CONTENTS

 

 

COMPANY HISTORY		1
INVESTMENT RESTRICTIONS		1
INVESTMENT POLICIES		2
OFFICERS AND DIRECTORS		19
CODE OF ETHICS AND PROXY VOTING POLICIES AND PROCEDURES		24
INVESTMENT ADVISORY AND OTHER SERVICES		25
PORTFOLIO TRANSACTIONS AND BROKERAGE		31
TAXATION OF THE FUNDS		33
CAPITAL STOCK		34
CONTROL PERSONS, PRINCIPAL HOLDERS, AND MANAGEMENT OWNERSHIP		35
BUYING AND SELLING SHARES		36
PRICING OF SHARES		38
FINANCIAL STATEMENTS		39
APPENDIX A – PROXY VOTING PROCEDURES		A-1

Fundamental Investment Policies and Restrictions

Each Fund has adopted certain investment restrictions as fundamental policies.  A fundamental policy may only be changed if the change is approved by (i) more than 50% of the relevant Fund’s outstanding shares or (ii) 67% or more of the relevant Fund’s shares present at a shareholder meeting, if more than 50% of the Fund’s outstanding shares are represented at the meeting in person or by proxy, whichever is less.

As a matter of fundamental policy, the Funds may not:

1.      Purchase or sell commodities, commodity contracts (except in conformity with regulations of the Commodities Futures Trading Commission such that the Fund would not be considered a commodity pool), or oil and gas interests or real estate.  Securities or other instruments backed by commodities are not considered commodities or commodity contracts for purposes of this restriction.  Debt or equity securities issued by companies engaged in the oil, gas, or real estate businesses are not considered oil or gas interests or real estate for purposes of this restriction.  First mortgage loans and other direct obligations secured by real estate are not considered real estate for purposes of this restriction.

2.      Make loans, except to the extent the purchase of debt obligations of any type are considered loans and except that each Fund may lend portfolio securities to qualified institutional investors in compliance with requirements established from time to time by the SEC and the securities exchanges on which such securities are traded.

 

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3.      Issue securities senior to its stock or borrow money or utilize leverage in excess of the maximum permitted by the Investment Company Act of 1940, as amended (the “1940 Act”), which is currently 33 1/3% of total assets (including 5% for emergency or other short-term purposes).

4.      Invest more than 25% of the value of its assets in a particular industry (except that U.S. government securities are not considered an industry).

5.      Act as an underwriter except to the extent the Fund may be deemed to be an underwriter when disposing of securities it owns or when selling its own shares.

6.      Except as may be described in the Prospectus, purchase securities on margin.

The term prospectus as referenced in restriction 6 includes this SAI.

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INVESTMENT POLICIES

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General

Each Fund’s investment objectives and principal investment strategies are described in the prospectus.  The following information supplements, and should be read in conjunction with, the prospectus.  For a description of certain permitted investments discussed below, see the section entitled, “Description of Permitted Investments” in this SAI.

Investment Techniques

Certain words or phrases used in the prospectus or this SAI may be used in descriptions of a Funds’ investment policies and strategies to give investors a general sense of a Fund’s level of investment.  They are broadly identified with, but not limited to, the following percentages of a Fund’s total assets:

“small portion”	less than 10%
“portion”	10% to 25%
“significant”	25% to 50%
“substantial”	50% to 66%
“primary”	66% to 80%
“predominant”	80% or more

The percentages above are not intended to be precise, nor are they limitations unless specifically stated as such in the Prospectus or elsewhere in this SAI.

The value of your shares in a Fund will increase as the value of the securities owned by such Fund increases and will decrease as the value of the Fund’s investments decrease.  In this way, you participate in any change in the value of the securities owned by a Fund.  In addition to the factors that affect the value of any particular security that a Fund owns, the value of such Fund’s shares may also change with movements in the stock and bond markets as a whole.

Capital Appreciation Fund

 

The Capital Appreciation Fund’s investment objective is capital appreciation.  This goal is fundamental, and may not be changed by the Board without the consent of shareholders.  There can be no assurance that the Capital Appreciation Fund will be able to achieve its investment objective.  The Capital Appreciation Fund is classified as a “diversified” investment company under the 1940 Act. This is a fundamental investment policy of the Fund, which may not be changed without a shareholder vote.

 

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A “diversified” investment company is an investment company for which at least 75% of its total assets is represented by cash and cash items, Government securities, securities of other investment companies and other securities for purposes of this calculation, limited in respect of any one issuer to an amount not greater in value than 5% of the value of the company’s total assets and to no more than 10% of the outstanding voting securities of such issuer.

The general investment policy of the Capital Appreciation Fund is to invest in securities using a value orientation consisting of bottom-up fundamental value analysis with an emphasis on balance sheet strength.  In pursuit of its value oriented strategy, the Capital Appreciation Fund will invest without regard to market capitalization.

Opportunity Fund

 

The Opportunity Fund’s investment objective is capital appreciation.  This goal is fundamental, and may not be changed by the Board without the consent of shareholders.  There can be no assurance that the Opportunity Fund will be able to achieve its investment objective.  The Opportunity Fund is classified as a “diversified” investment company under the 1940 Act. This is a fundamental investment policy of the Fund, which may not be changed without a shareholder vote.

The general investment policy of the Opportunity Fund is to invest using the same value orientation as the Capital Appreciation Fund.  In pursuit of its value-oriented strategy, the Opportunity Fund will invest significantly in small-to-mid capitalization companies with market capitalizations at the time of investment in the range of between $150 million and $15 billion.

Description of Permitted Investments

Each Fund will invest in equity securities, including securities convertible, exchangeable for, or expected to be exchanged into common stock (including convertible preferred and convertible debt securities).  There are no limitations on the percentage of each Fund’s assets that may be invested in equity securities, debt securities, or convertible securities.  The Funds reserve freedom of action to invest in these securities in such proportions as the Funds’ investment manager, Prospector Partners Asset Management, LLC, (the “Investment Manager,” or alternatively, “Prospector Partners Asset Management”) deems advisable.  The Funds may also invest in foreign securities and other investment company securities.

Each Fund may invest in any industry although it will not concentrate its investments in any one industry.

Each Fund may invest in securities that are traded on U.S. or foreign securities exchanges, the National Association of Securities Dealers Automated Quotation System (“NASDAQ”) national market system or in any domestic or foreign over-the-counter (“OTC”) market.  U.S. or foreign securities exchanges typically represent the primary trading market for U.S. and foreign securities.  A securities exchange brings together buyers and sellers of the same securities.  The NASDAQ national market system also brings together buyers and sellers of the same securities through an electronic medium which facilitates a sale and purchase of the security.  Many companies whose securities are traded on the NASDAQ national market system are smaller than the companies whose securities are traded on a securities exchange.  The OTC market refers to all other avenues whereby brokers bring together buyers and sellers of securities.

The following is a description of the various types of securities the Fund may buy and techniques it may use.

Equity Securities

Equity securities represent a proportionate share of the ownership of a company; their value is based on the success of the company’s business and the value of its assets, as well as general market conditions.  The purchaser of an equity security typically receives an ownership interest in the company as well as certain voting rights.  The owner of an equity security may participate in a company’s success through the receipt of dividends, which are distributions of earnings by the company to its owners.  Equity security owners also may participate in a company’s success or lack of success through increases or decreases in the value of the company’s shares as traded in the public trading market for such shares.  Equity securities generally are either common stock or preferred stock, as well as securities convertible into common stocks.  Preferred stockholders usually receive greater dividends but may receive less appreciation than common stockholders and may have different voting rights as well.  Equity securities may also include convertible securities, warrants, or rights.  Warrants or rights give the holder the right to buy an equity security at a given time for specified price.

 

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Convertible Securities

Convertible securities are debt securities, or in some cases preferred stock, that have the additional feature of converting into, exchanging or expecting to be exchanged for, common stock of a company after certain periods of time or under certain circumstances.  Holders of convertible securities gain the benefits of being a debt holder or preferred stockholder and receiving regular interest payments, in the case of debt securities, or higher dividends, in the case of preferred stock, with the possibility of becoming a common stockholder in the future.  A convertible security’s value normally reflects changes in the company’s underlying common stock value.

As with a straight fixed-income security, a convertible security tends to increase in market value when interest rates decline and decrease in value when interest rates rise.  Like a common stock, the value of a convertible security also tends to increase as the market value of the underlying stock rises, and it tends to decrease as the market value of the underlying stock declines.  Because both interest rate and market movements can influence its value, a convertible security is not as sensitive to interest rates as a similar fixed-income security, nor is it as sensitive to changes in share price as its underlying stock.

A convertible security tends to be senior to the issuer’s common stock, but subordinate to other types of fixed-income securities issued by that company.  A convertible security may be subject to redemption by the issuer, but only after a specified date and under circumstances established at the time the security is issued.  When a convertible security issued by an operating company is “converted,” the issuer often issues new stock to the holder of the convertible security.  However, if the convertible security is redeemable and the parity price of the convertible security is less than the call price, the issuer may pay out cash instead of common stock.

Smaller Companies

Each Fund may invest in securities issued by smaller companies.  Historically, smaller company securities have been more volatile in price than larger company securities, especially over the short term.  Among the reasons for the greater price volatility are the less certain growth prospects of smaller companies, the lower degree of liquidity in the markets for such securities, and the greater sensitivity of smaller companies to changing economic conditions.

In addition, smaller companies may lack depth of management, may be unable to generate funds necessary for growth or development, their products or services may be concentrated in one area, or they may be developing or marketing new products or services for which markets are not yet established and may never become established.

Hedging and Income Transactions

Each Fund may use various hedging strategies.  Hedging is a technique designed to reduce a potential loss to a Fund as a result of certain economic or market risks, including risks related to fluctuations in interest rates, currency exchange rates between U.S. and foreign securities or between different foreign currencies, and broad or specific market movements.  The hedging strategies that a Fund may use are also used by many mutual funds and other institutional investors.  When pursuing these hedging strategies, each Fund will primarily engage in forward foreign currency exchange contracts.  However, each Fund also may engage in the following currency transactions:  currency futures contracts, currency swaps, options on currencies, or options on currency futures.  In addition, each Fund may engage in other types of transactions, such as the purchase and sale of exchange-listed and OTC put and call options on securities, equity and fixed-income indices and other financial instruments; and, the purchase and sale of financial and other futures contracts and options on futures contracts (collectively, all of the above are called “Hedging Transactions”).

Some examples of situations in which Hedging Transactions may be used are:  (i) to attempt to protect against possible changes in the market value of securities held in or to be purchased for a Fund’s portfolio resulting from changes in securities markets or currency exchange rate fluctuations; (ii) to protect a Fund’s gains in the value of portfolio securities which have not yet been sold; (iii) to facilitate the sale of certain securities for investment purposes; and (iv) as a temporary substitute for purchasing or selling particular securities.

Any combination of Hedging Transactions may be used at any time as determined by the Investment Manager.  Use of any Hedging Transaction is a function of numerous variables, including market conditions and the Investment Manager’s expertise in utilizing such techniques.  The ability of a Fund to utilize Hedging Transactions successfully cannot be assured.  Each Fund will comply with applicable regulatory requirements when implementing these strategies, including the segregation of assets by proper notation on the books of the custodian bank.  Hedging Transactions involving futures and options on futures will be purchased, sold or entered into generally for hedging, risk management or portfolio management purposes.

 

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The various techniques described above as Hedging Transactions also may be used by each Fund for non-hedging purposes.  For example, these techniques may be used to produce income to a Fund where the Fund’s participation in the transaction involves the payment of a premium to the Fund.  Each Fund also may use a Hedging Transaction if the Investment Manager has a view about the fluctuation of certain indices, currencies or economic or market changes such as a reduction in interest rates.

Hedging Transactions, whether entered into as a hedge or for income, have risks associated with them.  The three most significant risks associated with Hedging Transactions are:  (i) possible default by the other party to the transaction; (ii) illiquidity; and (iii) to the extent the Investment Manager’s view as to certain market movements is incorrect, the risk that the use of such Hedging Transactions could result in losses greater than if they had not been used.  Use of put and call options may (i) result in losses to a Fund, (ii) force the purchase or sale of portfolio securities at inopportune times or for prices higher than or lower than current market values, (iii) limit the amount of appreciation a Fund can realize on its investments, (iv) increase the cost of holding a security and reduce the returns on securities or (v) cause a Fund to hold a security it might otherwise sell.

Although the use of futures and options transactions for hedging should tend to minimize the risk of loss due to a decline in the value of the hedged position, these transactions also tend to limit any potential gain which might result from an increase in value of the position taken.  As compared to options contracts, futures contracts create greater ongoing potential financial risks to a Fund because the Fund is required to make ongoing monetary deposits with futures brokers.  Losses resulting from the use of Hedging Transactions can reduce the net asset value (“NAV”), and possibly income, and such losses can be greater than if the Hedging Transactions had not been utilized.  The cost of entering into Hedging Transactions also may reduce a Fund’s total return to investors.

When conducted outside the U.S., Hedging Transactions may not be regulated as rigorously as in the U.S., may not involve a clearing mechanism and related guarantees, and are subject to the risk of governmental actions affecting trading in, or the prices of, foreign securities, currencies and other instruments.  The value of such positions also could be adversely affected by:  (i) other complex foreign political, legal and economic factors, (ii) lesser availability than in the U.S. of data on which to make trading decisions, (iii) delays in a Fund’s ability to act upon economic events occurring in foreign markets during nonbusiness hours in the U.S., (iv) the imposition of different exercise and settlement terms and procedures and margin requirements than in the U.S., and (v) lower trading volume and liquidity.

Foreign Securities

Each Fund may purchase securities of non-U.S. issuers whose values are quoted and traded in any currency in addition to the U.S. dollar.  Such investments involve certain risks not ordinarily associated with investments in securities of U.S. issuers.  Such risks include:  fluctuations in the value of the currency in which the security is traded or quoted as compared to the U.S. dollar; unpredictable political, social and economic developments in the foreign country where the security is issued or where the issuer of the security is located; and the possible imposition by a foreign government of limits on the ability of a Fund to obtain a foreign currency or to convert a foreign currency into U.S. dollars; or the imposition of other foreign laws or restrictions.

Since each Fund may invest in securities issued, traded or quoted in currencies other than the U.S. dollar, changes in foreign currency exchange rates will affect the value of securities in a Fund’s portfolio.  When deemed advantageous to a Fund, the Investment Manager may attempt, from time to time, to reduce such risk, known as “currency risk,” by “hedging,” which attempts to reduce or eliminate changes in a security’s value resulting from changing currency exchange rates.  Hedging is further described above.  In addition, in certain countries, the possibility of expropriation of assets, confiscatory taxation, or diplomatic developments could adversely affect investments in those countries.  Expropriation of assets refers to the possibility that a country’s laws will prohibit the return to the U.S. of any monies which a Fund has invested in the country.  Confiscatory taxation refers to the possibility that a foreign country will adopt a tax law which has the effect of requiring a Fund to pay significant amounts, if not all, of the value of the Fund’s investment to the foreign country’s taxing authority.  Diplomatic developments means that because of certain actions occurring within a foreign country, such as significant civil rights violations or because of the United States’ actions during a time of crisis in the particular country, all communications and other official governmental relations between the country and the United States could be severed.  This could result in the abandonment of any U.S. investors’, such as a Fund’s, money in the particular country, with no ability to have the money returned to the United States.

 

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There may be less publicly available information about a foreign company than about a U.S. company.  Foreign issuers may not be subject to accounting, auditing and financial reporting standards and requirements comparable to, or as uniform as, those of U.S. issuers.  The number of securities traded, and the frequency of such trading, in non-U.S. securities markets, while growing in volume, is for the most part, substantially less than in U.S. markets.  As a result, securities of many foreign issuers are less liquid and their prices more volatile than securities of comparable U.S. issuers.  Transaction costs, the costs associated with buying and selling securities, on non-U.S. securities markets may be higher than in the U.S. There is generally less government supervision and regulation of exchanges, brokers and issuers than there is in the U.S.  A Fund’s foreign investments may include both voting and non-voting securities, sovereign debt and participations in foreign government deals.  A Fund may have greater difficulty taking appropriate legal action with respect to foreign investments in non-U.S. courts than with respect to domestic issuers in U.S. courts.

Rule 144A Securities

Each Fund may invest in unregistered securities which may be sold under Rule 144A under the Securities Act of 1933 (“144A securities”).  144A securities are restricted, which generally means that a legend has been placed on the share certificates representing the securities which states that the securities were not registered with the SEC when they were initially sold and may not be resold except under certain circumstances.  In spite of the legend, certain securities may be sold to other institutional buyers provided that the conditions of Rule 144A are met.  In the event that there is an active secondary institutional market for 144A securities, the 144A securities may be treated as liquid.  As permitted by the federal securities laws, the board of directors has adopted procedures in accordance with Rule 144A which govern when specific 144A securities may be deemed to be liquid.  Due to changing markets or other factors, 144A securities may be subject to a greater possibility of becoming illiquid than securities that have been registered with the SEC for sale.

Borrowing

Each Fund is permitted to borrow under certain circumstances, as described under “Fundamental Investment Policies” above.  Under no circumstances will either Fund make additional investments while any amounts borrowed exceed 5% of the Fund’s total assets.

Cash Equivalent Investments

Cash equivalent investments are investments in certain types of short-term debt securities.  A Fund making a cash equivalent investment expects to earn interest at prevailing market rates on the amount invested and there is little, if any, risk of loss of the original amount invested.  A Fund’s cash equivalent investments are typically made in obligations issued or guaranteed by the U.S. or other governments, their agencies or instrumentalities and high-quality commercial paper issued by banks, corporations or others.  Commercial paper consists of short-term debt securities which carry fixed or floating interest rates.  A fixed interest rate means that interest is paid on the investment at the same rate for the life of the security.  A floating interest rate means that the interest rate varies as interest rates on newly issued securities in the marketplace vary.

Debt Securities

A debt security typically has a fixed payment schedule which obligates the company to pay interest to the lender and to return the lender’s money over a certain time period.  A company typically meets its payment obligations associated with its outstanding debt securities before it declares and pays any dividends to holders of its equity securities.  While most debt securities are used as an investment to produce income to an investor as a result of the fixed payment schedule, debt securities also may increase or decrease in value.

The market value of debt securities generally varies in response to changes in interest rates and the financial condition of each issuer.  During periods of declining interest rates, the value of debt securities generally increases.  Conversely, during periods of rising interest rates, the value of such securities generally declines.  These changes in market value will be reflected in a Fund’s NAV.  These increases or decreases are more significant for longer duration debt securities.

Each Fund may invest in a variety of debt securities, including bonds and notes issued by domestic or foreign corporations and the U.S. or foreign governments and their agencies and instrumentalities.  Bonds and notes differ in the length of the issuer’s repayment schedule.  Bonds typically have a longer payment schedule than notes.  Typically, debt securities with a shorter repayment schedule pay interest at a lower rate than debt securities with a longer repayment schedule.

 

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The debt securities which each Fund may purchase may either be unrated, or rated in any rating category established by one or more independent rating organizations, such as Standard & Poor’s Ratings Group (“S&P”) or Moody’s Investors Service (“Moody’s”).  Securities are given ratings by independent rating organizations, which grade the company issuing the securities based upon its financial soundness.  Each Fund may invest in securities that are rated in the medium to lowest rating categories by S&P and Moody’s.  Generally, lower rated and unrated debt securities are riskier investments.  Debt securities rated BB or lower by S&P or Moody’s are considered to be high yield, high risk debt securities, commonly known as “junk bonds.” The lowest rating category established by Moody’s is “C” and by S&P is “D.” Debt securities with a D rating are in default as to the payment of principal and interest, which means that the issuer does not have the financial soundness to meet its interest payments or its repayment schedule to security holders.  These ratings represent the opinions of the rating services with respect to the issuer’s ability to pay interest and repay principal.  They do not purport to reflect the risk of fluctuations in market value and are not absolute standards of quality.

If the rating on an issue held in a Fund’s portfolio is changed by the rating service or the security goes into default, this event will be considered by the Investment Manager in its evaluation of the overall investment merits of that security, but will not generally result in an automatic sale of the security.

Each Fund generally will invest in debt securities under circumstances similar to those under which they will invest in equity securities; namely, when, in the Investment Manager’s opinion, such debt securities are available at prices less than their intrinsic value.  Investing in fixed-income securities under these circumstances may lead to the potential for capital appreciation.  Consequently, when investing in debt securities, a debt security’s rating is given less emphasis in the Investment Manager’s investment decision-making process.  Each Fund may invest in debt securities issued by domestic or foreign companies that are, or are about to be, involved in reorganizations, financial restructurings or bankruptcy (“Distressed Companies”), because such securities often are available at less than their intrinsic value.  Debt securities of such companies typically are unrated, lower rated, in default or close to default.  While posing a greater risk than higher rated securities with respect to payment of interest and repayment of principal at the price at which the debt security was originally issued, a Fund will generally purchase these debt securities at discounts to the original principal amount.  Such debt typically ranks senior to the equity securities of Distressed Companies and may offer the potential for capital appreciation and additional investment opportunities.

Medium and Lower Rated Corporate Debt Securities

Each Fund may invest in securities of Distressed Companies when the intrinsic values of such securities, in the opinion of the Investment Manager, warrant such investment.  Each Fund may invest in securities that are rated in the medium to lowest rating categories by S&P and Moody’s, some of which may be so-called “junk bonds.” Corporate debt securities rated Baa are regarded by Moody’s as being neither highly protected nor poorly secured.  Interest payments and principal security appear adequate to Moody’s for the present, but certain protective elements may be lacking or may be characteristically unreliable over any great length of time.  Such securities are regarded by Moody’s as lacking outstanding investment characteristics and having speculative characteristics.  Corporate debt securities rated BBB are regarded by S&P as having adequate capacity to pay interest and repay principal.  Such securities are regarded by S&P as normally exhibiting adequate protection parameters, although adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to pay interest and repay principal for securities in this rating category than in higher rated categories.  Companies issuing lower rated higher yielding debt securities are not as strong financially as those with higher credit ratings.  These companies are more likely to encounter financial difficulties and are more vulnerable to changes in the economy, such as a recession or a sustained period of rising interest rates, that could prevent them from making interest and principal payments.  If an issuer is not paying or stops paying interest and/or principal on its securities, payments on the securities may never resume.

Corporate debt securities that are rated B are regarded by Moody’s as generally lacking characteristics of the desirable investment.  In Moody’s view, assurance of interest and principal payments or of maintenance of other terms of the security over any long period of time may be small.  Corporate debt securities rated BB, B, CCC, CC and C are regarded by S&P on balance as predominantly speculative with respect to capacity to pay interest and repay principal in accordance with the terms of the obligation.  In S&P’s view, although such securities likely have some quality and protective characteristics, these are outweighed by large uncertainties or major risk exposures to adverse conditions.  BB and B are regarded by S&P as indicating the two lowest degrees of speculation and CC and CCC the two highest degrees of speculation in this group of ratings.

Securities rated D by S&P or C by Moody’s are in default and are not currently performing.

 

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Each Fund may also invest in unrated securities.  Each Fund will rely on the Investment Manager’s judgment, analysis and experience in evaluating such debt securities.  In this evaluation, the Investment Manager will take into consideration, among other things, the issuer’s financial resources, its sensitivity to economic conditions and trends, its operating history, the quality of the issuer’s management and regulatory matters as well as the price of the security.  The Investment Manager also may consider, although it does not rely primarily on, the credit ratings of Moody’s and S&P in evaluating lower rated corporate debt securities.  Such ratings evaluate only the safety of principal and interest payments, not market value risk.  Additionally, because the creditworthiness of an issuer may change more rapidly than is able to be timely reflected in changes in credit ratings, the Investment Manager monitors the issuers of corporate debt securities held in a Fund’s portfolios.  The credit rating assigned to a security is a factor considered by the Investment Manager in selecting a security for a Fund, but the intrinsic value in comparison to market price and the Investment Manager’s analysis of the fundamental values underlying the issuer are generally of greater significance.  Because of the nature of medium and lower rated corporate debt securities, achievement by a Fund of its investment objective when investing in such securities is dependent on the credit analysis of the Investment Manager.  If a Fund purchased primarily higher rated debt securities, such risks would be substantially reduced.

A general economic downturn or a significant increase in interest rates could severely disrupt the market for medium and lower grade corporate debt securities and adversely affect the market value of such securities.  Securities in default are relatively unaffected by such events or by changes in prevailing interest rates.  In addition, in such circumstances, the ability of issuers of medium and lower grade corporate debt securities to repay principal and to pay interest, to meet projected business goals and to obtain additional financing may be adversely affected.  Such consequences could lead to an increased incidence of default for such securities and adversely affect the value of the corporate debt securities in a Fund’s portfolio.  The secondary market prices of medium and lower grade corporate debt securities are less sensitive to changes in interest rates than are higher rated debt securities, but are more sensitive to adverse economic changes or individual corporate developments.  Adverse publicity and investor perceptions, whether or not based on rational analysis, also may affect the value and liquidity of medium and lower grade corporate debt securities, although such factors also present investment opportunities when prices fall below intrinsic values.  Yields on debt securities in a Fund’s portfolio that are interest rate sensitive can be expected to fluctuate over time.  In addition, periods of economic uncertainty and changes in interest rates can be expected to result in increased volatility of market price of any medium to lower grade corporate debt securities in a Fund’s portfolio and thus could have an effect on the NAV of the Fund if other types of securities did not show offsetting changes in values.  The prices of high yield debt securities fluctuate more than higher-quality securities.  Prices are often closely linked with the company’s stock prices and typically rise and fall in response to factors that affect stock prices.  In addition, the entire high yield securities market can experience sudden and sharp price swings due to changes in economic conditions, stock market activity, large sustained sales by major investors, a high-profile default, or other factors.

High yield securities are also generally less liquid than higher-quality bonds.  Many of these securities do not trade frequently, and when they do trade their prices may be significantly higher or lower than previously quoted market prices.  At times, it may be difficult to sell these securities promptly at an acceptable price, which may limit a Fund’s ability to sell securities in response to specific economic events or to meet redemption requests.  The secondary market value of corporate debt securities structured as zero coupon securities or payment in kind securities may be more volatile in response to changes in interest rates than debt securities which pay interest periodically in cash.  Because such securities do not pay current interest, but rather, income is accreted, to the extent that a Fund does not have available cash to meet distribution requirements with respect to such income, it could be required to dispose of portfolio securities that it otherwise would not.  Such disposition could be at a disadvantageous price.  Failure to satisfy distribution requirements could result in a Fund failing to qualify as a pass-through entity under the Internal Revenue Code of 1986, as amended (the “Code”).  Investment in such securities also involves certain other tax considerations.

The Investment Manager values each Fund’s investments pursuant to guidelines adopted and periodically reviewed by the Board.  To the extent that there is no established retail market for some of the medium or lower grade or unrated corporate debt securities in which a Fund may invest, there may be thin or no trading in such securities and the ability of the Investment Manager to accurately value such securities may be adversely affected.  Further, it may be more difficult for a Fund to sell such securities in a timely manner and at their stated value than would be the case for securities for which an established retail market did exist.  The effects of adverse publicity and investor perceptions may be more pronounced for securities for which no established retail market exists as compared with the effects on securities for which such a market does exist.  During periods of reduced market liquidity and in the absence of readily available market quotations for medium and lower grade and unrated corporate debt securities held in a Fund’s portfolio, the responsibility of the Investment Manager to value the Fund’s securities becomes more difficult and the Investment Manager’s judgment may play a greater role in the valuation of the Fund’s securities due to a reduced availability of reliable objective data.

 

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Depositary Receipts

Each Fund may invest in securities commonly known as American Depositary Receipts (“ADRs”), European Depositary Receipts (“EDRs”) or Global Depositary Receipts (“GDRs”) of non-U.S. issuers.  Such depositary receipts are interests in a non-U.S. company’s securities which have been deposited with a bank or trust company.  The bank or trust company then sells interests to investors in the form of depositary receipts.  Depositary receipts can be unsponsored or sponsored by the issuer of the underlying securities or by the issuing bank or trust company.  ADRs are certificates issued by a U.S. bank or trust company and represent the right to receive securities of a foreign issuer deposited in a domestic bank or foreign branch of a U.S. bank and traded on a U.S. exchange or in an over-the-counter market.  EDRs are receipts issued in Europe generally by a non-U.S. bank or trust company that evidence ownership of non-U.S. or domestic securities.  Generally, ADRs are in registered form and EDRs are in bearer form.  There are no fees imposed on the purchase or sale of ADRs or EDRs although the issuing bank or trust company may impose charges for the collection of dividends and the conversion of ADRs and EDRs into the underlying securities.  Investment in ADRs may have certain advantages over direct investment in the underlying non-U.S. securities, since:  (i) ADRs are U.S. dollar denominated investments which are often easily transferable and for which market quotations are generally readily available and (ii) issuers whose securities are represented by ADRs are subject to the same auditing, accounting and financial reporting standards as domestic issuers.  EDRs are not necessarily denominated in the currency of the underlying security.

Depositary receipts of non-U.S. issuers may have certain risks, including trading for a lower price, having less liquidity than their underlying securities and risks relating to the issuing bank or trust company.  Holders of unsponsored depositary receipts have a greater risk that receipt of corporate information and proxy disclosure will be untimely, information may be incomplete and costs may be higher.

Emerging Markets Investments

Investments by each Fund in companies domiciled in emerging market countries may be subject to potentially higher risks than investments in developed countries.  These risks include (i) less economic stability; (ii) political and social uncertainty (for example, regional conflicts and risk of war); (iii) pervasiveness of corruption and crime; (iv) the small current size of the markets for such securities and the currently low or nonexistent volume of trading, which result in a lack of liquidity and in greater price volatility; (v) delays in settling portfolio transactions; (vi) risk of loss arising out of the system of share registration and custody; (vii) certain national policies that may restrict a Fund’s investment opportunities, including restrictions on investment in issuers or industries deemed sensitive to national interests; (viii) foreign taxation; (ix) the absence of developed legal structures governing private or foreign investment or allowing for judicial redress for injury to private property; (x) the absence of a capital market structure or market-oriented economy; and (xi) the possibility that recent favorable economic developments may be slowed or reversed by unanticipated political or social events.

In addition, many countries in which a Fund may invest have experienced substantial, and in some periods extremely high, rates of inflation for many years.  Inflation and rapid fluctuations in inflation rates have had and may continue to have negative effects on the economies and securities markets of certain countries.  Moreover, the economies of some developing countries may differ favorably or unfavorably from the U.S. economy in such respects as growth of gross domestic product, rate of inflation, currency depreciation, capital reinvestment, resource self-sufficiency, and balance of payments position.

Currency Transactions

Each Fund may from time to time engage in currency transactions with securities dealers, financial institutions or other parties (each a “Counterparty” and collectively, “Counterparties”) in order to hedge the value of portfolio holdings denominated in particular currencies against fluctuations in relative value between those currencies and the U.S. dollar.  Currency transactions include forward foreign currency exchange contracts, exchange-listed currency futures, exchange-listed and OTC options on currencies, and currency swaps.

A forward foreign currency exchange contract involves a privately negotiated obligation to purchase or sell (with delivery generally required) a specific currency at a future date, which may be any fixed number of days from the date of the contract agreed upon by the parties, at a price set at the time of the contract.  A currency swap is an agreement between a Fund and, typically, a brokerage firm, bank or other institutional party, to exchange cash flows on a notional amount of two or more currencies based on the relative value differential among them.  In some currency swap agreements, the swap agreement may include the delivery of the entire principal value of one designated currency for the other designated currency.

 

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Each Fund will usually enter into swaps on a net basis, which means the two payment streams are netted out in a cash settlement on the payment date or dates specified in the instrument, with the Fund receiving or paying, as the case may be, only the net amount of the two payments.  Each Fund will accrue its obligations under a swap agreement daily (offset by any amounts the counterparty owes the Fund).  If the swap agreement provides for other than a net basis, the full amount of the Fund’s obligations will be accrued on a daily basis.  To limit potential leveraging of the Fund’s portfolio, each Fund has adopted procedures to cover any accrued but unpaid net or full amounts owed to a swap counterparty by designating, on a daily basis, as segregated, liquid assets (not otherwise encumbered) equal in current market value to such swap amounts owed.  Under the procedures, each Fund designates the segregated assets by appropriate notation on the books of the Fund or its custodian.  To the extent a Fund enters into swap agreements for good faith hedging purposes and the Fund’s swap obligations are fully covered by an offsetting asset or right of the Fund, the obligations will not be subject to the Fund’s segregated assets procedures.  The Investment Manager and each Fund believe that swap agreement obligations that are covered, either by an offsetting asset or right or by the Fund’s segregated assets procedures (or a combination thereof), are not senior securities under the 1940 Act and are not subject to the Fund’s borrowing restrictions.

The use of swap transactions is a highly specialized activity, which involves investment techniques and risks different from those associated with ordinary portfolio securities transactions.  Whether a Fund will be successful in using swap agreements to achieve its investment objective depends on the ability of the Investment Manager correctly to predict which types of investments are likely to produce greater returns.  If the Investment Manager, in using swap agreements, is incorrect in its forecasts of market values, interest rates, currency exchange rates or other applicable factors, the investment performance of a Fund will be less than its performance would be using other investments.

The risk of loss to a Fund for swap transactions on a net basis depends on which party is obligated to pay the net amount to the other party.  If the counterparty is obligated to pay the net amount to the Fund, the risk of loss to the Fund is loss of the entire amount that the Fund is entitled to receive.  If the Fund is obligated to pay the net amount, the Fund’s risk of loss is limited to that net amount.  If the swap agreement involves the exchange of the entire principal value of a security, the entire principal value of that security is subject to the risk that the other party to the swap will default on its contractual delivery obligations.

Because swap agreements may have terms of greater than seven days, they may be illiquid and, therefore, subject to the Fund’s limitation on investments in illiquid securities.  If a swap transaction is particularly large or if the relevant market is illiquid, the Fund may not be able to establish or liquidate a position at an advantageous time or price, which may result in significant losses.  The swap markets have grown substantially in recent years, however, with a large number of banks and investment banking firms acting both as principals and agents, utilizing standardized swap documentation.  As a result, the swap markets have become relatively liquid in comparison with markets for other derivative instruments that are traded in the interbank market.

Swap agreements are not traded on exchanges and are not subject to government regulation like exchange markets.  As a result, swap participants are not as protected as participants on organized exchanges.  Performance of a swap agreement is the responsibility only of the swap counterparty and not of any exchange or clearinghouse.  As a result, each Fund is subject to the risk of the inability or refusal to perform such agreement by the counterparty.  No limitations on daily price movements or speculative position limits apply to swap transactions.  Counterparties may, however, limit the size or duration of positions to the Fund as a consequence of credit considerations.  Each Fund risks the loss of the accrued but unpaid amount under a swap agreement, which could be substantial, in the event of default by or insolvency or bankruptcy of a swap counterparty.  In such an event, each Fund will have contractual remedies pursuant to the swap agreements, but bankruptcy and insolvency laws could affect the Fund’s rights as a creditor.  If the counterparty’s creditworthiness declines, the value of a swap agreement would be likely to decline, potentially resulting in losses.

Each Fund may enter into currency transactions with counterparties which have received (or the guarantors of the obligations of such counterparties have received) a credit rating of A-1 or P-1 by S&P or Moody’s, respectively, or that have an equivalent rating from a nationally recognized statistical rating organization (“NRSRO”) or are determined to be of equivalent credit quality by the Investment Manager.  If there is a default by the counterparty, the Fund may have contractual remedies pursuant to the agreements related to the transaction.

Each Fund will limit its dealings in forward foreign currency exchange contracts and other currency transactions such as futures, options, options on futures and swaps to either specific transactions or portfolio positions.  Transaction hedging is entering into a currency transaction with respect to specific assets or liabilities of a Fund, which will generally arise in connection with the purchase or sale of its portfolio securities or the receipt of income from portfolio securities.  Position hedging is entering into a currency transaction with respect to portfolio security positions denominated or generally quoted in that currency.

 

Each Fund has filed a notice with the National Futures Association claiming exclusion from the definition of the term “commodity pool operator” under the Commodity Exchange Act (the “Act”) and therefore the Funds are not subject to registration or regulation as a commodity pool operators under the Act.

Options on Securities Indices and Other Financial Indices

Each Fund may purchase and sell call and put options on securities indices and other financial indices and in so doing can achieve many of the same objectives it would achieve through the sale or purchase of options on individual securities or other instruments.  Options on securities indices and other financial indices are similar to options on a security or other instrument except that, instead of settling by physical delivery of the underlying instrument, they settle by cash settlement, i.e., an option on an index gives the holder the right to receive, upon exercise of the option, an amount of cash if the closing level of the index upon which the option is based exceeds, in the case of a call, or is less than, in the case of a put, the exercise price of the option (except if, in the case of an OTC option, physical delivery is specified).  This amount of cash is equal to the excess of the closing price of the index over the exercise price of the option, which also may be multiplied by a formula value.  The seller of the option is obligated, in return for the premium received, to make delivery of this amount.  The gain or loss on an index depends on price movements in the instruments making up the market, market segment, industry or other composite on which the underlying index is based, rather than price movements in individual securities, as is the case with respect to options on securities.

Futures

Each Fund may enter into financial and other futures contracts or purchase or sell put and call options on such futures as a hedge against anticipated interest rate, currency or equity market changes, for duration management and for risk management purposes.  Futures are generally bought and sold on the commodities exchanges where they are listed with payment of initial and variation margin as described below.  The sale of a futures contract creates a firm obligation by a Fund, as seller, to deliver to the buyer the specific type of financial instrument or other commodity called for in the contract at a specific future time for a specified price (or, with respect to index futures and Eurodollar instruments, the net cash amount).  Options on futures contracts are similar to options on securities, except that an option on a futures contract gives the purchaser the right in return for the premium paid to assume a position in a futures contract and obligates the seller to deliver such option.

The Funds’ use of futures and options on futures will be consistent with applicable regulatory requirements and, in particular, the rules of the Commodity Futures Trading Commission and such transactions will be entered into only for hedging, risk management (including duration management) or other portfolio management purposes.  Typically, maintaining a futures contract or selling an option on a futures contract, requires the relevant Fund to deposit with a financial intermediary, as security for its obligations, an amount of cash or other specified assets (initial margin) which initially is typically 1% to 10% of the face amount of the contract (but may be higher in some circumstances).  Additional cash or assets (variation margin) may be required to be deposited thereafter on a daily basis as the mark-to-market value of the contract fluctuates.  The purchase of an option on futures involves payment of a premium for the option without any further obligation on the part of the Fund.  If a Fund exercises an option on a futures contract, it will be obligated to post initial margin (and potential subsequent variation margin) for the resulting futures positions just as it would for any position.  Futures contracts and options on futures contracts are generally settled by entering into an offsetting transaction, but there can be no assurance that the position can be offset prior to settlement at an advantageous price nor that delivery will occur.

Each Fund will only invest in futures contracts after complying with the requirements of the CFTC.

 

	Portfolio Turnover During Fiscal Periods Ended December 31
	2008	2007*
Capital Appreciation Fund	21%	5%
Opportunity Fund	66%	18%

OFFICERS AND DIRECTORS

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Officers and Directors

The Board is responsible for managing the business affairs of the Company and the Funds and exercising all of its powers except those reserved for shareholders.  The Board consists of five Directors, four of whom are not “interested persons” (as defined in the 1940 Act) of the Company (the “Independent Board Members”).  The following table gives information about each Board member and the senior officers of the Company.  Each Director and officer holds office until the person resigns, is removed, or replaced.  Unless otherwise noted, the persons have held their principal occupations for more than five years.  The address for all Directors and officers is 370 Church Street, Guilford, Connecticut 06437, unless otherwise indicated.

Name and Year of Birth		Position		Term of Office and Length of Time Served		Principal Occupation During Past 5 Years		Number of Portfolios in Fund Complex Overseen by Director	Other Directorships Served
Independent Board Members
Harvey D. Hirsch* Year of Birth: 1941		Director		Indefinite; Since September 7, 2007		Senior Vice President, Marketing, Van Eck Associates Corporation, an investment adviser, since May 2007.   Independent (self-employed) marketing consultant from 1996 to May 2007.		2	None
Joseph Klein III* Year of Birth: 1961		Director		Indefinite; Since September 7, 2007		Managing Director of Gauss Capital Advisors, LLC, a financial consulting and investment advisory firm focused on biopharmaceuticals since he founded the company in March 1998.   Founding Venture Partner of Red Abbey Venture Partners, LP, a private health venture fund, since September 2003.		2	BioMarin Pharmaceutical, Inc.   ISIS Pharmaceuticals, Inc.   OSI Pharmaceuticals, Inc.   Savient Pharmaceuticals, Inc.   PDL BioPharma Inc.

 

 

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Name and Year of Birth

Position

Term of Office and Length of Time Served

Principal Occupation During Past 5 Years

Number of Portfolios in Fund Complex Overseen by Director

Other Directorships Served

Roy L. Nersesian* Year of Birth: 1939		Director		Indefinite; Since September 7, 2007		Associate professor of the School of Business, Monmouth University, since September 1985.   Adjunct Professor of the Center for Energy and Marine Transportation, Columbia University, since September 2000.   Consultant, Poten & Partners, provider of brokerage and consulting services to the energy and ocean transportation industries, since September 1992.		2	None
John T. Rossello, Jr.* Year of Birth: 1951		Director		Indefinite; Since September 7, 2007		Retired.   Partner at PricewaterhouseCoopers LLP, an accounting firm, from October 1988 to June 2007.		2	None
Interested Board Members and Officers
John D. Gillespie † * Year of Birth: 1959		Director President		Indefinite; Since September 7, 2007		Managing member of the Investment Manager.  Managing member of Prospector Partners, LLC, an affiliate of the Investment Manager, and portfolio manager of the investment funds sponsored by Prospector Partners, LLC since 1997.   Chairman and President of White Mountains Advisors, an investment adviser, from 2002 to 2005.		2	White Mountains Insurance Group, Ltd.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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Name and Year of Birth

Position

Term of Office and Length of Time Served

Principal Occupation During Past 5 Years

Number of Portfolios in Fund Complex Overseen by Director

Other Directorships Served

Richard P. Howard Year of Birth: 1946		Executive Vice President		Indefinite; Since September 7, 2007		Portfolio Manager at the Investment Manager.  Portfolio Manager at Prospector Partners, LLC since August 2005.   Managing Director of White Mountains Advisors, LLC from 2001 to August 2005.   Senior Vice President of OneBeacon Insurance Group from 2001 to August 2005.		N/A	OneBeacon Insurance Group, Ltd.
Kevin R. O’Brien Year of Birth: 1963		Executive Vice President		Indefinite; Since September 7, 2007		Portfolio Manager at the Investment Manager.  Portfolio Manager at Prospector Partners, LLC since April 2003.   Managing Director of White Mountains Advisors, LLC from April 2003 to August 2005.		N/A	None
Peter N. Perugini, Jr. Year of Birth: 1970		Secretary Treasurer		Indefinite; Secretary since September 7, 2007   Indefinite; Treasurer since June 6, 2007		Chief Financial Officer at Prospector Partners, LLC since 2000.   Controller of Prospector Partners, LLC from 1997-2000.		N/A	None
Kim Just Year of Birth: 1967		Chief Compliance Officer		Indefinite; Since September 7, 2007		Chief Compliance Officer at Prospector Partners, LLC since March 2006.   Manager, Whittlesey & Hadley, P.C., an accounting services firm from September 1997 to March 2006.		N/A	None

 

 

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Name and Year of Birth

Position

Term of Office and Length of Time Served

Principal Occupation During Past 5 Years

Number of Portfolios in Fund Complex Overseen by Director

Other Directorships Served

Brian Wiedmeyer Year of Birth: 1973		Assistant Secretary		Indefinite; Since September 7, 2007		Assistant Vice President for U.S. Bancorp Fund Services, LLC, a mutual fund service provider, since January 2005.   Accounting Operations Manager for UMB Fund Services, a mutual fund service provider, from 2003 to 2005.		N/A	None
Douglas Schafer Year of Birth: 1970		Assistant Secretary		Indefinite; Since September 7, 2007		Compliance Officer for U.S. Bancorp Fund Services, LLC, a mutual fund service provider, since April 2002.		N/A	None

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

* Each of the Company’s directors was elected by written consent of the sole shareholder of the Funds on September 7, 2007.

† John D. Gillespie is an interested director of the Fund because he is also the managing member of the Investment Manager.

Compensation

The Company intends to pay each Independent Director $25,000 per year.  The Company is a recently formed entity.  In addition, Board members are reimbursed by the Company for expenses incurred in connection with attending board meetings.  For its fiscal year ended December 31, 2008, the Funds paid the following compensation to its Independent Directors:

Name of Person and Position	Aggregate Compensation from Capital Appreciation Fund	Aggregate Compensation from Opportunity Fund	Pension or Retirement Benefits Accrued as Part of Fund Expenses	Estimated Annual Benefits upon Retirement	Total Compensation from Fund and Fund Complex Paid to Directors
Harvey D. Hirsch, Independent Director	$14,254	$10,746	$0	$0	$25,000
Joseph Klein III, Independent Director	$14,254	$10,746	$0	$0	$25,000
Roy L. Nersesian, Independent Director	$14,254	$10,746	$0	$0	$25,000
John T. Rossello, Jr., Independent Director	$14,254	$10,746	$0	$0	$25,000

 

 

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Fund Shares Owned by Board Members

As of December 31, 2008, the Directors owned shares of the Funds in the following dollar ranges, as indicated below:

 

Amount Invested Key
A.	$1 - $10,000
B.	$10,001 - $50,000
C.	$50,001 - $100,000
D.	Over $100,000

Independent Directors	Dollar Range of Equity Securities in the Capital Appreciation Fund	Dollar Range of Equity Securities in the Opportunity Fund	Aggregate Dollar Range of Equity Securities in all Registered Investment Companies Overseen by Director in Family of Investment Companies
Harvey D. Hirsch	B.	—	B.
Joseph Klein III	C.	D.	D.
Roy L. Nersesian	B.	—	B.
John T. Rossello, Jr.	D.	D.	D.
Interested Director
John D. Gillespie	D.	D.	D.

As of December 31, 2008, neither the Independent Board Members, nor members of their immediate families, own securities beneficially or of record in the Investment Manager, the Distributor, as defined below, or an affiliate of the Investment Manager or Distributor.

Board Committees

The Board maintains three standing committees:  the Audit Committee, the Valuation Committee, and the Nominating Committee.  The Audit Committee is generally responsible for recommending the selection of the Company’s independent registered public accounting firm (“auditors”), including evaluating their independence and meeting with such auditors to consider and review matters relating to the Company’s financial reports and internal accounting.  During the fiscal year ended December 31, 2008, the Audit Committee met twice with respect to the Funds.

The Nominating Committee is generally responsible for nominating candidates for Independent Board Member positions and presenting such nominations to the Board.  When vacancies arise or elections are held, the Nominating Committee shall review candidates for, and make nominations of directors and committee members to the Board.  The Nominating Committee Charter does not contemplate the acceptance of candidates from shareholders. During the fiscal year ended December 31, 2008, the Nominating Committee did not meet with respect to the Funds.

 

 

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The Valuation Committee is generally responsible for, among other things, determining and monitoring the value of the Funds’ assets.  Additionally, it is also responsible for valuing securities held by the Funds for which current and reliable market quotations are not readily available.  During the fiscal year ended December 31, 2008, the Valuation Committee met six times with respect to the Funds.

Committee	Members
Audit Committee	Harvey D. Hirsch Roy L. Nersesian John T. Rossello, Jr.
Valuation Committee	John D. Gillespie Joseph Klein III Harvey D. Hirsch Richard P. Howard Kevin R. O’Brien Peter N. Perugini, Jr. Kim Just
Nominating Committee	Harvey D. Hirsch Joseph Klein III Roy L. Nersesian John T. Rossello, Jr.

 

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CODE OF ETHICS AND PROXY VOTING POLICIES AND PROCEDURES

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Code of Ethics

The Company, the Investment Manager, and the Distributor have each adopted codes of ethics pursuant to Rule 17j-1 of the 1940 Act.  These codes of ethics restrict personnel from investing in securities that are being considered for the Funds or that are currently held by the Funds.

Proxy Voting Policies and Procedures

The Board of Directors has delegated the responsibility to vote proxies for securities held in the Funds’ portfolios to the Investment Manager, subject to the Board’s oversight. The Investment Manager’s proxy voting policies, attached hereto as Appendix A, are reviewed periodically, and, accordingly are subject to change. Each Fund’s voting record relating to portfolio securities during the most recent twelve month period ended June 30, may be obtained upon request and without charge by calling toll free   (877) PFI-STOCK or (877) 734-7862, on the Fund’s website at www.prospectorfunds.com, and on the SEC’s website at http://www.sec.gov.

 

 

 

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INVESTMENT ADVISORY AND OTHER SERVICES

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INVESTMENT MANAGER AND SERVICES PROVIDED

The Funds’ Investment Manager is Prospector Partners Asset Management, LLC, a Delaware limited liability company controlled by John D. Gillespie and owned by Prospector Partners, LLC and Richard P. Howard.  Mr. John D. Gillespie is the managing member of Prospector Partners, LLC, and together with Kevin R. O’Brien, owns a majority of that entity.  Subject to the general supervision of the Directors, the Investment Manager provides investment advisory services to each Fund pursuant to an Advisory Agreement between the Company and the Investment Manager.  The Investment Manager, located at 370 Church Street, Guilford, CT 06437, is a registered investment advisor with the Securities and Exchange Commission.  The Investment Manager is responsible for developing the investment policies and guidelines for each of the Funds.

The Investment Manager provides investment research and portfolio management services, and selects the securities for each Fund to buy, hold or sell.  The Investment Manager also selects the brokers who execute each Fund’s portfolio transactions.  The Investment Manager provides periodic reports to the Board, which reviews and supervises the Investment Manager’s investment activities.  To protect each Fund, the Investment Manager and its officers, directors and employees are covered by fidelity insurance.

The Advisory Agreement remains in effect for a period of two years from the date of its effectiveness.  Subsequently, the Advisory Agreement must be approved at least annually by the Board or by majority vote of the shareholders, and in either case, by a majority of the Directors who are not parties to the Advisory Agreement or interested persons of any such party.

The Advisory Agreement is terminable without penalty by the Board or by majority vote of the relevant Fund’s outstanding voting securities (as defined by the 1940 Act) on 60 days’ written notice by either party and will terminate automatically upon assignment.

Management Fees

Each Fund pays the Investment Manager a fee equal to an annual rate of 1.10% of the average daily net assets of the Fund.

The fee is computed at the close of business on the last business day of each month, according to the terms of the Advisory Agreement.

The Funds paid the following management fees to the Investment Manager for the fiscal years shown:

	Management Fees Accrued by Investment Manager	Management Fees Waived	Management Fees Recouped	Net Management Fees Paid to Investment Manager
Fiscal year ended December 31, 2008
Capital Appreciation Fund	$173,103	$173,103	$0	$0
Opportunity Fund	$121,147	$121,147	$0	$0
Fiscal period ended December 31, 2007
Capital Appreciation Fund	$17,571	$17,571	$0	$0
Opportunity Fund	$13,247	$13,247	$0	$0

 

 

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Fund Expenses

In addition to the fees payable to the Investment Manager, the Company pays, its (i) operating expenses, including fees of its service providers, expenses of preparing prospectuses, proxy solicitation material and reports to shareholders, costs of custodial services and registering its shares under federal and state securities laws, pricing and insurance expenses, brokerage costs, interest charges, taxes and organization expenses and (ii) other expenses, including audit and legal expenses.

The Investment Manager has contractually agreed to waive a portion of its fees and/or pay Fund expenses (excluding interest, taxes and extraordinary expenses) in order to limit the Net Annual Fund Operating Expenses for each of the Funds to 1.50% of their respective average daily net assets (the “Expense Cap”).  The Expense Cap will remain in effect until the third anniversary of the date the Funds commenced operations, unless the Board of Directors approves its earlier termination or revision. The Investment Manager is permitted to recoup fee waivers and/or expense payments made in the prior three fiscal years from the date the fees were waived and/or Fund expenses were paid. This reimbursement may be requested by the Investment Manager if the aggregate amount actually paid by each Fund toward operating expenses for such fiscal year (taking into account the recoupment) does not exceed the Expense Cap.

PORTFOLIO MANAGERS

The Capital Appreciation Fund and the Opportunity Fund are managed by a team of John D. Gillespie, Richard P. Howard and Kevin R. O’Brien.  Mr. Howard acts as the lead member of the Capital Appreciation Fund’s portfolio management team. Mr. Gillespie and Mr. O’Brien act as the lead members of the Opportunity Fund’s portfolio management team.  Mr. Gillespie is the managing member of the Investment Manager and has veto power with respect to each investment made by the team.

Other Client Accounts

As of December 31, 2008, the Investment Manager was responsible for the day-to-day management of certain Other Client Accounts, as follows:

	Registered Investment Companies			Other Pooled Investment Vehicles			Other Accounts
Portfolio Manager	Number of Accounts	Total Assets		Number of Accounts	Total Assets		Number of Accounts	Total Assets
John D. Gillespie**	0	$0		6*	$509 million*		7 ∆	$278 million ∆
Kevin R. O’Brien**	0	$0		6*	$509 million*		7 ∆	$278 million ∆
Richard P. Howard	0	$0		1	$54 million		17	$1.199 billion

*	Accounts listed above are subject to a performance-based advisory fee.

**	John D. Gillespie and Kevin R. O’Brien share responsibility for the management of the Other Pooled Investment Vehicles and Other Accounts set forth beside their names above.

∆	One of the seven accounts listed, representing $30 million of total assets, is subject to a performance-based advisory fee.

The Investment Manager and its affiliates manage other institutional client accounts, including private pooled investment funds (collectively, “Other Client Accounts”).

The portfolio managers that comprise each portfolio management team are responsible for managing other accounts, including proprietary accounts, separate accounts and other pooled investment vehicles.  The members of the portfolio management team do not presently manage any other registered investment companies.  They manage separate accounts or other pooled investment vehicles which may have materially higher or different fee arrangements than the registrant and may also be subject to performance-based fees.

 

 

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The Investment Manager may give advice and take action with respect to any of the Other Client Accounts it manages, or for its own account, that may differ from action taken by the Investment Manager on behalf of a Fund.  Similarly, with respect to the Funds, the Investment Manager is not obligated to recommend, buy or sell, or to refrain from recommending, buying or selling any security that the Investment Manager and access persons, as defined by applicable federal securities laws, may buy or sell for its or their own account or for Other Client Accounts.  The Investment Manager is not obligated to refrain from investing in securities held by a Fund or Other Client Accounts it manages.

The Company and the Investment Manager have each adopted a code of ethics, as required by federal securities laws.  Under the code of ethics, employees who are designated as access persons may engage in personal securities transactions, but are restricted from purchasing securities that are being considered for the Funds or that are currently held by the Funds.  The personal securities transactions of access persons of the Funds and the Investment Manager will be governed by the code of ethics.  The code of ethics is on file with, and available from, the SEC.

Each Fund pays the Investment Manager a fee based on the assets under management of the Fund as set forth in the Advisory Agreement.  The Investment Manager and its affiliates pay its investment professionals out of its total revenues and other resources, including the advisory fee earned with respect to the Funds.

Compensation

The compensation structure of the Investment Manager and its affiliates is designed to attract and retain high caliber investment professionals necessary to deliver high quality investment management services to its clients.  The compensation of each of the portfolio managers includes a fixed base salary and incentive components.  It is expected that the portfolio managers will receive an incentive payment based on the revenues earned by the Investment Manager and its affiliates from the Funds and from Other Client Accounts.  It is expected that the incentive compensation component with respect to all portfolios managed by the portfolio managers can, and typically will, represent a significant portion of each portfolio manager’s overall compensation, and can vary significantly from year to year.

Ownership of Fund Shares

As of December 31, 2008, the Portfolio Managers owned shares of the Funds in the following dollar ranges, as indicated below:

Amount Invested Key
A.	$1 - $10,000
B.	$10,001 - $50,000
C.	$50,001 - $100,000
D.	Over $100,000

Portfolio Managers	Capital Appreciation Fund	Opportunity Fund
John D. Gillespie	D.	D.
Richard P. Howard	D.	D.
Kevin R. O’Brien	D.	D.

As of December 31, 2008, the Investment Manager beneficially owns 3,369 shares of the Capital Appreciation Fund and 3,362 shares of the Opportunity Fund.

 

 

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CONFLICTS

As an investment adviser and fiduciary, the Investment Manager, owes its clients a duty of loyalty.  In recognition of the fact that conflicts of interest are inherent in the investment management business, the Investment Manager has adopted policies and procedures reasonably designed to identify and manage the effects of actual or potential conflicts of interest in the areas of employee personal trading, managing multiple accounts for multiple clients and allocation of investment opportunities.  All employees of the Investment Manager and its affiliates are subject to these policies.

The Investment Manager has adopted a Code of Ethics that is designed to detect and prevent conflicts of interest when personnel own, buy or sell securities which may be owned, bought or sold for clients.  Personal securities transactions may raise a potential conflict of interest when an employee owns or trades in a security that is owned or considered for purchase or sale by a client, or recommended for purchase or sale by a client.  The Investment Manager’s personnel are not permitted to engage in transactions for their personal accounts in any security to be purchased or sold or considered for purchase or sale for a client until a specified number of days after the completion of the client transaction.  Subject to reporting requirements, preclearance and other limitations in the Code of Ethics, the Investment Manager permits its employees to engage in personal securities transactions in other securities and to acquire shares of the Funds.  The Investment Manager’s Code of Ethics requires disclosure of all personal accounts and reporting of all securities transactions.

The portfolio managers manage multiple portfolios for multiple clients.  These accounts may include mutual funds, separate accounts and private pooled investment vehicles (commonly referred to as “hedge funds”).  Each portfolio manager may have responsibility for managing the investments of multiple accounts with a common investment strategy or several investment styles.  Accordingly, client portfolios may have investment objectives, strategies, time horizons, tax considerations and risk profiles that differ from those of the Funds.  The portfolio managers make investment decisions for each Fund based on the Fund’s investment objective, policies, practices, cash flows, tax and other relevant investment considerations.  Consequently, the portfolio managers may purchase or sell securities for one client portfolio and not another client portfolio, and the performance of securities purchased for one portfolio may vary from the performance of securities purchased for other portfolios.  In addition, a particular security may be bought for one or more client portfolios when one or more other client portfolios are opening a short position.  The portfolio managers may place transactions on behalf of other clients or a Fund that are directly or indirectly contrary to investment decisions made on behalf of the other Fund, which has the potential to adversely impact such Fund, depending on market conditions.  In addition, some of these Other Client Account structures have fee structures, such as performance based fees, that differ (and may be lower or higher than) the Funds.  Accordingly, conflicts of interest may arise when the Investment Manager has a particular financial incentive, such as a performance-based fee, relating to an account.

The Investment Manager has adopted and implemented policies and procedures intended to address conflicts of interest relating to the management of multiple accounts and the allocation of investment opportunities.  The Investment Manager reviews investment decisions for the purpose of ensuring that all accounts with substantially similar investment objectives are treated equitably.  The performance of similarly managed accounts is also regularly compared to determine whether there are any unexplained significant discrepancies.  In addition, the Investment Manager’s allocation procedures specify the factors that are taken into account in making allocation decisions and require that, to the extent that orders are aggregated, the client orders are price averaged.  Finally, the Investment Manager’s procedures also require objective allocation for limited opportunities (such as initial public offerings and private placements) to ensure fair and equitable allocation among accounts.  These areas are monitored by the Investment Manager’s Chief Compliance Officer.

DISTRIBUTOR

On September 7, 2007, Quasar Distributors, LLC (the “Distributor”), an affiliate of U.S. Bancorp, 615 East Michigan Street, Milwaukee, Wisconsin 53202, was approved to serve as distributor for the Company effective September 28, 2007. The Distribution Agreement is effective for an initial term of two years and shall continue in effect for successive one-year periods, provided such continuance is specifically approved at least annually by the Board, including a majority of the Independent Directors, or vote of a majority of outstanding shares of the Company. The offering of the Funds’ shares is continuous. The Distribution Agreement provides that the Distributor, as agent in connection with the distribution of the Fund shares, will use its best efforts to distribute the Funds’ shares. The Distributor is a Delaware limited liability company that is wholly owned by U.S. Bancorp.

The Distributor, Administrator, Fund Accountant, Transfer Agent and Custodian, as defined in this SAI, are affiliated entities under the common control of U.S. Bancorp.

 

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Distribution Plan

In accordance with Rule 12b-1 under the 1940 Act, each Fund has adopted a distribution plan (the “Plan”), which provides for the reimbursement by the Fund of distribution expenses incurred by Quasar Distributors, LLC on behalf of the Fund at an annual rate of up to 0.25% of the average daily net assets of the Fund.

 

The Plan provides that Quasar Distributors, LLC may incur expenses for any distribution-related purpose it deems necessary or appropriate, including:  (i) any sales, marketing and other activities primarily intended to result in the sale of shares of the Funds, (ii) reviewing the activity in Funds’ accounts; (iii) providing training and supervision of the Company’s personnel; (iv) maintaining and distributing current copies of prospectuses and shareholder reports; (v) advertising the availability of its services and products; (vi) providing assistance and review in designing materials to send to customers and potential customers and developing methods of making such materials accessible to customers and potential customers; (vii) responding to customers’ and potential customers’ questions about the Funds; and (viii) providing ongoing account services to shareholders (including establishing and maintaining shareholder accounts, answering shareholder inquiries, and providing other personal services to shareholders).  Expenses for such activities include compensation to employees, and expenses, including overhead and telephone and other communication expenses, of Distributor and various financial institutions or other persons who engage in or support the distribution of shares of the Funds, or who respond to shareholder inquiries regarding the Funds’ operations; the incremental costs of printing (excluding typesetting) and distributing prospectuses, statements of additional information, annual reports and other periodic reports for use in connection with the offering or sale of shares of the Funds to any prospective investors; and the costs of preparing, printing and distributing sales literature and advertising materials used by Distributor or others in connection with the offering of shares of the Funds for sale to the public.

The Plan requires the Funds and Quasar Distributors, LLC to prepare and submit to the Board, at least quarterly, and the Board to review, written reports setting forth all amounts expended under the Plan and identifying the activities for which those expenditures were made.

The Plan provides that it will remain in effect for one year from the date of its adoption and thereafter shall continue in effect provided it is approved at least annually by the Board, including a majority of the independent Directors.  The Plan further provides that it may not be amended to materially increase the costs, which the Funds bear for distribution pursuant to the Plan without shareholder approval and that other material amendments of the Plan must be approved by the Independent Directors.  The Plan may be terminated at any time by a majority of the Independent Directors or by shareholders of the Funds.

The following tables show the dollar amounts by category allocated to the Funds for distribution related expenses:

Capital Appreciation Fund
Actual 12b-1 Expenditures Paid by the Fund During the Fiscal Year Ended December 31, 2008
	Total Dollars Allocated
Advertising / Marketing	$379
Printing / Postage	$2,274
Payment to Distributor	$15,725
Payment to Dealers	$568
Compensation to Sales Personnel	$0
Interest, Carrying, or Other Financial Charges	$0
Other	$0
Total	$18,946

 

 

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Opportunity Fund
Actual 12b-1 Expenditures Paid by the Fund During the Fiscal Year Ended December 31, 2008
	Total Dollars Allocated
Advertising / Marketing	$253
Printing / Postage	$1,519
Payment to Distributor	$10,507
Payment to Dealers	$380
Compensation to Sales Personnel	$0
Interest, Carrying, or Other Financial Charges	$0
Other	$0
Total	$12,659

CUSTODIAN

U.S. Bank N.A. (the “Custodian”), 1555 N. River Center Drive, Suite 302, Milwaukee, Wisconsin, 53212, is custodian for the securities and cash of each Fund.  Under the Custody Agreement, the Custodian holds the Funds’ portfolio securities in safekeeping and keeps all necessary records and documents relating to its duties.  The Custodian is compensated with an asset-based fee plus transaction fees and is reimbursed for out-of-pocket expenses.

FUND ACCOUNTANT AND TRANSFER AGENT

USBFS, located at 615 E. Michigan Street. Milwaukee, WI 53202, serves as fund accountant (the “Fund Accountant”) and transfer agent (the “Transfer Agent”) to the Funds pursuant to a Fund Accounting Servicing Agreement and a Transfer Agent Servicing Agreement between the Company and USBFS.  Under the Fund Accounting Servicing Agreement, USBFS will provide portfolio accounting services, expense accrual and payment services, fund valuation and financial reporting services, tax accounting services and compliance control services. USBFS will receive a fund accounting fee.

Under the Transfer Agent Servicing Agreement, USBFS will provide all of the customary services of a transfer agent and dividend disbursing agent including, but not limited to: (1) receiving and processing orders to purchase or redeem shares; (2) mailing shareholder reports and prospectuses to current shareholders; and (3) providing blue sky services to monitor the number of Fund shares sold in each state.  USBFS will receive a transfer agent fee.

ADMINISTRATOR

USBFS serves as Fund Administrator (the “Administrator”) pursuant to a Fund Administration Servicing Agreement among the Company, the  Investment Manager (with respect to the compensation section only), and USBFS. USBFS provides the following services under the Fund Administration Servicing Agreement. USBFS (i) facilitates general Fund management; (ii) monitors Fund compliance with federal and state regulations; (iii) supervises the maintenance of the Funds’ general ledger and prepares the Funds’ monthly financial statements; and (iv) prepares other specified financial and tax reports and information.

Effective September 28, 2007, under the Fund Administration Servicing Agreement, USBFS receives an administration fee from the Company at an annual rate of 0.08% on the first $300 million and 0.07% on the next $500 million and 0.04% on the balance, subject to a minimum annual fee of $40,000 per Fund.

 

 

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The table below shows the amount of administration fees paid by the Funds to USBFS for the fiscal years shown.

Administration Fees Paid During Fiscal Periods Ended December 31,
Capital Appreciation Fund	2008 $43,741	2007 * $10,672
Opportunity Fund	2008 $42,292	2007 * $10,672

*       The amount shown is for the period from September 28, 2007, through December 31, 2007.

INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Ernst & Young, LLP, 220 South Sixth Street, Suite 1400, Minneapolis, Minnesota, is the Company’s Independent Registered Public Accounting Firm.  The Independent Registered Public Accounting Firm has audited the financial statements included in the Company’s Annual Report to Shareholders.

 

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PORTFOLIO TRANSACTIONS AND BROKERAGE

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The Investment Manager selects brokers and dealers to execute each Fund’s portfolio transactions in accordance with criteria set forth in the Advisory Agreement and any directions that the Board may give.

When placing a portfolio transaction, the Investment Manager seeks to obtain “best execution” - the best combination of high quality transaction execution services, taking into account the services and products to be provided by the broker or dealer, and low relative commission rates with the view of maximizing value for the Fund and the Investment Manager’s other clients.  For most transactions in equity securities, the amount of commission paid is negotiated between the Investment Manager and the broker executing the transaction.  The determination and evaluation of the reasonableness of the brokerage commissions paid are based to a large degree on the professional opinions of the investment personnel of the Investment Manager responsible for placement and review of the transactions.  These opinions are based on the experience of these individuals in the securities industry and information available to them about the level of commissions being paid by other institutional investors.  The Investment Manager may also place orders to buy and sell equity securities on a principal rather than agency basis if the Investment Manager believes that trading on a principal basis will provide best execution.  Purchases of portfolio securities from underwriters will include a commission or concession paid by the issuer to the underwriter, and purchases from dealers will include a spread between the bid and ask price.

The Investment Manager may cause a Fund to pay certain brokers commissions that are higher than those another broker may charge, if the Investment Manager determines in good faith that the amount paid is reasonable in relation to the value of the brokerage and research services it receives.  This may be viewed in terms of either the particular transaction or the Investment Manager’s overall responsibilities to client accounts over which it exercises investment discretion.  The brokerage commissions that are used to acquire services other than brokerage are known as “soft dollars.” Research provided can be either proprietary (created and provided by the broker-dealer, including tangible research products as well as access to analysts and traders) or third party (created by a third party but provided by the broker-dealer).  To the extent permitted by applicable law, the Investment Manager may use soft dollars to acquire both proprietary and third party research.

The research services that brokers may provide to the Investment Manager include, among others, supplying information about particular companies, markets, countries, or local, regional, national or transnational economies, statistical data, quotations and other securities pricing information, and other information that provides lawful and appropriate assistance to the Investment Manager in carrying out its investment advisory responsibilities.  These services may not always directly benefit the Fund.  They must, however, be of value to the Investment Manager in carrying out its overall responsibilities to its clients.

 

 

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It is not possible to place an accurate dollar value on the special execution or on the research services the Investment Manager receives from dealers effecting transactions in portfolio securities.  The allocation of transactions to obtain additional research services allows the Investment Manager to supplement its own research and analysis activities and to receive the views and information of individuals and research staffs from many securities firms.  It is not anticipated that the receipt of these products and services will reduce the Investment Manager’s research activities in providing investment advice to the Funds.

As long as it is lawful and appropriate to do so, the Investment Manager and its affiliates may use this research and data in their investment advisory capacities with other clients.  Each Fund may obtain other services from brokers in connection with the Fund’s investment transactions with such brokers.  Such services will be limited to services that would otherwise be a Fund expense.

If purchases or sales of securities of a Fund and one or more other clients managed by the Investment Manager are considered at or about the same time, transactions in these securities will be allocated among the several clients in a manner deemed equitable to all by the Investment Manager, taking into account the respective sizes of the accounts and the amount of securities to be purchased or sold.  In some cases this procedure could have a detrimental effect on the price or volume of the security so far as the Fund is concerned.  In other cases it is possible that the ability to participate in volume transactions may improve execution and reduce transaction costs to the Funds.

Because each Fund may, from time to time, invest in broker-dealers, it is possible that the Fund will own more than 5% of the voting securities of one or more broker-dealers through whom the Fund placed portfolio brokerage transactions.  In such circumstances, the broker-dealer would be considered an affiliated person of such Fund.  To the extent a Fund places brokerage transactions through such a broker-dealer at a time when the broker-dealer is considered to be an affiliate of the Fund, the Fund will be required to adhere to certain rules relating to the payment of commissions to an affiliated broker-dealer.  These rules require the Fund to adhere to procedures adopted by the board to ensure that the commissions paid to such broker-dealers do not exceed what would otherwise be the usual and customary brokerage commissions for similar transactions.

The following tables set forth the brokerage commissions were paid by the Funds during the fiscal years ended December 31, 2007 and December 31, 2008.  There were no brokerage commissions paid to affiliated broker-dealers by the Portfolios for the fiscal years ended December 31, 2007 and December 31, 2008.

 

Capital Appreciation Fund
Aggregate Brokerage Commissions Paid During Fiscal Years Ended December 31,
2008	2007 *
$22,682	$5,275

*              The amount shown is for the period from September 28, 2007, through December 31, 2007.

 

Opportunity Fund
Aggregate Brokerage Commissions Paid During Fiscal Years Ended December 31,
2008	2007 *
$21,189	$4,970

*              The amount shown is for the period from September 28, 2007, through December 31, 2007.

 

 

 

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TAXATION OF THE FUNDS

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Qualification as a Regulated Investment Company

Each Fund has elected to be treated as a regulated investment company under Subchapter M of the Code.  A regulated investment company qualifying under Subchapter M of the Code is required to distribute to its shareholders at least 90% of its investment company taxable income (including the excess of net short-term capital gain over net long-term capital losses) and generally is not subject to federal income tax to the extent that it distributes annually 100% of its investment company taxable income and net capital gain (that is, the excess of net long-term capital gain over net short-term capital loss) in the manner required under the Code.  Each Fund intends to distribute at least annually all of its investment company taxable income and net capital gain and therefore does not expect to pay federal income tax, although in certain circumstances, a Fund may determine that it is in the interest of shareholders to distribute less than that amount.

To be treated as a regulated investment company under Subchapter M of the Code, each Fund must also (a) derive at least 90% of its gross income from dividends, interest, payments with respect to securities loans and gains from the sale or other disposition of securities or foreign currencies, or other income (including, but not limited to, gains from options, futures or forward contracts) derived with respect to the business of investing in such securities or currencies, or net income derived from interests in certain qualified publicly traded partnerships, and (b) diversify its holdings so that, at the end of each fiscal quarter, (i) at least 50% of the market value of each Fund’s assets is represented by cash, U.S. government securities and securities of other regulated investment companies, and other securities (for purposes of this calculation, generally limited in respect of any one issuer, to an amount not greater than 5% of the market value of the Fund’s assets and 10% of the outstanding voting securities of such issuer) and (ii) not more than 25% of the value of its assets is invested in (A) the securities of (other than U.S. government securities or the securities of other regulated investment companies) any one issuer or two or more issuers which the Fund controls and which are determined to be engaged in the same or similar trades or businesses, or (B) the securities of one or more qualified publicly traded partnerships.

If for any taxable year a Fund does not qualify as a regulated investment company, all of its taxable income will be subject to tax at regular corporate rates without any deduction for dividends paid to shareholders, and the dividends will be taxable to the shareholders as ordinary income to the extent of the Fund’s current and accumulated earnings and profits.  Failure to qualify as a regulated investment company would thus have a negative impact on a Fund’s income and performance.

As of December 31, 2008, the Opportunity Fund had capital loss carryforwards of $311,833, which if not offset by subsequent capital gains, will expire on December 31, 2016. To the extent the Opportunity Fund realizes future net capital gains, taxable distributions to its shareholders will be offset by any unused capital loss carryforwards to the extent allowed by the Internal Revenue Code (“IRC”).

Excise Tax

Under the Code, a nondeductible excise tax of 4% is imposed on the excess of a regulated investment company’s “required distribution” for the calendar year ending within the regulated investment company’s taxable year over the “distributed amount” for such calendar year.  The term “required distribution” means the sum of (a) 98% of ordinary income (generally net investment income) for the calendar year, (b) 98% of capital gain (both long-term and short-term) for the one-year period ending on October 31 of the calendar year (or December 31 if elected by the Funds) and (c) the sum of any untaxed, undistributed net investment income and net capital gains of the regulated investment company for prior periods.  The term “distributed amount” generally means the sum of (a) amounts actually distributed by a Fund from its current year’s ordinary income and capital gain net income and (b) any amount on which a Fund pays income tax for the taxable year ending in the calendar year.  Although each Fund intends to distribute its net investment income and net capital gains so as to avoid excise tax liability, a Fund may determine that it is in the interest of shareholders to distribute a lesser amount.

 

 

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Certain Tax Rules Applicable to the Funds’ Transactions

Certain listed options, regulated futures contracts, and forward foreign currency contracts are considered “section 1256 contracts” for federal income tax purposes.  Section 1256 contracts held by a Fund at the end of each taxable year will be “marked to market” and treated for federal income tax purposes as though sold for fair market value on the last business day of such taxable year.  Gain or loss realized by a Fund on section 1256 contracts (other than certain foreign currency contracts) generally will be considered 60% long-term and 40% short-term capital gain or loss.

Under the Code, gains or losses attributable to fluctuations in exchange rates which occur between the time a Fund accrues interest or other receivables or accrues expenses or other liabilities denominated in a foreign currency and the time the Fund actually collects such receivables or pays such liabilities are treated as ordinary income or ordinary loss.  Similarly, gains or losses from the disposition of foreign currencies, from the disposition of debt securities denominated in a foreign currency, or from the disposition of a forward contract denominated in a foreign currency which are attributable to fluctuations in the value of the foreign currency between the date of acquisition of the asset and the date of disposition also are treated as ordinary income or loss.  These gains or losses, referred to under the Code as “section 988” gains or losses, increase or decrease the amount of a Fund’s investment company taxable income available to be distributed to its shareholders as ordinary income, rather than increasing or decreasing the amount of such Fund’s net capital gain.

Sale or Redemption of Shares

In general, you will recognize a gain or loss on the sale or redemption of shares of a Fund in an amount equal to the difference between the proceeds of the sale or redemption and your adjusted tax basis in the Fund shares.  All or a portion of any loss so recognized may be disallowed if you purchase (for example, by reinvesting dividends) other shares of the Fund within 30 days before or after the sale or redemption (a so called “wash sale”).  If disallowed, the loss will be reflected in an upward adjustment to the basis of the shares acquired.  In general, any gain or loss arising from the sale or redemption of shares of a Fund will be capital gain or loss and will be long-term capital gain or loss if the shares were held for longer than one year.  Any capital loss arising from the sale or redemption of shares held for six months or less, however, is treated as a long-term capital loss to the extent of the amount of distributions of net capital gain received on such shares.  In determining the holding period of such shares for this purpose, any period during which your risk of loss is offset by means of options, short sales or similar transactions is not counted.  Capital losses in any year are deductible only to the extent of capital gains plus, in the case of a noncorporate taxpayer, $3,000 of ordinary income.

For purposes of calculating capital gain distributions, each Fund offsets any prior taxable year’s capital loss carryforwards against the current taxable year’s realized capital gains, if any; accordingly, no capital gain distributions will be made by a Portfolio for a taxable year until it has realized gains in that year in excess of any such loss carryforward.

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CAPITAL STOCK

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The Company has authorized 1,000,000,000 shares of $.001 par value common stock.  All shares are of the same class, with equal rights and privileges.  Each share is entitled to one vote and participates equally in dividends and distributions declared.  The shares are fully paid and non-assessable when issued, are transferable, and have no preemptive, conversion, or exchange rights.

The Company has non-cumulative voting rights.  For Board member elections, this gives holders of more than 50% of the shares the ability to elect all of the members of the Board.  If this happens, holders of the remaining shares entitled to vote will not be able to elect anyone to the Board.

The Funds do not intend to hold annual shareholder meetings and are not required to.  The Funds may hold special meetings, however, for matters requiring shareholder approval.  A special meeting also may be called by the Board and certain officers in their discretion.

 

 

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CONTROL PERSONS, PRINCIPAL HOLDERS, AND MANAGEMENT OWNERSHIP

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Management Ownership.   As of March 31, 2009, the Funds’ officers and board members, as a group, owned of record and beneficially, directly or indirectly, 18.51% of the outstanding shares of the Capital Appreciation Fund and 15.20% of the outstanding shares of the Opportunity Fund.  The officers and board members may own shares in other pooled investment vehicles or management accounts managed by Prospector Partners Asset Management, LLC or its affiliates.

Control Persons and Principal Holders.   A principal shareholder is any person who owns of record or beneficially 5% or more of the outstanding shares of a Fund.  A control person is one who owns, beneficially or through one or more controlled companies, more than 25% of the voting securities of a company or acknowledges the existence of such control.  Shareholders with a controlling interest could affect the outcome of voting or the direction of management of the Funds.

 

As of March 31, 2009, the following shareholders were considered to be either a control person or a principal shareholder of the Funds:

 

Capital Appreciation Fund
Name and Address	Parent Company	Jurisdiction	Number of Shares	% Ownership	Type of Ownership
National Financial Services, LLC 200 Liberty Street One World Financial Center New York, NY 10281-1003	Fidelity Management & Research Co.	DE	662,583	33.73%	Record
Richard P. Howard 370 Church Street Guilford, Connecticut 06437	N/A	N/A	150,436	7.66%	Beneficial
Charles Schwab & Co., Inc. 101 Montgomery Street San Francisco, CA 94104-4151	N/A	N/A	137,127	6.98%	Record
John D. Gillespie 370 Church Street Guilford, Connecticut 06437	N/A	N/A	130,704	6.65%	Beneficial

 

Opportunity Fund
Name and Address	Parent Company	Jurisdiction	Number of Shares	% Ownership	Type of Ownership

National Financial Services, LLC 200 Liberty Street One World Financial Center New York, NY 10281-1003	Fidelity Management & Research Co.	DE	603,953	42.54%	Record
Charles Schwab & Co., Inc. 101 Montgomery Street San Francisco, CA 94104-4151	N/A	N/A	130,974	9.22%	Record
John D. Gillespie 370 Church Street Guilford, Connecticut 06437	N/A	N/A	123,693	8.71%	Beneficial

 

 

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BUYING AND SELLING SHARES

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For investors outside the U.S., the offering of Fund shares may be limited in many jurisdictions.  An investor who wishes to buy shares of a Fund should determine, or have a broker-dealer determine, the applicable laws and regulations of the relevant jurisdiction.  Investors are responsible for compliance with tax, currency exchange or other regulations applicable to redemption and purchase transactions in any jurisdiction to which they may be subject.  Investors should consult appropriate tax and legal advisors to obtain information on the rules applicable to these transactions. The Funds may reject any order to buy shares placed by an investor outside the U.S., in their discretion.

All checks, drafts, wires and other payment mediums used to buy or sell shares of a Fund must be denominated in U.S. dollars.  The Company may, in its sole discretion, either (a) reject any order to buy or sell shares denominated in any other currency or (b) honor the transaction or make adjustments to your account for the transaction as of a date and with a foreign currency exchange factor determined by the drawee bank.  We may deduct any applicable banking charges imposed by the bank from your account.

If you buy shares through the reinvestment of dividends, the shares will be purchased at the NAV determined on the business day following the dividend record date (sometimes known as the “ex-dividend date”).  The processing date for the reinvestment of dividends may vary and does not affect the amount or value of the shares acquired.

Investment by Asset Allocators

Each Fund permits investment in the Funds by certain asset allocators (“Asset Allocators”) who represent underlying clients that have granted a power of attorney to the Asset Allocators to invest on their behalf.  The Asset Allocators typically make asset allocation decisions across similarly situated underlying accounts that are invested in the Funds.  As a result of adjustments in such asset allocation decisions, the Funds may experience relatively large purchases and redemptions when the Asset Allocators implement their asset allocation adjustment decisions.  The Company, based on monitoring of the trading activity of such Asset Allocator accounts, reserves the right to treat such Asset Allocators as market timers.  In such circumstances, the Company may restrict or reject trading activity by Asset Allocators if, in the judgment of the Investment Manager, such trading may interfere with the efficient management of a Fund’s portfolio, may materially increase a Fund’s transaction costs or taxes, or may otherwise be detrimental to the interests of a Fund and its shareholders.  Neither the Company, the Funds, nor the Investment Manager nor any other affiliated party receives any compensation or other consideration in return for permitting investments by Asset Allocators.

Other Payments

From time to time, Prospector Partners Asset Management, at its expense, may provide additional compensation to dealers which sell or arrange for the sale of shares of a Fund.  Such compensation may include financial assistance to dealers that enable Prospector Partners Asset Management to participate in and/or present at conferences or seminars, sales or training programs for invited registered representatives and other employees, client and investor events and other dealer-sponsored events.  These payments may vary depending upon the nature of the event.

Other compensation may be offered to the extent not prohibited by state laws or any self-regulatory agency, such as the Financial Industry Regulatory Authority (“FINRA”).  Prospector Partners Asset Management makes payments for events it deems appropriate, subject to Prospector Partners Asset Management guidelines and applicable law.

You can ask your dealer for information about any payments it receives from Prospector Partners Asset Management and any services provided.

Redemptions in Kind

In the case of redemption requests, the board reserves the right to make payments in whole or in part in securities or other assets of a Fund, in case of an emergency, or if the payment of such a redemption in cash would be detrimental to the existing shareholders of the Fund.  In these circumstances, the securities distributed would be valued at the price used to compute the Fund’s net assets and you may incur brokerage fees in converting the securities to cash.  The Company does not intend to redeem illiquid securities in kind.  If this happens, however, you may not be able to recover your investment in a timely manner.

 

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The Funds have elected to be governed by Rule 18f-1 under the 1940 Act, pursuant to which the relevant Fund is obligated to redeem shares solely in cash up to the lessor of $250,000 or 1% of the net asset value of the Fund during any 90-day period for any one shareholder.

Share Certificates

We will credit your shares to your Fund account.  We do not issue share certificates.  This eliminates the costly problem of replacing lost, stolen or destroyed certificates.

General Information

The proceeds from distributions will be either paid in cash or reinvested in additional shares at NAV.  If you do not make an election as to the form in which you wish to receive distributions, distribution proceeds will be reinvested in additional shares at NAV.

Interest or income earned on redemption checks sent to you during the time the checks remain uncashed will be retained by U.S. Bancorp Fund Services, LLC.  The Company and the Funds will not be liable for any loss caused by your failure to cash such checks.  The Funds are not responsible for tracking down uncashed checks, unless a check is returned as undeliverable.

In most cases, if mail is returned as undeliverable we are required to take certain steps to try to find you free of charge.  If these attempts are unsuccessful, however, we may deduct the costs of any additional efforts to find you from your account.  These costs may include a percentage of the account when a search company charges a percentage fee in exchange for its location services.

Sending redemption proceeds by wire or electronic funds transfer (“ACH”) is a special service that we make available whenever possible.  By offering this service to you, the Company is not bound to meet any redemption request in less than the seven-day period prescribed by law.  Neither the Funds, the Company nor their agents shall be liable to you or any other person if, for any reason, a redemption request by wire or ACH is not processed as described in the prospectus.

If you buy or sell shares through your securities dealer, we use the NAV next calculated after your securities dealer receives your request, which is promptly transmitted to the Fund.  If you sell shares through your securities dealer, it is your dealer’s responsibility to transmit the order to the Fund in a timely fashion.  Your redemption proceeds will not earn interest between the time we receive the order from your dealer and the time we receive any required documents.  Any loss to you resulting from your dealer’s failure to transmit your redemption order to the Fund in a timely fashion must be settled between you and your securities dealer.

Certain shareholder servicing agents may be authorized to accept your transaction request.

For institutional and bank trust accounts, there may be additional methods of buying or selling Fund shares than those described in this SAI or in the prospectus.  Institutional and bank trust accounts include accounts opened by or in the name of a person (includes a legal entity or an individual) that has signed an Institutional Account Application or Bank Trust Account Application accepted by Prospector Partners Asset Management or entered into a selling agreement and/or servicing agreement with Prospector Partners Asset Management or USBFS.  For example, the Company permits the owner of an institutional account to make a same day wire purchase if a good order purchase request is received (a) before the close of the New York Stock Exchange (“NYSE”) or (b) through the National Securities Clearing Corporation’s automated system for processing purchase orders (“Fund/SERV”), even though funds are delivered by wire after the close of the NYSE.  If funds to be wired are not received as scheduled, the purchase order may be cancelled or reversed and the institutional account owner could be liable for any losses or fees the Company, Prospector Partners Asset Management and/or USBFS may incur.

In the event of disputes involving conflicting claims of ownership or authority to control your shares, the Company has the right (but has no obligation) to:  (i) restrict the shares and require the written agreement of all persons deemed by the Company to have a potential interest in the shares before executing instructions regarding the shares; or (ii) interplead disputed shares or the proceeds from the court-ordered sale thereof with a court of competent jurisdiction.

Should the Company be required to defend against joint or multiple shareholders in any action relating to an ownership dispute, you expressly grant the Company the right to obtain reimbursement for costs and expenses including, but not limited to, attorneys’ fees and court costs, by unilaterally redeeming shares from your account.

 

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The Company may be required (i) pursuant to a validly issued levy, to turn your shares over to a levying officer who may, in turn, sell your shares at a public sale; or (ii) pursuant to a final order of forfeiture to sell your shares and remit the proceeds to the U.S. or state government as directed.

Clients of financial advisors whose firms have a Selling Agreement with Prospector Partners Asset Management, and who are eligible for the Financial Advisor Service Team (“FAST”) may be eligible for the Valued Investor Program which offers enhanced service and transaction capabilities.  Please call Shareholder Services toll free at (877) PFI-STOCK or (877) 734-7862 for additional information on this program.

Quasar Distributors, LLC may be entitled to payments from the Fund under the Rule 12b-1 plans, as discussed below.  Quasar Distributors, LLC receives no other compensation from the Fund for acting as underwriter.

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PRICING OF SHARES

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When you buy shares, you pay the NAV per share.  The number of Fund shares you will be issued will equal the amount invested divided by the applicable offering price for those shares, calculated to three decimal places using standard rounding criteria.

When you sell shares, you receive the NAV per share minus any applicable redemption fees.

The NAV of a mutual fund is determined by deducting the Fund’s liabilities from the total assets of the portfolio.  The NAV per share is determined by dividing the total NAV of the Fund by the applicable number of shares outstanding.

Each Fund calculates its NAV per share after the close of trading on the NYSE (normally 4:00 p.m., Eastern time) each business day the NYSE is open.  The Funds do not calculate the NAV on days the NYSE is closed for trading, which include New Year’s Day, Martin Luther King Jr. Day, President’s Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day.

When determining its NAV, each Fund values cash and receivables at their realizable amounts, and records interest as accrued and dividends on the ex-dividend date.  Each Fund may utilize independent pricing services to assist in determining a current market value for each security.  If market quotations are readily available for portfolio securities listed on a securities exchange or on the NASDAQ National Market System, each Fund values those securities at the last quoted sale price or the official closing price of the day, respectively, or, if there is no reported sale, at the last quoted bid price.  Each Fund values over-the-counter portfolio securities at the last quoted bid price.  If a security is traded or dealt in on more than one exchange, or on one or more exchanges and in the over-the-counter market, quotations from the market in which the security is primarily traded shall be used.

Requests to buy and sell shares are processed at the NAV per share next calculated after we receive your request in proper form.

Generally, trading in corporate bonds, U.S. government securities and money market instruments is substantially completed each day at various times before the close of the NYSE.  The value of these securities used in computing the NAV is determined as of such times.  Occasionally, events affecting the values of these securities may occur between the times at which they are determined and the close of the NYSE that will not be reflected in the computation of the NAV.  Each Fund may rely on third party pricing vendors to monitor for events materially affecting the value of these securities during this period.  If an event occurs the third party pricing vendors will provide revised values to the relevant Fund.

Any securities or other assets for which market quotations are not readily available are valued at fair value as determined in good faith by the Valuation Committee pursuant to procedures established under the general supervision and responsibility of the Funds’ Board.

 

 

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An example of how the Funds calculated the total offering price per share as of December 31, 2008 is as follows:

 

Capital Appreciation Fund

 

Net Assets	=	NAV
Shares Outstanding
$20,091,382	=	$10.85
1,851,610

 

Opportunity Fund

 

Net Assets	=	NAV
Shares Outstanding
$16,024,616	=	$12.04
1,331,206

 

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FINANCIAL STATEMENTS

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The Annual Report to shareholders for the fiscal year ended December 31, 2008, is a separate document supplied with this SAI and the financial statements, accompanying notes, and the report of the independent registered public accounting firm appearing therein are incorporated by reference in this SAI.

 

 

 

 

 

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APPENDIX A – PROXY VOTING PROCEDURES

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PROSPECTOR FUNDS, INC.

Proxy Voting Policies and Procedures

Adopted September 7, 2007

SECTION 1.  Purpose

Shareholders of the various series (“Series”) of Prospector Funds, Inc. (the “Fund”) expect the Fund to vote proxies received from issuers whose voting securities are held by a Series.  The Fund exercises its voting responsibilities as a fiduciary, with the goal of maximizing the value of the Fund’s and its shareholders’ investments.

This document describes the Policies and Procedures for Voting Proxies (“Policies”) received from issuers whose voting securities are held by each Series.

SECTION 2.  Responsibilities

(A)             Adviser.   Pursuant to the investment advisory agreement between the Fund and the investment adviser providing advisory services to the Series (the “Adviser”), the Fund has delegated the authority to vote proxies received by each Series regarding securities contained in its portfolio to the Adviser. Accordingly, the Fund incorporates herein and makes a part hereof, the Adviser’s proxy voting policies and procedures (attached hereto as Appendix A).  These Policies are to be implemented by the Adviser for each Series for which it provides advisory services.  To the extent that these Policies do not cover potential voting issues with respect to proxies received by a Series, the Adviser shall act on behalf of the applicable Series to promote the Series’ investment objectives, subject to the provisions of these Policies.

The Adviser shall periodically inform its employees (i) that they are under an obligation to be aware of the potential for conflicts of interest on the part of the Adviser with respect to voting proxies on behalf of the Series, both as a result of the employee’s personal relationships and due to circumstances that may arise during the conduct of the Adviser’s business, and (ii) that employees should bring conflicts of interest of which they become aware to the attention of the management of the Adviser.

The Adviser shall be responsible for coordinating the delivery of proxies by the Series’ custodian to the Adviser or to an agent of the Adviser selected by the Adviser to vote proxies with respect to which the Adviser has such discretion (a “Proxy Voting Service”).

(B)             Proxy Manager.   The Fund will appoint a proxy manager (the “Proxy Manager”), who shall be an officer of the Fund.  The Proxy Manager shall oversee compliance by the Adviser and the Fund’s other service providers with these Policies.  The Proxy Manager will, from to time, periodically review the Policies and industry trends in comparable proxy voting policies and procedures.  The Proxy Manager may recommend to the Board, as appropriate, revisions to update these Policies.

SECTION 3.  Scope

These Policies summarize the Fund’s positions on various issues of concern to investors in issuers of publicly-traded voting securities, and give guidance about how the Adviser should vote the Series’ shares on each issue raised in a proxy statement.  These Policies are designed to reflect the types of issues that are typically presented in proxy statements for issuers in which a Series may invest; they are not meant to cover every possible proxy voting issue that might arise.  Accordingly, the specific policies and procedures listed below are not exhaustive and do not address all potential voting issues or the intricacies that may surround specific issues in all cases.  For that reason, there may be instances in which votes may vary from these Policies.

 

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SECTION 4.  Policies and Procedures for Voting Proxies

(A)           General

(1)            Use of Adviser Proxy Voting Guidelines or Proxy Voting Service.   If (A) the Adviser has proprietary proxy voting guidelines that it uses for its clients and/or the Adviser uses a Proxy Voting Service and the Proxy Voting Service has published guidelines for proxy voting; (B) the Company’s Board of Directors (the “Board”) has been notified that the Adviser intends to use either such Adviser or Proxy Voting Service proxy voting guidelines to vote an applicable Series’ proxies and has approved such guidelines; and (C) the Adviser’s and/or Proxy Voting Service’s Guidelines are filed as an exhibit to the applicable Series’ Registration Statement (collectively considered “Adviser Guidelines”), then the Adviser may vote, or may delegate to the Proxy Voting Service the responsibility to vote, the Series’ proxies consistent with such Adviser Guidelines.

(2)            Independence .   The Adviser will obtain an annual certification from the Proxy Voting Service that it is independent from the Adviser.  The Adviser shall also ensure that the Proxy Voting Service does not have a conflict of interest with respect to any vote cast for the Adviser on behalf of the Series.

(3)            Absence of Proxy Voting Service Guidelines. In the absence of Adviser Guidelines, the Adviser shall vote the Series’ proxies consistent with Sections B and C below.

(B)           Routine Matters

As the quality and depth of management is a primary factor considered when investing in an issuer, the recommendation of the issuer’s management on any issue will be given substantial weight.  The position of the issuer’s management will not be supported in any situation where it is determined not to be in the best interests of the Series’ shareholders.

(1)            Election of Directors.   Proxies should be voted for a management-proposed slate of directors unless there is a contested election of directors or there are other compelling corporate governance reasons for withholding votes for such directors.  Management proposals to limit director liability consistent with state laws and director indemnification provisions should be supported because it is important for companies to be able to attract qualified candidates.

(2)            Appointment of Auditors.   Management recommendations will generally   be supported.

(3)            Changes in State of Incorporation or Capital Structure.   Management recommendations about reincorporation should be supported unless the new jurisdiction in which the issuer is reincorporating has laws that would materially dilute the rights of shareholders of the issuer.  Proposals to increase authorized common stock should be examined on a case-by-case basis.  If the new shares will be used to implement a poison pill or another form of anti-takeover device, or if the issuance of new shares could excessively dilute the value of outstanding shares upon issuance, then such proposals should be evaluated to determine whether they are in the best interest of the Series’ shareholders.

(C)    Non-Routine Matters

(1)            Corporate Restructurings, Mergers and Acquisitions.   These proposals should be examined on a case-by-case basis.

(2)            Proposals Affecting Shareholder Rights.   Proposals that seek to limit shareholder rights, such as the creation of dual classes of stock, generally should not be supported.

(3)            Anti-takeover Issues.   Measures that impede takeovers or entrench management will be evaluated on a case-by-case basis taking into account the rights of shareholders and the potential effect on the value of the company.

(4)            Executive Compensation.   Although management recommendations should be given substantial weight, proposals relating to executive compensation plans, including stock option plans, should be examined on a case-by-case basis to ensure that the long-term interests of management and shareholders are properly aligned.

(5)            Social and Political Issues.   These types of proposals should generally not be supported if they are not supported by management unless they would have a readily-determinable, positive financial effect on shareholder value and would not be burdensome or impose unnecessary or excessive costs on the issuer.

 

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(D)           Conflicts of Interest

The Adviser is responsible for maintaining procedures to identify conflicts of interest.  The Fund recognizes that under certain circumstances an Adviser may have a conflict of interest in voting proxies on behalf of a Series advised by the Adviser.  A “conflict of interest” includes, for example, any circumstance when the Series, the Adviser, the principal underwriter, or one or more of their affiliates (including officers, directors and employees) knowingly does business with, receives compensation from, or sits on the board of, a particular issuer or closely affiliated entity, and, therefore, may appear to have a conflict of interest between its own interests and the interests of   Fund shareholders in how proxies of that issuer are voted.

If the Adviser determines that it, or a Proxy Voting Service, has a conflict of interest with respect to voting proxies on behalf of a Series, then the Adviser shall contact the Chairman of the Board.  In the event that the Chairman determines that he has a conflict of interest, the Chairman shall submit the matter for determination to another member of the Board who is not an “interested person” of the Fund, as defined in the Investment Company Act of 1940, as amended.  In making a determination, the Chairman will consider the best interests of the Series’ shareholders and may consider the recommendations of the Adviser or independent third parties that evaluate proxy proposals.  The Adviser will vote the proposal according the determination and maintain records relating to this process.

(E)           Abstention

The Fund may abstain from voting proxies in certain circumstances.  The Adviser or the Proxy Manager may determine, for example, that abstaining from voting is appropriate if voting may be unduly burdensome or expensive, or otherwise not in the best economic interest of the Series’ shareholders, such as when foreign proxy issuers impose unreasonable or expensive voting or holding requirements or when the costs to the Series to effect a vote would be uneconomic relative to the value of the Series’ investment in the issuer.

(F)           Reporting

The Series are required to file Form N-PX annually with the SEC which lists the Series’ complete proxy voting record for the twelve month period ended June 30 th .  This form is available on the SEC’s website or is available by calling the Series’ toll-free number as listed on the prospectus.

 

 

 

 

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PROSPECTOR PARTNERS ASSET MANAGEMENT, LLC

Proxy Voting Policy and Procedures

Adopted September 7, 2007

I.           Statement of Policy

Proxy voting is an important right of shareholders and reasonable care and diligence must be undertaken to ensure that such rights are properly and timely exercised.  Prospector Partners Asset Management, LLC (the “Advisor”) generally retains proxy-voting authority with respect to securities purchased for its clients.  Under such circumstances, the Advisor votes proxies in the best interest of its clients and in accordance with these policies and procedures.

II.           Use of Third-Party Proxy Voting Service

The Advisor has entered into an agreement with Institutional Shareholder Services (the “Proxy Voting Service”), an independent third party, for the Proxy Voting Service to provide the Advisor with its  research on proxies and to facilitate the electronic voting of proxies.

The Advisor has instructed the Proxy Voting Service that it is generally not to execute any ballot on behalf of the Advisor without first receiving specific instruction from the Advisor. If no approval is received by Proxy Voting Service by the voting deadline, the Proxy Voting Service will execute ballots in accordance with its recommendation and will notify the Advisor immediately that a vote has been executed on its behalf and the character of the vote.

The SEC has expressed its view that although the voting of proxies remains the duty of a registered adviser, an adviser may contract with service providers to perform certain functions with respect to proxy voting so long as the adviser is comfortable that the proxy voting service is independent from the issuer companies on which it completes its proxy research.  In assessing whether a proxy voting service is independent (as defined by the SEC), the SEC counsels investment advisers that they should not follow the recommendations of an independent proxy voting service without first determining, among other things, that the proxy voting service (a) has the capacity and competence to analyze proxy issues and (b) is in fact independent and can make recommendations in an impartial manner in the best interests of the adviser’s clients.

At a minimum annually, or more frequently as deemed necessary, the Compliance Officer will ensure that a review of the independence and impartiality of the Proxy Voting Service is carried out, including obtaining certification or other information from the Proxy Voting Service to enable the Advisor to make such an assessment.  The Compliance Officer will also monitor any new SEC interpretations regarding the voting of proxies and the use of third-party proxy voting services and revise the Advisor’s policies and procedures as necessary.

Proxies relating to securities held in client accounts will be sent directly to the Proxy Voting Service.  If a proxy is received by the Advisor and not sent directly to the Proxy Voting Service, the Compliance Officer will promptly forward it to the Proxy Voting Service.  In the event that the Proxy Voting Service is unable to complete/provide its research regarding a security on a timely basis or the Advisor has made a determination that it is in the best interests of the Advisor’s clients for the Advisor to vote the proxy, the Advisor’s general proxy-voting procedures are required to be followed, as follows.  The Compliance Officer will:

1.      Keep a record of each proxy received;

2.      Forward the proxy to the Portfolio Manager or Analyst responsible for voting the proxy on behalf of the Advisor;

3.      Determine which accounts managed by the Advisor hold the security to which the proxy relates;

4.      Provide the Portfolio Manager or Analyst with a list of accounts that hold the security, together with the number of votes each account controls (reconciling any duplications), and the date by which the Advisor must vote the proxy in order to allow enough time for the completed proxy to be returned to the issuer prior to the vote taking place;

5.      Absent material conflicts (see Section V), the Portfolio Manager or Analyst will determine whether the Advisor will follow the Proxy Voting Service’s recommendations or vote the proxy directly in accordance with the Advisor’s voting guidelines.  The Portfolio Manager or Analyst will send his/her decision on how the Advisor will vote a proxy to the Proxy Voting Service, or will instruct the Compliance Officer to vote and mail the proxy in a timely and appropriate manner.  It is desirable to have the Proxy Voting Service complete the actual voting so there exists one central source for the documentation of the Advisor’s proxy voting records.

 

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III.           General Voting Guidelines

To the extent that the Advisor is voting a proxy itself and not utilizing the Proxy Voting Service, the Advisor will follow these general voting guidelines.  Investment professionals of the Advisor each have the duty to vote proxies in a way that, in their best judgment, is in the best interest of the Advisor’s clients.  Generally, the Advisor believes that voting proxies in accordance with the following guidelines is in the best interests of its clients.  However, it is anticipated that circumstances may arise where votes are inconsistent with these general guidelines.  In addition, the Advisor will vote proxies in the best interests of each particular client, which may result in different votes for proxies for the same issuer.

A.     Elections of Directors

Unless there is a proxy fight for seats on the Board of Directors, the Advisor will generally vote in favor of the management proposed slate of directors.  The Advisor may withhold votes if the board fails to act in the best interests of shareholders, including, but not limited to, their failure to:

·	Implement proposals to declassify boards

·	Implement a majority vote requirement

·	Submit a rights plan to a shareholder vote

·	Act on tender offers where a majority of shareholders have tendered their shares

The Advisor may withhold votes for directors of non-U.S. issuers if insufficient information about the nominees is disclosed in the proxy statement.

B.     Appointment of Auditors

The Advisor generally believes that the company remains in the best position to choose its auditors and will generally support management’s recommendation for the appointment of auditors.

The Advisor will generally oppose the appointment of auditors when:

·	The fees for non-audit related services are disproportionate to the total audit fees

·	Other reasons to question the independence of the auditors exist

C.     Changes In Capital Structure

Absent a compelling reason to the contrary, the Advisor will generally cast votes in accordance with the company’s management.  However, the Advisor will review and analyze on a case-by-case basis any non-routine proposals that are likely to affect the structure and operation of the company or have a material economic effect on the company.

The Advisor will generally favor increases in authorized common stock when it is necessary to:

·	Implement a stock split

·	Aid in restructuring or acquisition

·	Provide a sufficient number of shares for an employee savings plan, stock option plan or executive compensation plan

 

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The Advisor will generally oppose increases in authorized common stock when:

·	There is evidence that the shares will be used to implement a poison pill or another form of anti-takeover defense

·	The issuance of new shares could excessively dilute the value of the outstanding shares upon issuance

D.     Corporate Restructurings, Mergers and Acquisitions

The Advisor will analyze such proposals on a case-by-case basis, taking into account, among other things, the views of investment professionals managing the portfolios in which the stock is held.

E.      Proposals Affecting Shareholder Rights

The Advisor believes that certain fundamental rights of shareholders must be protected.  The Advisor will weigh the financial impact of proposed measures against the impairment of shareholder rights.

The Advisor will generally favor proposals that give shareholders a greater voice in the affairs of the company, and generally oppose proposals that have the effect of restricting shareholders’ voice in the affairs of the company.

F.      Corporate Governance

The Advisor believes that good corporate governance is important in ensuring that management and the Board of Directors fulfill their obligations to the company’s shareholders.

The Advisor will generally favor proposals that promote transparency and accountability within a company, such as those promoting:

·	Equal access to proxies

 

·	A majority of independent directors on key committees

 

·	The Advisor will generally oppose:

 

·	Companies having two classes of shares

 

·	The existence of a majority of interlocking directors

 

G.     Anti-Takeover Measures

 

In general, proposed measures (whether advanced by management or shareholder groups) that impede takeovers or have the effect of entrenching management may be detrimental to the rights of shareholders and may negatively impact the value of the company.

 

The Advisor will generally favor proposals that have the purpose or effect of restricting or eliminating existing anti-takeover measures that have previously been adopted, such as:

 

·	Shareholder proposals that seek to require the company to submit a shareholder rights plan to a shareholder vote.

 

·	The Advisor will generally oppose proposals that have the purpose or effect of entrenching management or diluting shareholder ownership, such as:

 

·	“Blank check” preferred stock

 

·	Classified boards

 

·	Supermajority vote requirements

 

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H.     Executive Compensation

 

The Advisor generally believes that company management and the compensation committee of the Board of Directors should, within reason, be given latitude in determining the types and mix of compensation and benefit awards offered.

 

·	The Advisor will review proposals relating to executive compensation plans on a case-by-case basis to ensure:
·	The long-term interests of management and shareholders are properly aligned

 

·	The option exercise price is not below market price on the date of grant

 

·	An acceptable number of employees are eligible to participate in such compensation programs

 

The Advisor will generally favor proposals that have the purpose or effect of fairly benefiting both management and shareholders, such as proposals to:

 

·	“Double trigger” option vesting provisions

 

·	Seek treating employee stock options as an expense

 

The Advisor will generally oppose proposals that have the purpose or effect of unduly benefiting management, such as:

 

·	Plans that permit re-pricing of underwater employee stock options

 

·	“Single trigger” option vesting provisions

 

I.       Social And Corporate Responsibility

 

The Advisor will review and analyze on a case-by-case basis proposals relating to social, political and environmental issues to determine their financial impact on shareholder value.  The Advisor will generally oppose such social, political and environmental proposals that have a negative financial impact on shareholder value, such as measures that are unduly burdensome or result in unnecessary and excessive costs to the company. 

 

J.      Abstentions; Determination Not to Vote; Closed Positions

 

The Advisor will abstain from voting or affirmatively decide not to vote if the Advisor determines that abstention or not voting is in the best interests of the client.  In making this determination, the Advisor will consider various factors, including, but not limited to, (i) the costs associates with exercising the proxy (e.g., translation or travel costs); and (ii) any legal restrictions on trading resulting from the exercise of a proxy.  The Advisor may determine not to vote proxies relating to securities in which clients have no position as of the receipt of the proxy (for example, when the Advisor has sold, or has otherwise closed, a client position after the proxy record date but before the proxy receipt date). 

 

IV.           Disclosure

 

A.      The Advisor will disclose in its Form ADV Part II that clients may contact the Compliance Officer via e-mail or telephone in order to obtain information on how the Advisor voted such client’s proxies, and to request a copy of these policies and procedures.  If a client requests this information, the Compliance Officer will prepare a written response to the client that lists, with respect to each voted proxy that the client has inquired about, (1) the name of the issuer; (2) the proposal voted upon and (3) how the Advisor voted the client’s proxy.

 

B.      A concise summary of these Proxy Voting Policies and Procedures will be included in the Advisor’s Form ADV Part II, and will be updated whenever these policies and procedures are updated.  The Compliance Officer will arrange for a copy of this summary to be sent to all existing clients.

 

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V.           Potential Conflicts of Interest

 

A.      In the event that the Advisor is directly voting a proxy, the Compliance Officer will examine conflicts that exist between the interests of the Advisor and its clients.  This examination will include a review of the relationship of the Advisor, its personnel and its affiliates with the issuer of each security and any of the issuer’s affiliates to determine if the issuer is a client of the Advisor or an affiliate of the Advisor or has some other relationship with the Advisor, its personnel or a client of the Advisor.

 

B.      If, as a result of the Compliance Officer’s examination, a determination is made that a material conflict of interest exists, the Advisor will determine whether voting in accordance with the voting guidelines and factors described above is in the best interests of the client.  If the proxy involves a matter covered by the voting guidelines and factors described above, the Advisor will generally vote the proxy in accordance with the voting guidelines.  Alternatively, the Advisor may vote the proxy in accordance with the recommendation of the Proxy Voting Service.

 

C.      The Advisor may disclose the conflict to the affected clients and, except in the case of clients that are subject to the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), give the clients the opportunity to vote their proxies themselves.  In the case of ERISA clients, if the Investment Management Agreement reserves to the ERISA client the authority to vote proxies when the Advisor determines it has a material conflict that affects its best judgment as an ERISA fiduciary, the Advisor will give the ERISA client the opportunity to vote the proxies themselves.

 

D.      If the Advisor determines that it, or a Proxy Voting Service, has a conflict of interest with respect to voting proxies on behalf of a series (the “Series”) of Prospector Funds, Inc. (the “Mutual Fund”), then the Advisor shall contact the Chairman of the Board of the Mutual Fund.  In the event that the Chairman determines that he has a conflict of interest, the Chairman shall submit the matter for determination to another member of the Board who is not an “interested person” of the Mutual Fund, as defined in the Investment Company Act of 1940, as amended.  In making a determination, the Chairman will consider the best interests of the Series’ shareholders and may consider the recommendations of the Advisor or independent third parties that evaluate proxy proposals.  The Advisor will vote the proposal according the determination and maintain records relating to this process.

 

VI.           Proxy Recordkeeping

 

The Compliance Officer will maintain files relating to the Advisor’s proxy voting procedures in an easily accessible place.  (Under the services contract between the Advisor and its Proxy Voting Service, the Proxy Voting Service will maintain the Advisor’s proxy-voting records).  Records will be maintained and preserved for five years from the end of the fiscal year during which the last entry was made on a record, with records for the most recent two years kept in the offices of the Advisor.  Records of the following will be included in the files:

 

	1.	copies of these proxy voting policies and procedures, and any amendments thereto;
	2.	A copy of each proxy statement that the Advisor receives regarding client securities (the Advisor may rely on third parties or EDGAR);

 

3.

A record of each vote that the Advisor casts;

 

4.

A copy of any document the Advisor created that was material to making a decision how to vote proxies, or that memorializes that decision. (For votes that are inconsistent with the Advisor’s general proxy voting polices, the reason/rationale for such an inconsistent vote is required to be briefly documented and maintained.); and

 

A copy of each written client request for information on how the Advisor voted such client’s proxies, and a copy of any written response to any (written or oral) client request for information on how the Advisor voted its proxies.