Minnesota Tax-Exempt Securities in which the Fund invests consist of
securities rated within the following grades assigned by Moody's Investors
Service, Inc. ("Moody's"): Aaa, Aa, A, Baa, Ba and B for bonds; MIG-1, MIG-2,
MIG-3 for notes; and Prime-1 and Prime-2 for commercial paper, or within the
following grades assigned by Standard & Poor's Ratings services, a division of
the McGraw-Hill Companies, INC. ("S&P"): AAA, AA, A, BBB, BB and B for bonds;
SP-1 and SP-2 for notes; and A-1 and A-2 for commercial paper. Currently the
Fund does not invest in bonds rated below A, and the Fund has no current
intention of doing so. The risk of default, including nonpayment of principal or
interest, on bonds and notes rated Baa or MIG-4 or below by Moody's or BBB or
SP-3 or below by S&P is higher than the risk on such securities rated within the
higher grades. Such securities are more speculative and more sensitive to
economic changes than higher rated bonds and notes. A description of ratings of
the Minnesota Tax-Exempt Securities in which the Fund may invest is included as
Appendix A to the Statement of Additional Information.
The Fund may invest in unrated Minnesota Tax-Exempt Securities, if, in the
judgment of ARM Capital Advisors, Inc. (the "Manager"), the financial condition
of the issuer of such securities at the time of purchase is comparable to and
the securities are otherwise similar in quality to those rated securities the
Fund would purchase. As a matter of fundamental policy, the Fund may not invest
more than 25% of its assets in unrated Minnesota Tax-Exempt Securities.
Although securities that are not rated are not necessarily of lower quality, the
market for them may not be as broad as for rated securities, since many
investors rely upon ratings agencies for credit appraisal.
As a matter of fundamental policy, the Fund may not purchase Minnesota Tax-
Exempt Securities that are not rated within the three highest grades by either
Moody's or S&P, or that are unrated, unless such securities are insured as to
the payment of all installments of principal and interest.
As a matter of fundamental policy, under normal circumstances at least 80% of
the value of the Fund's assets will be invested in Minnesota Tax-Exempt
Securities. Up to 20% of the assets of the Fund may generate interest that is
an item of tax preference for purposes of the Federal and Minnesota alternative
minimum tax ("AMT").
In addition, while the Fund attempts, under normal market conditions, to invest
all of its assets in Minnesota Tax-Exempt Securities, the Fund temporarily may
invest up to 20% of the value of its assets in taxable obligations (i) when the
Manager believes abnormal market conditions dictate a temporary defensive
posture in taxable obligations; (ii) pending investment of proceeds of sales of
shares or reinvestment of proceeds of sales of portfolio securities; or (iii) to
meet redemptions of shares by
5
<PAGE>
shareholders. Also, on a temporary defensive basis due to market conditions, the
Fund may invest up to 100% of its assets in taxable obligations or may hold up
to 100% of its assets in cash. The taxable obligations in which the Fund may
invest are obligations of the U.S. government, its agencies or
instrumentalities; other debt securities rated within the two highest grades by
either Moody's or S&P (or if unrated, of comparable quality in the opinion of
the Manager); commercial paper rated in the two highest grades by either of such
rating services (or of comparable quality); certificates of deposit, letters of
credit and bankers' acceptances of domestic banks and savings institutions
having total assets over one billion dollars or certificates of deposit of other
domestic banks or savings institutions which are fully insured by the Federal
Deposit Insurance Corporation; and repurchase agreements with respect to any of
the foregoing investments or Minnesota Tax-Exempt Securities which qualify for
investment by the Fund.
Minnesota Tax-Exempt Securities
The Minnesota Tax-Exempt Securities in which the Fund invests consist of bonds,
notes, commercial paper and municipal leases issued by the State of Minnesota,
its political subdivisions (including municipalities), governmental agencies or
instrumentalities, or Indian tribal governments located in Minnesota.
Bonds are obligations issued to obtain funds for various public purposes, such
as the construction or improvement of public facilities including airports,
highways, hospitals, housing, nursing homes, parks, public buildings,
recreational facilities, school facilities, and sewer and water works. Other
public purposes for which bonds may be issued include the refunding of
outstanding obligations, the anticipation of taxes or state aids, the payment of
judgments, the funding of student loans, community redevelopment, district
heating, the purchase of street maintenance and fire fighting equipment, or any
authorized corporate purpose of the issuer, except the payment of current
expenses. Notes and commercial paper are generally used to provide for short-
term capital needs and ordinarily have a maturity of up to one year. Notes are
frequently issued in anticipation of tax revenue, revenue from other government
sources or revenue from bond offerings. Short-term, unsecured commercial paper
is often used to finance seasonal working capital needs or to provide interim
construction financing.
Municipal leases are obligations of state and local government units incurred to
lease or purchase equipment or other property utilized by such governments. The
Fund will not originate leases as a lessor, but will instead purchase a
participation interest in the regular payment stream of the underlying lease
from a bank, equipment lessor or other third party.
In addition, certain types of securities (generally referred to as "private
activity bonds") may be issued by or on behalf of public authorities to finance
privately operated pollution control facilities, certain local water supply,
gas, electricity or waste disposal facilities, and the construction or
improvement of certain other privately operated facilities.
Minnesota Tax-Exempt Securities may also be classified into two types of
obligations: general obligation and limited obligation (or revenue) securities.
General obligation securities involve the pledge of the full faith and credit of
an issuer possessing taxing power and are payable from the issuer's general
unrestricted revenues and not from any particular fund or revenue source. The
characteristics and methods of enforcement of general obligation securities vary
according to the law applicable to the particular issuer. Limited obligation
(revenue) securities are payable only from the revenues derived from a
particular facility or class of facilities, or a specific revenue source, such
as the user of the facility. Private activity bonds are in most cases limited
obligation bonds payable solely from specific
6
<PAGE>
revenues of the project to be financed. The credit quality of private activity
bonds is therefore usually directly related to the credit standing of the user
of the facility (or the credit standing of a third-party guarantor or other
credit enhancement participant, if any).
Like all debt obligations, Minnesota Tax-Exempt Securities are subject to credit
risk and market risk. Credit risk relates to the issuer's ability to make timely
payments of principal and interest. Market risk relates to the changes in market
values that occur as a result of variations in the level of prevailing interest
rates, yield relationships and other factors in the tax-exempt securities
market. Generally, higher quality tax-exempt securities will provide a lower
yield than lower quality tax-exempt securities of similar maturity and are
subject to lesser credit risks than lower quality tax-exempt securities.
Furthermore, for any given change in the level of interest rates, prices tend to
fluctuate less for higher quality issues than for lower quality issues, and more
for longer maturity issues than for shorter maturity issues. It should be noted
that the creditworthiness of obligations issued by local Minnesota issuers may
be unrelated to the credit worthiness of obligations issued by the State of
Minnesota, and that there is no obligation on the part of the State to make
payment on such local obligations in the event of default.
Risk Factors Regarding Investments in Minnesota
Because the Fund will normally invest at least 80% of its assets in Minnesota
Tax-Exempt Securities and because it seeks to maximize income derived from
Minnesota Tax-Exempt Securities, it is more susceptible to factors adversely
affecting the state of Minnesota and issuers of Minnesota Tax-Exempt Securities
than would be a municipal bond fund that is not so concentrated in such
obligations.
The State relies heavily on a progressive individual income tax and a retail
sales tax for revenue, which results in a fiscal system that is sensitive to
economic conditions. Frequently in recent years, legislation has been required
to eliminate projected budget deficits by raising additional revenue, reducing
expenditures, including aids to political subdivisions and higher education,
reducing the State's budget reserve, imposing a sales tax on purchases by local
governmental units, and making other budgetary adjustments. The Minnesota
Department of Finance April 1996 estimates project that the current biennium
will end June 30, 1997 with a $1 million surplus, plus a $350 million cash flow
account balance plus a $270 million budget reserve. Total General Fund
expenditures and transfers for the biennium are projected to be $18.9 billion.
planning estimates (extrapolations) for the biennium ending June 30, 1999 show a
general fund deficit of $71 million, after funding a $350 million cash flow
account plus a $270 million budget reserve, if current law is not changed.
accordingly, there may be additional revenue increases or spending cuts relative
to current law. furthermore, under current law spending caps, State
expenditures for education finance (K-12 and correctionS) in the biennium
ending June 30, 1997 are not anticipated to be sufficient to maintain current
program levels. The State is party to a variety of civil actions that could
adversely affect the State's General Fund. In addition, substantial portions of
State and local revenues are derived from federal expenditures, and reductions
in federal aid to the State and its political subdivisions and other federal
spending cuts may have substantial adverse effects on the economic and fiscal
condition of the State and its local governmental units. The Department of
Finance February 1996 forecast states that possible federal spending cuts could
reduce federal aid to Minnesota's state and local governments by a total of $3.2
billion over seven years. Risks are inherent in making revenue and expenditure
forecasts. Economic or fiscal conditions less favorable than those reflected in
State budget forecasts and planning estimates may create additional budgetary
pressures.
State grants and aids represent a large percentage of the total revenues of
cities, towns, counties and school districts in Minnesota. Even with respect to
revenue obligations, no assurance can be given that
7
<PAGE>
economic or other fiscal difficulties and the resultant impact on State and
local government finances will not adversely affect the value or marketability
of Minnesota Tax-Exempt Securities held by the Fund or the ability of the
respective obligors to make timely payment of the principal and interest on such
obligations.
Diversity and a significant natural resource base are two important
characteristics of the Minnesota economy. Generally, the structure of the
State's economy parallels the structure of the United States economy as a whole.
There are, however, employment concentrations in durable goods and non-durable
goods manufacturing, particularly industrial machinery, instruments and
miscellaneous, food, paper and related industries, and printing and publishing.
During the period from 1980 to 1990, overall employment growth in Minnesota
lagged behind national employment growth, in large part due to declining
agricultural employment. The rate of non-farm employment growth in Minnesota
exceeded the rate of national growth, however, in the period of 1990 to 1995.
Since 1980, Minnesota per capita income generally has remained above the
national average. During 1994 and 1995, the State's monthly unemployment rate
generally was less than the national unemployment rate.
Both possible future changes in federal and State income tax laws, including
rate reductions, and recent Minnesota tax legislation could adversely affect the
value and marketability of Minnesota Tax-Exempt Securities held by the Fund.
See "What Is the Tax Status of Dividends and Distributions You Receive?" below.
Diversification
The Fund is a "non-diversified" management investment company and as such is not
required to meet any diversification requirements under the Investment Company
Act of 1940, as amended (the "Act"). The Fund is required to meet certain
standards to qualify as a regulated investment company ("RIC") under the
Internal Revenue Code of 1986, as amended (the "Code"). At the end of each
fiscal quarter with respect to at least 50% of its total assets: (1) the Fund
may not invest more than 5% of its total assets in the securities of any one
issuer (except U.S. Government obligations) and (2) the Fund may not own more
than 10% of the outstanding voting securities of any one issuer. (By comparison,
a "diversified" investment company must at all times satisfy those two
conditions with respect to 75% of the value of its total assets). As for the
other 50% of the Fund's total assets not subject to the limitations described
above, the sole limitation on concentration of these assets is that at the end
of each fiscal quarter not more than 25% of such assets may be invested in the
securities of any one issuer. Investment in a non-diversified investment company
such as the Fund may entail greater risks than investment in a "diversified"
fund. Because of the relatively small number of issuers of investment grade
Minnesota Tax-Exempt Securities, the Fund's non-diversified status permits it
from time to time to concentrate its assets in the securities of a few issuers
which the Fund's Manager deems to be attractive investments, rather than invest
in securities of a large number of issuers merely to satisfy the Act's
diversification requirements. Although the Fund's Manager believes that the
ability to concentrate the investments of the Fund in particular issuers is
advantageous when investing in Minnesota Tax-Exempt Securities, such
concentration involves an increased risk of loss to the Fund should any
particular issuer be unable to make interest or principal payments or should the
market value of particular securities decline.
The Fund reserves the right to invest more than 25% of its assets in private
activity revenue bonds. As a matter of fundamental policy, the Fund may not
concentrate in any one industry. In addition, as a matter of fundamental
policy, the Fund may not invest more than 25% of its assets in private activity
bonds which are based, directly or indirectly, on the credit of private entities
in any one industry or in securities of private issuers in any one industry
(governmental issuers are not considered part of any "industry").
8
<PAGE>
See "Investment Restrictions" in the Statement of Additional Information.
Insurance
The Fund may purchase Minnesota Tax-Exempt Securities that are not rated within
the three highest grades by Moody's or S&P, or are unrated, only if such
securities are insured as to the payment of all installments of principal and
interest. Insurance is not a substitute for the basic credit of an issuer, but
supplements the credit and provides additional security therefor. While
insurance minimizes the credit risk associated with the default of a particular
security, it does not protect against market risk and therefore does not
guarantee the market value of the securities in the Fund's portfolio or the
value of the shares of the Fund. (The market value of an insured security may
differ from the face value due to fluctuations in interest rates.) In addition,
insurance of principal refers to insuring the payment of the face or par value
of the insured security, and not the purchase price paid for the security by the
Fund. To the extent that the Fund purchases insured securities, the Fund may be
dependent upon the credit of the insurance companies issuing the policies
insuring such securities, and subject to the risk that a particular insurer of
securities the Fund may hold may encounter financial difficulties. Municipal
bond insurance is a relatively new form of insurance, and the issuers of
municipal bond insurance are for the most part relatively new companies without
any long-term historical record of claims under their policies. The Fund cannot
predict the level of risk involved in purchasing insured Minnesota Tax-Exempt
Securities.
Insured Minnesota Tax-Exempt Securities held by the Fund may be insured by (i) a
"New Issue Policy" obtained by the issuer of the security or another party
(generally a dealer) at the time of issuance, for which all premiums are paid in
advance; (ii) a "Secondary Market Policy" which is obtained at a time other
than issuance, generally by a person other than the issuer (such as the Fund),
and provides insurance to the maturity of the security (regardless of whether
the purchaser of the insurance continues to hold the security), and for which
all premiums are paid in advance, or (iii) a mutual fund "Portfolio Insurance
Policy" that the Fund has obtained from Financial Guaranty Insurance Company
("Financial Guaranty") or may obtain from another insurance company approved by
the Board of Directors. From time to time Financial Guaranty also may be the
issuer of New Issue Policies or Secondary Market Policies insuring securities
purchased by the Fund. If a Minnesota Tax-Exempt Security purchased by the Fund
is covered by a New Issue Policy or a Secondary Market Policy providing
insurance to maturity and issued by an insurer that the Manager believes is
satisfactory, then such a security is not required to be additionally insured by
the Fund under its own Portfolio Insurance Policy.
Coverage under a New Issue Policy or Secondary Market Policy is noncancellable
and will continue in force so long as the security insured thereunder is
outstanding and the insurer remains in business. The existence of such
insurance for securities in the Fund's portfolio may have an effect on the
resale value of such securities. New Issue Policies and Secondary Market
Policies may be considered to represent an element of market values of
securities insured thereunder, but the exact effect, if any, of this insurance
on such market values generally cannot be estimated.
Under the Portfolio Insurance Policy issued by Financial Guaranty, insurance on
any particular security will be effective only so long as the Fund is in
existence and continues to pay the applicable premium, Financial Guaranty
remains in business and such security continues to be held by the Fund.
Financial Guaranty cannot cancel coverage already in force with respect to
securities owned by the Fund and covered by the Portfolio Insurance Policy,
except for nonpayment of premiums. Any security for which insurance is canceled
as provided herein will be sold by the Fund as promptly thereafter as reasonably
possible. In the event of a sale by the Fund of any security insured by the
Portfolio Insurance Policy, or payment of the principal of the security prior to
maturity, the insurance purchased from Financial
9
<PAGE>
Guaranty will terminate as to such security.
Premium rates for each issue of Minnesota Tax-Exempt Securities covered by the
Portfolio Insurance Policy from Financial Guaranty will be fixed for the life of
the Fund. The premiums are payable monthly by the Fund and are adjusted for
purchases, sales and payments prior to maturity of covered securities during the
month. Premiums are paid from the Fund's assets and reduce its current yield by
the amount of such premiums. The Manager estimates that annual premiums for the
Portfolio Insurance Policy will range from approximately .1 of 1% to .2 of 1% of
average daily net assets.
Financial Guaranty may not cancel the Portfolio Insurance Policy except for
failure to pay the premium. Nonpayment of premiums on the Portfolio Insurance
Policy will, under certain circumstances, result in the cancellation of the
Portfolio Insurance Policy and will also permit Financial Guaranty to take
action against the Fund to recover premium payments due it. The Portfolio
Insurance Policy is terminable by the Fund upon sixty days' prior written notice
to Financial Guaranty. If it becomes necessary or desirable to do so, the Fund
may terminate the Portfolio Insurance Policy with Financial Guaranty and obtain
portfolio insurance from another insurer.
Under the provisions of the Portfolio Insurance Policy, Financial Guaranty
unconditionally and irrevocably agrees to pay to an independent agent that
portion of the principal of and interest on a security insured thereunder which
shall become due for payment but shall be unpaid by reason of nonpayment by the
issuer. Financial Guaranty will make such payments to the agent on the date such
principal or interest becomes due for payment or on the business day next
following the day on which Financial Guaranty receives notice of non-payment,
whichever is later. The agent will disburse to the Fund the amount of such
unpaid principal and/or interest upon receipt of evidence of the Fund's right to
receive payment of unpaid principal and/or interest and evidence that all of the
rights to such payment shall, upon disbursement by the agent, vest in Financial
Guaranty. Upon such disbursement, Financial Guaranty shall become the owner of,
as applicable, the security, appurtenant coupon or right to principal thereof,
and shall be fully subrogated to the Fund's rights thereunder.
Under the Portfolio Insurance Policy, Financial Guaranty is not obligated to
insure all Minnesota Tax-Exempt Securities that the Fund may wish to purchase.
In determining whether to insure any Minnesota Tax-Exempt Security, Financial
Guaranty will apply its own standards, which are not necessarily the same as the
criteria used in regard to selection of investments by the Manager. Financial
Guaranty's decision to insure a security is made prior to the purchase of such
security by the Fund. Contracts to purchase Minnesota Tax-Exempt Securities are
not covered by the Portfolio Insurance Policy, although securities underlying
such contracts (once approved by Financial Guaranty) are covered by such
insurance upon delivery to the Fund or its Custodian.
The Fund may at any time purchase from Financial Guaranty or any other approved
insurer a Secondary Market Policy, including on any security purchased by the
Fund which is covered by the Portfolio Insurance Policy. The coverage, and the
obligation to pay monthly premiums, under the Portfolio Insurance Policy with
respect to a security would cease with the purchase by the Fund of a Secondary
Market Policy on such security. The Fund may purchase insurance under a
Secondary Market Policy in lieu of coverage under the Portfolio Insurance Policy
at any time if the Manager believes such insurance would best serve the Fund's
interest in meeting its objectives and policies.
One of the purposes of acquiring such a Secondary Market Policy would be to
enable the Fund to sell the portfolio security to a third party as an "AAA"
rated insured security at a market price higher than what otherwise might be
obtainable if the security were sold without the insurance coverage. (Such
rating is
10
<PAGE>
not automatic, however, and must specifically be requested from Moody's or S&P
for each security.) Such Secondary Market Policy would likely be purchased if,
in the opinion of the Manager, the market value or net proceeds of a sale by the
Fund would exceed the current value of the security (without insurance) plus the
cost of the policy. Any difference between the excess of a security's market
value as an "AAA" rated security over its market value without such rating,
including the single premium cost thereof, would inure to the Fund in
determining the net capital gain or loss realized by the Fund upon the sale of
the portfolio security. No assurance can be given that the purchase of a
Secondary Market Policy will enable the Fund to obtain a higher price upon sale
of the security.
If an issuer defaults on a security, the Fund may be required to take one of
several actions. One possibility is that the Fund may purchase a Secondary
Market Policy for the security. In that case, the Fund may have the ability to
sell such security without realizing a significant loss or continuing to hold
the security in its portfolio in order to continue in force the coverage of the
Portfolio Insurance Policy, if the security is covered thereby. However, no
assurance can be given that the purchase of such insurance will enable the Fund
to so sell the security.
Alternatively, if a defaulted security is covered by the Portfolio Insurance
Policy, the Fund might continue to hold it. While a defaulted security subject
to the Portfolio Insurance Policy is held by the Fund, the Fund continues to pay
the insurance premium thereon but also collects interest payments from the
insurer and retains the right to collect the full amount of principal from the
insurer when the security comes due. Because coverage under the Portfolio
Insurance Policy terminates upon sale of a security from the Fund's portfolio,
such insurance does not have an effect on the resale value of the securities. It
is the intention of the Fund to retain any securities insured under a Portfolio
Insurance Policy which are in default or in significant risk of default, and to
place a value on the insurance which will be equal to the difference between the
market value of the defaulted security and the market value of similar
securities which are not in default. (See "How is the Offering Price of the
Fund's Shares Determined?"). To the extent that it holds defaulted securities,
the Fund may be unable under certain circumstances to purchase other Minnesota
Tax-Exempt Securities.
Financial Guaranty Insurance Company. Financial Guaranty is a New York stock
insurance company, with principal offices at 175 Water Street, New York, New
York 10038. As of June 30, 1996, Financial Guaranty's capital base (capital
and surplus plus contingency reserve) was approximately $1,485,200,000, as
reported to the New York State Insurance Department. For further information
regarding Financial Guaranty, see the Statement of Additional Information.
Floating Rate, Variable Rate, and Inverse Floating Rate Securities
The Fund may purchase floating and variable rate Minnesota Tax-Exempt
Securities, which are Minnesota Tax-Exempt Securities having a coupon (stated
interest rate paid by the issuer) that is adjusted or reset from time to time.
Certain of these securities ("floating or variable rate demand notes") have a
stated maturity in excess of one year, but permit the holder to demand payment
of principal plus accrued interest upon a specified number of days' notice. The
issuer of floating or variable rate demand notes normally has a corresponding
right, after a given period, to prepay at its discretion the outstanding
principal amount of the notes plus accrued interest upon a specified number of
days' notice to the noteholders. The interest rate on a floating rate demand
note is based on a known lending rate, such as a bank's prime rate and is
adjusted automatically each time such rate is adjusted. The interest rate on a
variable rate demand note is adjusted at specified intervals, based on a known
lending rate, generally the rate on 90-day U.S. Treasury bills. Frequently,
floating or variable rate demand notes are secured by letters of credit or other
credit support arrangements provided by banks. The Fund will invest in floating
11
<PAGE>
or variable rate demand notes so long as the letters of credit or other credit
support arrangements do not adversely affect the tax exempt status of these
obligations. The Manager will rely upon the opinion of the issuer's bond counsel
to determine whether such obligations are exempt from federal income taxes.
The Fund also may invest in inverse or reverse floating rate Minnesota Tax-
Exempt Securities. Inverse or reverse floating rate Minnesota Tax-Exempt
Securities are securities with a coupon that moves in the reverse direction to
an applicable index, such as the London Interbank Offered Rate ("LIBOR").
Accordingly, the coupon thereon will increase as interest rates decrease.
Inverse or reverse floating rate securities are typically more volatile than
fixed rate or other types of floating rate securities. Investments in inverse or
reverse floating rate securities may be made by the Fund to attempt to protect
against a reduction in the income earned on the Fund's investments due to a
decline in interest rates. The Fund would be adversely affected by the purchase
of such securities in the event of an increase in interest rates since the
coupon thereon will decrease as interest rates increase, and the value of the
securities may decrease more than would other debt securities, in some cases to
zero.
The Manager will monitor the creditworthiness of the issuers of floating rate,
variable rate, and inverse or reverse floating rate Minnesota Tax-Exempt
Securities. Such obligations are not as liquid as many other types of Minnesota
Tax-Exempt Securities.
Repurchase Agreements
The Fund may enter into repurchase agreements with broker-dealers and financial
institutions. A repurchase agreement is an agreement under which the Fund
acquires an instrument subject to resale to the seller at an agreed price and
date. The resale price reflects an agreed-upon return for the period the
instrument is held by the Fund and is unrelated to the coupon provided by the
instrument. Repurchase agreements are usually for periods of one week or less,
but may be for longer periods. As a fundamental policy the Fund will not enter
into repurchase agreements of more than seven days' duration if more than 10% of
its net assets would be invested collectively in such agreements and in other
securities deemed to be illiquid. Repurchase agreements will be fully
collateralized. If, however, the seller defaults on its obligation to
repurchase the underlying security, the Fund may experience delay or difficulty
in exercising its rights to realize upon the security and might incur a loss if
the value of the security has declined. The Fund might also incur disposition
costs in liquidating the security.
When-Issued Securities
The Fund may enter into commitments to purchase new issues of Minnesota Tax-
Exempt Securities on a when-issued basis. Delivery and payment for these
securities normally take place 15 to 45 days after the date of commitment.
There is a risk that due to changes in interest rates between the commitment
date and settlement date the market value of the security on the settlement date
may be less than its purchase price. With regard to each commitment agreement
for when-issued securities, the Fund will maintain in a segregated account with
its custodian commencing on the commitment date, cash or high-grade liquid debt
obligations equal in value to the purchase price due on the settlement date
under such agreement.
The Fund will only make commitments to purchase when-issued Minnesota Tax-Exempt
Securities with the intention of actually acquiring the securities, but if
deemed advisable the Fund may sell these securities before the settlement date
or may meet its payment obligations from proceeds of the sale of the when-issued
securities themselves (which may then have a market value greater or less than
the Fund's payment obligation).
12
<PAGE>
Investment Restrictions
In addition to the policies and limitations set forth above, the Fund is subject
to certain other investment policies and limitations set forth more fully in the
Statement of Additional Information. As a matter of fundamental policy, the Fund
may not: (1) borrow money, except for temporary purposes in emergency situations
and in an aggregate amount not in excess of 20% of the value of the total assets
of the Fund; provided that borrowings in excess of 5% of such value are
permitted from banks only; (2) mortgage or pledge assets, except that up to 10%
of the Fund's assets can be used to secure borrowings; (3) purchase securities
of any issuer if immediately thereafter, with respect to 50% of the Fund's total
assets, more than 5% of such assets would be invested in the securities of any
one issuer, except that this limitation does not apply to obligations issued or
guaranteed as to principal and interest either by the U.S. government or its
agencies or instrumentalities; or (4) purchase private activity bonds if
immediately thereafter more than 25% of the Fund's assets would be invested in
private activity bonds which are based, directly or indirectly, on the credit of
private entities in any one industry or in securities of private issuers in any
one industry.
Except as specifically noted above, the investment policies described above are
not fundamental and the Board of Directors of the Fund may change them without
the vote of a majority of the Fund's outstanding voting securities. The Board
may not change the Fund's investment objective, nor any other fundamental
policy, without such a vote. Under the Investment Company Act of 1940, a "vote
of a majority of the outstanding voting securities" of the Fund means the
affirmative vote of the lesser of (1) more than 50% of the outstanding shares of
the Fund or (2) 67% or more of the shares present at a shareholders' meeting if
more than 50% of the outstanding shares are represented at the meeting in person
or by proxy.
HOW IS THE FUND MANAGED?
The Board of Directors provides broad supervision over the affairs of the Fund.
Pursuant to an Investment Advisory and Management Agreement approved by the
Board and the shareholders of the Fund, ARM Capital Advisors, Inc. (the
"Manager") manages the investments of the Fund and administers its business and
other affairs. The address of the Manager is 200 Park Avenue, 20th Floor, New
York, New York 10166.
The Manager is a wholly-owned subsidiary of ARM Financial Group, Inc. ("ARM"), a
Delaware corporation. ARM is a financial services company providing retail and
institutional products and services to the long-term savings and retirement
market. The Morgan Stanley Leveraged Equity Fund II, L.P., Morgan Stanley
Capital Partners III, L.P., Morgan Stanley Capital Investors, L.P. and MSCP III
892 Investors, L.P., investment funds sponsored by Morgan Stanley Group, Inc.
("Morgan Stanley"), own approximately 91% of the outstanding shares of voting
stock of ARM. The Manager currently provides investment management services to
institutional and individual clients, including ARM and its subsidiaries, with
combined assets in excess of $5.9 billion.
The Manager commenced investment advisory operations on January 5, 1995, on
which date it acquired the domestic fixed income unit of Kleinwort Benson
Investment Management Americas Inc. The Manager has managed the Fund since June
14, 1995 and since that date has also managed the other mutual funds in the
State Bond Group of mutual funds: State Bond Cash Management Fund, State Bond
Common Stock Fund, State Bond Diversified Fund, State Bond Tax Exempt Fund, and
State Bond U.S. Government and Agency Securities Fund.
Keith O. Martens, Senior Vice President and Portfolio Manager of the Manager
and Vice President
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<PAGE>
of the Fund, is responsible for selection of investments and management of the
Fund. Mr. Martens has managed the Fund since the Fund's inception in December
of 1987. Mr. Martens is also the principal manager of the State Bond Common
Stock Fund, State Bond Diversified Fund, State Bond U.S. Government and Agency
Securities Fund, State Bond Cash Management Fund and State Bond Tax Exempt Fund.
The Fund pays the Manager a management fee, calculated daily and payable
monthly, equal to an annual fee of .85 of 1% of the first $100,000,000 of
average daily net assets of the Fund and .80 of 1% of the average daily net
assets of the Fund in excess of $100,000,000. A portion of this fee is paid to
ARM Financial Services, Inc. (the "Distributor") in connection with the Fund's
Plan of Distribution (the "Plan") (see "What About The Plan of Distribution?")
The gross management fee (before payment to the Distributor of the fee under the
Plan) is higher than the management fees paid by most other investment companies
principally because it includes the fee paid by the Manager under the Plan to
the Distributor. The Fund pays all its expenses other than those assumed by the
Manager. Total expenses for the Fund for its fiscal year ended June 30, 1996
amounted to 1.00% of average daily net assets after voluntary expense
reimbursement.
Proposed Reorganization of the Fund
The Board of Directors of the Fund has approved a proposal to reorganize the
Fund. The reorganization will involve the sale of the Fund's assets, subject to
certain liabilities, to Federated Municipal Opportunities Fund, Inc. (the
"Federated Fund"), a mutual fund advised by Federated Investors, in exchange for
shares of the Federated Fund. Shares of the Fund would be exchanged at net
asset value for shares of equivalent value of the Federated Fund. The
reorganization transaction is subject to approval by Fund shareholders and to
certain other conditions prior to closing, including the receipt of an opinion
as to the tax-free nature of the reorganization for the Fund, the Federated Fund
and their respective shareholders by outside counsel for the Federated Fund. It
is anticipated that the proxy statement/prospectus relating to the proposed
reorganization will be mailed to shareholders in October 1996 and that the
meeting of shareholders will be held in early December 1996. No sales charges
would be imposed on the proposed reorganization.
Federated Investors, a Pittsburgh-based money management firm, was founded in
1955. Federated is a global investment manager with $90 billion in mutual fund
assets under management or administration across more than 250 funds.
WHAT ARE THE FUND'S BROKERAGE COMMISSIONS?
The Manager places orders for the Fund's portfolio securities transactions. As
the Fund's portfolio is exclusively composed of debt (rather than equity)
securities, most of the Fund's portfolio transactions are effected with dealers
without the payment of brokerage commissions, but at net prices which usually
include a spread or markup. Most Fund transactions are with the issuer, or with
major dealers acting for their own account and not as brokers. In effecting
portfolio transactions the Fund seeks the most favorable net price consistent
with the best execution. However, frequently the Fund selects a dealer to
effect a particular transaction without contacting all dealers who might be able
to effect such transaction, because of the volatility of the market and the
desire of the Fund to accept a particular price for a security because the price
offered by the dealer meets its guidelines for profit, yield, or both. No
brokerage is allocated for the sale of Fund shares. The Fund will not deal with
affiliates of the Manager and Distributor in any transaction in which such
affiliate acts as principal.
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<PAGE>
While it is not expected that the Fund will effect any transactions on an agency
basis, if it does so the Manager will seek to obtain the best price and
execution of orders. Commission rates, being a component of price, are
considered together with other relevant factors. When consistent with these
criteria, business may be placed with broker-dealers who furnish investment
research services to the Manager. Such research services include advice, both
directly and in writing, as to the value of securities, the advisability of
investing in, purchasing, or selling securities, and the availability of
securities or purchasers or sellers of securities, as well as analyses and
reports concerning issues, industries, securities, economic factors and trends,
portfolio strategy, and the performance of accounts. This allows the Manager to
supplement its own investment research activities and enables it to obtain the
views and information of individuals and research staffs of many different
securities research firms prior to making investment decisions for the Fund. To
the extent portfolio transactions are effected with broker-dealers who furnish
research services to the Manager, the Manager receives a benefit, not capable of
evaluation in dollar amounts.
The Manager has not entered into any formal or informal agreements with any
broker-dealers, and it does not maintain any "formula" which must be followed in
connection with the placement of Fund portfolio transactions in exchange for
research services provided the Manager, except as noted below. If it is
believed to be in the best interests of the Fund, the Manager may place
portfolio transactions with brokers who provide the types of services described
above, even if it means the Fund will have to pay a higher commission (or, if
the broker's profit is part of the cost of the security, will have to pay a
higher price for the security) than would be the case if no weight were given to
the broker's furnishing of those services. This will be done, however, only if,
in the opinion of the Manager, the amount of additional commission or increased
cost is reasonable in relation to the value of the services. The Manager also
serves as investment adviser for other mutual funds. To the extent that the
Fund may pay a somewhat higher brokerage commission or somewhat higher price on
a trade because such trade is executed by a broker-dealer which also provides
research and statistical services, it is possible that said research and
statistical services may also be of value to one of the other mutual funds.
However, it is felt that this possibility of mutual benefit is not capable of
measurement.
HOW CAN YOU INVEST IN THE FUND?
ARM Financial Services, Inc. (the "Distributor"), and ARM Transfer Agency,
Inc. (the "Shareholder Servicing Agent"), each a subsidiary of ARM, act as
distributor and transfer agent, respectively, of the Fund's shares. Their
address is 100 North Minnesota Street, P.O. Box 69, New Ulm, Minnesota 56073-
0069.
Shares of the Fund are offered for sale through the Distributor and through
certain broker-dealers under contract with the Distributor. After you become a
shareholder, you may buy additional shares by sending a check drawn to State
Bond Minnesota Tax-Free Fund directly to the Shareholder Servicing Agent at
100 North Minnesota Street, P.O. Box 69, New Ulm, Minnesota 56073-0069. Orders
for the purchase of shares will be executed at the offering price based upon the
net asset value next determined after receipt and acceptance of the order by the
Distributor or the Shareholder Servicing Agent. Orders for shares placed
through broker-dealers will be executed at the offering price next determined
after the receipt of the order by the broker-dealer, provided that the broker-
dealer promptly transmits the order to the Distributor the same day. The
broker-dealer is responsible for transmitting the purchase order to the
Distributor. Shares will begin to earn dividends on the day when payment for
such shares is received by the Fund or the Distributor. The Fund reserves the
right to reject any order for the purchase of its shares. The minimum initial
investment is $500 and subsequent investments must be in the amount of at least
$50. The Fund reserves the right to change these minimum investments. The Fund
will not be
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<PAGE>
responsible for the consequences of delays in the banking or Federal Reserve
wire systems.
HOW IS THE OFFERING PRICE OF THE FUND'S SHARES DETERMINED?
The price you pay for shares of the Fund is the offering price, that is, the
next determined net asset value of the shares plus the applicable sales charge.
Net asset value per share is determined as of the time of close of the New York
Stock Exchange (generally 3:00 p.m. Central Time) on each day that the New York
Stock Exchange is open for business. Net asset value is determined by dividing
the value of the total assets of the Fund, less liabilities, by the number of
shares outstanding. In determining net asset value, the Fund utilizes the
valuations of its portfolio securities furnished by a pricing service approved
by the Board of Directors. The pricing service values portfolio securities which
have remaining maturities of more than sixty days from the date of valuation at
quoted bid prices or the yield equivalents when quotations are readily
available. Such securities for which quotations are not readily available (which
constitute a majority of the Fund's portfolio securities) are valued at fair
value as determined by the pricing service using methods which include
consideration of yields or prices of municipal bonds of comparable quality, type
of issue, coupon, maturity, and rating, indications as to value from dealers,
and general market conditions. The pricing service may employ electronic data
processing techniques and/or a matrix system to determine valuations. Short-term
holdings maturing in 60 days or less are valued at cost plus accrued interest
which approximates market value.
HOW ARE THE FUND'S SALES CHARGES DETERMINED?
Sales charges are determined in accordance with the following schedule:
<TABLE>
<CAPTION>
Regular Dealer
% of Net Amount Discount as % of
% of Offering Price Invested Offering Price
-------------------- ---------------- --------------------
<S> <C> <C> <C>
Less than $50,000 4.50% 4.71% 4.00%
$50,000 but less than $100,000 4.00% 4.17% 3.50%
$100,000 but less than $250,000 3.00% 3.09% 2.50%
$250,000 but less than $500,000 2.50% 2.56% 2.00%
$500,000 but less than $1,000,000 2.00% 2.04% 1.50%
$1,000,000 but less than $2,000,000 1.00% 1.01% 0.50%
$2,000,000 or more 0.50% 0.50% 0.25%
</TABLE>
The sales charge varies depending on the size of the purchase, the number of
shares of the mutual funds in the State Bond Group you already own, whether you
have entered into a Letter of Intent to purchase additional shares during a
13-month period, or any special purchase programs in effect. Complete details of
how you may purchase shares at reduced sales charges under Volume Discounts,
Rights of Accumulation or Letters of Intent are contained in the Statement of
Additional Information and are available from your investment agent or dealer,
or the Distributor.
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<PAGE>
Shares may be sold at net asset value without a sales charge to present and
retired directors, present and retired officers, and present and retired
employees (and their spouses and minor children) of the Fund, the other
investment companies in the State Bond Group, and ARM and its subsidiaries.
Such sales also may be made to employee benefit plans for such persons. Also,
shares may be sold at net asset value to sales representatives of the
Distributor and registered representatives of broker-dealers who have signed
dealer agreements with the Distributor for sale of the shares of the Fund
(including employee benefit plans for such persons and their spouses and minor
children). Shares may be sold to any investment advisory, custodial, trust or
other fiduciary account managed or advised by the Manager or any affiliate
wherein such entity has discretionary investment authority at a maximum sales
charge of 3% or such lesser sales charge as such account would otherwise qualify
for under the Fund's sales charge schedule and the Volume Discount, Right of
Accumulation, and Letter of Intent provisions. These sales may be made for
investment purposes only, and shares may be resold only to the Fund.
HOW CAN YOU "SELL" YOUR SHARES?
You may redeem your shares without charge at any time by writing to the
Shareholder Servicing Agent at 100 NORTH MINNESOTA STREET, P.O. BOX 69, NEW ULM,
MINNESOTA 56073-0069. You will receive the net asset value per share next
determined after receipt of your request in proper form by the Shareholder
Servicing Agent. The written redemption request should identify the account
number and be signed by the shareholder(s) exactly as the shares are registered.
For share redemptions valued at $20,000 or more, your signature or signatures
must be guaranteed by a national securities exchange, a member firm of a
principal stock exchange, a registered securities association, a clearing
agency, a bank or trust company, a savings association, a credit union, a
broker, a dealer, a municipal securities broker or dealer, a government
securities broker or dealer, or a representative of the Distributor. Further
documentation may be required from corporations, executors, partnerships,
administrators, trustees or custodians. If stock certificates have been issued
for the shares that you wish to redeem, you must surrender the certificates in
proper form, endorsed for transfer or accompanied by an endorsed stock power.
For your protection, any certificates should be sent by registered mail.
Shares may also be redeemed through authorized dealers and through
representatives of the Distributor. Requests for redemption received by the
Shareholder Servicing Agent from authorized dealers or representatives of the
Distributor prior to the close of the New York Stock Exchange will be executed
at the net asset value per share determined at the close of the New York Stock
Exchange on that day. Dealers and representatives are responsible for promptly
submitting such redemption requests to the Shareholder Servicing Agent in order
to obtain that day's closing price. Requests for redemption received by the
Shareholder Servicing Agent from dealers or representatives of the Distributor
after the close of the New York Stock Exchange will be executed at the net asset
value determined at the close of the New York Stock Exchange on the next trading
day.
A check for the proceeds of the redemption of your shares ordinarily will be
mailed to you within seven calendar days after a redemption request is received
in proper form. However, where shares purchased by means of an uncertified
check are redeemed before the fifteenth day after purchase, proceeds will not be
mailed until THE CHECK CLEARS, WHICH MAY BE UP TO fifteen days after purchase.
Proceeds of a redemption may be more or less than the cost of the shares when
purchased. You will not receive dividends on shares which are redeemed from
your account for the day that the redemption is effected.
Because of the relatively high cost of handling small accounts, the Fund
reserves the right to redeem, upon not less than 30 days' written notice, the
shares in an account which has a value of less than $500. You will be allowed
to make additional investments prior to the date fixed for such a redemption to
avoid liquidation
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<PAGE>
of your account. Shares will not be involuntarily redeemed if the value of the
shares drops below $500 due to market value changes.
Quick Redemption by Wire Transfer
If you have elected the Quick Redemption service, you may request that the
proceeds of a redemption of shares having a value of $5,000 or more be wired to
your account at a commercial bank in the United States which is a member of the
Federal Reserve System. This service is available only if you have designated
such a bank in your Investment Application and no certificates have been issued
for the shares to be redeemed. Redemption proceeds of less than $5,000 will not
be wired, but instead will be mailed to the shareholder's address of record. A
request for Quick Redemption may be made to the Shareholder Servicing Agent by
mail at 100 NORTH MINNESOTA STREET, P.O. BOX 69, NEW ULM, MINNESOTA 56073-0069
or by telephone at (800) 328-4735. Each request must include your name and
account number. There is currently a $10.00 charge for each wire transfer,
which is deducted from the redemption proceeds. The fee is waived for banks for
their fiduciary accounts. The Fund reserves the right to modify the Quick
Redemption service at any time.
Quick Redemption requests received before the close of the New York Stock
Exchange on a business day of the Fund will be effected at the net asset value
determined on that day. Quick Redemption requests received after the close of
the New York Stock Exchange will be effected at the net asset value determined
on the next business day of the Fund. Proceeds sent by wire will be transmitted
on the next business day after the day that the redemption is effected. Proceeds
sent by mail will be transmitted within seven days of receipt of your request.
If your bank is not a member of the Federal Reserve System, Quick Redemption
proceeds may be wired to a member bank which has a correspondent relationship
with your bank, provided you designate such a correspondent bank in the
Investment Application and note that your bank should be immediately advised of
the wire transfer. The failure of a correspondent bank to notify your bank of
the wire transfer immediately could delay the crediting of redemption proceeds
to your bank.
The Fund is not liable for any loss arising from telephone redemptions that the
Fund reasonably believes to be genuine. The Fund will employ reasonable
procedures to confirm that instructions communicated by telephone are genuine;
if it does not, it may be liable for any losses due to unauthorized or
fraudulent instructions. The procedures used by the Fund will include requesting
several items of personal identification information prior to acting upon
telephone instructions and sending a written confirmation on all such
transactions.
If you are already a Fund shareholder you may elect the Quick Redemption service
or change a designation of a bank account for the Quick Redemption service by
writing to the Shareholder Servicing Agent at 100 NORTH MINNESOTA STREET, P.O.
BOX 69, NEW ULM, MINNESOTA 56073-0069. The designation must be signed by all of
the registered owners of the Fund account, with signature(s) guaranteed by a
national securities exchange, a member firm of a principal stock exchange, a
registered securities association, a clearing agency, a bank or trust company, a
savings association, a credit union, a broker, a dealer, a municipal securities
broker or dealer, a government securities broker or dealer, or a representative
of the Distributor.
Check Redemptions
You may elect to participate in the Fund's free Check Redemption service, which
permits you to write checks payable to any person in amounts of $250 or more
(but not more than $100,000), provided that you have an account balance of
$5,000 or more. You may elect this service on the Investment Application or by
later
18
<PAGE>
written request to the Shareholder Servicing Agent at 100 NORTH MINNESOTA
STREET, P.O. BOX 69, NEW ULM, MINNESOTA 56073-0069. The Shareholder Servicing
Agent will supply you with blank checks which can be drawn on your account with
the Fund. The checks will be paid from the redemption of shares in your
account. When honoring a check presented for payment, the Shareholder Servicing
Agent will cause the Fund to redeem exactly enough full and fractional shares in
your account to cover the amount of the check. Shares for which certificates
have been issued may not be redeemed by check. Check redemption is subject to
bank rules and regulations governing checking accounts. Checks for less than
$250 or more than $100,000 will be returned and a fee may be charged. If there
are insufficient shares in your account to cover a check written under this
service, the check will be returned marked "insufficient funds" and a return fee
may be charged. Checks should not be used to close a Fund account because when
the check is written you will not know the exact total value of the account on
the day the check clears. Fund dividends and distributions continue to be
earned until a check clears for payment. The Fund reserves the right to
terminate or modify the Check Redemption service at any time upon written notice
to the Fund's shareholders.
How Can You Reinstate Your Investment?
If you redeem shares and then decide you should not have redeemed them, or that
you prefer to shift your investment to one of the other mutual funds in the
State Bond Group, you may, within 30 calendar days of the date of redemption,
use all or any part of the proceeds of the redemption to reinstate, free of
sales charge, your investment in shares of the Fund, or, if you held the shares
redeemed for seven calendar days or longer before redemption, invest in shares
of any of the other mutual funds (except the Cash Management Fund) in the State
Bond Group. To make such an investment free of sales charges in shares of the
State Bond Funds which have a higher sales charge than the Fund, you also must
have held the shares of the Fund for six months or longer before their
redemption. Your investment will be reinstated or made at the net asset value
per share next determined after your request is received. You may use this
privilege to reinstate an investment in the Fund only once.
Exercise of the Reinstatement Privilege does not alter the Federal income tax
status of any capital gain realized on a sale of Fund shares, but to the extent
that any shares are sold at a loss and the proceeds are reinvested in shares of
the same Fund, some or all of the loss will not be allowed as a deduction,
depending upon the percentage of the proceeds reinvested.
HOW DOES THE FUND'S EXCHANGE PRIVILEGE WORK?
If you have been a shareholder for seven calendar days or more, you may exchange
any or all of your investment for shares of the other mutual funds in the State
Bond Group. Any exchange for shares of other mutual funds in the State Bond
Group will be at the next determined respective net asset values after receipt
of the request for exchange. Exchanges generally will be made without any sales
charges; except that if, within six months of your investment in the Fund, you
exchange for shares of any fund in the State Bond Group which has a higher sales
charge, you must pay the difference in the sales charge applicable to the
purchase of shares of the Fund and the higher sales charge applicable to the
purchase of shares of such other fund. Exchanges of Fund shares are sales, and
may result in a gain or loss for Federal income tax purposes. Before making an
exchange, you should obtain and read the prospectus for the fund you are
considering. The Fund reserves the right to terminate or modify the terms of
this exchange privilege upon 60 days' notice to shareholders. The exchange
privilege is only available in states in which the shares of the fund to be
acquired are available for purchase.
Exchange requests may be made in writing, signed by all registered owners, to
the Shareholder Servicing Agent at 100 NORTH MINNESOTA STREET, P.O. BOX 69, NEW
ULM, MINNESOTA 56073-0069. Shares also may
19
<PAGE>
be exchanged by telephone by calling (800) 328-4735, provided you have on file
an Agreement for Exchange of Shares by Telephone (included on the Investment
Application or available from the Shareholder Servicing Agent). Shares held by
trustees of retirement plans may not be exchanged by telephone. During times
of drastic economic or market changes the telephone exchange privilege may be
difficult to implement. In order to implement an exchange, you will need to
provide the name in which your account is registered, your account number, such
other personal identification information as the Fund may request, the dollar
amount or share amount you wish to exchange, the name of the fund into which you
wish to exchange and, if you already have an account with the fund into which
you wish to exchange, the account registration and account number of such
account.
The Fund is not liable for any loss arising from telephone exchanges that the
Fund reasonably believes to be genuine. The Fund will employ reasonable
procedures to confirm that instructions communicated by telephone are genuine;
if it does not, it may be liable for any losses due to unauthorized or
fraudulent instructions. The procedures used by the Fund will include
requesting several items of personal identification information prior to acting
upon telephone instructions and sending a written confirmation on all such
transactions.
HOW DOES THE FUND PAY DIVIDENDS AND DISTRIBUTIONS?
The Fund declares daily dividends on all outstanding shares (dividends are
declared for the day on which shares are purchased but are not declared for
redeemed shares on the day of redemption). A shareholder who redeems all of his
or her Fund shares receives with the redemption proceeds the amount of all
dividends declared for the month to and including the date of redemption of
shares. Dividends in respect of all other redemptions are paid on the regular
dividend payment date. Distributions from taxable net realized investment
gains, if any, will generally be declared at least once each year.
What Are Your Dividend And Gain Distribution Options?
You may elect to:
1. Receive both dividends and gain distributions in additional shares of the
Fund.
2. Receive dividends in cash and gain distributions in additional shares of
the Fund.
3. Receive both dividends and gain distributions in cash.
If no election is made, dividends from investment income and gain distributions
will be reinvested and credited to your account as additional shares. Dividends
and gain distributions reinvestments are made at net asset value. To change
your election at any time, write to the Shareholder Servicing Agent at 100 NORTH
MINNESOTA STREET, P.O. BOX 69, NEW ULM, MINNESOTA 56073-0069.
WHAT IS THE TAX STATUS OF DIVIDENDS AND DISTRIBUTIONS YOU RECEIVE?
The Fund has fulfilled, and intends to continue to fulfill, the requirements of
the Internal Revenue Code of 1986, as amended (the "Code") which will enable it
to designate distributions from interest income generated by its investments in
Minnesota Tax-Exempt Securities as "Exempt-Interest Dividends" excludable from
gross income for federal income tax purposes. The Fund also intends to invest
its assets so that at least 95% of its EXEMPT-INTEREST DIVIDENDS ARE derived
from Minnesota Tax-Exempt Securities. Therefore, Exempt-Interest Dividends paid
by the Fund will not be subject to federal income tax or Minnesota personal
20
<PAGE>
income tax, except as indicated below.
Distributions by the Fund of net interest income received from certain temporary
taxable investments and net short-term capital gains realized by the Fund, if
any, will be taxable to shareholders as ordinary income whether received in cash
or additional shares. Any net long-term capital gains realized by the Fund,
whether received as cash or additional shares, will be taxable to shareholders
as long-term capital gains regardless of the length of time investors have held
their shares. Under federal law, long-term capital gains are currently subject
to a maximum tax rate of 28% while ordinary income is subject to a maximum
marginal rate equal to 39.6%. Under Minnesota law, long-term capital gains are
taxed at the same rates as ordinary income. Distributions to shareholders will
not qualify for the dividends received deduction for corporations. Market
discount recognized on Minnesota Tax-Exempt Securities is taxable as ordinary
income.
Up to 20% of the assets of the Fund may be invested in securities which generate
interest that is an item of tax preference for purposes of the federal and
Minnesota alternative minimum tax ("AMT"). Moreover, all Exempt-Interest
Dividends received by corporate shareholders will be a component of "adjusted
current earnings" for purposes of the corporate AMT. Individual and corporate
taxpayers whose taxable income plus certain tax preference items less an
exemption amount multiplied by the applicable alternative minimum tax rate
exceeds regular individual or corporate income tax liability (with certain
adjustments) are subject to AMT. Because AMT liability is dependent upon the
regular tax liability and tax preference items of a specific taxpayer, investors
should consult their tax advisers regarding the AMT consequences of an
investment in the Fund.
In addition, shareholders who are or may become recipients of Social Security
should be aware that Exempt-Interest Dividends are includable in computing
"modified adjusted gross income" for purposes of determining the amount, if any,
of social security benefits required to be included in gross income for federal
and Minnesota personal income tax purposes.
The Tax Reform Act of 1986 imposed new requirements on certain tax-exempt bonds
which, if not satisfied, could result in loss of tax exemption for interest on
such bonds, even retroactively to the date of issuance of the bonds. Proposals
to further restrict or eliminate the federal tax exemption for Minnesota Tax-
Exempt Securities may be introduced before Congress in the future. The Fund
cannot predict what additional legislation may be enacted that may affect
shareholders. If a bond in the Fund's portfolio were to lose its exempt status,
the Fund would make every effort to dispose of such investment on terms not
detrimental to the Fund.
The portion of Exempt-Interest Dividends derived from interest income on
Minnesota Tax-Exempt Securities is excluded from the Minnesota gross income of
individuals, estates and trusts, so long as at least 95% of the Exempt-Interest
Dividends paid by the Fund are derived from Minnesota Tax-Exempt Securities.
The remaining portion of such dividends and dividends that are not Exempt-
Interest Dividends or capital gain dividends (except for dividends, if any,
derived from interest paid on obligations of the U.S. Government, its
territories and possessions) are included in the Minnesota gross income of
individuals, estates and trusts. Exempt-Interest Dividends are not excludable
from the Minnesota gross income of corporations and banks.
Upon a sale or exchange of his or her shares, a shareholder will realize a
taxable gain or loss depending on his or her basis in the shares. Such gain
or loss will be treated as a capital gain or loss if the shares are capital
assets in the shareholder's hands and will be a long-term capital gain or loss
if the shares have been held for more than one year. Generally, any loss
realized on a sale or exchange will be disallowed to the extent shares disposed
of are replaced within a period of sixty-one days beginning thirty days before
and ending thirty days after the shares are disposed of. Any loss realized by a
shareholder on the sale of shares
21
<PAGE>
of the Fund held by the shareholder for six months or less will be disallowed to
the extent of any Exempt-Interest Dividends received by the shareholder with
respect to such shares, and will be treated for tax purposes as a long-term
capital loss to the extent of any distributions of net capital gains received by
the shareholder with respect to such shares.
In certain circumstances (such as the exercise of an exchange privilege), a load
charge may not be taken into account in determining the gain or loss on the sale
on redemption of shares in the Fund within 90 days of their acquisition. In
such case, the load charge is treated as incurred with respect to the shares
subsequently purchased.
Under the Code, interest on indebtedness incurred or continued to purchase or
carry Fund shares which is deemed to relate to exempt-interest dividends is not
deductible.
Entities or persons who are "substantial users" (or related persons) of
facilities financed by "private activity" bonds (some of which were formerly
referred to as "industrial development" bonds) should consult their tax advisers
before purchasing shares of the Fund. "Substantial user" is defined generally
as including a "non-exempt person" who regularly uses in its trade or business a
part of a facility financed from the proceeds of industrial development bonds.
The 1995 Minnesota Legislature enacted a statement of intent that interest on
obligations of Minnesota governmental units and Indian tribes be included in net
income of individuals, estates and trusts for Minnesota income tax purposes if a
court determines that Minnesota's exemption of such interest unlawfully
discriminates against interstate commerce because interest on obligations of
governmental issuers located in other states is so included. This provision
applies to taxable years that begin during or after the calendar year in which
any such court decision becomes final, irrespective of the date on which the
obligations were issued. The Fund is not aware of any decision in which a court
has held that a state's exemption of interest on its own bonds or those of its
political subdivisions or Indian tribes, but not of interest on the bonds of
other states or their political subdivisions or Indian tribes, unlawfully
discriminates against interstate commerce or otherwise contravenes the United
States Constitution. Nevertheless, the Fund cannot predict the likelihood that
interest on the Minnesota Tax-Exempt Securities held by the Fund would become
taxable under this Minnesota statutory provision.
Shareholders are sent a quarterly statement of account reflecting all
transactions in the prior quarter, including dividends and gain distributions.
Also, at year-end, all shareholders are sent a statement of account and
information on the aggregate amount and tax status of dividends and gain
distributions for the just-ended calendar year.
The foregoing discussion relates to federal and Minnesota income taxation as of
the date of the Prospectus Distributions from the Fund, including exempt-
interest dividends, may be taxable in states other than Minnesota. Prospective
investors should consult their tax advisers with regard to the tax consequences
of an investment in the Fund.
WHAT IS THE FUND'S PLAN OF DISTRIBUTION?
The Fund has adopted a Plan of Distribution (the "Plan") pursuant to Rule 12b-1
under the Act. Under the terms of the Plan and the Investment Advisory and
Management Agreement (the "Agreement"), a portion of the management fee paid to
the Manager is paid to the Distributor. Under the Plan and the Agreement, the
Fund pays the Distributor, indirectly through the Manager, a monthly fee
equivalent on an annual basis to .25 of 1% of the average daily net assets of
the Fund. The fee may be used by the Distributor to (i) provide
22
<PAGE>
initial and ongoing sales compensation to its investment executives and to other
broker-dealers in connection with the sale of Fund shares and to pay for other
advertising and promotional expenses in connection with the sale of Fund
("distribution expenses"), and (ii) to provide compensation to entities
("Service Entities") in connection with the provision of certain personal and
account maintenance services to Fund shareholders including, but not limited to,
responding to shareholder inquiries and providing information on their
investments ("shareholder servicing expenses").
In the future, Service Entities may include banks and other depository
institutions which, under the Glass Steagall Act and other applicable laws and
regulations, are prohibited from engaging in the business of underwriting,
selling or distributing certain types of securities. Such institutions will only
be allowed to provide administration, shareholder service and distribution
assistance if the scope of the assistance is such that, in the opinion of the
Manager, it does not fall within the aforementioned prohibition.
WHO ARE THE FUND'S FUND ACCOUNTING AGENT AND ITS CUSTODIAN?
Investors Fiduciary Trust Company ("IFTC") serves as the Fund's fund accounting
agent, and in that capacity, maintains certain books and records pursuant to an
agreement with the Fund. Its address is 127 West 10th Street, Kansas City,
Missouri 64105. IFTC also serves as custodian for the Fund's portfolio
securities and cash, and in that capacity, maintains certain financial and
accounting books and records pursuant to a separate agreement with the Fund.
WHAT SERVICES DOES THE FUND OFFER?
Information about various shareholder services is included above under "How Can
You `Sell' Your Shares?" In addition, the Fund also provides the following
services:
What About Shareholder Information?
For general information about the Fund, call or write ARM Financial Services,
Inc., 100 North Minnesota Street, P.O. Box 69, New Ulm, Minnesota 56073-0069.
Its telephone number is (800) 328-4735. For information about your account,
call or write the Shareholder Servicing Agent at 100 North Minnesota Street,
P.O. BOX 69, New Ulm, Minnesota 56073-0069, telephone number (800) 328-4735.
What Reports Will You Receive From the Fund?
As a shareholder, you will receive the Fund's annual and semi-annual reports.
You also will receive quarterly account statements confirming dividends paid by
the Fund, transactions in your account and the current balance of shares you
own.
Are Certificates Issued For Shares?
All shares will be issued as book credits by the Shareholder Servicing Agent.
Certificates will not be issued. Any existing certificates may be sent to the
Shareholder Servicing Agent to be transferred in your account to book credits.
Other Services
Pre-Authorized Payments enable you to purchase Fund shares by authorizing your
bank to make regular
23
<PAGE>
payments from your bank account in fixed amounts.
Payments at regular intervals can be made to you from your Fund account under
the Automatic Cash Withdrawal Plan if you own or purchase shares held as book
credits worth $5,000 or more.
Further information on these services and others is available by contacting the
Distributor.
GENERAL INFORMATION ABOUT STATE BOND MINNESOTA TAX-FREE INCOME FUND
State Bond Minnesota Tax-Free Income Fund is an investment portfolio of State
Bond Tax-Free Income Funds, Inc., a non-diversified, open-end management
investment company, or mutual fund, incorporated in Maryland on December 2,
1987. The Fund has only one class of capital stock, common shares, par value
$.00001 per share. Each outstanding share has one vote and an equal right to
dividends and distributions, if any. All shares have noncumulative voting rights
for the election of directors. Each share is fully paid and nonassessable, and
each is freely transferable.
INVESTMENT PERFORMANCE
Advertisements and other sales literature for the Fund may refer to "yield,"
"tax equivalent yield," "average annual total return," "cumulative total return"
or data concerning the Fund's performance since its inception. When the Fund
advertises yield, it also will advertise its average annual total return for the
most recent one year, five year, and ten year periods, or the life of the Fund,
if less.
When the advertised yield of the Fund is characterized as the "SEC 30-day
yield", it will be based upon a 30-day period stated in the advertisement and
calculated in accordance with a standardized method promulgated by regulations
of the Securities and Exchange Commission. Such yield is calculated by dividing
the net investment income per share (as defined in such regulations) earned
during the period by the maximum offering price per share on the last day of the
period. Maximum offering price includes the maximum sales charge and any other
nonrecurring charges. The result is then annualized using a formula that
provides for semi-annual compounding of income. The tax-equivalent yield is
calculated based on the Fund's yield, except that the yield is increased by
using a stated income tax to demonstrate the taxable yield necessary to produce
an after-tax yield equivalent to the Fund's yield.
Average annual total return is calculated by finding the average annual
compounded rate of return over the period that would equate the initial
investment to the ending redeemable value. Cumulative total return is the
percentage change between the public offering price of one Fund share at the
beginning of a period and the net asset value of that share at the end of the
period with dividend and capital gain distributions treated as reinvested. In
calculating the average annual total return and cumulative total return, the
maximum sales charge is deducted from the hypothetical investment and all
dividends and distributions during the period are assumed to be reinvested.
The Fund may from time to time compare its investment results to various
unmanaged indices or other mutual funds in reports to shareholders, sales
literature, and advertisements. This may include comparisons of relative
performance based upon data provided by services such as Lipper Analytical
Services, Incorporated. The results may be calculated on a total return and/or
yield basis for various periods, with or without sales charges. Results without
a sales charge will be higher. Total returns assume the reinvestment of all
dividends and capital gain distributions. The Fund also may refer to
publications which have mentioned the Fund, its Manager, or their personnel.
24
<PAGE>
For additional information regarding the calculation of the Fund's yield, and
total return, see "Calculation of Performance Data" in the Statement of
Additional Information.
Tax-Free vs. Taxable Yields. The following table shows the approximate yields
which taxable securities must earn in various income brackets to equal tax-
exempt yields under combined federal and State of Minnesota individual income
tax rates. The table is based on federal and State of Minnesota income tax rates
for taxable years beginning in 1996. The table reflects the new federal income
tax rates for individuals imposed by the revenue provisions of the Omnibus
Budget Reconciliation Act of 1993, which are applied to bracket amounts that
have been adjusted for inflation in 1996: 36% on the taxable income of single
individuals in excess of $122,300 and of married couples filing joint returns
in excess of $141,700, and a surtax of 10%, equaling an effective rate of
39.6%, on the taxable income of individuals filing both single and joint returns
in excess of $263,750. Combined tax rates take into account the deductibility
of state income taxes for federal income tax purposes. Tax rate brackets are
subject to annual adjustments based on changes in the Consumer Price Index.
Accordingly, tax rates and taxable equivalent yields for 1997 and subsequent
years may be lower at some income levels than indicated in the table. The table
does not take into consideration any federal or Minnesota alternative minimum
tax. Therefore, to the extent Fund distributions are, and a Fund shareholder is,
subject to the federal or Minnesota alternative minimum tax, taxable equivalent
yields will be less than those set forth in this table.
USE THIS TABLE TO FIND YOUR 1996 COMBINED FEDERAL
----
AND MINNESOTA TAX BRACKET BASED ON YOUR FEDERAL TAXABLE INCOME (000'S OMITTED)
<TABLE>
<S> <C> <C> <C> <C> <C> <C>
21.8% 33.8% 34.1% 36.9% 41.4% 44.7%
Joint $22-40 $40-86 $86-97 $97-148 $148-264 over
------ ------ ------ ------- -------- $264
----
Single $15-24 $24-49 $49-58 $58-121 $121-264 over
-- ------ ------ ------- -------- $264
----
</TABLE>
YOUR TAXABLE EQUIVALENT YIELD WOULD HAVE TO BE:
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
If your tax exempt yield is: 21.8% 33.8% 34.1% 36.9% 41.4% 44.7%
3.0% 3.8% 4.5% 4.6% 4.8% 5.1% 5.4%
3.5% 4.5% 5.3% 5.3% 5.5% 6.0% 6.3%
4.0% 5.1% 6.0% 6.1% 6.3% 6.8% 7.2%
4.5% 5.8% 6.8% 6.8% 7.1% 7.7% 8.1%
5.0% 6.4% 7.6% 7.6% 7.9% 8.5% 9.0%
5.5% 7.0% 8.3% 8.3% 8.7% 9.4% 9.9%
6.0% 7.7% 9.1% 9.1% 9.5% 10.2% 10.8%
7.0% 9.0% 10.6% 10.6% 11.1% 11.9% 12.7%
</TABLE>
25
<PAGE>
MANAGEMENT'S DISCUSSION OF FUND PERFORMANCE
The Fund's investment performance during the year ended June 30, 1996, was
primarily affected by the changes in interest rates and the investment decisions
related to those changes. During the fiscal year ended June 30, 1996, the
Federal Reserve reversed its position of the previous year and became
accommodative with reductions of .25% to the Federal Fund's rate in July 1995,
December 1995 and January 1996. With these decreases, the 30 year Treasury Bond
yield, which began the fiscal year at 6.6%, decreased to below 6.0% in
December 1995. However, economic activity began to increase during the first
quarter of 1996, and continued through June. This economic strength resulted in
the 30 year Treasury Bond yield increasing to the 6.9% level at June 30, 1996.
Due to the declining interest rate levels of the third and fourth quarters of
1995, the Fund attempted to hold its higher yielding quality bonds and did
little trading. With the increased interest rates experienced in the second
quarter of 1996, the Fund did some trading of bonds, purchasing issues having
maturities of 15 to 25 years. These purchased bonds extended the portfolios
duration, but more importantly, produced higher yields for the Fund's
shareholders.
The Fund continued its practice of maintaining a conservative, high quality
investment portfolio by limiting its investments to only A-rated or higher
securities, and selling any securities that receive a downgrade to a rating
below the A quality level. This resulted in the Fund's portfolio having a
weighted average quality of AA at the conclusion of the fiscal year ended June
30, 1996.
The Fund's average annual total return for the period ended June 30, 1996
(including the effects of the one time sales charge) was as follows:
<TABLE>
<CAPTION>
<S> <C>
One Year...................................... 0.06%
Five Years.................................... 5.41%
Life of Fund (since 1/28/88).................. 6.14%
</TABLE>
Past performance is not predictive of future performance.
The following chart compares the performance of a hypothetical $10,000
investment in the Fund over the life of the Fund (from February 1, 1988) to the
performance of an investment in the Lehman Brothers Municipal Bond Index (the
"Index"). The information in the chart assumes that the maximum current sales
charge was paid upon acquisition of the Fund shares and reflects all Fund
expenses during the period covered. The information in the chart regarding the
performance of the hypothetical investment in the Index assumes that no sales
charge was paid upon an investment in the Index and that there were no expenses
associated with an investment in the Index. The index that is used for
comparative purposes, the Lehman Brothers Municipal Bond Index, is a national
index; consequently, its performance may not be directly comparable to the
performance of the Fund, which is a single-state municipal securities fund.
<TABLE>
<CAPTION>
[GRAPH APPEARS HERE]
Year 1988 1989 1990 1991 1992 1993 1994 1995 1996
------ ------ ------ ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Fund 9,501 10,753 11,343 12,122 13,271 14,605 14,721 15,767 16,520
</TABLE>
26
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
INDEX 10,182 11,342 12,114 13,206 14,760 16,526 16,554 18,014 19,210
</TABLE>
All performance data and figures are based upon past performance. The investment
return on and principal value of an investment in the Fund will fluctuate, so
that an investor's shares, when redeemed, may be worth more or less than their
original cost.
The above performance data for the Fund assumes the applicability of the current
maximum sales charge and does not include adjustments for expenses which have
changed during the periods reflected. The Manager of the Fund historically has
paid a portion of the Fund's expenses. See "Financial Highlights" above.
NO DEALER, SALES REPRESENTATIVE OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS (AND/OR IN THE STATEMENT OF ADDITIONAL INFORMATION REFERRED TO ON THE
COVER PAGE OF THIS PROSPECTUS), AND, IF GIVEN OR MADE, SUCH INFORMATION OR
REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE FUND,
THE MANAGER OR ARM FINANCIAL SERVICES, INC. THIS PROSPECTUS DOES NOT
CONSTITUTE AN OFFER OR SOLICITATION BY ANYONE IN A STATE IN WHICH SUCH OFFER OR
SOLICITATION IS NOT AUTHORIZED, OR IN WHICH THE PERSON MAKING SUCH OFFER OR
SOLICITATION IS NOT QUALIFIED TO DO SO, OR TO ANY PERSON TO WHOM IT IS UNLAWFUL
TO MAKE SUCH OFFER OR SOLICITATION.
27
<PAGE>
PROSPECTUS
NOVEMBER 1, 1996
STATE BOND
MINNESOTA TAX-FREE
INCOME FUND
100 North Minnesota Street
P.O. Box 69
New Ulm, Minnesota 56073-0069.
STATE BOND
MINNESOTA TAX-FREE
INCOME FUND
INVESTMENT MANAGER:
ARM Capital Advisors, Inc.
200 Park Avenue
20th Floor
New York, New York 10166
DISTRIBUTOR
ARM Financial Services, Inc.
100 North Minnesota Street
P.O. BOX 69 [LOGO]
New Ulm, Minnesota 56073-0069.
TRANSFER, REDEMPTION AND
OTHER SHAREHOLDER
ACCOUNT SERVICES:
ARM Transfer Agency, Inc.
100 North Minnesota Street
P.O. BOX 69
New Ulm, Minnesota 56073-0069. A MUTUAL FUND SEEKING
TO MAXIMIZE
CURRENT INCOME
EXEMPT FROM FEDERAL
PORTFOLIO SECURITIES AND MINNESOTA PERSONAL
CUSTODIAN: INCOME TAXES TO THE
EXTENT CONSISTENT WITH
Investors Fiduciary Trust Company PRESERVATION OF CAPITAL
127 West 10th Street
Kansas City, Missouri 64105.
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STATEMENT OF ADDITIONAL INFORMATION
November 1, 1996
STATE BOND MINNESOTA TAX-FREE INCOME FUND
100 North Minnesota Street
P.O. Box 69
New Ulm, Minnesota 56073-0069
Telephone No. (507) 354-2144
This Statement of Additional Information supplements the information
contained in the current Prospectus of State Bond Minnesota Tax-Free Income Fund
(the "Fund") dated November 1, 1996. This Statement of Additional Information
is not a Prospectus, but should be read in conjunction with the Fund's
Prospectus, which may be obtained by contacting the Fund at the address or
telephone number noted above.
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TABLE OF CONTENTS
Page
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What Are The Fund's Investment Objectives, Policies, and Risks?........................... 2
(See "What Are The Fund's Investment Objectives And Policies?"
in the Prospectus)
Calculation of Performance Data........................................................... 4
What Are The Fund's Investment Limitations?............................................... 7
Who Manages The Fund?..................................................................... 9
(See "How Is The Fund Managed?" in the Prospectus)
The Manager............................................................................... 13
Management Agreement And Expenses......................................................... 14
(See "How Is The Fund Managed?" in the Prospectus)
Transfer Agent............................................................................ 15
Plan of Distribution...................................................................... 15
(See "What About the Plan of Distribution?" in the Prospectus)
Custodian................................................................................. 16
Independent Auditors...................................................................... 17
Portfolio Transactions And Brokerage...................................................... 17
(See "What Are the Fund's Brokerage Commissions?" in the Prospectus)
Purchase Of Shares........................................................................ 18
Offering Price............................................................................ 19
How Are Shares Distributed?............................................................... 19
How Can You "Sell" Your Shares?........................................................... 19
How Is Net Asset Value Per Share Determined?.............................................. 19
Tax Status Of The Fund.................................................................... 20
Additional Tax Information................................................................ 20
Will The Fund Withhold Taxes On Distributions?............................................ 21
General Information....................................................................... 21
Financial Statements...................................................................... 2
Appendix A - Description of Tax-Exempt Securities Ratings................................. 15
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NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS STATEMENT OF ADDITIONAL
INFORMATION OR THE PROSPECTUS DATED NOVEMBER 1, 1996, AND, IF GIVEN OR MADE,
SUCH INFORMATION OR REPRESENTATIONS MAY NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY THE FUND. THIS STATEMENT OF ADDITIONAL INFORMATION DOES NOT
CONSTITUTE AN OFFER TO SELL SECURITIES IN ANY STATE OR JURISDICTION IN WHICH
SUCH OFFERING MAY NOT LAWFULLY BE MADE. THE DELIVERY OF THIS STATEMENT OF
ADDITIONAL INFORMATION AT ANY TIME SHALL NOT IMPLY THAT THERE HAS BEEN NO CHANGE
IN THE AFFAIRS OF THE FUND SINCE THE DATE HEREOF.
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WHAT ARE THE FUND'S INVESTMENT OBJECTIVES, POLICIES, AND RISKS?
The Fund's investment objective is to maximize current income exempt from
both federal income tax and Minnesota personal income tax to the extent
consistent with preservation of capital. In addition, as more fully described in
the Prospectus, the Fund may invest up to 20% of its assets in taxable fixed-
income securities, may invest up to 25% of its assets in unrated Minnesota Tax-
Exempt Securities (as defined in the Prospectus), may enter into repurchase
agreements and may purchase securities on a when-issued basis. The Fund may only
purchase Minnesota Tax-Exempt Securities that are not rated within the three
highest grades by either Moody's or Standard & Poor's or are unrated if such
securities are at all times fully insured as to the scheduled payment of all
installments of principal and interest. See "Insurance" in the Prospectus.
Portfolio Turnover
- ------------------
Portfolio turnover rate for a fiscal year is the ratio of the lesser of
annual purchases or sales of portfolio securities to the average monthly value
of portfolio securities, excluding securities whose maturities at acquisition
were one year or less. The Fund cannot accurately predict its annual portfolio
turnover rate, but anticipates that it will not exceed 100%. The Fund's
portfolio turnover rate will not be a limiting factor when the Manager deems it
desirable to sell or purchase securities. The Fund's portfolio turnover rate was
13% for the fiscal year ended June 30, 1996.
Fixed-Income Securities
- -----------------------
Although the Manager seeks to manage the Fund with a view toward reducing
the price volatility of its portfolio, the net asset value of the Fund will
change with changes in the value of its portfolio securities. When interest
rates decline, the value of a fixed-income portfolio can be expected to rise.
Conversely, when interest rates rise, the value of a fixed-income portfolio can
be expected to decline.
Interest rate fluctuations may affect payment expectations on fixed-income
securities. For example, certain municipal obligations may contain redemption or
call provisions. If an issuer exercises these provisions in a declining interest
rate market, the Fund would likely have to replace the security with a lower
yielding security, resulting in a decreased return for investors. In addition, a
municipal obligation's value will decrease in a rising interest rate market,
resulting in a decrease in the value of the Fund's assets. If the Fund
experiences unexpected net redemptions, this may force it to sell its portfolio
securities without regard to their investment merits, thereby decreasing the
asset base upon which the Fund's expenses can be spread and possibly reducing
the Fund's rate of return.
For a discussion of the risks associated with investing in fixed-income
securities of issuers located in the State of Minnesota, see the Prospectus.
High-Yield Securities
- ---------------------
The Fund currently does not invest in securities rated below A by Standard
& Poor's Ratings Services, a division of the McGraw-Hill Companies, Inc. ("S&P")
or Moody's Investors Service, Inc. ("Moody's"), and has no current intention of
investing in such securities. In addition, as is discussed in the next section,
it is a fundamental policy of the Fund that the Fund will not acquire securities
that are not rated in the three highest grades by S&P or Moody's unless those
securities are covered by insurance guaranteeing the scheduled payment of
principal and interest thereon.
2
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Securities rated BB or B by S&P or Ba or B by Moody's (or equivalently
rated by another nationally recognized statistical rating organization) are
below investment grade and generally will involve more credit risk than
securities in the higher rating categories. Such securities are commonly known
as "junk" bonds. In some cases such securities are subordinated to the prior
payment of senior indebtedness, thus potentially limiting the holder's ability
to receive payments or to recover full principal when senior securities are in
default. Also, during an economic downturn or substantial period of rising
interest rates, highly leveraged issuers may experience financial stress which
would adversely affect their ability to service their principal and interest
payment obligations, to meet projected business goals, and to obtain additional
financing. If the Fund did acquire any lower-rated securities, upon any default,
the Fund could incur additional expenses to the extent it is required to seek
recovery of the payment of principal or interest on the relevant portfolio
holding. The credit risks associated with lower-rated securities may be reduced
by the Fund's policy of not acquiring securities that are not rated in one of
the top three grades by S&P or Moody's unless those securities are covered by
insurance guaranteeing scheduled payments of principal and interest. See
"Insurance" in the Prospectus.
In addition, lower-rated securities may be thinly traded, which may have an
adverse impact on market price and the ability of the holder to dispose of
particular issues when necessary to meet its liquidity needs or in response to a
specific economic event such as a deterioration in the creditworthiness of the
issuer. A thinly traded market also may interfere with the ability of the holder
to accurately value high-yield securities and, consequently, value the Fund's
assets. Furthermore, adverse publicity and investor perceptions, whether or not
based on fundamental analysis, may decrease the value and liquidity of high-
yield securities, especially in a thinly traded market.
Yields on high-yield securities will fluctuate over time. The prices of
high-yielding securities have been found to be less sensitive to interest rate
changes than higher-rated investments, but more sensitive to adverse economic
changes or developments affecting the issuer. In addition, periods of economic
uncertainty and changes can be expected to result in increased volatility of
market prices of high-yielding securities and, to the extent the Fund acquires
such securities, the Fund's asset value.
For more information covering the rating categories of debt securities and
commercial paper, see Appendix A to this Statement of Additional Information.
Insurance
- ---------
Minnesota Tax-Exempt Securities that are not rated within the three highest
grades by either Moody's or S&P or are unrated will be purchased by the Fund
only if such securities are covered by insurance guaranteeing the scheduled
payment of principal and interest thereon.
As described in the Prospectus, the Fund will receive payments of insurance
for any installment of interest or principal due for payment but which shall be
unpaid by reason of nonpayment by the issuer. The term "due for payment" means,
when referring to the principal of a security, its stated maturity date or the
date on which it shall have been called for mandatory sinking fund redemption
and does not refer to any earlier date on which payment is due by reason of call
for redemption (other than by mandatory sinking fund redemption), acceleration
or other advancement of maturity, and means, when referring to interest on a
security, the stated date for payment of interest. However, when the interest on
the security shall have been determined, as provided in the underlying
documentation relating to such security, to be subject to federal income
taxation, "due for payment" also means, when referring to the principal of such
security, the date on which it has been called for mandatory redemption as a
result of such determination of taxability, and when referring to interest on
such
3
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security, the accrued interest at the rate provided in such documentation to the
date on which it has been called for such mandatory redemption, together with
any applicable redemption premium.
The insurance feature insures the scheduled payment of interest and
principal and does not guarantee the market value of the insured municipal
securities nor the value of the shares of the Fund.
Financial Guaranty Insurance Company. Financial Guaranty, domiciled in the
State of New York, commenced its business of providing insurance and financial
guarantees for a variety of investment instruments in January, 1984. Since 1989,
Financial Guaranty has been a wholly owned subsidiary of GE Capital Corporation.
Financial Guaranty, in addition to providing insurance for the payment of
interest on and principal of municipal bonds and notes held in unit investment
trust and mutual fund portfolios, provides insurance for new and secondary
market issues of municipal bonds and notes and for portfolios of new and
secondary market issues of municipal bonds and notes. Financial Guaranty expects
to provide other forms of financial guarantees in the future. It is also
authorized to write fire, property damage liability and fidelity and surety
insurance. As of June 30, 1996, the total capital and surplus of Financial
Guaranty was approximately $1,485,200,000.
Financial Guaranty is currently licensed to provide insurance in 50 states
and the District of Columbia, files reports with state insurance regulatory
agencies and is subject to audit and review by such authorities. Financial
Guaranty is also subject to regulation by the New York State Insurance
Department. Such regulation, however, is no guarantee that Financial Guaranty
will be able to perform on its contracts of insurance in the event a claim
should be made thereunder at some time in the future.
The information relating to Financial Guaranty contained above and in the
Prospectus has been furnished by such corporation. The financial information
about Financial Guaranty contained in the Registration Statement and Prospectus
is unaudited but appears in reports or other materials filed with and subject to
audit and review by state insurance regulatory authorities. No representation is
made as to the accuracy or adequacy of such or as to the absence of subsequent
material adverse changes in such information.
The policies of insurance obtained by the Fund from Financial Guaranty and
the agreements and negotiations in respect thereof represent the only
relationship between Financial Guaranty and the Fund. Otherwise, neither
Financial Guaranty nor any affiliate has any significant relationship, direct or
indirect, with the Fund or its Manager. The Portfolio Insurance Policy is
terminable by the Fund upon sixty days' prior written notice to Financial
Guaranty. If it becomes necessary or desirable to do so, the Fund may terminate
the Portfolio Insurance Policy with Financial Guaranty and obtain portfolio
insurance from a comparable carrier.
CALCULATION OF PERFORMANCE DATA
SEC 30-Day Yield
- ----------------
Advertisements and other sales literature for the Fund may quote "SEC 30-
day yield," "tax equivalent yield,"and "total return" data. Such performance
data is computed on a standardized basis pursuant to formulas established by the
rules and regulations of the Securities and Exchange Commission.
The Fund's SEC 30-day yield for the 30-day period ended June 30, 1996 was
4.36%. Such yield is computed by dividing the net investment income per share
(as defined under Securities and Exchange
4
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Commission rules and regulations) earned during the computation period by the
maximum offering price per share on the last day of the period, according to the
following formula:
a-b
YIELD = 2[(----+1)/6/-1]
cd
WHERE: a = dividends and interest earned
during the period;
b = expenses accrued for the period
(net of reimbursements);
c = the average daily number of
shares outstanding during the
period that were entitled to
receive dividends; and
d = the maximum offering price per
share on the last day of the period.
Tax Equivalent Yield
- --------------------
The Fund's tax equivalent yield for the 30-day period ended June 30, 1996
was 7.11%. The Fund calculates its tax equivalent yield over a 30-day period.
The tax equivalent yield will be determined by first computing the yield as
discussed above. The Fund will then determine what portion of the yield is
attributable to securities, the income of which is exempt for federal tax
purposes. This portion of the yield will then be divided by one minus 39.6%
(the assumed maximum tax rate for individual taxpayers not subject to the
Alternative Minimum Tax) and then added to the portion of the yield that is
attributable to other securities.
Tax Fund's tax equivalent yield is calculated according to the following
formula:
Tax Equivalent Yield = Yield
----------
1-.396
Average Annual Total Return
- ---------------------------
The Fund's average annual total return over the one and five year periods
ended June 30, 1996 and the life of the Fund was as follows:
Life of Fund
One Year Five Years (From January 28, 1988)
-------- ---------- -----------------------
Average Annual
Total Return: 0.06% 5.41% 6.14%
5
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The average annual total return figures are computed by finding the average
annual compounded rates of return over the periods indicated that would equate
the initial amount invested to the ending redeemable value, 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; and
ERV = ending redeemable value
at the end of the period
of a hypothetical $1,000
payment made at the
beginning of such period.
This calculation deducts the maximum sales charge from the initial
hypothetical $1,000 investment, assumes all dividends and capital gains
distributions are reinvested at net asset value on the appropriate reinvestment
dates as described in the Prospectus, and includes all recurring fees, such as
investment advisory and management fees, charged to all shareholder accounts.
Cumulative Total Return
- -----------------------
Cumulative total return is computed by finding the cumulative compound rate
of return over the period indicated that would equate the initial amount
invested to the ending redeemable value, according to the following formula:
CTR = ERV - P X 100
-------
P
WHERE:
CTR = cumulative total return
ERV = ending redeemable value at the end of the period of a
hypothetical $1,000 payment made at the beginning of
period.
P = initial payment of $1,000
This calculation assumes all dividends and capital gains distributions are
reinvested at net assets value on the appropriate reinvestment dates as
described in the prospectus and includes all recurring fees, such as investment
advisory and management fees, charged to all shareholder accounts.
6
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Other Yields
- ------------
Current and effective yields of the Fund, not calculated in accordance with
the guidelines of the SEC as explained above, may be quoted in reports and sales
literature. Non-SEC current yield is computed based upon a recent seven-
calendar-day period by determining the net change, exclusive of capital changes,
in the value of a hypothetical pre-existing account having a balance of one
share at the beginning of the period, dividing the net change in account value
by the value of the account at the beginning of the period to obtain a base
period return, and multiplying the base period return by 365/7. Non-SEC
effective yield is computed by annualizing the seven-day return with all
dividends reinvested in additional Fund shares. The Fund's non-SEC yield
quotation may be inclusive or exclusive of taxable income, if any, as indicated
in such quotation. The Fund's non-SEC yield may fluctuate daily depending upon
such factors as market conditions, the composition of the Fund's portfolio and
operating expenses. Therefore, the Fund's non-SEC yield in the future may be
higher or lower than its past non-SEC yields and there can be no assurance that
historical yields will continue. That the Fund's non-SEC current yield will
fluctuate and that shareholders' principal is not guaranteed or insured should
be taken into account when comparing the yield on an investment in Fund shares
with yields on fixed-yield investments, such as insured savings accounts. These
factors and possible differences in the methods used in calculating non-SEC
yield should be considered when comparing the Fund's non-SEC current yield to
non-SEC yields published for other investment companies and other investment
vehicles. Yield should also be considered relative to changes in the value of
the Fund's shares and the Fund's investment goals and policies.
WHAT ARE THE FUND'S INVESTMENT LIMITATIONS?
Under the Fund's fundamental policies, which cannot be changed except by
vote of a majority of its outstanding voting securities, the Fund may not:
1. Borrow money, except for temporary purposes in emergency situations in an
aggregate amount not to exceed 20% of the value of the total assets of the
Fund; provided, that borrowings in excess of 5% of such value will be only
from banks, and the Fund will not purchase additional portfolio securities
while its borrowings exceed 5%;
2. Underwrite the securities of other issuers, except insofar as it may
technically be deemed an underwriter under the Securities Act of 1933 in
selling a portfolio security;
3. Purchase securities of any issuer if immediately thereafter, with respect
to 50% of the Fund's total assets, more than 5% of such assets would be
invested in the securities of any one issuer, except that this limitation
does not apply to obligations issued or guaranteed as to principal and
interest either by the U.S. government or its agencies or
instrumentalities;
4. Purchase industrial development revenue bonds (which shall be interpreted
to include private activity bonds) if immediately thereafter more than 25%
of the Fund's assets would be invested in revenue bonds which are based,
directly or indirectly, on the credit of private entities in any one
industry or in securities of private issuers in any one industry;
5. Issue any senior securities (as defined in the Investment Company Act of
1940, as amended);
6. Buy or hold any real estate or real estate investment trust securities;
7
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7. Buy or hold any commodity or commodity futures contracts, or any oil, gas
or other mineral exploration or development program;
8. Make loans, except to the extent that the purchase of bills, notes, bonds
or other debt obligations or the entry into repurchase agreements may be
considered loans;
9. Mortgage or pledge any of its assets, except to the extent that up to a
maximum of 10% of the value of its total assets may be mortgaged or pledged
if necessary to secure borrowings permitted by paragraph 1;
10. Buy securities on "margin," except that it may obtain such short-term
credits as may be necessary for the clearance of purchases or sales of
securities;
11. Make "short" sales of securities;
12. Write or purchase put or call options;
13. Buy securities which have legal or contractual restrictions on resale,
except in connection with repurchase agreements;
14. Buy securities of any issuer for the purpose of exercising control or
management; or buy securities issued by any other investment company,
except in connection with a merger, consolidation, acquisition or
reorganization;
15. Invest more than 10% of the Fund's net assets in any combination of
repurchase agreements maturing in more than seven days and other illiquid
securities;
16. Purchase Minnesota Tax-Exempt Securities (as defined in the Prospectus)
that are either not rated within the three highest grades by either Moody's
or S&P or are unrated unless such securities are insured as to the payment
of all installments of principal and interest;
17. Invest more than 25% of its assets in Minnesota Tax-Exempt Securities that
are unrated;
18. Invest more than 20% of the value of the Fund's assets in securities other
than Minnesota Tax-Exempt Securities, except that, on a temporary defensive
basis due to market conditions, the Fund may invest up to 100% of its
assets in cash or in taxable fixed-income securities.
If a percentage restriction described above is complied with at the time an
investment is made, a later increase or decrease in percentage resulting from a
change in values of portfolio securities or in the amount of net assets of the
Fund will not be considered a violation of the restriction.
Under the Investment Company Act of 1940, a "vote of a majority of the
outstanding voting securities" of the Fund means the affirmative vote of the
lesser of (1) more than 50% of the outstanding shares of the Fund or (2) 67% or
more of the shares present at a shareholders' meeting if more than 50% of the
outstanding shares are represented at the meeting in person or by proxy.
8
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WHO MANAGES THE FUND?
Directors and officers of the Fund, together with information as to their
principal business occupations during the past five years, are shown below. Each
Director who is an "interested person" of the Fund, as defined in the Investment
Company Act of 1940, is indicated by an asterisk. Unless otherwise indicated,
their addresses are 515 W. Market Street, Louisville, Kentucky.
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Name, Age and Address Position with the Fund Other Business Activities in Past 5 Years
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William B. Faulkner (68) Director President, William Faulkner & Associates,
business and institutional adviser since
1986; Consultant to American Hoist &
Derrick Company, construction equipment
manufacturer, from 1986 to 1989; prior
thereto, Vice President and Assistant to
the President, American Hoist & Derrick
Company. Director of the other mutual
funds in the State Bond Group
Chris L. Mahai (40) Director Senior Vice President, Strategic
Integration Unit, Star Tribune/Cowles
Media Company, since August 1995; Vice
President, Marketing Director, Star
Tribune, since September 1992; from 1990
to 1992, self-employed consultant,
marketing services; prior thereto, Senior
Vice President of Corporate Relations and
marketing, First Bank System, Inc.
Director of the other mutual funds in the
State Bond Group
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Name, Age and Address Position with the Fund Other Business Activities in Past 5 Years
- --------------------- ---------------------- -----------------------------------------
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John R. Lindholm (47)* Director President of Integrity Life Insurance
Company ("Integrity") and Vice President-
Chief Marketing Officer of National
Integrity Life Insurance Company
("National Integrity") since November 26,
1993; Executive Vice President-Chief
Marketing Officer of ARM Financial Group,
Inc. since July 27, 1993; since March
1992 Chief Marketing Officer of
Analytical Risk Management, L.P.; from
June 1990 to February 1992, Chief
Marketing Officer and a Managing Director
of the ICH Capital Management Group, ICH
Corporation, Louisville, Kentucky; prior
thereto, Chief Marketing Officer and
Managing Director for Capital Holding
Corporation's Accumulation and Investment
Group. Director of the other mutual funds
in the State Bond Group and of The
Legends Fund, Inc.
John Katz (57) Director Investment banker since January 1991;
10 Hemlock Road Chairman and Chief Executive Officer,
Hartsdale, NY Sam's Restaurant Group, Inc. (a
restaurant holding company), from June
1991 to August 1992; Executive Vice
President (from January 1989 to January
1991) and Senior Vice President (from
December 1985 to January 1989), Equitable
Investment Corporation (an indirect
wholly-owned subsidiary of The Equitable
Life Assurance Society of the United
States, through which it owns and manages
its investment operations). Director of
the other mutual funds in the State Bond
Group and of The Legends Fund, Inc.
Theodore S. Rosky (58) Director Retired since April 1992; Executive Vice
2304 Speed Avenue President, Capital Holding Corporation
Louisville, KY (from December 1991 to April 1992); prior
thereto, Executive Vice President and
Chief Financial Officer, Capital Holding
Corporation. Director of the other mutual
funds in the State Bond Group and of The
Legends Fund, Inc.
</TABLE>
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<CAPTION>
Name, Age and Address Position with the Fund Other Business Activities in Past 5 Years
- --------------------- ---------------------- -----------------------------------------
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Dale C. Bauman (59) President Vice President and Sales Manager, SBM
Financial Services, Inc., since June
1992; prior thereto, Vice President and
Division Manager, SBM Financial Services,
Inc., 1980 to June 1992. President of the
other mutual funds in the State Bond
Group
Keith O. Martens (57) Vice President Senior Portfolio Manager, ARM Capital
Advisors, Inc. since June 14, 1995;
Executive Vice President - Investments,
SBM Company; Vice President State Bond
and Mortgage Life Insurance Company and
SBM Certificate Company. Vice President
of the other mutual funds in the State
Bond Group.
Barry G. Ward (35 ) Controller Controller of ARM Financial Group, Inc.
since April 1996. From October 1993 to
April 1996, Mr. Ward was directly
responsible for the Company's financial
reporting function. From January 1989 to
October 1993, Mr. Ward served in various
positions within Ernst & Young LLP's
Insurance Industry Accounting and
Auditing Practice, the last of which was
Manager. Controller of the other mutual
funds in the State Bond Group and of The
Legends Fund, Inc.
Kevin L. Howard (32) Vice President and Assistant General Counsel of ARM
Secretary Financial Group, Inc. since January 31,
1994; Assistant General Counsel of
Capital Holding Corporation from April
1992 to January 1994; Attorney,
Greenebaum Doll & McDonald, 1989 to April
1992. Vice President and Secretary of the
other mutual funds in the State Bond
Group and Secretary of The Legends Fund,
Inc.
</TABLE>
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<TABLE>
<CAPTION>
Name, Age and Address Position with the Fund Other Business Activities in Past 5 Years
- --------------------- ---------------------- -----------------------------------------
<S> <C> <C>
Peter S. Resnik (35) Treasurer Treasurer of ARM Financial Group, Inc.,
Integrity and National Integrity since
December 1993; employed in various
financial and operational capacities by
Analytical Risk Management Ltd. since
December 14, 1992; Assistant Vice
President of the Commonwealth Life
Insurance Company subsidiary of Capital
Holding Corporation from 1986 to December
1992. Treasurer of the other mutual funds
in the State Bond Group and of The
Legends Fund, Inc.
Pamela R. Freeman (29) Assistant Secretary Financial Analyst with ARM Financial
Group, Inc. since October 1993; Senior
and various other capacities
with Ernst & Young LLP from 1989 to
September 1993.
</TABLE>
- ---------------
* Mr. Lindholm is an interested person, as defined in the 1940 Act, by virtue
of his positions with ARM Financial Group, Inc.
Directors of the Fund (including former Directors) received aggregate
remuneration of $5,716 during the Fund's fiscal year ended June 30, 1996.
Directors and officers of the Fund as a group owned directly or indirectly 1,005
shares, or 0.06% of the Fund's capital stock at June 30, 1996.
The following table sets forth, for the fiscal year ended June 30, 1996,
compensation paid by the Fund to the non-interested Directors and, for the 1995
calendar year, the aggregate compensation paid by the six funds in the State
Bond Group of mutual funds to the non-interested Directors. Directors who are
interested persons, as defined in the 1940 Act, received no compensation from
the Fund.
12
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<CAPTION>
Total Compensation
from State Bond
Aggregate Group of Mutual
Compensation Funds and The
Name of Director from Fund (a) Legends Fund, Inc. (b)
- ---------------- ------------- ----------------------
<S> <C> <C>
William B. Faulkner $1,336 $15,514
Patrick M. Finley* $ 222 $ 1,332
Arthur Gartland* $ 150 $ 900
John Katz $1,336 $15,514
Chris L. Mahai $1,336 $ 8,014
Theodore S. Rosky $1,336 $15,514
</TABLE>
____________________
(a) There were no pension or retirement benefits accrued for any of the named
persons by any of the funds.
(b) Messrs. Faulkner, Katz and Rosky are directors of The Legends Fund, Inc., a
mutual fund which is advised by the Manager, the compensation from which is
included in the above amounts of total compensation.
* Messrs. Finley and Gartland resigned as Directors in January 1996 and
November 1995, respectively.
THE MANAGER
ARM Capital Advisors, Inc. (the "Manager") manages the investments of the
Fund and administers its business and other affairs. The address of the Manager
is 200 Park Avenue, 20th Floor, New York, New York 10166. The predecessor to
the Manager was SBM Company, which served as manager of the Fund from the Fund's
inception until June 13, 1995. The Manager assumed management of the Fund on
June 14, 1995, effective for accounting purposes as of June 1, 1995, following
the acquisition of substantially all of the business operations of SBM Company
by ARM.
The Manager is a wholly-owned subsidiary of ARM Financial Group, Inc.
("ARM"), a Delaware corporation. ARM is a financial services company providing
retail and institutional products and services to the long-term savings and
retirement market. The Morgan Stanley Leveraged Equity Fund II, L.P., Morgan
Stanley Capital Partners III, L.P., Morgan Stanley Capital Investors, L.P. and
MSCP III 892 Investors, L.P., investment funds sponsored by Morgan Stanley
Group, Inc. ("Morgan Stanley"), own approximately 91% of the outstanding shares
of voting stock of ARM. The Manager currently provides investment management
services to institutional and individual clients, including ARM and its
subsidiaries, with combined assets in excess of $5.9 billion.
The Manager is also manager of the other mutual funds in the State Bond
Group of mutual funds: State Bond Cash Management Fund, State Bond Common Stock
Fund, State Bond Diversified Fund, State Bond Tax Exempt Fund, and State Bond
U.S. Government and Agency Securities Fund.
13
<PAGE>
MANAGEMENT AGREEMENT AND EXPENSES
Under the Investment Advisory and Management Agreement (the "Agreement"),
dated June 14, 1995, subject to the control of the Board of Directors, the
Manager manages the investment of the assets of the Fund, including making
purchases and sales of portfolio securities consistent with the Fund's
investment objectives and policies and administers its business and other
affairs. The Manager provides the Fund with such office space, administrative
services and executive personnel as are necessary for Fund operations. The
Manager also pays all the compensation of the directors of the Fund who are
employees of the Manager and of the officers and employees of the Fund. In
addition, the Manager pays distribution expenses pursuant to the Fund's 12b-1
Plan.
The Fund pays the Manager a management fee for its services, calculated
daily and payable monthly, equal to an annual fee of .85 of 1% of the first
$100,000,000 of average daily net assets of the Fund and .80% of 1% of the
average daily net assets of the Fund in excess of $100,000,000. A portion of
this fee is paid to SBM Financial Services, Inc. (the "Distributor") in
connection with the Fund's 12b-1 Plan (see Plan of Distribution). SBM Company,
the previous investment manager of the Fund received the following amounts from
the Fund as a management fee (excluding 12b-1 plan fees) during the periods
ended June 30, 1995 and 1994, respectively: $96,640 and $96,758. For the fiscal
year ended June 30, 1996 and for the period from June 1, 1995, the effective
date for accounting purposes on which the Manager assumed its duties with
respect to the Fund, through, June 30, 1995, the Manager received a management
fee (excluding 12b-1 plan fees) of $113,090 and $9,606, respectively. The
Manager has voluntarily undertaken, and SBM Company previously voluntarily
undertook, to reimburse the Fund for any expenses incurred by the Fund to the
extent the Fund's total expenses exceeded 1% of average daily net assets,
despite the fact that higher expenses may be permitted by state law. For the
fiscal year ended June 30, 1996 and for the period June 1, 1995 to June 30,
1995, the Manager reimbursed the Fund in the amount of $32,639 and $2,378,
respectively. SBM Company reimbursed the Fund during the periods ended June 30,
1995, and 1994 in the following amounts: $40,101 and $46,311, respectively.
The Fund pays all its expenses other than those assumed by the Manager,
including the investment advisory and management fee; outside legal, auditing
and accounting expenses; bookkeeping, record keeping, and Fund portfolio and
Fund shares pricing expenses; interest, taxes and governmental fees; expenses
incurred in connection with membership in investment company organizations;
brokerage commissions or charges, if any; fees of custodians, transfer agents,
registrars, accounting services agents, or other agents; expense of preparing
share certificates; expenses relating to the redemption or repurchase of the
Fund's shares; investor services expenses; expenses of registering and
qualifying Fund shares for sale under applicable federal and state law; expenses
of preparing, setting in print, printing and distributing prospectuses,
statements of additional information, reports, notices and dividends to Fund
shareholders; cost of stationery; costs of stockholder and other meetings of the
Fund; traveling expenses of officers, directors, and employees of the Fund, if
any; fees of the Fund's independent directors and salaries of any officers or
employees who are not affiliated with the Manager; the Fund's pro rata portion
of premiums on any fidelity bond and insurance covering the Fund; and general
corporate fees and expenses.
Under the regulations of various states in which the Fund's shares are
qualified for sale, the amount of annual expenses which the Fund may pay are
limited to certain percentages of its average net assets. The most stringent of
such requirements limits such expenses, with certain limited categories of
expenses excepted, to 2
14
<PAGE>
1/2% of the first $30 million of average net assets, 2% of the next $70 million,
and 1 1/2% of the remaining average net assets.
The Agreement may be terminated at any time on 60 days' written notice by
the Board of Directors, or by vote of a majority of the outstanding shares or by
the Manager. The Agreement will terminate automatically upon assignment. The
Agreement will continue in effect from year to year so long as continuance is
approved annually by either the Board of Directors of the Fund or by a vote of a
majority of the outstanding voting shares, provided that in either event such
continuance is also approved by the vote of a majority of the directors who are
not parties to such Agreement, or interested persons of such parties, cast in
person at a meeting called for the purpose of voting on such approval.
Accounting Services Agreement. Prior to June 1, 1995, SBM Company also
acted as the accounting services agent for the Fund pursuant to a separate
agreement. Under this agreement, SBM Company was paid a fee for keeping the
books, accounts, records, journals and other records of original entry relating
to the business of the Fund current. It also performed certain daily functions
in connection with the Fund's accounts and records. The Manager received $0 and
$625 from the Fund for accounting services provided by the Manager during the
fiscal year ended June 30, 1996 and for the period June 1, 1995 through June 14,
1995, respectively. SBM Company, as the previous accounting services agent,
received the following amounts from the Fund for the periods ended June 30, 1995
and 1994, respectively; $13,750 and $15,000.
TRANSFER AGENT
ARM Transfer Agency, Inc. acts as the transfer and dividend disbursing
agent for the Fund pursuant to an agreement with the Fund and is compensated on
a transactional basis under a schedule approved by the Fund's Board of
Directors. The transfer agent maintains shareholders lists, processes requested
account registration changes and stock certificate issuance and redemption
requests, administers withdrawal plans, administers mailing and tabulation of
Fund proxy solicitations, and administers payment of distributions declared by
the Fund. ARM Transfer Agency, Inc. received $2,988 in transfer agency fees
from the Fund for the fiscal year ended June 30, 1996. SBM Financial Services,
Inc. acted as the Fund's transfer and dividend disbursing agent for the period
June 1, 1995 to June 30, 1995 and for the period July 1, 1995 to January 31,
1996, and received transfer agency fees of $610 and $4,637 during such periods,
respectively. SBM Company, the Fund's previous transfer and dividend disbursing
agent, received the following amounts from the Fund for the periods ended
June 30, 1995 and 1994, respectively; $6,890 and $6,200.
PLAN OF DISTRIBUTION
The Fund has adopted a Plan of Distribution (the "Plan") pursuant to Rule
12b-1 under the Investment Company Act of 1940 pursuant to which a portion of
the fees paid to the Manager is paid by the Manager to the Distributor, as
described below.
ARM Financial Services, Inc. (the "Distributor"), a subsidiary of ARM, acts
as distributor of the shares of the Fund and of the other mutual funds in the
State Bond Group. Under the Investment Advisory and Management Agreement (the
"Agreement"), a portion of the advisory fee the Fund pays the Manager is paid by
the Manager to the Distributor to be used to pay for account servicing, to
compensate those who provide administration, shareholder service and
distribution assistance (the Service Entities), and to pay certain other
expenses of selling Fund shares. As noted above, the Manager will receive a
monthly fee equivalent on an annual basis to .85 of 1% of the first $100,000,000
of average daily net assets of the Fund and .80 of 1% of the average
15
<PAGE>
daily net assets in excess of $100,000,000. From this amount, .25 of 1% of the
average daily net assets of the Fund will be paid to the Distributor under the
Plan. A portion of the fee may be used for advertising and promotional expenses
including, by way of example but not by way of limitation, costs of printing and
mailing prospectuses, statements of additional information and shareholder
reports to prospective investors; preparation and distribution of sales
literature; advertising of any type; an allocation of overhead and other
expenses of the Distributor related to the distribution of Fund shares; and
payments to, and expenses of, officers, employees or representatives of the
Distributor, of other broker-dealers, banks or other financial institutions, and
of any other person who provides support services in connection with the
distribution of Fund shares, including travel, entertainment, and telephone
expenses.
The Prospectus outlines the general uses to which the Distributor is
authorized to apply the fees received by it. During the fiscal year ended
June 30, 1996, the Distributor received $47,120 in such fees. The Distributor
used these fees to cover the following expenses: compensation of sales
personnel - $36,462; compensation of marketing and sales administration
personnel - $10,100; marketing materials - $7,209, and promotion and travel -
$1,380.
The arrangements under which the Fund compensates, indirectly, those who
provide administration, shareholder service, and distribution assistance, as
described above, are set forth in the Plan. The Plan provides:
(i) That it shall continue in effect for a period of more than one year
from the date of its execution or adoption only so long as such
continuance is specifically approved at least annually by the Board
of Directors and by the Directors who are not interested persons of
the Fund and have no direct or indirect financial interest in the
operation of the Plan or in any agreement related to the Plan;
(ii) That any person authorized to direct the disposition of monies paid
or payable by the Fund pursuant to the Plan or any related agreement
shall provide to the Fund's Board of Directors, and the Directors
shall review, at least quarterly, a written report of the amounts so
expended and the purposes for which such expenditures were made; and
(iii) That it may be terminated at any time by vote of a majority of the
members of the Board of Directors of the Fund who are not interested
persons of the Fund and have no direct or indirect financial
interest in the operation of the Plan or in any agreements related
to the Plan or by vote of a majority of the outstanding voting
shares of the Fund.
The Plan provides that it may not be amended to increase materially the
amount to be spent for distribution without shareholder approval and that all
material amendments of the Plan must be approved by the Fund's Board of
Directors, including a majority of the Directors who are not interested persons
of the Fund and have no financial interest in the operation of the Plan or any
related agreements. The Fund may implement the Plan only if the selection and
nomination of the Fund's disinterested Directors are committed to the discretion
of the Fund's existing disinterested Directors. Under the terms of Rule 12b-1,
the Fund must preserve copies of any plan, agreement or report made pursuant to
the Rule for a period of not less than six years in an easily accessible place.
CUSTODIAN
16
<PAGE>
Investors Fiduciary Trust Company serves as custodian for the Fund's
portfolio securities and cash, and in that capacity, maintains certain financial
and accounting books and records pursuant to a separate agreement with the Fund.
INDEPENDENT AUDITORS
Ernst & Young LLP, One Kansas City Place, 1200 Main Street, Kansas City,
Missouri 64105-2143, independent auditors, have been selected as auditors of the
Fund and issue a report on the Fund's financial statements.
PORTFOLIO TRANSACTIONS AND BROKERAGE
As the Fund's portfolio is exclusively composed of debt (rather than
equity) securities, most of the Fund's portfolio transactions are effected with
dealers without the payment of brokerage commissions, but at net prices which
usually include a spread or markup. Most Fund transactions are with the issuer,
or with major dealers acting for their own account and not as brokers. In
effecting portfolio transactions the Fund seeks the most favorable net price
consistent with the best execution. However, frequently the Fund selects a
dealer to effect a particular transaction without contacting all dealers who
might be able to effect such transaction, because of the volatility of the
market and the desire of the Fund to accept a particular price for a security
because the price offered by the dealer meets its guidelines for profit, yield,
or both. No brokerage is allocated for the sale of Fund shares.
While it is not expected that the Fund will effect any transactions on an
agency basis, if it does so the Manager will seek to obtain the best price and
execution of orders. Commission rates, being a component of price, are
considered together with other relevant factors. When consistent with these
criteria, business may be placed with broker-dealers who furnish investment
research services to the Manager. Such research services include advice, both
directly and in writing, as to the value of securities, the advisability of
investing in, purchasing, or selling securities, and the availability of
securities or purchasers or sellers of securities, as well as analyses and
reports concerning issues, industries, securities, economic factors and trends,
portfolio strategy, and the performance of accounts. This allows the Manager to
supplement its own investment research activities and enables it to obtain the
views and information of individuals and research staffs of many different
securities research firms prior to making investment decisions for the Fund. To
the extent portfolio transactions are effected with broker-dealers who furnish
research services to the Manager, the Manager receives a benefit, not capable of
evaluation in dollar amounts.
The Manager has not entered into any formal or informal agreements with any
broker-dealers, and it does not maintain any "formula" which must be followed in
connection with the placement of Fund portfolio transactions in exchange for
research services provided the Manager, except as noted below. If it is believed
to be in the best interests of the Fund, the Manager may place portfolio
transactions with brokers who provide the types of services described above,
even if it means the Fund will have to pay a higher commission (or, if the
broker's profit is part of the cost of the security, will have to pay a higher
price for the security) than would be the case if no weight were given to the
broker's furnishing of those services. This will be done, however, only if, in
the opinion of the Manager, the amount of additional commission or increased
cost is reasonable in relation to the value of the services. The Manager also
serves as investment adviser for other mutual funds. To the extent that the Fund
may pay a somewhat higher brokerage commission or somewhat higher price on a
trade because such trade is executed by a broker-dealer which also provides
research and statistical services, it is possible that said research and
statistical services may also be of value to one of the other mutual funds.
However, it is felt that this possibility of mutual benefit is not capable of
measurement.
No brokerage commissions were paid by the Fund in any of the fiscal years
ended June 30, 1996, 1995, and 1994.
17
<PAGE>
PURCHASE OF SHARES
What Reductions are Provided?
- -----------------------------
Volume Discounts are provided if the total amount being invested in shares
of the Fund alone, or in any combination of shares of the Fund and the other
funds in the State Bond Group having a sales charge, reaches levels indicated in
the sales charge schedule set forth in the Prospectus.
The Right of Accumulation allows you to combine the amount being invested
in shares of the Fund and the other mutual funds in the State Bond Group having
a sales charge with the total net asset value of shares of those mutual funds
already owned and the total net asset value of shares you own of State Bond Cash
Management Fund which were acquired through an exchange of shares of another
mutual fund in the State Bond Group, to determine reduced sales charges in
accordance with the schedule in the Prospectus. The value of the shares owned,
including the value of shares of State Bond Cash Management Fund acquired in an
exchange, will be taken into account in orders placed, however, only if the
Distributor is notified by you or your dealer of the amount owned at the time
your purchase is made and is furnished sufficient information to permit
confirmation.
The schedule of sales charges is also applicable to the aggregate amount of
purchases made by a single person within a period of 13 months pursuant to a
written Purchase Intention and Price Agreement (the "Letter of Intent"), a form
of which is available from the Distributor. The Letter of Intent provides for a
price adjustment applicable to the amount of intended purchases specified in the
Letter of Intent based upon the amount of purchases specified plus the total net
asset value of the shares of the other mutual funds in the State Bond Group
already owned that have a sales charge and the total net asset value of the
shares owned of State Bond Tax Exempt Fund which were acquired through an
exchange of shares. The investor considering the possibility of signing a Letter
of Intent should read it carefully. The schedule of sales charges applicable to
all amounts invested under the Letter of Intent is computed as if the aggregate
amount had been invested immediately. Reduced sales charges also may apply to
purchases made within a 13-month period starting up to 90 days before the date
of execution of the Letter of Intent. Shares with a net asset value equal to 5%
of the minimum purchase amount specified are held in escrow to be applied toward
any sales charge deficiency that might result if the Letter of Intent is not
completed. The shares so held may be redeemed and proceeds thereof used as
required to pay additional sales charges which may be due if the amount of
purchases by such person during the 13 month period aggregates less than the
amount specified in the Letter of Intent. Escrow shares not redeemed will be
delivered to the investor upon completion of purchases under the Letter of
Intent.
If the gross amount invested within the 13 month period covered by the
Letter of Intent exceeds the specified purchase amount and reaches a level
allowing a smaller sales charge, a price adjustment will be made on the day it
reaches the new level. The Letter of Intent is not a binding agreement upon the
investor to purchase, or the Fund to sell, the full indicated amount.
Who Is Entitled To Reductions?
- ------------------------------
Reductions in sales charges apply to purchases by a "single person,"
including an individual; members of a family unit comprising husband, wife and
minor children; or a trustee or other fiduciary purchasing for a single
fiduciary account, including employee benefit plans qualified under Section 401
of the Internal Revenue Code.
18
<PAGE>
OFFERING PRICE
The public offering price is determined by adding to the Fund's current net
asset value per share (as described under "How is Net Asset Value Per Share
Determined?") the sales charge percentage applicable to the transaction. The
portfolio securities in which the Fund invests fluctuate in value, and hence the
net asset value per share of the Fund also fluctuates. The following sample
calculation is based upon the total net assets of the Fund on June 30, 1996 of
$19,196,912 and the total shares of the Fund outstanding as of that date of
1,818,405 and a transaction with an applicable sales charge of the maximum 4.5%:
Net Asset Value Per Share $10.56
($19,196,912 divided by
1,818,405 shares outstanding)
Maximum Offering Price Per Share $11.06
($10.56 divided by .955)
HOW ARE SHARES DISTRIBUTED?
ARM Financial Services, Inc., a subsidiary of ARM, acts as distributor of
the shares of the Fund and of the other mutual funds in the State Bond Group. As
distributor of the Fund's capital stock, ARM Financial Services, Inc. allows
concessions to all dealers of up to 4.0% on purchases to which the 4.5% sales
charge applies. In the event that the dealer concession is 90% or more of the
sales charge, dealers taking advantage of such concession may be deemed to be
underwriters under the Securities Act of 1933. The Distributor also pays sales
commissions to its own agents who sell Fund shares. The Distributor retains the
balance of sales charges paid by investors. The sales charges paid by investors
and received by the Distributor amounted to the following amounts during the
periods ended June 30, 1996, 1995, and 1994, respectively: $54,284; $90,322; and
$84,012. The Distributor retained these entire amounts.
The agreement between the Fund and the Distributor provides that the
Distributor will pay certain expenses such as printing costs of prospectuses and
Statements of Additional Information used in offering shares to prospective
investors, applications and confirmations, and all other expenses in connection
with the issuance and sale of the Fund's shares. The Fund will pay the costs of
registering and qualifying shares for sale and of preparing, setting in print,
and printing and distributing prospectuses to existing shareholders.
HOW CAN YOU "SELL" YOUR SHARES?
The procedure for redemption of Fund shares under ordinary circumstances is
set forth in the Prospectus.
In unusual circumstances, payment may be postponed if the orderly
liquidation of portfolio securities is prevented by the closing of, or
restricted trading on, the New York Stock Exchange during periods of emergency,
or such other periods as ordered by the Securities and Exchange Commission.
HOW IS NET ASSET VALUE PER SHARE DETERMINED?
Net asset value per Fund share is determined as of the close of the New
York Stock Exchange on each day that the New York Stock Exchange is open for
business. The New York Stock Exchange is closed on Saturdays and Sundays and is
also closed in observance of the following holidays: New Year's Day, President's
Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day
and Christmas Day. Net
19
<PAGE>
asset value is determined by dividing the value of the total assets of the Fund,
less liabilities, by the number of shares outstanding.
In determining net asset value, the Fund utilizes the valuations of its
portfolio securities furnished by a pricing service approved by the Board of
Directors. The pricing service values portfolio securities which have remaining
maturities of more than 60 days from the date of valuation at quoted bid prices
or the yield equivalents when quotations are readily available. Such securities
for which quotations are not readily available (which constitute a majority of
the Fund's portfolio securities) are valued at fair value as determined by the
pricing service using methods which include consideration of yields or prices of
municipal securities and other securities in the Fund's portfolio of comparable
quality, type of issue, coupon, maturity and rating; indications as to value
from dealers; and general market conditions. The pricing service may employ
electronic data processing techniques and/or a matrix system to determine
valuations. Short-term holdings maturing in 60 days or less are valued at cost
plus accrued interest, which approximates market value.
TAX STATUS OF THE FUND
The Fund has fulfilled during its most recent fiscal year, and intends to
continue to fulfill, the requirements of subchapter M of the Internal Revenue
Code of 1986, as amended (the "Code"), to qualify as a regulated investment
company, and so long as it remains so qualified, it will not be liable for
Federal income tax to the extent that it distributes all of its net taxable and
non-taxable income to shareholders.
ADDITIONAL TAX INFORMATION
Under the Code, interest on indebtedness incurred or continued to purchase
or carry shares of an investment company paying exempt-interest dividends, such
as the Fund, will not be deductible by a shareholder in proportion to the ratio
of exempt-interest dividends to all dividends other than those treated as long-
term capital gains. Minnesota law also restricts the deductibility of interest
on indebtedness incurred or continued to purchase or carry shares of the Fund.
Indebtedness may be allocated to shares of the Fund even though not directly
traceable to the purchase of such shares.
Any loss on the sale or exchange of shares held for six months or less
(although regulations may reduce this time period to 31 days) will be disallowed
for federal income tax purposes to the extent of the amount of any exempt-
interest dividend received with respect to such shares. Except to the extent
disallowed pursuant to the preceding sentence, any loss on the sale or exchange
of shares held for six months or less will be treated as a long-term capital
loss to the extent of the amount of any dividend received from long-term capital
gains with respect to such shares. Similar rules apply in the case of
individuals, estates and trusts under Minnesota law.
For federal tax purposes, if a shareholder exchanges shares of the Fund for
shares of any other fund in the State Bond Fund Group pursuant to the exchange
privilege (see "How does the Fund's Exchange Privilege Work?" in the
Prospectus), such exchange will be considered a taxable sale of the shares in
the Fund. Furthermore, if a shareholder carries out the exchange within 90 days
of purchasing the shares in the Fund, the sales charge incurred on the purchase
of those shares cannot be taken into account for determining the shareholder's
gain or loss on the sale of those shares to the extent that the sales charge on
the purchase of the later-acquired shares is reduced because of the exchange
privilege. However, the amount of the sales charge that may not be taken into
account in determining the shareholder's gain or loss on the sale of the shares
in the Fund may be taken into account in determining his gain or loss on the
eventual sale or exchange of the later-acquired shares.
20
<PAGE>
Pursuant to the Code, the Fund is subject to a non-deductible excise tax
equal to 4 percent of the excess, if any, of the amount required to be
distributed pursuant to the Code for each calendar year over the amount actually
distributed. In order to avoid the imposition of this excise tax, the Fund
generally must declare dividends by the end of a calendar year representing 98
percent of the Fund's ordinary income for the calendar year and 98 percent of
its capital gain net income (both long-term and short-term capital gains) for
the twelve-month period ending October 31 of the calendar year.
Certain deductions otherwise allowable to financial institutions and
property and casualty insurance companies will be eliminated or reduced by
reason of the receipt of certain exempt-interest dividends.
Information regarding the tax status of payments you receive is set forth
in the Prospectus.
WILL THE FUND WITHHOLD TAXES ON DISTRIBUTIONS?
Under Federal law, the Fund is required, subject to certain exceptions, to
withhold and remit to the U.S. Treasury 31% of distributions and redemption
proceeds paid on an account if the holder of the account provides the Fund with
either an incorrect tax identification number or no number at all, or fails to
certify to the Fund that he is not subject to such withholding.
GENERAL INFORMATION
As previously indicated, the Fund was incorporated in Maryland on December
12, 1987. In March 1993, the Fund was reorganized as an individual investment
portfolio of a series fund, "State Bond Tax-Free Income Funds, Inc."
Under Maryland law, each director of State Bond Tax-Free Income Funds, Inc.
owes certain duties to the Fund and its shareholders. Maryland law provides that
a director shall "perform his duties as a director in good faith, in a manner he
reasonably believes to be in the best interests of the corporation and with the
care that an ordinarily prudent person in a like position would use under
similar circumstances." Fiduciary duties of a director of a Maryland corporation
include, therefore, both a duty of "loyalty" (to act in good faith and in a
manner reasonably believed to be in the best interests of the corporation) and a
duty of "care" (to act with the care an ordinarily prudent person in a like
position would use under similar circumstances). Maryland law allows Maryland
corporations to eliminate or limit the personal liability of a director or an
officer to the corporation or its shareholders for monetary damages for breach
of the fiduciary duty of "care."
The Amended and Restated Articles of Incorporation of State Bond Tax-Free
Income Funds, Inc. contain a provision eliminating liability of directors and
officers to the corporation or its shareholders to the fullest extent permitted
by Maryland law. Therefore, directors and officers of State Bond Tax-Free Income
Funds, Inc. will not be liable for monetary damages to the Fund or its
shareholders for breach of the duty of care. However, such elimination of
liability is subject to several significant limitations. Applicable Maryland law
regarding a director's duty of care does not permit the elimination or
limitation of liability (1) to the extent that it is proved that the person
actually received an improper benefit or profit in money, property or services
for the amount of the benefit or profit in money, property or services actually
received; (2) to the extent that a judgment or other final adjudication adverse
to the person is entered in a proceeding based on a finding in the proceeding
that the person's action, or failure to act, was the result of active and
deliberate dishonesty and was material to the cause of action adjudicated in the
proceeding; or (3) for any action or failure to act occurring prior to February
18, 1988. In addition, due to the provisions of the Investment Company Act of
1940, shareholders would still have a right to pursue monetary claims against
directors or officers for acts involving willful malfeasance, bad faith, gross
negligence or reckless disregard of their duties as directors or officers.
21
<PAGE>
State Bond Minnesota Tax-Free Income Fund
Schedule of Investments
June 30, 1996
<TABLE>
<CAPTION>
MOODY'S/S&P PRINCIPAL
RATING AMOUNT VALUE
------------------------------------------
<S> <C> <C> <C>
MUNICIPAL BONDS (97.9%)
Albany, MN Independent School District
#745, G.O. Bonds, 6.000%, due 2009 Aa1/NR $250,000 $243,377
Bloomington Port Authority, Series 1994
A, 5.250%, due 2003 Aaa/AAA 200,000 201,430
Burnsville, MN Multi-Family Housing
Rev. Ref. Bonds, Coventry Court
Apartments Project, Series 1989, NR/AAA 100,000 104,710
7.500%, due 2027
Centennial Minnesota Independent School
District #12, G.O. Bonds, Series 1991
A, 7.150%, due 2011 Aaa/AAA 250,000 270,355
Coon Rapids, MN, G.O. Tax Increment
Bonds, Series 1986 B2, 7.750%,
due 2006 A/NR 150,000 150,416
Dakota County, MN, G.O. Ref. Bonds,
6.450%, due 2010 Aaa/AAA 300,000 313,122
Dakota County, MN Housing and Rev.
Authority, SFM Rev. Bonds, 7.200%,
due 2009 NR/AAA 170,000 176,402
Duluth, MN, G.O. Water Rev., Series
1992 A, 6.250%, due 2007 A/NR 285,000 295,539
Duluth, MN, Economic Development
Authority, 6.200%, due 2012 Aaa/AAA 60,000 64,730
Duluth, MN, Economic Development
Authority, 6.200%, due 2012 Aaa/AAA 140,000 144,865
Eden Prairie, MN Multi-Family Housing
Preserve Place Apartments, 7.875%,
due 2017 NR/AAA 100,000 104,463
Eden Prairie, MN Housing &
Redevelopment Authority, 6.200%,
due 2008 A/NR 300,000 312,639
Edina, MN Independent School District
#273, 5.497%, due 2013 A1/NR 300,000 300,408
Foley, MN Independent School District
#51 MBIA, 7.500%, due 2008 Aaa/AAA 100,000 104,395
</TABLE>
2
<PAGE>
<TABLE>
<CAPTION>
MOODY'S/S&P PRINCIPAL
RATING AMOUNT VALUE
-----------------------------------
MUNICIPAL BONDS (CONTINUED)
<S> <C> <C> <C>
Hennepin County, MN Lease Rev.
Certificate of Participation, Series
1991, 6.800%, due 2017 Aa/AA $165,000 $177,961
Kandiyohi County, MN, G.O. Ref. Bonds,
Series 1993, 5.650%, due 2011 A/NR 225,000 224,766
Metropolitan Council, MN, 7.250%, due
2007 Aaa/AAA 150,000 162,951
Minneapolis, MN, 5.750%, due 2010 Aaa/AAA 275,000 278,814
Minneapolis, MN, 6.250%, due 2012 Aaa/AAA 250,000 262,813
Minneapolis, MN Multi-Family Housing
Revenue, 7.125%, due 2010 NR/AAA 200,000 211,544
Minneapolis, MN Multi-Family Housing
Revenue, 7.050%, due 2022 NR/AAA 300,000 311,844
Minneapolis, MN Special School District
#001, 5.900%, due 2011 Aaa/AAA 400,000 406,948
Minnesota State University Board
Revenue, 6.000%, due 2013 A/NR 300,000 304,520
Minnesota Public Access Authority,
Water Pollution Control, Rev. Bonds,
Series 1990 A, 7.100%, due 2012 Aa1/AAA 300,000 329,502
Minnesota Public Facilities Authority,
Water Pollution Control, Rev. Bonds,
Series 1991 A, 6.950%, due 2013 Aa1/AAA 250,000 277,030
Minnesota Public Facilities Authority,
Water Pollution Control, Rev. Bonds,
Series 1992 A, 6.500%, due 2014 Aa1/AAA 250,000 266,708
Minnesota State, 7.000%, due 2007 Aaa/AAA 150,000 162,641
Minnesota State Housing Finance Agency,
7.300%, due 2017 Aa/AA+ 255,000 269,497
Minnesota State Housing Finance Agency,
Rental Housing, Series C Ref. Bonds,
6.150%, due 2014 NR/AA+ 175,000 175,768
</TABLE>
3
<PAGE>
State Bond Minnesota Tax-Free Income Fund
Schedule of Investments (continued)
<TABLE>
<CAPTION>
MOODY'S/S&P PRINCIPAL
RATING AMOUNT VALUE
------------------------------------------
<S> <C> <C> <C>
MUNICIPAL BONDS (CONTINUED)
Minnesota State Housing Insurance
Agency, 7.650%, due 2008 Aa/AA+ $ 95,000 $100,239
Minnesota State Housing Finance Agency,
6.000%, due 2014 NR/AA+ 160,000 159,645
Minnesota State Housing Finance Agency,
7.100%, due 2011 Aa/AA+ 195,000 205,345
Minnesota State Housing Finance Agency,
Single Family Mortgage, 5.850%, due
2011 Aa/AA+ 345,000 343,634
Minnesota State Higher Education
Facilities, 6.300%, due 2014 Aa/AA- 300,000 312,129
Minnesota State Higher Education
Facilities, 5.450%, due 2007 A1/NR 200,000 198,158
Minnesota State Higher Education
Facilities, 5.600%, due 2014 A1/NR 315,000 304,180
Minnesota State Housing Development
Single Family Mortgage, Series B,
7.250%, due 2016 Aa/AA+ 45,000 46,007
Minnetonka, MN Multi-Family Housing
Rev. Bonds (Cedar Hills East Project),
7.500%, due 2017 NR/AA 100,000 101,677
Moorhead, MN Public Utility Rev. Bonds,
Series 1992, 6.050%, due 2006 Aaa/AAA 300,000 314,427
Northern Municipal Power Agency, MN
Electric Rev. Ref. Bonds, Series A,
7.250%, due 2017 Aaa/AAA 285,000 309,060
Northern Municipal Power Agency, MN
Electric Rev. Ref. Bonds, 6.000%, due
2020 A/A 530,000 530,360
Owatonna, MN Public Utility Ref. Bonds,
Series 1990, 7.400%, due 2007 A1/NR 300,000 325,797
</TABLE>
4
<PAGE>
<TABLE>
<CAPTION>
MOODY'S/S&P PRINCIPAL
RATING AMOUNT VALUE
-------------------------------------------
<S> <C> <C> <C>
MUNICIPAL BONDS (CONTINUED)
Ramsey & Washington Counties Resource
Recovery Rev. Bonds, NSP Project,
6.750%, due 2006 A1/AA- $100,000 $105,155
Red Wing Independent School District
#256, G.O. School Building, Series
1998 A, 7.300%, due 2004 A1/NR 150,000 156,491
Robbinsdale Hospital Ref. Rev. NMMCP,
1989, 7.200%, due 2005 Aaa/AAA 100,000 108,324
Robbinsdale Hospital Ref. Rev. NMMCP,
Series A, 5.450%, due 2013 Aaa/AAA 300,000 289,083
Robbinsdale Hospital Revenue, 5.450%,
due 2013 Aaa/AAA 370,000 356,536
Rochester, MN Health Care Facility Rev.
Bonds, Mayo Medical Center, 6.250%,
due 2021 NR/AA+ 500,000 512,065
Rosemount, MN Independent School
District, 5.875%, due 2014 Aa1/AA 500,000 503,275
Roseville, MN Independent School
District, 5.250%, due 2013 Aaa/AAA 300,000 286,860
St. Anthony-New Brighton Independent
School District #282, G.O. Bonds,
5.700%, due 2012 Aa1/NR 300,000 301,599
St. Cloud, MN Hydro Electric Generator
Facility Gross Rev. Bonds, 7.375%, due
2018 NR/A- 250,000 257,533
St. Louis Park, MN Health Care
Facility, 5.200%, due 2016 Aaa/AAA 480,000 440,314
St. Paul, MN, G.O. Street Improvement,
Special Assessment Bonds, Series 1988
D, 7.200%, due 2008 Aa/AA+ 100,000 100,602
St. Paul, MN Housing & Redevelopment
Authority, Package R, 6.450%, due 2007 NR/A- 300,000 323,115
</TABLE>
5
<PAGE>
State Bond Minnesota Tax-Free Income Fund
Schedule of Investments (continued)
<TABLE>
<CAPTION>
MOODY'S/S&P PRINCIPAL
RATING AMOUNT VALUE
-----------------------------------
<S> <C> <C> <C>
MUNICIPAL BONDS (CONTINUED)
St. Paul, MN Housing and Redevelopment
Authority Revenue Bonds, 5.400%, due
2008 Aaa/AAA $300,000 $298,389
St. Paul, MN, Independent School
District #625, Series C, 5.550%, due
2012 Aa/AA 300,000 297,822
St. Paul, MN, Independent School
District #625, Series 1994 C, 6.050%,
due 2012 Aa/AA 400,000 409,000
St. Paul, MN, Independent School
District #625, School Building Bonds,
Series 1990 D, 7.250%, due 2009 Aa/AA 150,000 159,977
St. Paul, MN, Independent School
District #625, 5.250%, due 2015 Aa/AA 300,000 284,301
St. Paul, MN Independent School
District, 5.200%, due 2011 Aa1/AA 300,000 288,996
Southern MN Municipal Power Agency,
Power Supply, 8.125%, due 2018 Aaa/AAA 300,000 323,835
Stearns County, MN, G.O. Ref. Bonds,
Series B, 6.000%, due 2007 A/NR 325,000 336,427
Stearns County, MN, Independent #2753,
5.000%, due 2012 Aa1/NR 300,000 279,804
Vadnais Heights, MN Housing Development
Rev. Bonds, Riverwood Housing
Foundation, 7.500%, due 2009 NR/A+ 115,000 115,382
Wayzata, MN Tax Increment Bonds,
7.000%, due 2010 Aa/NR 200,000 215,932
Wayzata, MN Independent School District
#284, G.O. Bonds, Series 1994 B,
5.800%, due 2009 Aa1/NR 250,000 254,683
Western Minnesota Municipal Power
Agency, Power Supply Revenue Ref.
Bonds, 6.875%, due 2007 A1/A 300,000 309,558
Western Minnesota Municipal Power,
Series A, 6.125%, due 2016 A1/A 250,000 249,995
</TABLE>
6
<PAGE>
<TABLE>
<CAPTION>
MOODY'S/S&P PRINCIPAL
RATING AMOUNT VALUE
---------------------------------
MUNICIPAL BONDS (CONTINUED)
<S> <C> <C> <C>
Western Minnesota Municipal Power
Agency, Transmission Project Rev. Ref.
Bonds, Series 1991, 6.750%, due 2016 Aaa/AAA $200,000 $ 212,828
Whitewater Bear Lake School, 6.000%,
due 2012 Aa1/NR 250,000 255,635
Worthington, MN, G.O. Water Rev. Bonds,
Series 1990 A, 7.000%, due 2010 A/NR 100,000 106,325
Wright County, MN, G.O. Jail Ref.
Bonds, Series 1992 B, 6.000%, due 2007 A/NR 350,000 362,282
-----------
TOTAL MUNICIPAL BONDS (Cost $17,878,298) 18,362,939
SHORT-TERM SECURITIES (2.1%)
General Electric Capital Corp., 5.000%,
due 07/01/96 390,000 390,000
-----------
TOTAL SHORT-TERM SECURITIES (Cost $390,000) 390,000
-----------
TOTAL INVESTMENTS (100.0%) (Cost $18,268,298*) $18,752,939
===========
</TABLE>
*Also represents cost for federal income tax purposes.
Ratings were provided by Moody's Investors Service, Inc. and Standard & Poor's
Corporation and are not covered by the report of Ernst & Young LLP.
See accompanying notes.
7
<PAGE>
State Bond Minnesota Tax-Free Income Fund
Statement of Assets and Liabilities
June 30, 1996
<TABLE>
<CAPTION>
ASSETS
<S> <C>
Investment in securities, at value (cost $18,268,298)
See accompanying schedule $18,752,939
Cash 55,214
Receivable for reimbursable expenses 2,553
Interest and other receivables 398,629
-----------
TOTAL ASSETS 19,209,335
LIABILITIES
Payable to affiliates 12,423
-----------
NET ASSETS $19,196,912
===========
Net Assets consist of:
Paid-in capital $18,666,066
Accumulated undistributed net realized gain on investments 46,205
Net unrealized appreciation on investments 484,641
-----------
NET ASSETS, for 1,818,405 shares outstanding $19,196,912
===========
NET ASSET VALUE and redemption price per share $ 10.56
===========
Maximum offering price per share (includes maximum sales
charge of 4.5% reduced on purchases of $50,000 or more) $ 11.06
===========
</TABLE>
See accompanying notes.
8
<PAGE>
State Bond Minnesota Tax-Free Income Fund
Statement of Operations
Year Ended June 30, 1996
<TABLE>
<CAPTION>
<S> <C>
INVESTMENT INCOME
Interest $1,135,500
EXPENSES
Investment advisory and management fees 113,090
Rule 12b-1 plan fees 47,121
Professional fees 16,868
Printing expenses 8,069
Transfer agent fees 7,625
Accounting and custodian fees 18,684
Other expenses 9,666
---------
Total expenses before reimbursement 221,123
Less: expense reimbursement (32,639)
---------
Net expenses 188,484
---------
Net investment income 947,016
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS
Net realized gain on investments 53,432
Change in unrealized appreciation on investments (128,527)
---------
Net loss on investments (75,095)
---------
Net increase in net assets resulting from operations $ 871,921
=========
</TABLE>
See accompanying notes.
9
<PAGE>
State Bond Minnesota Tax-Free Income Fund
Statement of Changes in Net Assets
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
1996 1995
---------------------------
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSETS
Operations:
Net investment income $ 947,016 $ 945,895
Net realized gain on investments 53,432 27,592
Change in net unrealized appreciation (128,527) 268,408
---------------------------
Net increase in net assets resulting from
operations 871,921 1,241,895
Distributions to shareholders from:
Net investment income (947,016) (945,895)
Net realized gain (34,819) -
---------------------------
Total distributions to shareholders (981,835) (945,895)
Capital share transactions:
Proceeds from sales of shares 1,508,207 3,233,318
Proceeds from reinvested distributions 911,416 675,610
Cost of shares redeemed (1,290,750) (2,512,546)
---------------------------
Net increase in net assets resulting from share
transactions 1,128,873 1,396,382
---------------------------
Total increase in net assets 1,018,959 1,692,382
NET ASSETS
Beginning of year 18,177,953 16,485,571
---------------------------
End of year $19,196,912 $18,177,953
===========================
OTHER INFORMATION
Shares:
Sold 141,624 311,971
Issued through reinvestment of distributions 85,112 65,014
Redeemed (121,469) (241,814)
---------------------------
Net increase 105,267 135,171
===========================
</TABLE>
See accompanying notes.
10
<PAGE>
State Bond Minnesota Tax-Free Income Fund
Financial Highlights
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
-------------------------------------------------
1996 1995 1994 1993 1992
-------------------------------------------------
<S> <C> <C> <C> <C> <C>
SELECTED PER-SHARE DATA
Net asset value, beginning of year $ 10.61 $ 10.45 $ 10.94 $ 10.49 $ 10.18
Income from investment operations:
Net investment income .53 .56 .56 .59 .61
Net realized and unrealized gain
(loss) on investments (.03) .16 (.47) .45 .33
-------------------------------------------------
Total from investment operations .50 .72 .09 1.04 .94
Less distributions:
From net investment income (.53) (.56) (.56) (.59) (.61)
From net realized gain (.02) (.02) (.02)
-------------------------------------------------
Total distributions (.55) (.56) (.58) (.59) (.63)
-------------------------------------------------
Net asset value, end of year $ 10.56 $ 10.61 $ 10.45 $ 10.94 $ 10.49
=================================================
TOTAL RETURN (A) 4.78% 7.10% 0.79% 10.06% 9.47%
RATIOS/SUPPLEMENTAL DATA
Net assets, end of year
(in thousands) $19,197 $18,178 $16,486 $15,318 $12,244
Ratio of expenses to average net assets
1.00% 1.00% 1.00% 1.00% 1.00%
Ratio of net investment income to
average net assets 5.02% 5.37% 5.14% 5.41% 5.86%
Ratio of expenses to average net assets
before voluntary expense reimbursement
(Note 2) 1.17% 1.24% 1.29% 1.38% 1.54%
Ratio of net investment income to
average net assets before voluntary
expense reimbursement (Note 2) 4.85% 5.10% 4.87% 5.02% 5.32%
Portfolio turnover rate 13% 6% 2% 15% 1%
</TABLE>
(A) Total returns do not consider the effects of the one time sales charge.
11
<PAGE>
State Bond Minnesota Tax-Free Income Fund
Notes to Financial Statements
June 30, 1996
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
The State Bond Minnesota Tax-Free Income Fund (the "Fund") is the only
investment portfolio of State Bond Tax-Free Income Funds, Inc., which is
registered under the Investment Company Act of 1940, as amended, as an open-end
management investment company. The primary investment objective of the Fund is
to maximize current income exempt from both Federal income tax and Minnesota
personal income tax to the extent consistent with the preservation of capital,
with consideration given to the opportunity for capital gains by investing in
tax-exempt securities. The ability of the issuers of the securities held by the
Fund to meet their obligations may be affected by economic developments in
Minnesota or a specific industry or region.
ARM Financial Group, Inc. ("ARM") completed the acquisition of substantially all
of the assets and business operations of SBM Company ("SBM") on June 14, 1995.
As part of this acquisition, ARM Capital Advisors, Inc. ("ARM Capital
Advisors"), a subsidiary of ARM, assumed the responsibilities of SBM as manager
of the Fund. The Investment Advisory and Management Agreement between the Fund
and ARM Capital Advisors contains the same material terms and conditions
(including the fees payable to ARM Capital Advisors) as were contained in the
Fund"s prior Investment Advisory and Management Agreement with SBM.
As part of the acquisition, ARM acquired all of the issued and outstanding
common stock of SBM Financial Services, Inc. ("SBM Financial Services"), the
Fund's distributor. Effective February 1, 1996, ARM Transfer Agency, Inc. ("ARM
Transfer Agency") replaced SBM Financial Services as transfer agent for the
Fund. ARM Transfer Agency assumed SBM Financial Services' responsibility
pursuant to a transfer agency agreement with the Fund. ARM Transfer Agency is a
wholly-owned subsidiary of ARM.
BASIS OF PRESENTATION
The accompanying financial statements have been prepared in accordance with
generally accepted accounting principles for investment companies.
12
<PAGE>
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INVESTMENTS IN SECURITIES
Investment securities are stated at aggregate market values. Market valuations
are furnished by a pricing service approved by the Board of Directors. The
pricing service values portfolio securities which have remaining maturities of
more than 60 days from the date of valuation at quoted bid prices. Such
securities for which quotations are not readily available (which constitute a
majority of the Fund's portfolio securities) are valued at fair value as
determined by the pricing service. Securities which have remaining maturities of
60 days or less and short-term securities are valued at amortized cost which
approximates market value. The procedures of the pricing service and its
valuations are reviewed by the officers of the Fund under the general
supervision of the Board of Directors.
Security transactions are accounted for on trade date, and interest income is
recorded on the accrual basis. Realized gains or losses from investment
transactions are determined on the basis of specific identification.
At June 30, 1996, net unrealized appreciation on a federal income tax basis was
$484,641, which is comprised of unrealized appreciation of $608,832 and
unrealized depreciation of $124,191 for tax purposes.
INCOME TAX STATUS AND RELATED MATTERS
The Fund complied with the requirements of the Internal Revenue Code applicable
to regulated investment companies and distributed its taxable net investment
income and net realized gains. Therefore, no provision for federal income or
state income tax is required.
The Fund hereby designates $34,819 as capital gain dividends attributable to the
fiscal year ended June 30, 1996 for the purpose of the dividend paid deduction
in the Fund's federal income tax returns.
DISTRIBUTIONS TO SHAREHOLDERS
Exempt interest dividends from net investment income are declared daily and
distributed monthly. Distributions from net realized investment gains, if any,
are declared at least once a year. Dividends and distributions are recorded on
the ex-dividend date.
13
<PAGE>
State Bond Minnesota Tax-Free Income Fund
Notes to Financial Statements (continued)
2. INVESTMENT ADVISORY AGREEMENT AND PAYMENTS TO RELATED PARTIES
ARM Capital Advisors is the Fund's investment adviser. The investment
advisory fee is computed at the annual rate of .85% on the first
$100,000,000 of average daily net assets of the Fund and .80% on the
average daily net assets in excess of $100,000,000. Included in the
investment advisory fee is .25% of the average daily net assets which ARM
Capital Advisors pays to SBM Financial Services under a Rule 12b-1 plan of
share distribution. ARM Capital Advisors has voluntarily undertaken to
reimburse the Fund for any expenses in excess of 1% of the average daily
net assets despite the fact that higher expenses may be permitted by state
law.
Fees paid to SBM Financial Services for underwriting services in connection
with sales of the Fund's capital shares aggregated $54,284 for the fiscal
year ended June 30, 1996. Such fees are not an expense of the Fund and are
excluded from the proceeds received by the Fund for sales of its capital
shares as shown in the accompanying statement of changes in net assets.
Certain officers and directors of the Fund are also officers of ARM, ARM
Capital Advisors, ARM Transfer Agency, and SBM Financial Services.
3. PURCHASES AND SALES OF SECURITIES
Aggregate purchases and proceeds from sales of securities, excluding short-
term investments, during the fiscal year ended June 30, 1996, amounted to
$3,820,407 and $2,371,746, respectively.
4. CAPITAL SHARES
At June 30, 1996, the Fund had authority to issue ten billion shares of
common stock, with a par value of $.00001 each.
5. SUBSEQUENT EVENT
On August 26, 1996, the Board of Directors of the Fund approved a proposal to
reorganize the Fund. The reorganization will involve the sale of the Fund's
assets, subject to certain liabilities, to Federated Municipal Opportunities
Fund, Inc. (the "Federated Fund"), a mutual fund advised by Federated Investors,
in exchange for shares of the Federated Fund. Shares of the Fund would be
exchanged at net asset value for shares of equivalent value of the Federated
Fund. The reorganization transaction is subject to approval by Fund shareholders
and to certain other conditions prior to closing, including the receipt of an
opinion as to the tax-free nature of the reorganization for the Fund, the
Federated Fund and their respective shareholders. No sales charges would be
imposed on the proposed reorganization.
14
<PAGE>
Report of Independent Auditors
The Board of Directors and Shareholders
State Bond Minnesota Tax-Free Income Fund
We have audited the accompanying statement of assets and liabilities including
the schedule of investments of the State Bond Minnesota Tax-Free Income Fund
(the "Fund") as of June 30, 1996 and the related statement of operations for the
year then ended and changes in net assets and financial highlights for each of
the two years in the period then ended. These financial statements and financial
highlights are the responsibility of the Fund's management. Our responsibility
is to express an opinion on these financial statements and financial highlights
based on our audits. The financial highlights for the three years ended June 30,
1994 of the State Bond Minnesota Tax-Free Income Fund were audited by other
auditors whose report dated July 29, 1994 expressed an unqualified opinion.
We conducted our audits 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 and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned at June 30,
1996, by correspondence with the custodian. As to uncompleted securities
transactions, we performed other auditing procedures. 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 audits provide a reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of the
State Bond Minnesota Tax-Free Income Fund at June 30, 1996, and the results of
its operations for the year then ended, and changes in its net assets and
financial highlights for each of the two years in the period then ended, in
conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP
Kansas City, Missouri
August 9, 1996,
except for Note 5, as to which the date is
August 26, 1996.
15
<PAGE>
APPENDIX A
Description of Tax-Exempt Securities Ratings
Tax-Exempt Bonds
----------------
Moody's Investors Service, Inc.
- -------------------------------
Aaa: Tax-exempt bonds which are rated Aaa are judged to be of the best
quality. They carry the smallest degree of investment risk and are generally
referred to as "gilt edge." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of such issues.
Aa: Tax-exempt bonds which are rated Aa are judged to be a high quality by
all standards. Together with the Aaa group, they comprise what are generally
known as high grade bonds. They are rated lower than the best bonds because
margins of protection may not be as large or fluctuation of protective elements
may be of greater amplitude or there may be other elements present which make
the long-term risks appear somewhat larger than in Aaa securities.
A: Tax-exempt bonds which are rated A possess many favorable investment
attributes and are to be considered as upper medium grade obligations. Factors
giving security to principal and interest are considered adequate, but elements
may be present which suggest a susceptibility to impairment sometime in the
future.
Baa: Tax-exempt bonds which are rated Baa are considered as medium grade
obligations; i.e., they are neither highly protected nor poorly secured.
Interest payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
Ba: Tax-exempt bonds which are rated Ba are judged to have speculative
elements; their future cannot be considered as well assured. Often the
protection of interest and principal payments may be very moderate, and thereby
not well safeguarded during both good and bad times over the future. Uncertainty
of position characterizes bonds in this class.
B: Tax-exempt bonds which are rated B generally lack characteristics of
the desirable investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time may be
small.
NOTE: Moody's applies numerical modifiers 1,2, and 3 in each generic rating
classification from Aa through B in its bond ratings. The modifier 1 indicates
that the security ranks in the higher end of its generic rating category. The
modifier 2 indicates a mid-range ranking; and modifier 3 indicates that the
issue ranks in the lower end of its generic rating category.
A-1
<PAGE>
Standard & Poor's Ratings Services
AAA: Tax-exempt bonds rated AAA are highest grade obligations. They
possess the ultimate degree of protection as to principal and interest. In the
market they move with interest rates, and hence provide the maximum safety on
all counts.
AA: Tax-exempt bonds rated AA also qualify as high-grade obligations,
and in the majority of instances differ from AAA issues only in small degree.
Here, too, prices move with the long-term money market.
A: Tax-exempt bonds rated A are regarded as upper medium grade. They
have considerable investment strength but are not entirely free from adverse
effects of changes in economic and trade conditions. Interest and principal are
regarded as safe. They predominantly reflect money rates in their market
behavior, but also to some extent, economic conditions.
BBB: Tax-exempt bonds rated BBB are regarded as having adequate capacity
to pay principal and interest. Whereas they normally exhibit adequate
protection parameters, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity to pay principal and interest for
bonds in this category than for bonds in the A category.
BB or B: Tax-exempt bonds rated BB or B are regarded, on balance, as
predominantly speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligation. BB indicates the
lowest degree of speculation and B a higher degree of speculation. While such
debt will likely have some quality and protective characteristics, these are
outweighed by large uncertainties or major risk exposures to adverse conditions.
NOTE: The S&P ratings may be modified by the addition of a plus (+) or
minus (-) sign to show relative standing within the major rating categories.
Tax-Exempt Notes
----------------
Moody's
Moody's ratings for state, municipal and other short-term obligations are
designated Moody's Investment Grade ("MIG"). This distinction is in recognition
of the differences between short-term credit risk and long-term risk. Factors
affecting the liquidity of the borrower are uppermost in importance in short-
term borrowing, while various factors of primary importance in long-term
borrowing risk are of lesser importance in the short run. Symbols used are as
follows:
MIG-1: Notes are of the best quality enjoying strong protection from
established cash flows of funds for their servicing or from established and
broad-based access to the market for refinancing, or both.
MIG-2: Notes are of high quality, with margins of protection ample,
although not so large as in the preceding group.
MIG-3: Notes are of favorable quality, with all security elements
accounted for, but lacking the undeniable strength of the preceding grades.
Market access for refinancing, in particular, is likely to be less well
established.
A-2
<PAGE>
Standard & Poor's
Until June 29, 1984, Standard & Poor's used the same rating symbols for
notes and bonds. After June 29, 1984, for new municipal note issues due in
three years or less the ratings below usually will be assigned. Notes maturing
beyond three years will most likely receive a bond rating of the type recited
above.
SP-1: Issues carrying this designation have a very strong or strong
capacity to pay principal and interest. Issues determined to possess
overwhelming safety characteristics will be given a "plus" (+) designation.
SP-2: Issues carrying this designation have a satisfactory capacity to pay
principal and interest.
Commercial Paper
----------------
Moody's
Moody's Commercial Paper ratings, which are also applicable to municipal
paper investments permitted to be made by the Fund, are opinions of the ability
of issuers to repay punctually their promissory obligations not having an
original maturity in excess of nine months. Moody's employs the following
designations, all judged to be investment grade, to indicate the relative
repayment capacity of rated Issuers:
P-1 (Prime-1): Superior capacity for repayment.
P-2 (Prime-2): Strong capacity for repayment.
Standard & Poor's
S&P's ratings are a current assessment of the likelihood of timely payment
of debt having an original maturity of no more than 365 days. Ratings are
graded into four categories, ranging from "A" for the highest quality
obligations to "D" for the lowest. Issues with the "A" category are delineated
with the numbers 1,2 and 3 to indicate the relative degree of safety, as
follows:
A-1: This designation indicates the degree of safety regarding timely
payment is very strong. A "plus" (+) designation indicates an even stronger
likelihood of timely payment.
A-2: Capacity for timely payment on issues with this designation is
strong. However, the relative degree of safety is not as overwhelming as for
issues designated A-1.
A-3
<PAGE>
PART C
OTHER INFORMATION
STATE BOND MINNESOTA TAX-FREE INCOME FUND
Item 24. Financial Statements and Exhibits
- -------------------------------------------
(a) Financial Statements and Report of Independent Auditors
Contained in Part A:
Financial Highlights for each year in the eight year period
ended June 30, 1996, and for the period January 6, 1988
(commencement of operations) to June 30, 1988
Contained in Part B:
Schedule of Investments - June 30, 1996
Statement of Assets and Liabilities - June 30, 1996
Statement of Operations - Year ended June 30, 1996
Statement of Changes in Net Assets - Years ended June 30, 1996
and 1995
Financial Highlights for each period in the five year period
ended June 30, 1996
Notes to Financial Statements
Report of Independent Auditors
(b) Exhibits
(1) Articles of Incorporation--filed as an exhibit to Post-Effective
Amendment No. 7 to Form N-1A Registration Statement of this
Registrant on August 31, 1993, File Nos. 33-18934 and 811-5412.
(2) Bylaws--filed as an exhibit to Post-Effective Amendment No. 7 to
Form N-1A Registration Statement of this Registrant on August 31,
1993, File Nos. 33-18934 and 811-5412.
(3) Not applicable.
(4) Instruments Defining Rights of Shareholders--see generally
Article IV of the Articles of Incorporation, and Articles II and
VII of the Bylaws, filed as exhibits to Post-Effective Amendment
No. 7 to Form N-1A Registration Statement of this Registrant on
August 31, 1993, File Nos. 33-18934 and 811-5412.
(5) Investment Advisory and Management Agreement--filed as an exhibit
to Post-Effective Amendment No. 10 to Form N-1A Registration
Statement of this Registrant on August 28, 1995, File Nos. 33-
18934 and 811-5412.
(6) (a) Underwriting Agreement--filed as an exhibit to Post-
Effective Amendment No. 10 to Form N-1A Registration
Statement of this Registrant on August 28, 1995, File Nos.
33-18934 and 811-5412.
(b) Form of Agreement between principal underwriter and dealers
--incorporated by reference to Post-Effective Amendment
No. 20 to Form N-1A Registration Statement of State Bond
Securities Funds, Inc., File No. 2-30162, filed on September
28, 1993.
(7) Not applicable.
<PAGE>
(8) Custodian Agreement, filed as an Exhibit hereto.
(9) Transfer Agency Agreement, filed as an Exhibit hereto.
(10) Opinion and Consent of Counsel--filed as an exhibit to Post-
Effective Amendment No. 10 to Form N-1A Registration Statement of
this Registrant on August 28, 1995, File Nos. 33-18934 and 811-
5412.
(11) Consent of Ernst & Young LLP, dated September 11, 1996, filed as
an Exhibit hereto.
(12) Not applicable.
(13) Agreement Regarding Initial Capital--filed as an Exhibit to Post-
Effective Amendment No. 1 to Form N-1A Registration Statement of
this Registrant on January 15, 1988, File No. 33-18934.
(14) Not Applicable.
(15) Plan Pursuant to Rule 12b-1--incorporated by reference to
Registrant's Registration Statement on Form N-1A filed on
August 31, 1993.
(16) Schedules for Computation of Performance Data, filed as an
Exhibit hereto.
(17) Other Exhibits--Powers of attorney dated July 31, 1995 filed as
an exhibit to Post-Effective Amendment No. 10 to Form N-1A
Registration Statement of this Registrant on August 28, 1995,
File Nos. 33-18934 and 811-5412.
(18) Not applicable.
(27) Financial Data Schedule, filed as an Exhibit hereto.
Item 25. Persons Controlled by or under Common Control with Registrant
- -----------------------------------------------------------------------
None
Item 26. Number of Holders of Securities
- -----------------------------------------
Number of Record Holders
Title of Class (within last 90 days)
-------------- ------------------------
Common - $.00001 par 393 as of July 31, 1996
Item 27. Indemnification
- -------------------------
Article VII, Section 1 of the Amended and Restated Articles of
Incorporation of the Registrant provides that the Registrant shall indemnify its
directors and officers, whether serving the Registrant or at its request any
other entity, to the full extent permitted by the laws of the State of Maryland.
This indemnification shall not protect any director or officer against liability
to the Registrant or its shareholders to which he otherwise would be subject by
reason of willful misfeasance, gross negligence, or reckless disregard of the
duties involved in the conduct of his office.
Section 6.01 of the By-Laws of the Registrant provides that the Registrant
shall indemnify any person who was or is a party or is threatened to be made a
party to any action, suit or proceeding, whether civil, criminal, administrative
or investigative (other than a proceeding by or in the right of the Registrant
in which such person shall have been adjudged to be liable to the Registrant),
by reason of
<PAGE>
being or having been a director or officer of the Registrant, or serving or
having served at the request of the Registrant as a director, officer, partner,
trustee, employee or agent of another entity in which the Registrant has an
interest as a shareholder, creditor or otherwise (a "Covered Person"), against
all liabilities and penalties, and reasonable expenses (including attorney's
fees) actually incurred by the Covered Person in connection with such action,
suit or proceeding, except (i) liability in connection with any proceeding in
which it is determined that (A) the act or omission of the Covered Person was
material to the matter giving rise to the proceeding, and was committed in bad
faith or was the result of active and deliberate dishonesty, or (B) the Covered
Person actually received an improper personal benefit in money, property or
services, or (C) in the case of any criminal proceeding, the Covered Person had
reasonable cause to believe that the act or omission was unlawful and (ii)
liability to the Corporation or its security holders to which the Covered Person
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.
Article VII, Section 2 of the Amended and Restated Articles of
Incorporation of the Registrant provides that no director or officer of the
Registrant shall be personally liable to the Registrant or its security holders
for money damages, to the full extent permitted by Maryland law and the
Investment Company Act of 1940.
Pursuant to the Registrant's agreement with its principal underwriter, the
Registrant has agreed to indemnify the underwriter from and against any and all
claims, demands, liabilities and expenses (including the cost of investigating
or defending such claims, demands or liabilities and any counsel fees incurred
in connection therewith) which it or any controlling person may incur, under the
Investment Company Act of 1940, or under common law or otherwise, arising out of
or based upon any alleged untrue statement of a material fact contained in the
Registrant's Registration Statement or Prospectus or arising out of or based
upon any alleged omission to state a material fact required to be stated in
either thereof or necessary to make the statements in either thereof not
misleading; provided, however, that the indemnity agreement, to the extent that
it might require indemnity of any person who is a controlling person and who is
also a director of the Registrant, may not inure to the benefit of such person
unless a court of competent jurisdiction shall determine, or it shall have been
determined by controlling precedent, that such result would not be against
public policy as expressed in the Investment Company Act of 1940; and further
provided that in no event shall anything contained in the indemnity agreement be
so construed as to protect the underwriter against any liability to the
Registrant or its security holders to which the underwriter would otherwise be
subject by reason of willful misfeasance, bad faith, or gross negligence, in the
performance of its duties, or by reason of its reckless disregard of any
obligations and duties under the underwriting agreement.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the foregoing provision, or otherwise, the Registrant has
been advised that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the Registrant of expenses incurred
or paid by a director, officer or controlling person of the Registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of counsel the matter has
been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question
<PAGE>
whether such indemnification by it is against public policy as expressed in the
Act and will be governed by the final adjudication of such issue.
The Registrant, its investment adviser, and its principal underwriter have
obtained directors and officers and errors and omissions liability insurance
insuring the activities of the Registrant, the investment advisory activities of
the investment adviser, and the activities of the principal underwriter as
distributor of investment company securities.
Item 28. Business and Other Connections of Investment Adviser
- --------------------------------------------------------------
ARM Capital Advisors, Inc., the Registrant's investment adviser, is a
registered investment adviser providing investment management services to
investment companies and institutional and individual clients.
The business, profession, vocation or employment of a substantial nature
which each director or officer of the investment adviser, is or has been, at any
time during the past two fiscal years, engaged for his own account or in the
capacity of director, officer, employee, partner or trustee is as follows:
Name and Principal Business Address* Position and Offices
- ------------------------------------ --------------------
with Adviser
------------
John Franco Director and Co-
Co-Chief Executive Officer Chief Executive Officer
Martin H. Ruby Director and Co-
Co-Chief Executive Officer Chief Executive Officer
Emad A. Zikry Director, President and
Since October 1994: Chief Investment Officer
Executive Vice President-Chief
Investment Officer
200 Park Avenue, 20th Floor
New York NY 10166
1992-October 1994:
President-Chief Investment Officer
Kleinwort Benson Investment Management
Americas Inc.
200 Park Avenue, 20th Floor
New York NY 10166
<PAGE>
Keith O. Martens Senior Vice
Since June 1995: President and Senior
200 Park Avenue, 20th Floor Portfolio Manager
New York NY 10166
1969-June 1995:
Executive Vice President-Investments
SBM Company
8400 Normandale Lake Boulevard
Suite 1150
Minneapolis MN 55437
Robert E. Mackey Chief Operating Officer
Since January 1995:
200 Park Avenue, 20th Floor
New York NY 10166
1993-December 1994:
Sr. Portfolio Manager-Client
Services Manager-Managing Director
Kleinwort Benson Investment Management
Americas Inc.
200 Park Avenue, 20th Floor
New York NY 10166
Robert L. Maddox Chief Compliance Officer
Since October 1995: and Secretary
Legal Officer and Assistant Counsel
1994-October 1995:
Assistant General Counsel
Providian Corp.
400 West Market Street
Louisville KY 40202
Peter S. Resnik Treasurer
Treasurer
Barry G. Ward Controller
Controller
Rose M. Culbertson Tax Officer
Tax Officer
Kevin Howard Assistant Secretary
Legal Officer and Assistant Counsel
<PAGE>
*All addresses are ARM Financial Group, Inc., 515 W. Market Street, 8th Floor,
Louisville KY 40202. Unless otherwise indicated, each individual has been
employed by ARM Financial Group or its predecessor-in-interest, Analytical Risk
Management, Ltd., for the last two years.
Item 29. Principal Underwriters
- --------------------------------
(a) SBM Financial Services, Inc. acts as principal underwriter for the
Fund, and for each of the following investment companies:
State Bond Investment Funds, Inc.
(State Bond Diversified Fund Portfolio)
State Bond Money Funds, Inc.
(State Bond Cash Management Fund Portfolio)
State Bond Equity Funds, Inc.
(State Bond Common Stock Fund Portfolio)
State Bond Income Funds, Inc.
(State Bond U.S. Government and Agency Securities Fund Portfolio)
State Bond Municipal Funds, Inc.
(State Bond Tax Exempt Fund Portfolio)
SBM Certificate Company
(b) The following table sets forth information concerning each director,
officer or partner of the principal underwriter.
<TABLE>
<CAPTION>
Name and Principal Positions & Offices Positions & Offices
Business Address with Underwriter with Registrant
- ---------------- ---------------- ---------------
<S> <C> <C>
John R. McGeeney* Director, Secretary, None
General Counsel and
Compliance Officer
Edward J. Haines* Director and President None
Walter W. Balek*** Vice President None
Dale C. Bauman*** Vice President President
Robert Bryant Vice President None
1550 East Shaw, #120
Fresno CA 93710
Ronald Geiger*** Vice President None
Peter S. Resnik* Treasurer Treasurer
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
Barry G. Ward* Controller Controller
William H. Guth** Operations Officer None
David L. Anders** Marketing Officer None
Rose M. Culbertson* Tax Officer None
Robert L. Maddox* Assistant Secretary None
Sheri L. Bean* Assistant Secretary None
* Address is 515 W. Market Street, 8th Floor, Louisville, KY 40202
** Address is 200 East Wilson Bridge Road, Worthington, OH 43085
*** Address is 100 North Minnesota Street, New Ulm, MN 56073
(c) Not applicable.
</TABLE>
Item 30. Location of Accounts and Records
- -----------------------------------------
Investors Fiduciary Trust Company
127 West 10th Street
Kansas City, MO 64105-1716
SBM Financial Services, Inc.
100 North Minnesota Street
New Ulm, MN 56073
Item 31. Management Services
- -----------------------------
Not Applicable
Item 32. Undertakings
- ----------------------
Not Applicable
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant certifies that it meets all of
the requirements for effectiveness of this Post-Effective Amendment to the
Registration Statement pursuant to Rule 485(a) under the Securities Act of 1933
and has duly caused this Post-Effective Amendment to the Registration Statement
to be signed on its behalf by the undersigned, thereunto duly authorized, in the
City of Louisville and State of Kentucky, on the 12th day of September, 1996.
STATE BOND TAX-FREE INCOME FUNDS, INC.
By: /s/ Kevin L. Howard
---------------------------------------------
Kevin L. Howard, Vice President and Secretary
Pursuant to the requirements of the Securities Act of 1933, this Post-
Effective Amendment to the Registration Statement has been signed by the
following persons in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signatures Title Date
- ---------- ----- ----
<S> <C> <C>
/s/ Dale Bauman President September 12, 1996
- ------------------------- (Principal Executive Officer)
/s/ Peter S. Resnik Treasurer September 12, 1996
- ------------------------- (Principal Financial Officer)
/s/ Barry G. Ward Controller September 12, 1996
- ------------------------- (Principal Accounting Officer)
* Director
- -------------------------
(William B. Faulkner)
* Director
- -------------------------
(John R. Lindholm)
* Director
- -------------------------
(John Katz)
* Director
- -------------------------
(Theodore S. Rosky)
* This Amendment has been signed
by each of the persons so indicated
by the undersigned as Attorney-in-Fact.
*By: /s/ Kevin L. Howard September 12, 1996
-------------------
</TABLE>
<PAGE>
Exhibits
(1) Articles of Incorporation--filed as an exhibit to Post-Effective
Amendment No. 7 to Form N-1A Registration Statement of this
Registrant on August 31, 1993, File Nos. 33-18934 and 811-5412.
(2) Bylaws--filed as an exhibit to Post-Effective Amendment No. 7 to
Form N-1A Registration Statement of this Registrant on August 31,
1993, File Nos. 33-18934 and 811-5412.
(3) Not applicable.
(4) Instruments Defining Rights of Shareholders--see generally
Article IV of the Articles of Incorporation, and Articles II and
VII of the Bylaws, filed as exhibits to Post-Effective Amendment
No. 7 to Form N-1A Registration Statement of this Registrant on
August 31, 1993, File Nos. 33-18934 and 811-5412.
(5) Investment Advisory and Management Agreement--filed as an exhibit
to Post-Effective Amendment No. 10 to Form N-1A Registration
Statement of this Registrant on August 28, 1995, File Nos. 33-
18934 and 811-5412.
(6) (a) Underwriting Agreement--filed as an exhibit to Post-
Effective Amendment No. 10 to Form N-1A Registration
Statement of this Registrant on August 28, 1995, File Nos.
33-18934 and 811-5412.
(b) Form of Agreement between principal underwriter and dealers
--incorporated by reference to Post-Effective Amendment
No. 20 to Form N-1A Registration Statement of State Bond
Securities Funds, Inc., File No. 2-30162, filed on September
28, 1993.
(7) Not applicable.
(8) Custodian Agreement, filed as an Exhibit hereto.
(9) Transfer Agency Agreement, filed as an Exhibit hereto.
(10) Opinion and Consent of Counsel--filed as an exhibit to Post-
Effective Amendment No. 10 to Form N-1A Registration Statement of
this Registrant on August 28, 1995, File Nos. 33-18934 and 811-
5412.
(11) Consent of Ernst & Young LLP, dated September 11, 1996, filed as
an Exhibit hereto.
(12) Not applicable.
(13) Agreement Regarding Initial Capital--filed as an Exhibit to Post-
Effective Amendment No. 1 to Form N-1A Registration Statement of
this Registrant on January 15, 1988, File No. 33-18934.
(14) Not Applicable.
(15) Plan Pursuant to Rule 12b-1--incorporated by reference to
Registrant's Registration Statement on Form N-1A filed on
August 31, 1993.
(16) Schedules for Computation of Performance Data, filed as an
Exhibit hereto.
(17) Other Exhibits--Powers of attorney dated July 31, 1995 filed as
an exhibit to Post-Effective Amendment No. 10 to Form N-1A
Registration Statement of this Registrant on August 28, 1995,
File Nos. 33-18934 and 811-5412.
(18) Not applicable.
(27) Financial Data Schedule, filed as an Exhibit hereto.
<PAGE>
CUSTODY AND INVESTMENT ACCOUNTING AGREEMENT
-------------------------------------------
THIS AGREEMENT made the 30th day of October, 1995, by and between INVESTORS
FIDUCIARY TRUST COMPANY, a trust company chartered under the laws of the state
of Missouri, having its trust office located at 127 West 10th Street, Kansas
City, Missouri 64105 ("Custodian"), and STATE BOND TAX-FREE INCOME FUNDS, INC.,
a Maryland corporation, having its principal office and place of business at 100
North Minnesota Street, P.O. Box 69, New Ulm, Minnesota 56073-0069 ("Fund").
WITNESSETH:
WHEREAS, Fund desires to appoint Investors Fiduciary Trust Company as
custodian of the securities and monies of Fund's investment portfolio and as its
agent to perform certain investment accounting and recordkeeping functions; and
WHEREAS, Investors Fiduciary Trust Company is willing to accept such
appointment;
NOW THEREFORE, for and in consideration of the mutual promises contained
herein, the parties hereto, intending to be legally bound, mutually covenant and
agree as follows:
1. APPOINTMENT OF CUSTODIAN. Fund hereby constitutes and appoints Custodian
------------------------
as:
A. Custodian of the securities and monies at any time owned by the Fund;
and
B. Agent to perform certain accounting and recordkeeping functions
relating to portfolio transactions required of a duly registered
investment company under Rule 31a of the Investment Company Act of 1940
(the "1940 Act") and to calculate the net asset value of the Fund.
2. REPRESENTATIONS AND WARRANTIES.
------------------------------
A. Fund hereby represents, warrants and acknowledges to Custodian:
1. That it is a corporation or trust (as specified above) duly
organized and existing and in good standing under the laws of its
state of organization, and that it is registered under the 1940
Act; and
<PAGE>
2. That it has the requisite power and authority under applicable law,
its articles of incorporation and its bylaws to enter into this
Agreement; that it has taken all requisite action necessary to
appoint Custodian as custodian and investment accounting and
recordkeeping agent for the Fund; that this Agreement has been duly
executed and delivered by Fund; and that this Agreement constitutes
a legal, valid and binding obligation of Fund, enforceable in
accordance with its terms.
B. Custodian hereby represents, warrants and acknowledges to Fund:
1. That it is a trust company duly organized and existing and in good
standing under the laws of the State of Missouri; and
2. That it has the requisite power and authority under applicable
law, its charter and its bylaws to enter into and perform this
Agreement; that this Agreement has been duly executed and
delivered by Custodian; and that this Agreement constitutes a
legal, valid and binding obligation of Custodian, enforceable in
accordance with its terms.
3. DUTIES AND RESPONSIBILITIES OF CUSTODIAN.
----------------------------------------
A. Delivery of Assets
------------------
Except as permitted by the 1940 Act, Fund will deliver or cause to be
delivered to Custodian on the effective date of this Agreement, or as
soon thereafter as practicable, and from time to time thereafter, all
portfolio securities acquired by it and monies then owned by it or from
time to time coming into its possession during the time this Agreement
shall continue in effect. Custodian shall have no responsibility or
liability whatsoever for or on account of securities or monies not so
delivered.
-2-
<PAGE>
B. Delivery of Accounts and Records
--------------------------------
Fund shall turn over or cause to be turned over to Custodian all of the
Fund's relevant accounts and records previously maintained. Custodian
shall be entitled to rely conclusively on the completeness and
correctness of the accounts and records turned over to it, and Fund
shall indemnify and hold Custodian harmless of and from any and all
expenses, damages and losses whatsoever arising out of or in connection
with any error, omission, inaccuracy or other deficiency of such
accounts and records or in the failure of Fund to provide, or to
provide in a timely manner, any accounts, records or information needed
by the Custodian to perform its functions hereunder.
C. Delivery of Assets to Third Parties
-----------------------------------
Custodian will receive delivery of and keep safely the assets of Fund
delivered to it from time to time segregated in a separate account, and
if Fund is comprised of more than one portfolio of investment
securities (each a "Portfolio") Custodian shall keep the assets of each
Portfolio segregated in a separate account. Custodian will not deliver,
assign, pledge or hypothecate any such assets to any person except as
permitted by the provisions of this Agreement or any agreement executed
by it according to the terms of Section 3.S. of this Agreement. Upon
delivery of any such assets to a subcustodian pursuant to Section 3.S.
of this Agreement, Custodian will create and maintain records
identifying those assets which have been delivered to the subcustodian
as belonging to the Fund, by Portfolio if applicable. The Custodian is
responsible for the safekeeping of the securities and monies of Fund
only until they have been transmitted to and received by other persons
as permitted under the terms of this Agreement, except for securities
and monies transmitted to subcustodians appointed under Section 3.S. of
this Agreement, for which Custodian remains responsible to the extent
provided in Section 3.S. hereof. Custodian may participate directly or
indirectly through a subcustodian in the Depository Trust Company
-3-
<PAGE>
(DTC), Treasury/Federal Reserve Book Entry System (Fed System), Participant
Trust Company (PTC) or other depository approved by the Fund (as such
entities are defined at 17 CFR Section 270.17f-4(b)) (each a "Depository"
and collectively, the "Depositories").
D. Registration of Securities
--------------------------
The Custodian shall at all times hold registered securities of the Fund in
the name of the Custodian, the Fund, or a nominee of either of them, unless
specifically directed by instructions to hold such registered securities in
so-called "street name," provided that, in any event, all such securities
and other assets shall be held in an account of the Custodian containing
only assets of the Fund, or only assets held by the Custodian as a
fiduciary or custodian for customers, and provided further, that the
records of the Custodian at all times shall indicate the Fund or other
customer for which such securities and other assets are held in such
account and the respective interests therein. If, however, the Fund directs
the Custodian to maintain securities in "street name", notwithstanding
anything contained herein to the contrary, the Custodian shall be obligated
only to utilize its best efforts to timely collect income due the Fund on
such securities and to notify the Fund of relevant corporate actions
including, without limitation, pendency of calls, maturities, tender or
exchange offers. All securities, and the ownership thereof by Fund, which
are held by Custodian hereunder, however, shall at all times be
identifiable on the records of the Custodian. The Fund agrees to hold
Custodian and its nominee harmless for any liability as a shareholder of
record of securities held in custody, except to the extent attributable to
any negligence or willful misconduct of the Custodian.
-4-
<PAGE>
E. Exchange of Securities
----------------------
Upon receipt of instructions as defined herein in Section 4.A., Custodian
will exchange, or cause to be exchanged, portfolio securities held by it
for the account of Fund for other securities or cash issued or paid in
connection with any reorganization, recapitalization, merger,
consolidation, split-up of share, change of par value, conversion or
otherwise, and will deposit any such securities in accordance with the
terms of any reorganization or protective plan. Without instructions,
Custodian is authorized to exchange securities held by it in temporary form
for securities in definitive form, to effect an exchange of shares when the
par value of the stock is changed, and, upon receiving payment therefor, to
surrender bonds or other securities held by it at maturity or when advised
of earlier call for redemption, except that Custodian shall receive
instructions prior to surrendering any convertible security.
F. Purchases of Investments of the Fund -- Other Than Options and Futures
----------------------------------------------------------------------
Fund will, on each business day on which a purchase of securities (other
than options and futures) shall be made by it, deliver to Custodian
instructions which shall specify with respect to each such purchase:
1. If applicable, the name of the Portfolio making such purchase;
2. The name of the issuer and description of the security;
3. The number of shares and the principal amount purchased, and accrued
interest, if any;
4. The trade date;
5. The settlement date;
6. The purchase price per unit and the brokerage commission, taxes and
other expenses payable in connection with the purchase;
7. The total amount payable upon such purchase;
-5-
<PAGE>
8. The name of the person from whom or the broker or dealer through whom
the purchase was made; and
9. Whether the security is to be received in certificated form or via a
specified Depository.
In accordance with such instructions, Custodian will pay for such
securities held for the account of Fund, but only insofar as such monies
are available for such purpose, and receive the portfolio securities so
purchased by or for the account of Fund, except that Custodian may in its
sole discretion advance funds to the Fund which may result in an overdraft
because the monies held by the Custodian on behalf of the Fund are
insufficient to pay the total amount payable upon such purchase. Except as
otherwise instructed by Fund, such payment shall be made by the Custodian
only upon receipt of securities: (a) by the Custodian; (b) by a clearing
corporation of a national exchange of which the Custodian is a member; or
(c) by a Depository. Notwithstanding the foregoing, (i) in the case of a
repurchase agreement, the Custodian may release funds to a Depository prior
to the receipt of advice from the Depository that the securities underlying
such repurchase agreement have been transferred by book-entry into the
account maintained with such Depository by the Custodian, on behalf of its
customers, provided that the Custodian's instructions to the Depository
require that the Depository make payment of such finds only upon transfer
by book-entry of the securities underlying the repurchase agreement in such
account; (ii) in the case of time deposits, call account deposits, currency
deposits and other deposits, foreign exchange transactions, futures
contracts or options, the Custodian may make payment therefor before
receipt of an advice or confirmation evidencing said deposit or entry into
such transaction; and (iii) in the case of the purchase of securities, the
settlement of which occurs outside of the United States of America, the
Custodian may make, or cause a subcustodian appointed pursuant to Section
3.S.2. of this Agreement to
-6-
<PAGE>
make, payment therefor in accordance with generally accepted local custom
and market practice.
G. Sales and Deliveries of Investments of the Fund -- Other than Options
---------------------------------------------------------------------
and Futures
-----------
Fund will, on each business day on which a sale of investment securities
(other than options and futures) of Fund has been made, deliver to
Custodian instructions specifying with respect to each such sale:
1. If applicable, the name of the Portfolio making such sale;
2. The name of the issuer and description of the securities;
3. The number of shares and principal amount sold, and accrued interest,
if any;
4. The date on which the securities sold were purchased or other
information identifying the securities sold and to be delivered;
5. The trade date;
6. The settlement date;
7. The sale price per unit and the brokerage commission, taxes or other
expenses payable in connection with such sale;
8. The total amount to be received by Fund upon such sale; and
9. The name and address of the broker or dealer through whom or person to
whom the sale was made.
In accordance with such instructions, Custodian will deliver or cause to be
delivered the securities thus designated as sold for the account of Fund to
the broker or other person specified in the instructions relating to such
sale. Except as otherwise instructed by Fund, such delivery shall be made
upon receipt of payment therefor: (a) in such form as is satisfactory to
the Custodian; (b) credit to the account of the Custodian with a clearing
corporation of a national securities exchange of which the Custodian is a
member; or (c) credit to the account of the Custodian, on behalf of its
customers, with a Depository. Notwithstanding the foregoing: (i) in the
case of
-7-
<PAGE>
securities held in physical form, such securities shall be delivered in
accordance with "street delivery custom" to a broker or its clearing agent;
or (ii) in the case of the sale of securities, the settlement of which
occurs outside of the United States of America, the Custodian may make, or
cause a subcustodian appointed pursuant to Section 3.S.2. of this Agreement
to make, payment therefor in accordance with generally accepted local
custom and market practice.
H. Purchases or Sales of Options and Futures
-----------------------------------------
Fund will, on each business day on which a purchase or sale of the
following options and/or futures shall be made by it, deliver to Custodian
instructions which shall specify with respect to each such purchase or
sale:
1. If applicable, the name of the Portfolio making such purchase or sale;
2. Security Options
a. The underlying security:
b. The price at which purchased or sold;
c. The expiration date;
d. The number of contracts;
e. The exercise price;
f. Whether the transaction is an opening, exercising, expiring or
closing transaction;
g. Whether the transaction involves a put or call;
h. Whether the option is written or purchased;
i. Market on which option traded; and
j. Name and address of the broker or dealer through whom the sale or
purchase was made.
-8-
<PAGE>
3. Options on Indices
a. The index;
b. The price at which purchased or sold;
c. The exercise price;
d. The premium;
e. The multiple;
f. The expiration date;
g. Whether the transaction is an opening, exercising, expiring or
closing transaction;
h. Whether the transaction involves a put or call;
i. Whether the option is written or purchased; and
j. The name and address of the broker or dealer through whom the
sale or purchase was made, or other applicable settlement
instructions.
4. Security Index Futures Contracts
a. The last trading date specified in the contract and, when
available, the closing level, thereof;
b. The index level on the date the contract is entered into;
c. The multiple;
d. Any margin requirements;
e. The need for a segregated margin account (in addition to
instructions, and if not already in the possession of Custodian,
Fund shall deliver a substantially complete and executed
custodial safekeeping account and procedural agreement which
shall be incorporated by reference into this Custody Agreement);
and
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<PAGE>
f. The name and address of the futures commission merchant through
whom the sale or purchase was made, or other applicable
settlement instructions.
5. Options on Index Future Contracts
a. The underlying index future contract;
b. The premium;
c. The expiration date;
d. The number of options;
e. The exercise price;
f. Whether the transaction involves an opening, exercising, expiring
or closing transaction;
g. Whether the transaction involves a put or call;
h. Whether the option is written or purchased; and
i. The market on which the option is traded.
I. Securities Pledged or Loaned
----------------------------
If specifically allowed for in the prospectus of Fund, and subject to such
additional terms and conditions as Custodian may require:
1. Upon receipt of instructions, Custodian will release or cause to be
released securities held in custody to the pledgee designated in such
instructions by way of pledge or hypothecation to secure any loan
incurred by Fund; provided, however, that the securities shall be
released only upon payment to Custodian of the monies borrowed, except
that in cases where additional collateral is required to secure a
borrowing already made, further securities may be released or caused
to be released for that purpose upon receipt of instructions. Upon
receipt of instructions, Custodian will pay, but only from funds
available for such purpose, any such loan upon redelivery to it of the
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<PAGE>
securities pledged or hypothecated therefor and upon surrender of the
note or notes evidencing such loan.
2. Upon receipt of instructions, Custodian will release securities held
in custody to the borrower designated in such instructions; provided,
however, that the securities will be released only upon deposit with
Custodian of full cash collateral as specified in such instructions,
and that Fund will retain the right to any dividends, interest or
distribution on such loaned securities. Upon receipt of instructions
and the loaned securities, Custodian will release the cash collateral
to the borrower.
J. Routine Matters
---------------
Custodian will, in general, attend to all routine and mechanical matters in
connection with the sale, exchange, substitution, purchase, transfer, or
other dealings with securities or other property of Fund except as may be
otherwise provided in this Agreement or directed from time to time by the
Fund in writing.
K. Deposit Accounts
----------------
Custodian will open and maintain one or more special purpose deposit
accounts in the name of Custodian ("Accounts"), subject only to draft or
order by Custodian upon receipt of instructions. All monies received by
Custodian from or for the account of Fund shall be deposited in said
Accounts. Barring events not in the control of the Custodian such as
strikes, lockouts or labor disputes, riots, war or equipment or
transmission failure or damage, fire, flood, earthquake or other natural
disaster, action or inaction of governmental authority or other causes
beyond its control, at 9:00 a.m., Kansas City time, on the second business
day after deposit of any check into an Account, Custodian agrees to make
Fed Funds available to the Fund in the amount of the check. Deposits made
by Federal Reserve wire will be available to the Fund immediately and ACH
wires will be available to the Fund on the next business day.
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<PAGE>
Income earned on the portfolio securities will be credited to the Fund
based on the schedule attached as Exhibit A. The Custodian will be entitled
to reverse any credited amounts were credits have been made and monies are
not finally collected. If monies are collected after such reversal, the
Custodian will credit the Fund in that amount. Custodian may open and
maintain Accounts in its own banking department, or in such other banks or
trust companies as may be designated by it or by Fund in writing, all such
Accounts, however, to be in the name of Custodian and subject only to its
draft or order. Funds received and held for the account of different
Portfolios shall be maintained in separate Accounts established for each
Portfolio.
L. Income and Other Payments to Fund
---------------------------------
Custodian will:
1. Collect, claim and receive and deposit for the account of Fund all
income and other payments which become due and payable on or after the
effective date of this Agreement with respect to the securities
deposited under this Agreement, and credit the account of Fund in
accordance with the schedule attached hereto as Exhibit A. If, for any
reason, the Fund is credited with income that is not subsequently
collected, Custodian may reverse that credited amount.
2. Execute ownership and other certificates and affidavits for all
federal, state and local tax purposes in connection with the
collection of bond and note coupons; and
3. Take such other action as may be necessary or proper in connection
with:
a. the collection, receipt and deposit of such income and other
payments, including but not limited to the presentation for
payment of:
1. all coupons and other income items requiring presentation; and
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<PAGE>
2. all other securities which may mature or be called,
redeemed, retired or otherwise become payable and regarding
which the Custodian has actual knowledge, or should
reasonably be expected to have knowledge; and
b. the endorsement for collection, in the name of the Fund, of all
checks, drafts or other negotiable instruments.
Custodian, however, will not be required to institute suit or take other
extraordinary action to enforce collection except upon receipt of
instructions and upon being indemnified to its satisfaction against the
costs and expenses of such suit or other actions. Custodian will receive,
claim and collect all stock dividends, rights and other similar items and
will deal with the same pursuant to instructions. Unless prior instructions
have been received to the contrary, Custodian will, without further
instructions, sell any rights held for the account of Fund on the last
trade date prior to the date of expiration of such rights.
M. Payment of Dividends and other Distributions
--------------------------------------------
On the declaration of any dividend or other distribution on the shares of
capital stock of Fund ("Fund Shares") by the Board of Directors of Fund,
Fund shall deliver to Custodian instructions with respect thereto. On the
date specified in such instructions for the payment of such dividend or
other distribution, Custodian will pay out of the monies held for the
account of Fund, insofar as the same shall be available for such purposes,
and credit to the account of the Dividend Disbursing Agent for Fund, such
amount as may be specified in such instructions.
N. Shares of Fund Purchased by Fund
--------------------------------
Whenever any Fund Shares are repurchased or redeemed by Fund, Fund or its
agent shall advise Custodian of the aggregate dollar amount to be paid for
such shares and shall confirm such advice in writing. Upon receipt of such
advice, Custodian shall
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<PAGE>
charge such aggregate dollar amount to the account of Fund and either
deposit the same in the account maintained for the purpose of paying for
the repurchase or redemption of Fund Shares or deliver the same in
accordance with such advice. Custodian shall not have any duty or
responsibility to determine that Fund Shares have been removed from the
proper shareholder account or accounts or that the proper number of Fund
Shares have been cancelled and removed from the shareholder records.
O. Shares of Fund Purchased from Fund
----------------------------------
Whenever Fund Shares are purchased from Fund, Fund will deposit or cause to
be deposited with Custodian the amount received for such shares. Custodian
shall not have any duty or responsibility to determine that Fund Shares
purchased from Fund have been added to the proper shareholder account or
accounts or that the proper number of such shares have been added to the
shareholder records.
P. Proxies and Notices
-------------------
Custodian will promptly deliver or mail or have delivered or mailed to Fund
all proxies properly signed, all notices of meetings, all proxy statements
and other notices, requests or announcements affecting or relating to
securities held by Custodian for Fund and will, upon receipt of
instructions, execute and deliver or cause its nominee to execute and
deliver or mail or have delivered or mailed such proxies or other
authorizations as may be required. Except as provided by this Agreement or
pursuant to instructions hereafter received by Custodian, neither it nor
its nominee will exercise any power inherent in any such securities,
including any power to vote the same, or execute any proxy, power of
attorney, or other similar instrument voting any of such securities, or
give any consent, approval or waiver with respect thereto, or take any
other similar action.
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<PAGE>
Q. Disbursements
-------------
Custodian will pay or cause to be paid, insofar as funds are available for
the purpose, bills, statements and other obligations of Fund (including but
not limited to obligations in connection with the conversion, exchange or
surrender of securities owned by Fund, interest charges, dividend
disbursements, taxes, management fees, custodian fees, legal fees,
auditors' fees, transfer agents' fees, brokerage commissions, compensation
to personnel, and other operating expenses of Fund0 pursuant to
instructions of Fund setting forth the name of the person to whom payment
is to be made, the amount of the payment, and the purpose of the payment.
R. Daily Statement of Accounts
---------------------------
Custodian will, within a reasonable time, render to Fund a detailed
statement of the amounts received or paid and of securities received or
delivered for the account of Fund during each business day. Custodian will,
from time to time, upon request by Fund, render a detailed statement of the
securities and monies held for Fund under this Agreement, and Custodian
will maintain such books and records as are necessary to enable it to do
so. Custodian will permit such persons as are authorized by Fund, including
Fund's independent public accountants, reasonable access to such records or
will provide reasonable confirmation of the contents of such records, and
if demanded, Custodian will permit federal and state regulatory agencies to
examine the securities, books and records. Upon the written instructions of
Fund or as demanded by federal or state regulatory agencies, Custodian will
instruct any subcustodian to permit such persons as are authorized by Fund,
including Fund's independent public accountants, reasonable access to such
records or to provide reasonable confirmation of the contents of such
records, and to permit such agencies to examine the books, records and
securities held by such subcustodian which relate to the Fund.
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<PAGE>
S. Appointment of Subcustodian
---------------------------
1. Notwithstanding any other provisions of this Agreement, all or any of
the monies or securities of Fund may be held in Custodian's own
custody or in the custody of one or more other banks or trust
companies acting as sub custodians as may be selected by Custodian.
Any such subcustodian selected by the Custodian must have the
qualifications required for a custodian under the 1940 Act, as
amended. Custodian shall be responsible to the Fund for any loss,
damage or expense suffered or incurred by the Fund resulting from the
actions or omissions of any subcustodians selected and appointed by
Custodian (except subcustodians appointed at the request of Fund and
as provided in Subsection 2 below) to the same extent Custodian would
be responsible to the Fund under Section 5. of this Agreement if it
committed the act or omission itself. Upon request of the Fund,
Custodian shall be willing to contract with other subcustodians
reasonably acceptable to the Custodian for purposes of (i) effecting
third-party repurchase transactions with banks, brokers, dealers, or
other entities through the use of a common custodian or subcustodian,
or (ii) providing depository and clearing agency services with respect
to certain variable rate demand note securities, or (iii) for other
reasonable purposes specified by Fund; provided, however, that the
Custodian shall be responsible to the Fund for any loss, damage or
expense suffered or incurred by the Fund resulting from the actions or
omissions of any such subcustodian only to the same extent such
subcustodian is responsible to the Custodian. The Fund shall be
entitled to review the Custodian's contracts with any such
subcustodians appointed at the request of Fund. Custodian shall be
responsible to the Fund for any loss, damage or expense suffered or
incurred by the Fund resulting from the actions or omissions of any
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<PAGE>
Depository only to the same extent such Depository is responsible to
Custodian.
2. Notwithstanding any other provisions of this Agreement, Fund's foreign
securities (as defined in Rule 17f-5(c)(1) under the 1940 Act) and
Fund's cash or cash equivalents, in amounts deemed by the Fund to be
reasonably necessary to effect Fund's foreign securities transactions,
may be held in the custody of one or more banks or trust companies
acting as subcustodians, and thereafter, pursuant to a written
contract or contracts as approved by Fund's Board of Directors, may be
transferred to accounts maintained by any such subcustodian with
eligible foreign custodians, as defined in Rule 17f-5(c)(2). Custodian
shall be responsible to the Fund for any loss, damage or expense
suffered or incurred by the Fund resulting from the actions or
omissions of any foreign subcustodian only to the same extent the
foreign subcustodian is liable to the domestic subcustodian with which
the Custodian contracts for foreign subcustody purposes.
T. Accounts and Records
--------------------
Custodian will prepare and maintain, with the direction and as interpreted
by the Fund, Fund's accountants and/or other advisors, in complete,
accurate and current form all accounts and records (i) required to be
maintained by Fund with respect to portfolio transactions under Rule 31a of
the 1940 Act, (ii) required to be maintained as a basis for calculation of
the Fund's net asset value, and (iii) as otherwise agreed upon between the
parties. The Custodian shall also perform such accounting and recordkeeping
functions and other ministerial administrative services as are necessary to
enable it to complete on a timely basis worksheets in the forms attached
hereto as Exhibit B, as they may be amended by agreement of the parties
from time to time (the "Worksheets"); provided, however, that the Custodian
shall not be responsible for
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<PAGE>
rendering any legal or tax advice or opinions in connection therewith, or
for advising the Fund as to the resolution of any compliance issues thereby
identified. Custodian will preserve all records prepared hereunder in the
manner and for the periods prescribed in the 1940 Act or for such longer
period as is agreed upon by the parties. Custodian relies upon Fund to
furnish, in writing or its electronic digital equivalent, accurate and
timely information needed by Custodian to complete Fund's records and the
Worksheets and perform daily calculation of the Fund's net asset value.
Custodian shall incur no liability and Fund shall indemnify and hold
harmless Custodian from and against any liability arising from any failure
of Fund to furnish such information in a timely and accurate manner, even
if Fund subsequently provides accurate but untimely information. It shall
be the responsibility of Fund to furnish Custodian with the declaration,
record and payment dates and amounts of any dividends or income and any
other special actions required concerning each of its securities when such
information is not readily available from generally accepted securities
industry services or publications.
U. Accounts and Records Property of Fund
-------------------------------------
Custodian acknowledges that all of the accounts and records maintained by
Custodian pursuant to this Agreement are the property of Fund, and will be
made available to Fund for inspection or reproduction within a reasonable
period of time, upon demand. Custodian will assist Fund's independent
auditors, or upon approval of Fund, or upon demand, any regulatory body, in
any requested review of Fund's accounts and records but shall be reimbursed
by Fund for all expenses and employee time invested in any such review
outside of routine and normal periodic reviews. Upon receipt from Fund of
the necessary information or instructions, Custodian will supply
information from the books and records it maintains for Fund that Fund
needs for tax returns,
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<PAGE>
questionnaires, period reports to shareholders and such other reports and
information requests as Fund and Custodian shall agree upon from time to
time.
V. Adoption of Procedures
----------------------
Custodian and Fund may from time to time adopt procedures as they agree
upon, and Custodian may conclusively assume that no procedure approved or
directed by Fund or its accountants or other advisors conflicts with or
violates any requirements of its prospectus, articles of incorporation,
bylaws, any applicable law, rule or regulation, or any order, decree or
agreement by which Fund may be bound. Fund will be responsible to notify
Custodian of any changes in statutes, regulations, rules, requirements or
policies which might necessitate changes in Custodian's responsibilities or
procedures.
W. Calculation of Net Asset Value
------------------------------
Custodian will calculate Fund's net asset value, in accordance with Fund's
prospectus. Custodian will price the securities and foreign currency
holdings of Fund for which market quotations are available by the use of
outside services designated by Fund which are normally used and contracted
with for this purpose; all other securities and foreign currency holdings
will be priced in accordance with Fund's instructions. Custodian will have
no responsibility for the accuracy of the prices quoted by these outside
services or for the information supplied by Fund or for acting upon such
instructions, except to the extent attributable to the negligence or
willful misconduct of the Custodian.
X. Advances
--------
In the event Custodian or any subcustodian shall, in its sole discretion,
advance cash or securities for any purpose (including but not limited to
securities settlements, purchase or sale of foreign exchange or foreign
exchange contracts and assumed settlement) for the benefit of any
Portfolio, the advance shall be payable by the Fund
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<PAGE>
on demand. Any such cash advance shall be subject to an overdraft charge at
the rate set forth in the then-current fee schedule from the date advanced
until the date repaid. As security for each such advance, Fund hereby grants
Custodian and such subcustodian a lien on and security interests in all
property at any time held for the account of the applicable Portfolio,
including without limitation all assets acquired with the amount advanced.
Should the Fund fail to promptly repay the advance, the Custodian and each
subcustodian shall be entitled to utilize available cash and to dispose of
such Portfolio's assets pursuant to applicable law to the extent necessary
to obtain reimbursement of the amount advanced and any related overdraft
charges.
Y. Exercise of Rights; Tender Offers
---------------------------------
Upon receipt of instructions, the Custodian shall: (a) deliver warrants,
puts, calls, rights or similar securities to the issuer or trustee thereof,
or to the agent of such issuer or trustee, for the purpose of exercise or
sale, provided that the new securities, cash or other assets, if any, are to
be delivered to the Custodian; and (b) deposit securities upon invitations
for tenders thereof, provided that the consideration for such securities is
to be paid or delivered to the Custodian or the tendered securities are to
be returned to the Custodian.
4. INSTRUCTIONS.
------------
A. The term "instructions," as used herein, means written (including telecopied
or telexed) or oral instructions which Custodian reasonably believes were
given by a designated representative of Fund. Fund shall deliver to
Custodian, prior to delivery of any assets to Custodian and thereafter from
time to time as changes therein are necessary, written instructions naming
one or more designated representatives to give instructions in the name and
on behalf of the Fund, which instructions may be received and accepted by
Custodian as conclusive evidence of the authority of any designated
representative to act for Fund and may be considered to be in full force and
effect
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<PAGE>
(and Custodian will be fully protected in acting in reliance thereon) until
receipt by Custodian of notice to the contrary. Unless such written
instructions delegating authority to any person to give instructions
specifically limit such authority to specific matters or require that the
approval of anyone else will first have been obtained, Custodian will be
under no obligation to inquire into the right of such person, acting alone,
to give any instructions whatsoever which Custodian may receive from such
person. If Fund fails to provide Custodian any such instructions naming
designated representatives, any instructions received by Custodian from a
person reasonably believed to be an appropriate representative of Fund shall
constitute valid and proper instructions hereunder.
B. No later than the next business day immediately following each oral
instruction, Fund will send Custodian written confirmation of such oral
instruction. At Custodian's sole discretion, Custodian may record on tape,
or otherwise, any oral instruction whether given in person or via telephone,
each such recording identifying the parties, the date and the time of the
beginning and ending of such oral instruction.
C. If Custodian shall provide Fund direct access to any computerized
recordkeeping and reporting system used hereunder or if Custodian and Fund
shall agree to utilize any electronic system of communication, Fund shall be
fully responsible for any and all consequences of the use or misuse of the
terminal device, passwords, access instructions and other means of access to
such system(s) which are utilized by, assigned to or otherwise made
available to the Fund. Fund agrees to implement and enforce appropriate
security policies and procedures to prevent unauthorized or improper access
to or use of such system(s). Custodian shall be fully protected in acting
hereunder upon any instructions, communications, data or other information
received by Custodian by such means as fully and to the same effect as if
delivered to Custodian by written instrument signed by the requisite
authorized representative(s)
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<PAGE>
of Fund. Fund shall indemnify and hold Custodian harmless from and
against any and all losses, damages, payments, liability and reasonable
costs and expenses, including reasonable attorney's fees, which may be
suffered or incurred by Custodian as a result of the use or misuse,
whether authorized or unauthorized, of any such system(s) by Fund or by
any person who acquires access to such system(s) through the terminal
device, passwords, access instructions or other means of access to such
system(s) which are utilized by, assigned to or otherwise made available
to the Fund, except to the extent attributable to any negligence or
willful misconduct by Custodian.
5. LIMITATION OF LIABILITY OF CUSTODIAN.
------------------------------------
A. Custodian shall at all times use reasonable care and due diligence and
act in good faith in performing its duties under this Agreement.
Custodian shall not be responsible for, and the Fund shall indemnify and
hold Custodian harmless from and against, any and all losses, damages,
payments, liability and reasonable costs and expenses, including
reasonable attorney's fees, which may be asserted against Custodian,
incurred by Custodian or for which Custodian may be held to be liable,
arising out of or attributable to:
1. All actions taken by Custodian pursuant to this Agreement or any
instructions provided to it hereunder, provided that Custodian has
acted in good faith and with due diligence and reasonable care,
except to the extent attributable to the negligence or willful
misconduct of the Custodian; and
2. The Fund's refusal or failure to comply with the terms of this
Agreement (including without limitation the Fund's failure to pay or
reimburse Custodian under this indemnification provision), the
Fund's negligence or willful misconduct, or the failure of any
representation or warranty of the Fund hereunder to be and remain
true and correct in all respects at all times.
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<PAGE>
B. Custodian may request and obtain, at the expense of Fund, the advice and
opinion of counsel for Fund or, of its own expense, the advice and
opinion of its own counsel with respect to questions or matters of law,
and it shall be without liability to Fund for any action taken or
omitted by it in good faith, in conformity with such advice or opinion.
If Custodian reasonably believes that it could not prudently act
according to the instructions of the Fund or the Fund's accountants or
counsel, it may in its discretion, with notice to the Fund, not act
according to such instructions.
C. Custodian may rely upon the advice and statements of Fund, Fund's
accountants and officers or other authorized individuals, and other
persons believed by it in good faith to be expert in matters upon which
they are consulted, and Custodian shall not be liable for any actions
taken, in good faith, upon such advice and statements.
D. If Fund requests Custodian in any capacity to take any action which
involves the payment of money by Custodian, or which might make it or
its nominee liable for payment of monies or in any other way, Custodian
shall be indemnified and held harmless by Fund against any liability on
account of such action; provided, however, that nothing herein shall
obligate Custodian to take any such action except in its sole
discretion.
E. Custodian shall be protected in acting as custodian hereunder upon any
instructions, advice, notice, request, consent, certificate or other
instrument or paper appearing to it to be genuine and to have been
properly executed. Custodian shall be entitled to receive upon request
as conclusive proof of any fact or matter required to be ascertained
from Fund hereunder a certificate signed by an officer or designated
representative of Fund. Fund shall also provide Custodian instructions
with respect to any matter concerning this Agreement requested by
Custodian.
F. Custodian shall be under no duty or obligation to inquire into, and
shall not be liable for:
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<PAGE>
1. The validity of the issue of any securities purchased by or for
Fund, the legality of the purchase of any securities or foreign
currency positions or evidence of ownership required by Fund to
be received by Custodian, or the propriety of the decision to
purchase or amount paid therefor;
2. The legality of the sale of any securities or foreign currency
positions by or for Fund, or the propriety of the amount for
which the same are sold;
3. The legality of the issue or sale of any Fund Shares, or the
sufficiency of the amount to be received therefor;
4. The legality of the repurchase or redemption of any Fund Shares,
or the propriety of the amount to be paid therefor; or
5. The legality of the declaration of any dividend by Fund, or the
legality of the issue of any Fund Shares in payment of any stock
dividend.
G. Custodian shall not be liable for, or considered to be Custodian of,
any money represented by any check, draft, wire transfer,
clearinghouse funds, uncollected funds, or instrument for the payment
of money to be received by it on behalf of Fund until Custodian
actually receives such money; provided, however, that it shall advise
Fund promptly if it fails to receive any such money in the ordinary
course of business and shall cooperate with Fund toward the end that
such money shall be received.
H. Except as provided in Section 3.S., Custodian shall not be responsible
for loss occasioned by the acts, neglects, defaults or insolvency of
any broker, bank, trust company, or any other person with whom
Custodian may deal.
I. Custodian shall not be responsible or liable for the failure or delay
in performance of its obligations under this Agreement, or those of
any entity for which it is responsible hereunder, arising out of or
caused, directly or indirectly, by circumstances beyond the affected
entity's reasonable control, including, without limitation: any
interruption, loss or malfunction of any utility, transportation,
computer (hardware or
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<PAGE>
software) or communication service; inability to obtain labor,
material, equipment or transportation, or a delay in mails;
governmental or exchange action, statute, ordinance, rulings,
regulations or direction; war, strike, riot, emergency, civil
disturbance, terrorism, vandalism, explosions, labor disputes,
freezes, floods, fires, tornados, acts of God or public enemy,
revolutions, or insurrection.
J. IN NO EVENT AND UNDER NO CIRCUMSTANCES SHALL EITHER PARTY TO THIS
AGREEMENT BE LIABLE TO ANYONE, INCLUDING, WITHOUT LIMITATION TO THE
OTHER PARTY, FOR CONSEQUENTIAL, SPECIAL OR PUNITIVE DAMAGES FOR ANY
ACT OR FAILURE TO ACT UNDER ANY PROVISION OF THIS AGREEMENT EVEN IF
ADVISED OF THIS POSSIBILITY THEREOF.
6. COMPENSATION. In consideration for its services hereunder as Custodian and
investment accounting and recordkeeping agent, Fund will pay to Custodian
such compensation as shall be set forth in a separate fee schedule to be
agreed to by Fund and Custodian from time to time. A copy of the initial
fee schedule is attached hereto and incorporated herein by reference.
Custodian shall also be entitled to receive, and Fund agrees to pay to
Custodian, on demand, reimbursement for Custodian's cash disbursements and
reasonable out-of-pocket costs and expenses, including attorney's fees,
incurred by Custodian in connection with the performance of services
hereunder. Custodian may charge such compensation against monies held by it
for the account of Fund. Custodian will also be entitled to charge against
any monies held by it for the account of Fund the amount of any loss,
damage, liability, advance, overdraft or expense for which it shall be
entitled to reimbursement from Fund, including but not limited to fees and
expenses due to Custodian for other services provided to the Fund by
Custodian. Custodian will be entitled to reimbursement by the Fund for the
losses, damages, liabilities, advances, overdrafts and expenses of
subcustodians only to the extent that (i)
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<PAGE>
Custodian would have been entitled to reimbursement hereunder if it had
incurred the same itself directly, and (ii) Custodian is obligated to
reimburse the subcustodian therefor.
7. TERM AND TERMINATION. The initial term of this Agreement shall be for a
period of one (1) year. Thereafter, either party to this Agreement may
terminate the same by notice in writing, delivered or mailed, postage
prepaid, to the other party hereto and received not less than sixty (60)
days prior to the date upon which such termination will take effect. Upon
termination of this Agreement, Fund will pay Custodian its fees and
compensation due hereunder and its reimbursable disbursements, costs and
expenses paid or incurred to such date and Fund shall designate a successor
custodian by notice in writing to Custodian by the termination date. In the
event no written order designating a successor custodian has been delivered
to Custodian on or before the date when such termination becomes effective,
then Custodian may, at its option, deliver the securities, funds and
properties of Fund to a bank or trust company at the selection of
Custodian, and meeting the qualifications for custodian set forth in the
1940 Act and having not less than Two Million Dollars ($2,000,000)
aggregate capital, surplus and undivided profits, as shown by its last
published report, or apply to a court of competent jurisdiction for the
appointment of a successor custodian or other proper relief, or take any
other lawful action under the circumstances; provided, however, that Fund
shall reimburse Custodian for its costs and expenses, including reasonable
attorney's fees, incurred in connection therewith. Custodian will, upon
termination of this Agreement and payment of all sums due to Custodian from
Fund hereunder or otherwise, deliver to the successor custodian so
specified or appointed, or as specified by the court, at Custodian's
office, all securities then held by Custodian hereunder, duly endorsed and
in form for transfer, and all funds and other properties of Fund deposited
with or held by Custodian hereunder, and Custodian will co-operate in
effecting changes in book-entries at all Depositories. Upon delivery to a
successor custodian or as specified by the court, Custodian will have no
further obligations or liabilities under this Agreement. Thereafter such
successor will be the
-26-
<PAGE>
successor custodian under this Agreement and will be entitled to reasonable
compensation for its services. In the event that securities, funds and
other properties remain in the possession of the Custodian after the date
of termination hereof owing to failure of the Fund to appoint a successor
custodian, the Custodian shall be entitled to compensation as provided in
the then-current fee schedule hereunder for its services during such period
as the Custodian retains possession of such securities, funds and other
properties, and the provisions of this Agreement relating to the duties and
obligations of the Custodian shall remain in full force and effect.
8. NOTICES. Notices, requests, instructions and other writings addressed to
Fund at 239 South Fifth Street, 12th Floor, Louisville, Kentucky 40202,
Attention: Kevin Howard, or at such other address as Fund may have
designated to Custodian in writing, will be deemed to have been properly
given to Fund hereunder; and notices, requests, instructions and other
writings addressed to Custodian at its offices at 127 West 10th Street,
Kansas City, Missouri 64105, Attention: Custody Department, or to such
other address as it may have designated to Fund in writing, will be deemed
to have been properly given to Custodian hereunder.
9. CONFIDENTIALITY.
---------------
A. Fund shall preserve the confidentiality of the computerized investment
portfolio recordkeeping and accounting system used by Custodian (the
"Portfolio Accounting System") and the tapes, books, reference
manuals, instructions, records, programs, documentation and
information of, and other materials relevant to, the Portfolio
Accounting System and the business of Custodian ("Confidential
Information"). Fund shall not voluntarily disclose any such
Confidential Information to any other person other than its own
employees who reasonably have a need to know such information pursuant
to this Agreement. Fund shall return all such Confidential Information
to Custodian upon termination or expiration of this Agreement.
-27-
<PAGE>
B. Fund has been informed that the Portfolio Accounting System is licensed
for use by Custodian from DST Systems, Inc. ("Licensor"), and Fund
acknowledges that Custodian and Licensor have proprietary rights in and
to the Portfolio Accounting System and all other Custodian or Licensor
programs, code, techniques, know-how, databases, supporting
documentation, data formats, and procedures, including without
limitation any changes or modifications made at the request or expense
or both of Fund (collectively, the "Protected Information"). Fund
acknowledges that the Protected Information constitutes confidential
material and trade secrets of Custodian and Licensor. Fund shall
preserve the confidentiality of the Protected Information, and Fund
hereby acknowledges that any unauthorized use, misuse, disclosure or
taking of Protected Information, residing or existing internal or
external to a computer, computer system, or computer network, or the
knowing and unauthorized accessing or causing to be accessed of any
computer, computer system, or computer network, may be subject to civil
liabilities and criminal penalties under applicable law. Fund shall so
inform employees and agents who have access to the Protected Information
or to any computer equipment capable of accessing the same. Licensor is
intended to be and shall be a third party beneficiary of the Fund's
obligations and undertakings contained in this paragraph.
10. MULTIPLE PORTFOLIOS. If Fund is comprised of more than one Portfolio:
A. Each Portfolio shall be regarded for all purposes hereunder as a
separate party apart from each other Portfolio. Unless the context
otherwise requires, with respect to every transaction covered by this
Agreement, every reference herein to the Fund shall be deemed to relate
solely to the particular Portfolio to which such transaction relates.
Under no circumstances shall the rights, obligations or remedies with
respect to a particular Portfolio constitute a right, obligation or
remedy applicable to any other Portfolio. The use of this single
document to memorialize the separate agreement of
-28-
<PAGE>
each Portfolio is understood to be for clerical convenience only and
shall not constitute any basis for joining the Portfolios for any
reason.
B. Additional Portfolios may be added to this Agreement, provided that
Custodian consents to such addition, which consent shall not be
unreasonably withheld. Rates or charges for each additional Portfolio
shall be as agreed upon by Custodian and Fund in writing.
11. MISCELLANEOUS.
A. This Agreement shall be construed according to, and the rights and
liabilities of the parties hereto shall be governed by, the laws of the
State of Missouri, without reference to the choice of laws principles
thereof.
B. All terms and provisions of this Agreement shall be binding upon, inure
to the benefit of and be enforceable by the parties hereto and their
respective successors and permitted assigns.
C. The representations and warranties, the indemnifications extended
hereunder, and the provisions of Section 9. hereof are intended to and
shall continue after and survive the expiration, termination or
cancellation of this Agreement.
D. No provisions of the Agreement may be amended or modified in any manner
except by a written agreement properly authorized and executed by each
party hereto.
E. The failure of either party to insist upon the performance of any terms
or conditions of this Agreement or to enforce any rights resulting from
any breach of any of the terms or conditions of this Agreement,
including the payment of damages, shall not be construed as a continuing
or permanent waiver of any such terms, conditions, rights or privileges,
but the same shall continue and remain in full force and effect as if no
such forbearance or waiver had occurred. No waiver, release or discharge
of any party's rights hereunder shall be effective unless contained in a
written instrument signed by the party sought to be charged.
-29-
<PAGE>
F. The captions in the Agreement are included for convenience of reference
only, and in no way define or limit any of the provisions hereof or
otherwise affect their construction or effect.
G. This Agreement may be executed in two or more counterparts, each of
which shall be deemed an original but all of which together shall
constitute one and the same instrument.
H. If any provision of this Agreement shall be determined to be invalid or
unenforceable, the remaining provisions of this Agreement shall not be
affected thereby, and every provision of this Agreement shall remain in
full force and effect and shall remain enforceable to the fullest extent
permitted by applicable law.
I. This Agreement may not be assigned by either party hereto without the
prior written consent of the other party.
J. Neither the execution nor performance of this Agreement shall be deemed
to create a partnership or joint venture by and between Custodian and
Fund.
K. Except as specifically provided herein, this Agreement does not in any
way affect any other agreements entered into among the parties hereto
and any actions taken or omitted by either party hereunder shall not
affect any rights or obligations of the other party hereunder.
-30-
<PAGE>
IN WITNESS WHEREOF, the parties have caused this Agreement to be executed
by their respective duly authorized officers.
INVESTORS FIDUCIARY TRUST COMPANY
By: /s/ Allen Strain
------------------------------
Title: Executive Vice President
--------------------------
STATE BOND TAX-FREE INCOME FUNDS, INC.
By: /s/ Kevin L. Howard
------------------------------
Kevin L. Howard
Title: Secretary
--------------------------
-31-
<PAGE>
EXHIBIT A
---------
INVESTORS FIDUCIARY TRUST COMPANY
AVAILABILITY SCHEDULE BY TRANSACTION TYPE
<TABLE>
<CAPTION>
TRANSACTION DTC PHYSICAL FED
----------- --- -------- ---
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
TYPE CREDIT DATE FUNDS TYPE CREDIT DATE FUNDS TYPE CREDIT DATE FUNDS TYPE
---- ----------- ---------- ----------- ---------- ----------- ----------
- ----------------------------------------------------------------------------------------------------
Calls Puts As Received C or F* As Received C or F*
- ----------------------------------------------------------------------------------------------------
Maturities As Received C or F* Mat. Date C or F* Mat. Date F
- ----------------------------------------------------------------------------------------------------
Tender Reorgs. As Received C As Received C N/A
- ----------------------------------------------------------------------------------------------------
Dividends Paydate C Paydate C N/A
- ----------------------------------------------------------------------------------------------------
Floating Rate Int. Paydate C Paydate C N/A
- ----------------------------------------------------------------------------------------------------
Floating Rate Int. N/A As Rate Received C N/A
(No Rate)
- ----------------------------------------------------------------------------------------------------
Mtg. Backed P&I Paydate C Paydate + 1 C Paydate F
Bus. Day
- ----------------------------------------------------------------------------------------------------
Fixed Rate Int. Paydate C Paydate C Paydate F
- ----------------------------------------------------------------------------------------------------
Euroclear N/A C Paydate C
- ----------------------------------------------------------------------------------------------------
</TABLE>
Legend
- ------
C = Clearinghouse Funds
F = Fed Funds
N/A = Not Applicable
* Availability based on how received.
<PAGE>
TRANSFER AGENCY AGREEMENT
This Agreement, dated as of the 1st day of February, 1996, made by and
between State Bond Tax-Free Income Funds, Inc. (the "Fund"), a corporation
operating as an open-end investment company, duly organized and existing under
the laws of the State of Maryland, and ARM Transfer Agency, Inc., (the "Agent"),
a Delaware corporation;
WITNESSETH THAT:
WHEREAS, the Agent has agreed to act as Transfer Agent and Dividend
Disbursing Agent of the Fund, as Administrator of Plans, and to perform certain
check redemption procedures.
NOW, THEREFORE, in consideration of the premises and mutual covenants
contained herein, the parties hereto, intending to be legally bound, do hereby
agree as follows:
Section 1. The terms as defined in this Section wherever used in this
Agreement, or in any amendment or supplement hereto, shall have the meanings
herein specified, unless the context otherwise requires.
Bank: The term Bank shall mean the entity that maintains the Fund's check
redemption account.
Custodian: The term Custodian shall mean that entity which is acting as
custodian of the Fund's assets from time to time.
Share Certificates: The term Share Certificates shall mean the stock
certificates for the Shares of the Fund.
Shareholders: The term Shareholders shall mean the registered owners from
time to time of the Shares of the Fund in accordance with the stock registry
records of the Fund.
Shares: The term Shares shall mean the issued and outstanding shares of
common stock of the Fund.
Plan: The term Plan shall include such investment plans, dividend or
capital gains reinvestment plans, systematic withdrawal plans or other types of
plans set forth in the prospectus of the Fund, in form acceptable to the Agent,
which the Fund may from time to time adopt and make available to its
Shareholders, including plans or accounts established for pension and profit-
sharing plans established by self-employed individuals or partnerships.
Planholder: The term Planholder shall mean a Shareholder who, at the time
of reference, is participating in a Plan, and shall include any underwriter,
representative or broker-dealer.
Section 2. The Fund hereby appoints the Agent as its Transfer, Redemption
and Dividend Disbursing Agent and as Administrator of its Plans, and the Agent
accepts such appointment and agrees to act in such capacities upon the terms set
forth in this Agreement.
TRANSFER AGENCY
Section 3. The Fund shall furnish to the Agent, as Transfer Agent, a
sufficient supply of blank Share Certificates and from time to time will renew
such supply upon the request of the Agent. Such blank Share Certificates shall
be signed manually or by facsimile signatures of officers of the Fund authorized
by law or the bylaws of the Fund to sign Share Certificates and, if required,
shall bear the corporate seal or a facsimile thereof.
Section 4. The Agent, as Transfer Agent, shall make original issues of
Shares in accordance with the provisions of Sections 14 and 15 below and the
Fund's prospectus.
Section 5. Transfers of Shares shall be registered and new Share
Certificates issued by the Agent upon surrender of outstanding Share
Certificates (a) in form deemed by the Agent to be properly endorsed for
transfer, (b) with all necessary endorsers' signatures guaranteed in such manner
and form as the Agent may require by a guarantor
<PAGE>
reasonably believed by the Agent to be responsible, accompanied by (c) such
assurances as the Agent shall deem necessary or appropriate to evidence the
genuineness and effectiveness of each necessary endorsement, and (d)
satisfactory evidence of compliance with all applicable laws relating to the
payment or collection of taxes.
Section 6. When mail is used for delivery of Share Certificates, the
Agent shall forward Share Certificates in "non-negotiable" form by first-class
mail, and Share Certificates in "negotiable" form by registered mail, all mail
deliveries to be covered while in transit to the addressee by insurance arranged
for by the Agent.
Section 7. In registering transfers, the Agent, as Transfer Agent, may
rely upon the Uniform Commercial Code or any other statutes which in the opinion
of counsel protect the Agent and the Fund in not requiring complete
documentation, in registering transfer without inquiry into adverse claims, in
delaying registration for purposes of such inquiry, or in refusing registration
where in its judgment an adverse claim requires such refusal.
Section 8. The Agent, as Transfer Agent, may issue new Share Certificates
in place of Share Certificates represented to have been lost, destroyed or
stolen, upon receiving indemnity satisfactory to the Agent and may issue new
Share Certificates in exchange for, and upon surrender of, mutilated Share
Certificates.
Section 9. In case any officer of the Fund who shall have signed manually
or whose facsimile signature shall have been affixed to blank Share Certificates
shall die, resign or be removed prior to the issuance of such Share
Certificates, the Agent, as Transfer Agent, may issue or register such Share
Certificates as the Share Certificates of the Fund notwithstanding such death,
resignation or removal; and the Fund shall file promptly with the Agent such
approval, adoption or ratification as may be required by law.
Section 10. The Agent will maintain stock registry records in the usual
form in which it will note the issuance and redemption of Shares and the
issuance and transfer of Share Certificates, and is also authorized to maintain
an account entitled Unissued Certificate Account in which it will record the
Shares and fractions issued and outstanding from time to time for which issuance
of Shares Certificates is deferred. The Agent is authorized to keep records,
which will be part of the stock transfer records, as well as its records of the
Plans, in which it will note the names and registered addresses of Planholders,
and the number of Shares and fractions from time to time owned by them for which
no Share Certificates are outstanding. Each Shareholder or Planholder, whether
he holds one or more Share Certificates or owns Shares held under one or more
Plans, or whether he holds or owns Shares by both methods, will be assigned a
single account number. Whenever a Shareholder deposits Shares represented by
Share Certificates in a Plan permitting the deposit of Shares thereunder, the
Agent, as Transfer Agent, upon receipt of the Share Certificates registered in
the name of the Shareholder (or, if not so registered, in proper form for
transfer), shall cancel such Share Certificates, debit the Shareholder's
individual stock account and credit the Shares to the unissued Certificate
Account. The Agent, as Plan Administrator, shall credit the Shares so deposited
to the proper Plan account.
Section 11. The Agent will issue Share Certificates for Shares of the Fund
only upon receipt of a written request from a Shareholder. In all other cases,
the Fund authorizes the Agent to dispense with the issuance and countersignature
of Share Certificates whenever Shares are purchased. In such case, the Agent, as
Transfer Agent, shall merely note on its stock registry records the issuance of
the Shares and fractions (if any), shall credit the Unissued Certificate Account
with the Shares and fractions issued and shall credit the proper number of
Shares and fractions to the respective Shareholders. Likewise, whenever a
Shareholder requests the redemption of Shares for which the Agent's records
indicate that no Share Certificates have been issued, the Agent may cause said
Shares to be redeemed without tender of Share Certificates for same. The Fund
authorizes the Agent in such cases to process the transactions by appropriated
entries in its stock transfer records, and debiting of the Unissued Certificate
Account and the records of issued Shares outstanding.
Section 12. The Agent in its capacity as Transfer Agent will, in addition
to the duties and functions above-mentioned, perform the usual duties and
functions of a stock transfer agent for a corporation. It will countersign for
issuance or reissuance Share Certificates representing original issue or
reissued treasury shares, and will transfer Share Certificates, and Shareholder
account registrations where no Share Certificates are outstanding, registered in
the name of Shareholders from one Shareholder to another in the usual manner.
The Agent may rely conclusively and act without further investigation upon any
list, instruction, certification, authorization, Share Certificate or other
instrument or paper believed by it in good faith to be genuine and unaltered,
and to have been signed, countersigned or executed by duly
<PAGE>
authorized person or persons, or upon the instructions of any officer of the
Fund, or upon the advice of counsel for the Fund or for the Agent. The agent may
record any transfer of Share Certificates which is reasonably believed by it in
good faith to have been duly authorized or may refuse to record any transfer of
Share Certificates if in good faith the Agent in its capacity as Transfer Agent
reasonably deems such refusal necessary in order to avoid any liability either
to the Fund or to the Agent. The Fund agrees to indemnify and hold harmless the
Agent from and against any and all losses, costs, claims and liability which it
may suffer or incur by reason of so relying or acting or refusing to act.
Section 13. In case of any request or demand for the inspection of the
share records of the Fund, the Agent, as Transfer Agent, shall endeavor to
notify the Fund and to secure instructions as to permitting or refusing such
inspection. However, the Agent may exhibit such records to any person in any
case where it is advised by its counsel that it may be held liable for failure
to do so.
ISSUANCE OF SHARES
Section 14. Prior to the daily determination of net asset value in
accordance with the Funds prospectus, the Agent shall process all payments by
Shareholders and Planholders received since the last determination of the Fund's
net asset value for which the Agent has sufficient information to establish a
new Shareholder account or purchase Shares for an existing account. Immediately
after the Fund's calculation of its net asset value on each day that both the
Fund and the Agent are open for business, the Agent shall obtain from the Fund a
quotation (on which it may conclusively rely) of the net asset value per Share
determined on that day. The Agent shall proceed to calculate the amount
available for investment in Shares at the quoted net asset value and the number
of Shares and fractional Shares to be purchased. The Agent, as agent for the
Shareholders and Planholders, shall place a purchase order on each day that both
the Fund and the Agent are open for business with the Fund for the proper number
of Shares and fractional Shares to be purchased and confirm such number to the
Fund.
Section 15. The proper number of Shares and fractional Shares shall then
be issued daily and credited by the Agent to the Unissued Certificate Account.
The Shares and fractional Shares purchased for each Shareholder and Planholder
will be credited by the Agent to such Shareholder's or Planholder's separate
account. The Agent shall then cause to be mailed to each Shareholder and
Planholder a confirmation of each purchase, with copies to the Fund if
requested. Such confirmations will show the prior Share balance, the new Share
balance, the Shares held under a Plan (if any), the Shares for which Stock
Certificates are outstanding (if any), the amount invested and the price paid
for the newly purchased Shares.
REDEMPTIONS
Section 16. Except for check redemptions, which shall be governed by the
check redemption procedures provided for in Sections 18 through 24, the Agent
shall, prior to the daily determination of net asset value in accordance with
the Fund's prospectus, process all requests from Shareholders to redeem Shares
received in accordance with the procedures set forth in the Fund's prospectus.
The Fund shall then quote to the Agent the applicable net asset value, whereupon
the Agent shall determine the number of Shares required to be redeemed to make
monthly payments, automatic payments or the like. The Agent shall then advise
the Fund of the number of Shares and fractional Shares requested to be redeemed
and shall process the redemption by filing with the Custodian an appropriate
statement and making the proper distribution and application of the redemption
proceeds in accordance with the Fund's prospectus. The stock registry books
recording outstanding Shares, the Unissued Certificate Account and the
individual account of the Shareholder or Planholder shall be properly debited.
Section 17. The proceeds of redemption shall be remitted by the Agent in
accordance with the Fund's prospectus as follows:
(a) By check mailed to the Shareholder or Planholder at his registered
address. If a request for redemption of Shares is valued at $20,000 or more, or
the proceeds of the redemption are to be paid to someone other than the
Shareholder, a signature guarantee of a national securities exchange, a member
firm of a principal stock exchange, a registered securities association, a
clearing agency, a bank or trust company, a savings association, a credit union,
a broker, a dealer, a municipal securities broker or dealer, a government
securities broker or dealer, or a representative of the Distributor, the Agent,
shall accompany the redemption request.
<PAGE>
(b) By instructions to the Fund's Custodian to wire redemption proceeds on
the next business day to a designated bank upon telephone request, without
signature guarantee, if such redemption procedure has been requested by the
Shareholder or Planholder on an authorized form filed with the Agent and the
redemption proceeds are $5,000 or more. Any change in the designated bank
account will be accepted by the Agent only if made in writing by the Shareholder
or Planholder with signature guaranteed as required by paragraph (a) of this
Section 17.
(c) By check redemption procedures as provided for in Sections 18 through
24.
(d) By other procedures commonly followed by mutual funds and mutually
agreed upon by the Fund and the Agent.
For the purposes of redemption of Shares which have been purchased by
uncertified check, such Shares may not be redeemed within 14 days of purchase.
CHECK REDEMPTION
Section 18. The Agent shall perform check redemption services for the Fund
subject to the terms and conditions set forth in the Fund's prospectus. The
duties and obligations of the Agent with respect to check redemptions are
limited to those specifically set forth in Sections 18 through 24 of this
Agreement.
Section 19. The Fund shall maintain balances in a check redemption account
with the Bank which shall be sufficient to pay all checks received by the Bank
drawn against the check redemption account. The balance to be maintained in the
check redemption account shall be estimated from time to time by the Fund and
the Agent, based on redemption experience.
Section 20. The Agent shall provide, at the Fund's expense, check blank
forms for the check redemption account to Shareholders of the Fund who
appropriately request the same on the Fund's investment application form and
shall process checks drawn by said Shareholders on the check redemption account
in accordance with applicable laws and rules governing checks; provided,
however, that the Agent shall be required, in verifying the drawer's signature,
only to ascertain whether the signature(s) on the check reasonably appear to the
signature(s) on the Shareholder's signature card, but shall not be required,
either as drawee or as redemption agent for any Shareholder, to obtain any
guarantee of any Shareholder signature.
Section 21. If there are not sufficient Shares in the drawer's Share
account which have been held for 15 days or more which are not represented by
issued Share Certificates to cover the check, the Agent shall direct the Bank
not to pay the check and shall immediately notify the Fund of such fact.
Section 22. The Agent shall, from time to time as often as necessary for
the purpose of properly performing its check redemption duties hereunder,
determine whether the Fund has deposited in the check redemption account
sufficient balances to pay all checks received by the Bank drawn against the
check redemption account. If the Fund has not deposited sufficient balances to
pay all such checks, the Bank shall pay checks only to the extent balances are
in the check redemption account. The Agent may select those checks to be paid
and those to be returned arbitrarily by any method selected by the Agent. If
checks received by the Bank drawn against the check redemption account exceed
the balances in the check redemption account, the Agent shall immediately notify
the Fund of such fact and give the Fund reasonable time to provide sufficient
collected balances. In no event shall "reasonable time" for the Fund to provide
sufficient collected balances extend beyond 10:00 a.m. on the day of the Bank's
midnight deadline with respect to any check. In no event shall the Agent
authorize the Bank to honor or pay checks drawn on the check redemption account
for which balances are not on hand in the check redemption account, and the Fund
hereby agrees to indemnify, defend and hold the Bank and the Agent harmless from
any loss, claim or expense arising out of the return of redemption checks due to
any such insufficiency of collected balances of which the Agent gave the Fund
immediate notices as required below.
Section 23. The Agent shall notify the Fund, as of the morning of the next
business day, of the balances in the check redemption account and a list of all
redemptions paid the preceding day, by name of Shareholder and
<PAGE>
amount.
Section 24. The Fund may terminate the check redemption procedure at any
time upon 30 days' written notice to the Agent, and in the event of such
termination, the effect shall be to delete all references to check redemption
procedures in this Agreement.
DIVIDENDS AND DISTRIBUTIONS
Section 25. It is mutually understood by the parties that the Fund intends
to declare daily dividends payable to Shareholders and Planholders of record as
of the close of business each day, and that all dividends are to be payable and
automatically reinvested in additional Shares as of the last business day of the
Fund each month, except in cases where Shareholders have elected to receive
dividends in cash, in which case checks will be mailed within three business
days after the payable date. On each business day, the Fund shall notify the
Agent of the amount of net income of the Fund earned for that business day and
the amount of net income that will be earned for the ensuing days that will not
be business days. Based on the number of Shares outstanding as of the close of
business on each such business day, the Agent shall thereupon compute the
dividends per Share payable with respect to the account of each Shareholder and
Planholder and monthly the number of additional Shares and fractional Shares to
be issued with respect to such dividends. The Agent shall notify the Fund
monthly of the total number of additional Shares and fractional Shares issued
and the amount of dividends to be paid in cash. On or before the payment date
for each dividend, the Fund shall transfer, or cause the Custodian to transfer,
to the Bank sufficient cash to pay those dividends payable in cash on that
payment date. Dividend checks will be mailed by the Agent within three days
after the payment date. The Agent shall maintain records as to the additional
Shares and fractional Shares issued with respect to dividends which are
reinvested in additional Shares by crediting each Shareholder's or Planholder's
account for Shares purchased by them by means of reinvestment of dividends
payable on Shares in their account. The Agent shall cause to be mailed to each
Shareholder and Planholder a confirmation of each such purchase by reinvestment
of such dividend.
Section 26. In the event that the Fund changes its dividend policy or the
Fund orders the distribution of any extraordinary long-term gains, the Fund
shall notify the Agent of each resolution of the Funds Board of Directors
declaring such distribution or change in its dividend policy, the amount payable
per share, the record date for determining Shareholders or Planholders entitled
to payment, the net asset value to be used for reinvestments of such other
distribution or dividends, and the payment date. The Agent shall, prior to the
designated payment date, calculate the amount of such dividend or other
distribution to be reinvested in Shares and fractional Shares of each
Shareholder and Planholder and the amount to be paid in cash. On or before each
payment date the Fund shall transfer, or cause the Custodian to transfer, to the
Bank sufficient cash to pay any such dividends or other distributions payable in
cash. Checks for such dividends or distributions payable in cash will be mailed
by the Agent within three business days after the payment date. The Agent shall
maintain records as to additional Shares and fractional Shares issued with
respect to such dividends or other distributions which are reinvested in
additional Shares by crediting each Shareholder's or Planholder's account for
Shares purchased by them by means of reinvestment of such dividends or
distributions payable on Shares in their account. The Agent shall cause to be
mailed to each Shareholder and Planholder a confirmation of each such purchase
by reinvestment of such dividend or distribution.
GENERAL PROVISIONS
Section 27. The Agent shall maintain records (which may be part of the
stock transfer records) in connection with the issuance and redemption of
Shares, the disbursement of dividends and the administration of the Plans and
dividend reinvestments, in which will be noted the transactions effected for
each Shareholder and Planholder and the number of Shares and fractional Shares
owned by each for which no Share Certificates are outstanding.
Section 28. In addition to the services provided for in this Agreement, the
Agent will perform other services for the Fund as agreed from time to time,
including but not limited to, preparation of and mailing Federal 1099 Forms,
mailing semi-annual reports of the Fund, preparation of an annual list of
Shareholders and Planholders, mailing notices of Shareholder's meetings, proxies
and proxy statements, and examination and tabulation of returned proxies and
certification of vote to the Fund.
Section 29. Nothing contained in this Agreement is intended to or shall
require the Agent, in any capacity
<PAGE>
hereunder, to perform any functions or duties on any holiday or other day of
special observance on which the Agent is closed. Functions or duties normally
scheduled to be performed on such days shall be performed on, and as of, the
next business day on which the Fund and the Agent are open.
Section 30. The Fund agrees to pay the Agent compensation for its services
and to reimburse the Agent for its expenses as shall be agreed upon from time to
time.
Section 31. The Agent shall not be liable for any taxes, assessments or
governmental charges which may be levied or assessed on any basis whatsoever,
upon the securities held or processed hereunder, or otherwise in connection with
the Agent's activities or status under this Agreement.
Section 32. The Agent, at any time, may apply to the Fund for instructions
with respect to any matter in connection with the Agent's performance of its
duties under this Agreement, and the Agent shall be entitled to rely
conclusively on such instructions from the Fund.
The Fund will indemnify and hold the Agent harmless from all loss, cost,
damage and expense, including reasonable expenses for counsel, incurred by it
resulting from any claim, demand, action or omission by it in the performance of
its duties hereunder, or as a result of acting upon any instruction believed by
it to have been given by a duly authorized officer of the Fund; provided that
this indemnification shall not apply to actions or omissions of the Agent in
cases of its own willful misfeasance, bad faith, gross negligence or reckless
disregard of its duties hereunder; and further provided that, prior to
confessing any claim against it which may be the subject of this
indemnification, the Agent shall give the Fund reasonable opportunity to defend
against said claim in its own name or in the name of the Agent.
The Agent will indemnify and hold the Fund harmless from all loss, cost,
damage and expense, including reasonable expenses for counsel, incurred or
sustained by it as a result of or in connection with the Agent's failure to give
the Bank instructions to refuse acceptance and payment of any check under the
Fund's check redemption service which is wrongfully paid either when a signature
on a particular check is not authentic according to the applicable authorized
signature card supplied by the Shareholder or when the number of Shares in a
Shareholder's account is insufficient to cover the amount of the check.
Section 33. The practices and procedures of the Agent and the Fund set
forth in this Agreement, or any other terms or conditions of this Agreement, may
be altered or modified from time to time as may be mutually agreed by the
parties to this Agreement without the consent of any Shareholder or Planholder,
so long as the intent and purposes of the Plans, as stated from time to time in
the prospectus of the Fund, or other applicable limitations of the prospectus,
are observed. In special cases the parties hereto may adopt such procedures as
may be appropriate or practical under the circumstances, and the Agent may
conclusively assume that any special procedure which has been approved by the
Fund does not conflict with or violate any requirements of its Articles of
Incorporation, Bylaws or prospectus, or any rule, regulation or requirement of
any regulatory body.
Section 34. The Fund currently has one class of stock issued and
outstanding, that being the "State Bond Minnesota Tax-Free Income Fund" class,
and one investment portfolio, the "State Bond Minnesota Tax-Free Income Fund"
portfolio. The Board of Directors of the Fund may from time to time create other
classes of stock and other corresponding investment portfolios. Should the
Fund's Board of Directors create such other classes of stock and other
portfolios, it is understood that the Agent shall carry out its duties and
responsibilities hereunder so as to treat such portfolios, the shares of such
classes of stock, and the dividends and distributions relating to such
portfolios and classes of stock separately and distinctly as if each class and
its corresponding portfolio were a separate fund for all purposes hereunder. In
doing so, the Agent shall maintain a separate set of records for each class of
stock and its corresponding portfolio.
Section 35. This Agreement may be amended from time to time by a
supplemental agreement executed by the Fund and the Agent.
Section 36. Either the Fund or the Agent may give 60 days' written notice
to the other of the termination of this Agreement, such termination to take
effect at the time specified in the notice.
<PAGE>
Section 37. Any notice or other communication required by or permitted to
be given in connection with this Agreement shall be in writing, and shall be
delivered in person or sent by first-class mail, postage prepaid, to the
respective parties as follows:
If to the Fund:
State Bond Tax-Free Income Funds, Inc.
100 N. Minnesota Street
New Ulm, Minnesota 56073
If to the Agent:
ARM Transfer Agency, Inc.
100 N. Minnesota Street
New Ulm, Minnesota 56073
Section 38. This Agreement may be executed in two or more counterparts,
each of which when so executed shall be deemed an original, but such
counterparts shall together constitute but one and the same instrument.
Section 39. This Agreement shall be governed by the laws of the State of
Minnesota.
Section 40. This Agreement shall extend to and shall be binding upon the
parties hereto and their respective successors and assigns; provided, however,
that this Agreement shall not be assignable by the Fund without the written
consent of the Agent or by the Agent without the written consent of the Fund,
authorized or approved by a resolution of its Board of Directors.
Section 41. The accounts and records, in the agreed upon format, specified
herein to be maintained by the Bank shall be preserved for the periods specified
by Rule 31a-2 under the Investment Company Act of 1940 and shall be the property
of the Fund and shall be made available to the Fund within a reasonable period
of time upon proper demand. The Agent shall assist the Fund's independent
auditors, or upon approval of the Fund or upon demand, any regulatory body, in
any requested review of the Fund's accounts and records, but shall be reimbursed
for all expenses and employee time invested in any such review outside of
routine and normal periodic reviews. Upon receipts from the Fund of the
necessary information, the Agent shall supply the necessary data for the Fund or
accountant's completion of any necessary tax returns, questionnaires, periodic
reports to Shareholders and such other reports and information requests as the
Fund and the Agent shall agree upon from time to time.
IN WITNESS WHEREOF, the Fund and the Agent have caused this Agreement to be
signed by their respective duly authorized officers as of the day and year first
above written.
STATE BOND TAX-FREE INCOME FUNDS, INC.
By: /s/ Kevin L. Howard
------------------------
Kevin L. Howard
Its: Secretary
------------------------
ARM TRANSFER AGENCY, INC.
By: /s/ John R. McGeeney
------------------------
John R. McGeeney
Its: Secretary
------------------------
<PAGE>
EXHIBIT 11
Consent of Independent Auditors
We consent to the references of our firm under the captions "Financial
Highlights" and "Independent Auditors" and to the use of our report dated August
9, 1996, except for Note 5, as to which the date is August 26, 1996, in the
Post-Effective Amendment No. 11 to the Registration Statement (Form N-1A) and
Related Prospectus of the State Bond Minnesota Tax-Free Income Fund.
/s/ Ernst & Young LLP
Ernst & Young LLP
Kansas City, Missouri
September 11, 1996
<PAGE>
Exhibit 16
Computation of Performance Quotations
The Fund's 30-day yield for the period ended June 30, 1996 is calculated as
follows:
Formula:
6
30-Day Yield = 2[(a-b +1) -1]
---
cd
Where: a = dividends and interest earned during the period
b = expenses accrued for the period (net of reimbursements)
c = the average daily number of shares outstanding during the
period that were entitled to receive dividends
d = the maximum offering price per share on the last day of the
period
6
4.36% = 2 88,997.36 - 16,529.24 + 1] -1
----------------------
(1,820,411.554) (11.06)
Average annual total return figures for the current one year and five year
periods and for the life of the Fund (beginning January 28, 1988) to the period
ending June 30, 1996 are calculated as follows:
n 1/n
Formula: P(1+T) = ERV; or T = (ERV/P) -1
Where: P = hypothetical initial investment 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
One year period:
.06% = 1,000.62 -1
--------
1000
Five year period:
1/5
5.41% = 1,301.43 -1
--------
1000
Life of Fund (from January 28, 1988)
1/8.42
6.14% = 1,652.03 -1
--------
1000
<PAGE>
Tax Equivalent Yield figure for the period ended June 30, 1996 is calculated
as follows:
Formula: Tax Equivalent Yield = Yield
------
1-.396
7.11% = 4.36 x .9850
------------
.604
Cumulative total return figures for the period beginning August 1, 1984 ending
June 30, 1996 are calculated as follows:
Formula: CTR = ERV - P x 100
-------
P
Where: CTR = cumulative total return
ERV = ending redeemable value at the end of the
period of a hypothetical $1,000 payment
made at the beginning of the period
P = initial payment of $1,000
65.20% = 1,652.03 - $1,000 x 100
-----------------
$1,000
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 6
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
ANNUAL REPORT TO SHAREHOLDERS FOR THE STATE BOND MINNESOTA TAX-FREE INCOME FUND
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<CIK> 0000826037
<NAME> STATE BOND TAX FREE INCOME FUNDS, INC.
<SERIES>
<NUMBER> 1
<NAME> STATE BOND MINNESOTA TAX-FREE INCOME FUND
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1996
<PERIOD-START> JUL-01-1995
<PERIOD-END> JUN-30-1996
<INVESTMENTS-AT-COST> 18,268,298
<INVESTMENTS-AT-VALUE> 18,752,939
<RECEIVABLES> 401,182
<ASSETS-OTHER> 55,214
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 19,209,335
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 12,423
<TOTAL-LIABILITIES> 12,423
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 18,666,066
<SHARES-COMMON-STOCK> 1,818,405
<SHARES-COMMON-PRIOR> 1,713,138
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 46,205
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 484,641
<NET-ASSETS> 19,196,912
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 1,135,500
<OTHER-INCOME> 0
<EXPENSES-NET> 188,484
<NET-INVESTMENT-INCOME> 947,016
<REALIZED-GAINS-CURRENT> 53,432
<APPREC-INCREASE-CURRENT> (128,527)
<NET-CHANGE-FROM-OPS> 871,921
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 947,016
<DISTRIBUTIONS-OF-GAINS> 34,819
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 141,624
<NUMBER-OF-SHARES-REDEEMED> 121,469
<SHARES-REINVESTED> 85,112
<NET-CHANGE-IN-ASSETS> 1,018,959
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> 27,592
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 113,090
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 221,123
<AVERAGE-NET-ASSETS> 18,848,333
<PER-SHARE-NAV-BEGIN> 10.61
<PER-SHARE-NII> 0.53
<PER-SHARE-GAIN-APPREC> (0.03)
<PER-SHARE-DIVIDEND> 0.53
<PER-SHARE-DISTRIBUTIONS> 0.02
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 10.56
<EXPENSE-RATIO> 1.00
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
