FILE NOS. 33-37459 AND 811-6200
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON FEBRUARY 26, 2014
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-1A
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REGISTRATION STATEMENT
UNDER
THE
SECURITIES ACT OF 1933
Post-Effective Amendment No. 114
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x
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and
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REGISTRATION STATEMENT
UNDER
THE
INVESTMENT COMPANY ACT OF 1940
Amendment No. 118
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x
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SCHWAB
INVESTMENTS
(Exact Name of Registrant as Specified in Charter)
211 Main Street, San Francisco, California 94105
(Address of Principal Executive Offices) (zip code)
(800) 648-5300
(Registrants Telephone Number, including Area Code)
Marie Chandoha
211 Main
Street, San Francisco, California 94105
(Name and Address of Agent for Service)
Copies of communications to:
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Douglas P. Dick, Esq.
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John M. Loder, Esq.
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David J. Lekich, Esq.
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Dechert LLP
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Ropes & Gray LLP
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Charles Schwab Investment Management, Inc.
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1900 K Street, N.W.
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800 Boylston Street
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211 Main Street
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Washington, DC 20006
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Boston, MA 02199-3600
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SF211MN-05-491
San Francisco, CA 94105
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It is proposed that this filing will become effective (check appropriate box):
¨
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Immediately upon filing pursuant to paragraph (b)
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x
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On February 28, 2014, pursuant to paragraph (b)
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¨
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60 days after filing pursuant to paragraph (a)(1)
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¨
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On (date) pursuant to paragraph (a)(1)
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¨
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75 days after filing pursuant to paragraph (a)(2)
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¨
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On (date) pursuant to paragraph (a)(2) of Rule 485
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If appropriate, check the following box:
¨
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This post-effective amendment designates a new effective date for a previously filed post-effective amendment.
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Schwab Equity Index Funds
®
Prospectus
February 28, 2014
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Schwab
®
S&P
500 Index Fund
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SWPPX
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Schwab 1000
Index
®
Fund
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SNXFX
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Schwab
Small-Cap
Index Fund
®
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SWSSX
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Schwab Total Stock Market Index Fund
®
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SWTSX
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Schwab International Index Fund
®
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SWISX
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As with all mutual funds, the Securities and Exchange Commission (SEC) has not approved these securities or passed on whether the information in this prospectus is adequate and accurate.
Anyone who indicates otherwise is committing a federal crime.
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Schwab Equity Index Funds
®
Schwab
®
S&P 500 Index Fund
Ticker Symbol:
SWPPX
Investment objective
The funds goal is to track the total return of the S&P
500
®
Index.
Fund fees and expenses
This table describes the fees and expenses you may pay if you buy and hold shares of the fund.
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Shareholder fees
(fees paid
directly from your investment)
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Redemption fee (as a % of the amount sold or exchanged within 30 days of purchase)
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2.00
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Annual fund operating expenses
(expenses that you pay each year
as a % of the value of your investment)
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Management fees
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0.06
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Distribution
(12b-1)
fees
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None
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Other expenses
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0.03
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Total annual fund operating expenses
1
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0.09
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1
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The investment adviser and its affiliates have agreed to limit the total annual fund operating expenses (excluding interest, taxes and certain non-routine
expenses) of the fund to 0.09% for so long as the investment adviser serves as the adviser to the fund. This agreement may only be amended or terminated with the approval of the funds Board of Trustees.
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This example is intended to help you compare the cost of investing in the fund with the cost of investing in other mutual funds. The example assumes that you invest $10,000 in the fund for the time
periods indicated and then redeem all of your shares at the end of those time periods. The example also assumes that your investment has a 5% return each year and that the funds operating expenses remain the same. The figures are based on
total annual fund operating expenses after expense reduction. The expenses would be the same whether you stayed in the fund or sold your shares at the end of each period. Your actual costs may be higher or lower.
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Expenses on a $10,000 investment
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1 year
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3 years
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5 years
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10 years
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$9
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$29
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$51
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$115
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The fund pays transaction costs, such as commissions, when it buys and sells securities (or turns over its portfolio). A higher portfolio turnover may indicate higher transaction costs and may
result in higher taxes when fund shares are held in a taxable account. These costs, which are not reflected in the annual fund operating expenses or in the example, affect the funds performance. During the most recent fiscal year, the
funds portfolio turnover rate was 1% of the average value of its portfolio.
Principal investment strategies
To pursue its goal, the fund generally invests in stocks that are included in the S&P 500
®
Index
1
.
It is the funds policy
that under normal circumstances it will invest at least 80% of its net assets in these stocks; typically, the actual percentage is considerably higher. The fund will notify its shareholders at least 60 days before changing this policy.
The fund generally gives the same weight to a given stock as the index does. However, when the investment adviser believes it is in the best interest of
the fund, such as to avoid purchasing
odd-lots
(
i.e.
, purchasing less than the usual number of shares traded for a security), for tax considerations, or to address liquidity considerations with
respect to a stock, the investment adviser may cause the funds weighting of a stock to be more or less than the indexs weighting of the stock. The fund may sell securities that are represented in the index in anticipation of their
removal from the index, or buy securities that are not yet represented in the index in anticipation of their addition to the index.
The
S&P 500 Index includes the stocks of 500 leading U.S. publicly-traded companies from a broad range of industries. Standard & Poors, the company that maintains the index, uses a variety of
measures to determine which stocks are listed in the index. Each
1
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Index ownership Standard & Poors
®
, S&P
®
, and S&P 500
®
are registered trademarks of Standard & Poors
Financial Services LLC (S&P), and Dow Jones
®
is a registered trademark of Dow Jones Trademark Holdings LLC (Dow Jones) and have
been licensed for use by S&P Dow Jones Indices LLC and its affiliates and sublicensed for certain purposes by Charles Schwab Investment Management (CSIM). The S&P 500
®
Index is a product of S&P Dow Jones Indices LLC or its affiliates, and has been licensed for use by CSIM. The Schwab S&P 500
®
Index Fund is not sponsored, endorsed, sold or promoted by S&P Dow Jones Indices LLC, Dow Jones, S&P, or their respective affiliates, and neither S&P Dow Jones
Indices LLC, Dow Jones, S&P, nor their respective affiliates make any representation regarding the advisability of investing in the fund.
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Schwab
®
S&P 500 Index Fund
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1
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stock is represented in the index in proportion to its total market value.
The fund may
invest in derivatives, principally futures contracts, and lend its securities to minimize the gap in performance that naturally exists between any index fund and its corresponding index. This gap occurs mainly because, unlike the index, the fund
incurs expenses and must keep a small portion of its assets in cash for business operations. By using futures, the fund potentially can offset a portion of the gap attributable to its cash holdings. In addition, any income realized through
securities lending may help reduce the portion of the gap attributable to expenses.
The fund may concentrate its investments in an industry or
group of industries to the extent that its comparative index is also so concentrated.
Principal risks
The fund is subject to risks, any of which could cause an investor to lose money. The funds principal risks include:
Market Risk.
Equity markets rise and fall daily. As with any investment whose performance is tied to these markets, the value of your
investment in the fund will fluctuate, which means that you could lose money.
Equity Risk.
The prices of equity securities rise
and fall daily. These price movements may result from factors affecting individual companies, industries or the securities market as a whole. In addition, equity markets tend to move in cycles, which may cause stock prices to fall over short or
extended periods of time.
Investment Style Risk.
The fund primarily follows the
large-cap
portion of the U.S. stock market, as measured by the index. It follows these stocks during upturns as well as downturns. Because of its indexing strategy, the fund does not take steps to reduce market exposure or to lessen the effects of a
declining market. In addition, because of the funds expenses, the funds performance may be below that of the index.
A significant
percentage of the index may be composed of securities in a single industry or sector of the economy. If the fund is focused in an industry or sector, it may present more risks than if it were broadly diversified over numerous industries and sectors
of the economy.
Tracking Error Risk.
As an index fund, the fund seeks to track the performance of its comparative index, although
it may not be successful in doing so. The divergence between the performance of the fund and its index, positive or negative, is called tracking error. Tracking error can be caused by many factors and it may be significant. For example,
the fund may not invest in certain securities in the index, or match the securities weightings to the index, due to regulatory, operational, custodial or liquidity constraints; corporate transactions; asset valuations; transaction costs and
timing; tax considerations; and index rebalancing, which may result in tracking error.
Large-Cap
Risk.
Although the S&P 500
®
Index encompasses stocks from many different sectors of the economy, its performance
primarily reflects that of
large-cap
stocks, which tend to go in and out of favor based on market and economic conditions. As a result, during a period
when these stocks fall behind other types of investments bonds or
mid-
or
small-cap
stocks, for instance the funds performance also will
lag those investments.
Concentration Risk.
To the extent that the funds or the indexs portfolio is concentrated
in the securities of issuers in a particular market, industry, group of industries, sector or asset class, the fund may be adversely affected by the performance of those securities, may be subject to increased price volatility and may be more
susceptible to adverse economic, market, political or regulatory occurrences affecting that market, industry, group of industries, sector or asset class.
Derivatives Risk.
The funds use of derivative instruments involves risks different from, or possibly greater than, the risks associated with investing directly in securities and other
traditional investments and could cause the fund to lose more than the principal amount invested. In addition, investments in derivatives may involve leverage, which means a small percentage of assets invested in derivatives can have a
disproportionately large impact on the fund.
Liquidity Risk.
A particular investment may be difficult to purchase or sell. The
fund may be unable to sell illiquid securities at an advantageous time or price.
Securities Lending Risk.
Securities lending
involves the risk of loss of rights in the collateral or delay in recovery of the collateral if the borrower fails to return the security loaned or becomes insolvent.
Your investment in the fund is not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency.
For more information on the risks of investing in the fund, please see the Fund details section in the prospectus.
Performance
The bar chart below shows
how the funds investment results have varied from year to year, and the following table shows how the funds average annual total returns for various periods compared to that of the index. This information provides some indication of the
risks of investing in the fund. All figures assume distributions were reinvested. Keep in mind that future performance (both before and after taxes) may differ from past performance. For current performance information, please see
www.schwabfunds.com/prospectus
. On September 9, 2009, the Investor Share class, Select Share class, and e.Shares class were combined into a single class of shares of the fund, and the fund no longer offers multiple classes of shares. The
performance history of the fund, prior to September 9, 2009, is that of the funds former Select Shares.
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2
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Schwab
®
S&P 500 Index Fund
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Annual total returns
(%) as of 12/31
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Best quarter: 15.81% Q2 2009
Worst quarter: (21.80%) Q4 2008
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Average annual total returns
(%) as of 12/31/13
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1 year
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5 years
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10 years
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Before taxes
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32.27%
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17.83%
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7.36%
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After taxes on distributions
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31.74%
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17.46%
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7.00%
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After taxes on distributions and sale of shares
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18.68%
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14.52%
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5.96%
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Comparative Index (reflects no deduction for expenses or taxes)
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S&P 500
®
Index
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32.39%
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17.94%
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7.41%
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The
after-tax
figures reflect the highest individual federal income tax rates
in effect during the period and do not reflect the impact of state and local taxes. Your actual
after-tax
returns depend on your individual tax situation. In addition,
after-tax
returns are not relevant if you hold your fund shares through a
tax-deferred
arrangement, such as a 401(k) plan, an individual retirement account
(IRA) or other
tax-advantaged
account.
Investment adviser
Charles Schwab Investment Management, Inc.
Portfolio managers
Agnes Hong, CFA,
Managing Director and Head of Passive Equity Strategies, is responsible for the day-to-day co-management of the fund. She has managed the fund since 2012.
Ferian Juwono, CFA,
Managing Director and Senior Portfolio Manager, is responsible for the day-to-day co-management of the fund. He has managed the fund since 2013.
Ron Toll
, Portfolio Manager, is responsible for the day-to-day co-management of the fund. He has
managed the fund since 2008.
Purchase and sale of fund shares
The fund is open for business each day that the New York Stock Exchange (NYSE) is open. When you place orders to purchase, exchange or redeem fund shares through an account at Charles Schwab
& Co., Inc. (Schwab) or another financial intermediary, you must follow Schwabs or the other financial intermediarys transaction procedures.
Eligible Investors (as determined by the fund and which generally are limited to institutional investors) may invest directly in the fund by placing purchase, exchange and redemption orders through the
funds transfer agent. Eligible Investors must contact the transfer agent by phone or in writing to obtain an account application. Eligible Investors may contact the transfer agent:
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by telephone at
1-800-407-0256; or
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by mail to Boston Financial Data Services, Attn: Schwab Funds, P.O. Box 8283, Boston, MA
02266-8323.
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The minimum initial investment for the fund is $100. The minimum may be waived for certain investors or in the
funds sole discretion.
Tax information
Dividends and capital gains distributions received from the fund will generally be taxable as ordinary income or capital gains, unless you are investing through an IRA, 401(k) or other
tax-advantaged
account.
Payments to financial intermediaries
If you purchase shares of the fund through a broker-dealer or other financial intermediary (such as a bank), the fund and its related companies may pay
the intermediary for the sale of fund shares and related services. These payments may create a conflict of interest by influencing the broker-dealer or other financial intermediary and your salesperson to recommend the fund over another investment.
Ask your salesperson or visit your financial intermediarys website for more information.
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Schwab
®
S&P 500 Index Fund
|
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3
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Schwab 1000 Index
®
Fund
Ticker Symbol: SNXFX
Investment objective
The funds goal is to match the total return of the Schwab 1000
Index
®
.
Fund fees and expenses
This table describes the fees and expenses you may pay if you buy and hold shares of the fund.
|
|
|
|
|
Shareholder fees
(fees paid
directly from your investment)
|
|
Redemption fee (as a % of the amount sold or exchanged within 30 days of purchase)
|
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|
2.00
|
|
|
|
|
|
|
Annual fund operating expenses
(expenses that you pay each year
as a % of the value of your investment)
|
|
Management fees
|
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0.23
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Distribution
(12b-1)
fees
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None
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Other expenses
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0.11
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Acquired fund fees and expenses (AFFE)
1
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0.01
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Total annual fund operating expenses
1
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0.35
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Less expense reduction
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(0.05
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)
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Total annual fund operating expenses (including AFFE) after expense reduction
1
,2
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0.30
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1
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The total annual fund operating expenses in the fee table may differ from the expense ratios in the funds Financial highlights because the
financial highlights include only the funds direct operating expenses and do not include AFFE, which reflect the estimated amount of fees and expenses incurred indirectly by the fund through its investments in other investment companies,
including business development companies (BDCs), during its prior fiscal year. Expenses of BDCs and other investment companies are not direct costs paid by the fund shareholders and have no impact on costs associated with fund
operations. The expenses are also not used to calculate the funds net asset value.
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2
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The investment adviser and its affiliates have agreed to limit the total annual fund operating expenses (excluding interest, taxes and certain non-routine
expenses) of the fund to 0.29% for so long as the investment adviser serves as the adviser to the fund. This agreement may only be amended or terminated with the approval of the funds Board of Trustees. This agreement is limited to the
funds direct operating expenses and does not apply to AFFE.
|
This example is intended to help you compare the cost of investing in the fund with the cost of investing in other mutual funds. The example assumes that you invest $10,000 in the fund for the time
periods indicated and then redeem all of your shares at the end of
those time periods. The example also assumes that your investment has a 5% return each year and that the funds operating expenses remain the same. The figures are based on total annual fund
operating expenses (including AFFE) after expense reduction. The expenses would be the same whether you stayed in the fund or sold your shares at the end of each period. Your actual costs may be higher or lower.
|
Expenses on a $10,000 investment
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1 year
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3 years
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5 years
|
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10 years
|
$31
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|
$97
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|
$169
|
|
$381
|
The fund pays transaction costs, such as commissions, when it buys and sells securities (or turns over its portfolio). A higher portfolio turnover may indicate higher transaction costs and may
result in higher taxes when fund shares are held in a taxable account. These costs, which are not reflected in the annual fund operating expenses or in the example, affect the funds performance. During the most recent fiscal year, the
funds portfolio turnover rate was 4% of the average value of its portfolio.
Principal investment strategies
To pursue its goal, the fund generally invests in stocks that are included in the Schwab 1000 Index
®
.
It is the funds policy that under normal circumstances it will invest at least 80% of its net assets in these stocks; typically, the actual percentage is
considerably higher. The fund will notify its shareholders at least 60 days before changing this policy.
The fund generally gives the same
weight to a given stock as the index does. However, when the investment adviser believes it is in the best interest of the fund, such as to avoid purchasing
odd-lots
(
i.e.
, purchasing less than the
usual number of shares traded for a security), for tax considerations, or to address liquidity considerations with respect to a stock, the investment adviser may cause the funds weighting of a stock to be more or less than the indexs
weighting of the stock. The fund may sell securities that are represented in the index in anticipation of their removal from the index, or buy securities that are not yet represented in the index in anticipation of their addition to the index.
The Schwab 1000 Index includes the stocks of the largest 1,000 publicly-traded companies in the United States, with size being
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4
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Schwab 1000 Index
®
Fund
|
determined by market capitalization (total market value of all shares outstanding). The index is designed to be a measure of the performance of
large-
and
mid-cap
U.S. stocks
The fund may invest in derivatives, principally futures contracts, and
lend its securities to minimize the gap in performance that naturally exists between any index fund and its corresponding index. This gap occurs mainly because, unlike the index, the fund incurs expenses and must keep a small portion of its assets
in cash for business operations. By using futures, the fund potentially can offset a portion of the gap attributable to its cash holdings. In addition, any income realized through securities lending may help reduce the portion of the gap
attributable to expenses.
The fund may concentrate its investments in an industry or group of industries to the extent that its comparative
index is also so concentrated.
Principal risks
The fund is subject to risks, any of which could cause an investor to lose money. The funds principal risks include:
Market Risk.
Equity markets rise and fall daily. As with any investment whose performance is tied to these markets, the value of your investment in the fund will fluctuate, which means that
you could lose money.
Equity Risk.
The prices of equity securities rise and fall daily. These price movements may result from
factors affecting individual companies, industries or the securities market as a whole. In addition, equity markets tend to move in cycles, which may cause stock prices to fall over short or extended periods of time.
Investment Style Risk.
The fund primarily follows the
large-
and
mid-cap
portions of the U.S. stock market, as measured by the index. It follows these stocks during upturns as well as downturns. Because of its indexing strategy, the fund does not take steps to reduce
market exposure or to lessen the effects of a declining market. In addition, because of the funds expenses, the funds performance may be below that of the index.
A significant percentage of the index may be composed of securities in a single industry or sector of the economy. If the fund is focused in an industry or sector, it may present more risks than if it
were broadly diversified over numerous industries and sectors of the economy.
Tracking Error Risk.
As an index fund, the fund
seeks to track the performance of its comparative index, although it may not be successful in doing so. The divergence between the performance of the fund and its index, positive or negative, is called tracking error. Tracking error can
be caused by many factors and it may be significant. For example, the fund may not invest in certain securities in the index, or match the securities weightings to the index, due to regulatory, operational, custodial or liquidity constraints;
corporate transactions; asset valuations; transaction costs and timing; tax considerations; and index rebalancing, which may result in tracking error.
Large-
and
Mid-Cap
Risk.
Many of the risks of this fund are associated with its investment in the
large-
and
mid-cap
segments of the U.S. stock market. Both
large-
and
mid-cap
stocks tend to go in and out of favor based on market and economic conditions. However, stocks of
mid-cap
companies
tend to be more volatile than those of
large-cap
companies because
mid-cap
companies tend to be more susceptible to adverse business or economic events than larger more
established companies. During a period when
large-
and
mid-cap
U.S. stocks fall behind other types of investments bonds, for instance the
funds performance also will lag those investments.
Concentration Risk.
To the extent that the funds or the
indexs portfolio is concentrated in the securities of issuers in a particular market, industry, group of industries, sector or asset class, the fund may be adversely affected by the performance of those securities, may be subject to increased
price volatility and may be more susceptible to adverse economic, market, political or regulatory occurrences affecting that market, industry, group of industries, sector or asset class.
Derivatives Risk.
The funds use of derivative instruments involves risks different from, or possibly greater than, the risks associated with investing directly in securities and other
traditional investments and could cause the fund to lose more than the principal amount invested. In addition, investments in derivatives may involve leverage, which means a small percentage of assets invested in derivatives can have a
disproportionately large impact on the fund.
Liquidity Risk.
A particular investment may be difficult to purchase or sell. The
fund may be unable to sell illiquid securities at an advantageous time or price.
Securities Lending Risk.
Securities lending
involves the risk of loss of rights in the collateral or delay in recovery of the collateral if the borrower fails to return the security loaned or becomes insolvent.
Your investment in the fund is not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency.
For more information on the risks of investing in the fund, please see the Fund details section in the prospectus.
Performance
The bar chart below shows
how the funds investment results have varied from year to year, and the following table shows how the funds average annual total returns for various periods compared to that of two indices. This information provides some indication of
the risks of investing in the fund. All figures assume distributions were reinvested. Keep in mind that future performance (both before and after taxes) may differ from past performance. For current performance information, please see
www.schwabfunds.com/prospectus. On September 18, 2009, the Investor Share class and Select Share class were combined into a single class of shares of the fund, and the fund no longer offers multiple classes of shares. The performance history of
the fund,
|
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|
|
Schwab 1000 Index
®
Fund
|
|
|
5
|
|
prior to September 18, 2009, is that of the funds former Investor Shares.
|
Annual total returns
(%) as of 12/31
|
Best quarter: 16.09% Q2 2009
Worst quarter: (22.34%) Q4 2008
|
Average annual total returns
(%) as of
12/31/13
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1 year
|
|
|
5 years
|
|
|
10 years
|
|
Before taxes
|
|
|
32.67%
|
|
|
|
18.15%
|
|
|
|
7.54%
|
|
After taxes on distributions
|
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31.22%
|
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17.30%
|
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|
6.99%
|
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After taxes on distributions and sale of shares
|
|
|
19.60%
|
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14.85%
|
|
|
|
6.13%
|
|
Comparative Indices (reflect no deduction for expenses or taxes)
|
|
|
|
|
|
|
|
|
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|
Schwab 1000 Index
|
|
|
33.04%
|
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|
18.51%
|
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|
|
7.83%
|
|
S&P 500
®
Index
|
|
|
32.39%
|
|
|
|
17.94%
|
|
|
|
7.41%
|
|
The
after-tax
figures reflect the highest individual federal income tax rates
in effect during the period and do not reflect the impact of state and local taxes. Your actual
after-tax
returns depend on your individual tax situation. In addition,
after-tax
returns are not relevant if you hold your fund shares through a
tax-deferred
arrangement, such as a 401(k) plan, an individual retirement account
(IRA) or other
tax-advantaged
account.
Investment adviser
Charles Schwab Investment Management, Inc.
Portfolio managers
Agnes Hong, CFA,
Managing Director and Head of Passive Equity Strategies, is responsible for the day-to-day co-management of the fund. She has managed the fund since 2012.
Ferian Juwono, CFA,
Managing Director and Senior Portfolio Manager, is responsible for the
day-to-day co-management of the fund. He has managed the fund since 2013.
Ron Toll,
Portfolio Manager, is responsible for the
day-to-day co-management of the fund. He has managed the fund since 2008.
Purchase and sale of fund shares
The fund is open for business each day that the New York Stock Exchange (NYSE) is open. When you place orders to purchase, exchange or redeem
fund shares through an account at Charles Schwab & Co., Inc. (Schwab) or another financial intermediary, you must follow Schwabs or the other financial intermediarys transaction procedures.
Eligible Investors (as determined by the fund and which generally are limited to institutional investors) may invest directly in the fund by placing
purchase, exchange and redemption orders through the funds transfer agent. Eligible Investors must contact the transfer agent by phone or in writing to obtain an account application. Eligible Investors may contact the transfer agent:
|
|
|
by telephone at
1-800-407-0256; or
|
|
|
|
by mail to Boston Financial Data Services, Attn: Schwab Funds, P.O. Box 8283, Boston, MA
02266-8323.
|
The minimum initial investment for the fund is $100. The minimum may be waived for certain investors or in the
funds sole discretion.
Tax information
Dividends and capital gains distributions received from the fund will generally be taxable as ordinary income or capital gains, unless you are investing through an IRA, 401(k) or other
tax-advantaged
account.
Payments to financial intermediaries
If you purchase shares of the fund through a broker-dealer or other financial intermediary (such as a bank), the fund and its related companies may pay
the intermediary for the sale of fund shares and related services. These payments may create a conflict of interest by influencing the broker-dealer or other financial intermediary and your salesperson to recommend the fund over another investment.
Ask your salesperson or visit your financial intermediarys website for more information.
|
|
|
6
|
|
Schwab 1000 Index
®
Fund
|
Schwab
Small-Cap
Index Fund
®
Ticker Symbol: SWSSX
Investment objective
The funds goal is to track the performance of a benchmark index that measures the total return of small capitalization U.S. stocks.
Fund fees and expenses
This table describes the fees and expenses you may pay if you buy and hold shares of the fund.
|
|
|
|
|
Shareholder fees
(fees paid
directly from your investment)
|
|
Redemption fee (as a % of the amount sold or exchanged within 30 days of purchase)
|
|
|
2.00
|
|
|
|
|
|
|
Annual fund operating expenses
(expenses that you pay each year
as a % of the value of your investment)
|
|
Management fees
|
|
|
0.15
|
|
Distribution
(12b-1)
fees
|
|
|
None
|
|
Other expenses
|
|
|
0.05
|
|
Acquired fund fees and expenses (AFFE)
1
|
|
|
0.10
|
|
|
|
|
|
|
Total annual fund operating expenses
1
|
|
|
0.30
|
|
Less expense reduction
|
|
|
(0.03
|
)
|
|
|
|
|
|
Total annual fund operating expenses (including AFFE) after expense reduction
1,2
|
|
|
0.27
|
|
|
|
|
|
|
1
|
The total annual fund operating expenses in the fee table may differ from the expense ratios in the funds Financial highlights because the
financial highlights include only the funds direct operating expenses and do not include AFFE, which reflect the estimated amount of fees and expenses incurred indirectly by the fund through its investments in other investment companies,
including business development companies (BDCs), during its prior fiscal year. Expenses of BDCs and other investment companies are not direct costs paid by the fund shareholders and have no impact on costs associated with fund
operations. The expenses are also not used to calculate the funds net asset value.
|
2
|
The investment adviser and its affiliates have agreed to limit the total annual fund operating expenses (excluding interest, taxes and certain non-routine
expenses) of the fund to 0.17% for so long as the investment adviser serves as the adviser to the fund. This agreement may only be amended or terminated with the approval of the funds Board of Trustees. This agreement is limited to the
funds direct operating expenses and does not apply to AFFE.
|
This example is intended to help you compare the cost of investing in the fund with the cost of investing in other mutual funds. The example assumes that you invest $10,000 in the fund for the time
periods indicated and then redeem all of your shares at the end of those time periods. The example also assumes that your investment has a 5% return each year and that the funds operating expenses remain the same. The figures are based on
total annual fund operating expenses (including AFFE) after expense reduction. The expenses would be
the same whether you stayed in the
fund or sold your shares at the end of each period. Your actual costs may be higher or lower.
|
Expenses on a $10,000 investment
|
|
|
|
|
|
|
|
1 year
|
|
3 years
|
|
5 years
|
|
10 years
|
$28
|
|
$87
|
|
$152
|
|
$343
|
The fund pays transaction costs, such as commissions, when it buys and sells securities (or turns over its portfolio). A higher portfolio turnover may indicate higher transaction costs and may
result in higher taxes when fund shares are held in a taxable account. These costs, which are not reflected in the annual fund operating expenses or in the example, affect the funds performance. During the most recent fiscal year, the
funds portfolio turnover rate was 11% of the average value of its portfolio.
Principal investment strategies
To pursue its goal, the fund generally invests in stocks that are included in the Russell 2000
®
Index.
1
It is the funds policy that under normal circumstances it will invest at least 80% of its net assets in these stocks; typically, the actual percentage is considerably higher. The fund will notify
its shareholders at least 60 days before changing this policy.
The fund generally gives the same weight to a given stock as the index does.
However, when the investment adviser believes it is in the best interest of the fund, such as to avoid purchasing
odd-lots
(
i.e.
, purchasing less than the usual number of shares traded for a
1
|
Index ownership Russell 2000
®
is a registered mark of the Frank Russell Company (Russell) and has been licensed for use by the Schwab Small-Cap Index Fund. The Schwab Small-Cap Index
Fund is not sponsored, endorsed, sold or promoted by Russell and Russell makes no representation regarding the advisability of investing in the fund.
|
|
|
|
|
|
Schwab
Small-Cap
Index Fund
®
|
|
|
7
|
|
security), for tax considerations, or to address liquidity considerations with respect to a stock, the investment adviser may cause the funds weighting of a stock to be more or less than
the indexs weighting of the stock. The fund may sell securities that are represented in the index in anticipation of their removal from the index, or buy securities that are not yet represented in the index in anticipation of their addition to
the index.
The Russell 2000 Index measures the performance of the small-cap sector of the U.S. equity market. The
index is a subset of the Russell 3000
®
Index, representing approximately the 2000 smallest issuers and, as of
December 31, 2013, approximately 10% of the total market capitalization of the Russell 3000 Index.
The fund may invest in derivatives,
principally futures contracts, and lend its securities to minimize the gap in performance that naturally exists between any index fund and its corresponding index. This gap occurs mainly because, unlike the index, the fund incurs expenses and must
keep a small portion of its assets in cash for business operations. By using futures, the fund potentially can offset a portion of the gap attributable to its cash holdings. In addition, any income realized through securities lending may help reduce
the portion of the gap attributable to expenses.
The fund may concentrate its investments in an industry or group of industries to the extent
that its comparative index is also so concentrated.
Principal risks
The fund is subject to risks, any of which could cause an investor to lose money. The funds principal risks include:
Market Risk.
Equity markets rise and fall daily. As with any investment whose performance is tied to these markets, the value of your investment in the fund will fluctuate, which means that
you could lose money.
Equity Risk.
The prices of equity securities rise and fall daily. These price movements may result from
factors affecting individual companies, industries or the securities market as a whole. In addition, equity markets tend to move in cycles, which may cause stock prices to fall over short or extended periods of time.
Investment Style Risk.
The fund primarily follows the
small-cap
portion of the U.S. stock market,
as measured by the index. It follows these stocks during upturns as well as downturns. Because of its indexing strategy, the fund does not take steps to reduce market exposure or to lessen the effects of a declining market. In addition, because of
the funds expenses, the funds performance may be below that of the index.
A significant percentage of the index may be composed of
securities in a single industry or sector of the economy. If the fund is focused in an industry or sector, it may present more risks than if it were broadly diversified over numerous industries and sectors of the economy.
Tracking Error Risk.
As an index fund, the fund seeks to track the performance of its comparative index, although it may not be successful in
doing so. The divergence between the performance of
the fund and its index, positive or negative, is called tracking error. Tracking error can be caused by many factors and it may be significant. For example, the fund may not invest in
certain securities in the index, or match the securities weightings to the index, due to regulatory, operational, custodial or liquidity constraints; corporate transactions; asset valuations; transaction costs and timing; tax considerations;
and index rebalancing, which may result in tracking error.
Small-Cap
Risk.
Historically,
small-cap
stocks have been riskier than
large-
and
mid-cap
stocks. Stock prices of smaller companies
may be based in substantial part on future expectations rather than current achievements and may move sharply, especially during market upturns and downturns.
Small-cap
companies themselves may be more
vulnerable to adverse business or economic events than larger, more established companies. During a period when
small-cap
stocks fall behind other types of investments bonds or
large-cap
stocks, for instance the funds performance also will lag those investments.
Concentration Risk.
To the extent that the funds or the indexs portfolio is concentrated in the securities of issuers in a
particular market, industry, group of industries, sector or asset class, the fund may be adversely affected by the performance of those securities, may be subject to increased price volatility and may be more susceptible to adverse economic, market,
political or regulatory occurrences affecting that market, industry, group of industries, sector or asset class.
Derivatives
Risk.
The funds use of derivative instruments involves risks different from, or possibly greater than, the risks associated with investing directly in securities and other traditional investments and could cause the fund to lose more
than the principal amount invested. In addition, investments in derivatives may involve leverage, which means a small percentage of assets invested in derivatives can have a disproportionately large impact on the fund.
Liquidity Risk.
A particular investment may be difficult to purchase or sell. The fund may be unable to sell illiquid securities at an
advantageous time or price.
Securities Lending Risk.
Securities lending involves the risk of loss of rights in the collateral or
delay in recovery of the collateral if the borrower fails to return the security loaned or becomes insolvent.
Your investment in the fund is
not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency.
For more
information on the risks of investing in the fund, please see the Fund details section in the prospectus.
Performance
The bar chart below shows how the funds investment results have varied from year to year, and the following table shows how the
funds average annual total returns for various periods compared to that of the index. This information provides some indication of the risks of investing in the fund. All figures assume distributions were
|
|
|
8
|
|
Schwab
Small-Cap
Index Fund
®
|
reinvested. Keep in mind that future performance (both before and after taxes) may differ from past performance. For current performance information, please see
www.schwabfunds.com/prospectus
. On August 21, 2009, the Investor Share class and Select Share class were combined into a single class of shares of the fund, and the fund no longer offers multiple classes of shares. The performance
history of the fund, prior to August 21, 2009, is that of the funds former Select Shares.
|
Annual total returns
(%) as of
12/31
|
Best quarter: 25.57% Q2 2009
Worst quarter: (26.86%) Q4 2008
|
|
|
|
|
|
|
|
|
|
|
|
|
Average annual total returns
(%) as of 12/31/13
|
|
|
|
1 year
|
|
|
5 years
|
|
|
10 years
|
|
Before taxes
|
|
|
38.69%
|
|
|
|
22.13%
|
|
|
|
9.75%
|
|
After taxes on distributions
|
|
|
36.58%
|
|
|
|
21.01%
|
|
|
|
8.53%
|
|
After taxes on distributions and sale of shares
|
|
|
23.12%
|
|
|
|
17.97%
|
|
|
|
7.77%
|
|
Comparative Index (reflects no deduction for expenses or taxes)
|
|
|
|
|
|
|
|
|
|
|
|
|
Russell 2000 Index
|
|
|
38.82%
|
|
|
|
20.08%
|
|
|
|
9.07%
|
|
The
after-tax
figures reflect the highest individual federal income tax rates
in effect during the period and do not reflect the impact of state and local taxes. Your actual
after-tax
returns depend on your individual tax situation. In addition,
after-tax
returns are not relevant if you hold your fund shares through a
tax-deferred
arrangement, such as a 401(k) plan, an individual retirement account
(IRA) or other
tax-advantaged
account.
Investment adviser
Charles Schwab Investment Management, Inc.
Portfolio managers
Agnes Hong, CFA,
Managing Director and Head of Passive Equity Strategies, is responsible for the day-to-day co-management of the fund. She has managed the fund since 2012.
Ferian Juwono, CFA,
Managing Director and Senior Portfolio Manager, is responsible for the day-to-day co-management of the fund. He has managed the fund since 2013.
Ron Toll
, Portfolio Manager, is responsible for the day-to-day co-management of the fund. He has managed the fund since 2008.
Purchase and sale of fund shares
The fund is open for business each day that the New York Stock Exchange (NYSE) is open. When you place orders to purchase, exchange or redeem fund shares through an account at Charles Schwab
& Co., Inc. (Schwab) or another financial intermediary, you must follow Schwabs or the other financial intermediarys transaction procedures.
Eligible Investors (as determined by the fund and which generally are limited to institutional investors) may invest directly in the fund by placing purchase, exchange and redemption orders through the
funds transfer agent. Eligible Investors must contact the transfer agent by phone or in writing to obtain an account application. Eligible Investors may contact the transfer agent:
|
|
|
by telephone at
1-800-407-0256; or
|
|
|
|
by mail to Boston Financial Data Services, Attn: Schwab Funds, P.O. Box 8283, Boston, MA
02266-8323.
|
The minimum initial investment for the fund is $100. The minimum may be waived for certain investors or in the
funds sole discretion.
Tax information
Dividends and capital gains distributions received from the fund will generally be taxable as ordinary income or capital gains, unless you are investing through an IRA, 401(k) or other
tax-advantaged
account.
Payments to financial intermediaries
If you purchase shares of the fund through a broker-dealer or other financial intermediary (such as a bank), the fund and its related companies may pay
the intermediary for the sale of fund shares and related services. These payments may create a conflict of interest by influencing the broker-dealer or other financial intermediary and your salesperson to recommend the fund over another investment.
Ask your salesperson or visit your financial intermediarys website for more information.
|
|
|
|
|
Schwab
Small-Cap
Index Fund
®
|
|
|
9
|
|
Schwab Total Stock Market Index Fund
®
Ticker
Symbol: SWTSX
Investment objective
The funds goal is to track the total return of the entire U.S. stock market, as measured by The Dow Jones U.S. Total Stock Market Index
SM
.
Fund fees and expenses
This table describes the fees and expenses you may pay if you buy
and hold shares of the fund.
|
|
|
|
|
Shareholder fees
(fees paid
directly from your investment)
|
|
Redemption fee (as a % of the amount sold or exchanged within 30 days of purchase)
|
|
|
2.00
|
|
|
|
|
|
|
Annual fund operating expenses
(expenses that you pay each year
as a % of the value of your investment)
|
|
Management fees
|
|
|
0.06
|
|
Distribution
(12b-1)
fees
|
|
|
None
|
|
Other expenses
|
|
|
0.04
|
|
|
|
|
|
|
Total annual fund operating expenses
|
|
|
0.10
|
|
Less expense reduction
|
|
|
(0.01
|
)
|
|
|
|
|
|
Total annual fund operating expenses after expense
reduction
1
|
|
|
0.09
|
|
|
|
|
|
|
1
|
The investment adviser and its affiliates have agreed to limit the total annual fund operating expenses (excluding interest, taxes and certain
non-routine
expenses) of the fund to 0.09% for so long as the investment adviser serves as the adviser to the fund. This agreement may only be amended or terminated with the approval of the funds Board of
Trustees.
|
This example is intended to help you compare the cost of investing in the fund with the cost of investing in other mutual funds. The example assumes that you invest $10,000 in the fund for the time
periods indicated and then redeem all of your shares at the end of those time periods. The example also assumes that your investment has a 5% return each year and that the funds operating expenses remain the same. The figures are based on
total annual fund operating expenses after expense reduction. The expenses would be
the same whether you stayed in the fund or sold your shares at the end of each period. Your actual costs may be higher or lower.
|
Expenses on a $10,000 investment
|
|
|
|
|
|
|
|
1 year
|
|
3 years
|
|
5 years
|
|
10 years
|
$9
|
|
$29
|
|
$51
|
|
$115
|
The fund pays transaction costs, such as commissions, when it buys and sells securities (or turns over its portfolio). A higher portfolio turnover may indicate higher transaction costs and may
result in higher taxes when fund shares are held in a taxable account. These costs, which are not reflected in the annual fund operating expenses or in the example, affect the funds performance. During the most recent fiscal year, the
funds portfolio turnover rate was 2% of the average value of its portfolio.
Principal investment strategies
To pursue its goal, the fund generally invests in stocks that are included in The Dow Jones U.S. Total Stock Market Index
SM1
.
It is the funds policy that under normal circumstances it will invest at least 80% of its net assets in
these stocks; typically, the actual percentage is considerably higher. The fund will notify its shareholders at least 60 days before changing this policy.
The fund generally gives the same weight to a given stock as the index does. However, when the investment adviser believes it is in the best interest of the fund, such as to avoid purchasing
odd-lots
(
i.e.
, purchasing less than the usual number of shares traded for a security), for tax considerations, or to address liquidity considerations with respect to a stock, the investment adviser may
cause the funds weighting of a stock to be more or less than the indexs weighting of the stock. The fund may sell securities that are represented in the index in anticipation of their removal from the index, or buy securities that are
not yet represented in the index in anticipation of their addition to the index.
The Dow Jones U.S. Total Stock
Market Index
SM
includes all publicly traded stocks of
companies headquartered in the
1
|
Index ownership Standard & Poors
®
and S&P
®
are registered trademarks of Standard & Poors Financial Services LLC (S&P), and Dow Jones
®
is a registered trademark of Dow Jones Trademark Holdings LLC (Dow Jones) and have been licensed for use by S&P Dow Jones Indices LLC and its
affiliates and sublicensed for certain purposes by CSIM. The Dow Jones U.S. Total Stock Market Index
SM
is a product of S&P Dow Jones Indices LLC or its
affiliates, and has been licensed for use by Charles Schwab Investment Management (CSIM). The Schwab Total Stock Market Index Fund
®
is not sponsored,
endorsed, sold or promoted by S&P Dow Jones Indices LLC, Dow Jones, S&P, or their respective affiliates, and neither S&P Dow Jones Indices LLC, Dow Jones, S&P, nor their respective affiliates make any representation regarding the
advisability of investing in the fund.
|
|
|
|
10
|
|
Schwab Total Stock Market Index Fund
®
|
United States for which pricing information is readily available currently more than 3,600 stocks. The index is a float-adjusted market capitalization weighted index that
reflects the shares of securities actually available to investors in the marketplace.
Because it may not be possible or practical to purchase
all of the stocks included in the index, the investment adviser seeks to track the total return of the index by using statistical sampling techniques. These techniques involve investing in a limited number of index securities which, when taken
together, are expected to perform similarly to the index as a whole. These techniques are based on a variety of factors, including capitalization, performance attributes, dividend yield, price/earnings ratio, risk factors, industry factors and other
characteristics. The fund generally expects that its portfolio will include the largest 2,000 to 2,800 U.S. stocks (measured by the float-adjusted market capitalization), and that its industry weightings, dividend yield and price/earnings ratio
will be similar to those of the index.
The fund may invest in derivatives, principally futures contracts, and lend its securities to minimize
the gap in performance that naturally exists between any index fund and its corresponding index. This gap occurs mainly because, unlike the index, the fund incurs expenses and must keep a small portion of its assets in cash for business operations.
By using futures, the fund potentially can offset a portion of the gap attributable to its cash holdings. In addition, any income realized through securities lending may help reduce the portion of the gap attributable to expenses.
The fund may concentrate its investments in an industry or group of industries to the extent that its comparative index is also so concentrated.
Principal risks
The fund is
subject to risks, any of which could cause an investor to lose money. The funds principal risks include:
Market Risk.
Equity
markets rise and fall daily. As with any investment whose performance is tied to these markets, the value of your investment in the fund will fluctuate, which means that you could lose money.
Equity Risk.
The prices of equity securities rise and fall daily. These price movements may result from factors affecting individual companies, industries or the securities market as a whole.
In addition, equity markets tend to move in cycles, which may cause stock prices to fall over short or extended periods of time.
Investment
Style Risk.
The fund follows the U.S. stock market, as measured by the index. It follows this market during upturns as well as downturns. Because of its indexing strategy, the fund does not take steps to reduce market exposure or to
lessen the effects of a declining market. In addition, because of the funds expenses, the funds performance may be below that of the index.
A significant percentage of the index may be composed of securities in a single industry or sector of the economy. If the fund is focused in an industry or sector, it may present more risks than if it
were broadly diversified over numerous industries and sectors of the economy.
Tracking Error Risk.
As an index fund, the fund seeks to track the performance of its
comparative index, although it may not be successful in doing so. The divergence between the performance of the fund and its index, positive or negative, is called tracking error. Tracking error can be caused by many factors and it may
be significant. For example, the fund may not invest in certain securities in the index, or match the securities weightings to the index, due to regulatory, operational, custodial or liquidity constraints; corporate transactions; asset
valuations; transaction costs and timing; and index rebalancing, which may result in tracking error.
Sampling Index Tracking
Risk.
The fund does not fully replicate its comparative index and may hold securities not included in the index. As a result, the fund is subject to the risk that the investment advisers investment strategy, the implementation of
which is subject to a number of constraints, may not produce the intended results. Because the fund utilizes a sampling approach, it may not track the return of the index as well as it would if the fund purchased all of the securities in the index.
Concentration Risk.
To the extent that the funds or the indexs portfolio is concentrated in the securities of issuers
in a particular market, industry, group of industries, sector or asset class, the fund may be adversely affected by the performance of those securities, may be subject to increased price volatility and may be more susceptible to adverse economic,
market, political or regulatory occurrences affecting that market, industry, group of industries, sector or asset class.
Large-
and
Mid-Cap
Risk.
Many of the risks of this fund are associated with its investment in the
large-
and
mid-cap
segments of the U.S. stock market. Both
large-
and
mid-cap
stocks tend to go in and out of favor based on market and
economic conditions. However, stocks of
mid-cap
companies tend to be more volatile than those of
large-cap
companies because
mid-cap
companies tend to be more susceptible to adverse business or economic events than larger more established companies. During a period when
large-
and
mid-cap
U.S. stocks fall behind other types of investments bonds, for instance the funds performance also will lag those investments.
Small-Cap
Risk.
Historically,
small-cap
stocks have been
riskier than
large-
and
mid-cap
stocks. Stock prices of smaller companies may be based in substantial part on future expectations rather than current achievements and
may move sharply, especially during market upturns and downturns.
Small-cap
companies themselves may be more vulnerable to adverse business or economic events than larger, more established companies. During a
period when
small-cap
stocks fall behind other types of investments
large-cap
stocks, for instance the funds performance also will lag
those investments.
Derivatives Risk.
The funds use of derivative instruments involves risks different from, or possibly
greater than, the risks associated with investing directly in securities and other traditional investments and could cause the fund to lose more than the principal amount invested. In addition, investments in derivatives
|
|
|
|
|
Schwab Total Stock Market Index Fund
®
|
|
|
11
|
|
may involve leverage, which means a small percentage of assets invested in derivatives can have a disproportionately large impact on the fund.
Liquidity Risk.
A particular investment may be difficult to purchase or sell. The fund may be unable to sell illiquid securities at an
advantageous time or price.
Securities Lending Risk.
Securities lending involves the risk of loss of rights in the collateral or
delay in recovery of the collateral if the borrower fails to return the security loaned or becomes insolvent.
Your investment in the fund is
not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency.
For more
information on the risks of investing in the fund, please see the Fund details section in the prospectus.
Performance
The bar chart below shows how the funds investment results have varied from year to year, and the following table shows how the
funds average annual total returns for various periods compared to that of the index. This information provides some indication of the risks of investing in the fund. All figures assume distributions were reinvested. Keep in mind that future
performance (both before and after taxes) may differ from past performance. For current performance information, please see
www.schwabfunds.com/prospectus
. On September 18, 2009, the Investor Share class and Select Share class were
combined into a single class of shares of the fund, and the fund no longer offers multiple classes of shares. The performance history of the fund, prior to September 18, 2009, is that of the funds former Select Shares.
|
Annual total returns
(%) as of
12/31
|
Best quarter: 16.24% Q2 2009
Worst quarter: (22.54%) Q4 2008
|
|
|
|
|
|
|
|
|
|
|
|
|
Average annual total returns
(%) as of 12/31/13
|
|
|
|
1 year
|
|
|
5 years
|
|
|
10 years
|
|
Before taxes
|
|
|
33.36%
|
|
|
|
18.77%
|
|
|
|
8.11%
|
|
After taxes on distributions
|
|
|
32.73%
|
|
|
|
18.38%
|
|
|
|
7.74%
|
|
After taxes on distributions and sale of shares
|
|
|
19.37%
|
|
|
|
15.32%
|
|
|
|
6.57%
|
|
Comparative Index (reflects no deduction for expenses or taxes)
|
|
|
|
|
|
|
|
|
|
|
|
|
Dow Jones U.S. Total Stock Market Index
SM
|
|
|
33.47%
|
|
|
|
18.86%
|
|
|
|
8.09%
|
|
The
after-tax
figures reflect the highest individual federal income
tax rates in effect during the period and do not reflect the impact of state and local taxes. Your actual
after-tax
returns depend on your individual tax situation. In addition,
after-tax
returns are not relevant if you hold your fund shares through a
tax-deferred
arrangement, such as a 401(k) plan, an individual retirement account
(IRA) or other
tax-advantaged
account.
Investment adviser
Charles Schwab Investment Management, Inc.
Portfolio managers
Agnes Hong, CFA,
Managing Director and Head of Passive Equity Strategies, is responsible for the day-to-day co-management of the fund. She has managed the fund since 2012.
Ferian Juwono, CFA,
Managing Director and Senior Portfolio Manager, is responsible for the day-to-day co-management of the fund. He has managed the fund since 2013.
Purchase and sale of fund shares
The
fund is open for business each day that the New York Stock Exchange (NYSE) is open. When you place orders to purchase, exchange or redeem fund shares through an account at Charles Schwab & Co., Inc. (Schwab) or another financial
intermediary, you must follow Schwabs or the other financial intermediarys transaction procedures.
Eligible Investors (as
determined by the fund and which generally are limited to institutional investors) may invest directly in the fund by placing purchase, exchange and redemption orders through the funds transfer agent. Eligible Investors must contact the
transfer agent by phone or in writing to obtain an account application. Eligible Investors may contact the transfer agent:
|
|
|
by telephone at
1-800-407-0256; or
|
|
|
|
by mail to Boston Financial Data Services, Attn: Schwab Funds, P.O. Box 8283, Boston, MA 02266-8323.
|
The minimum initial investment for the fund is $100. The minimum may be waived for certain investors or in the funds sole discretion.
Tax information
Dividends and capital
gains distributions received from the fund will generally be taxable as ordinary income or capital gains, unless you are investing through an IRA, 401(k) or other
tax-advantaged
account.
Payments to financial intermediaries
If
you purchase shares of the fund through a broker-dealer or other financial intermediary (such as a bank), the fund and its related companies may pay the intermediary for the sale of fund shares and related services. These payments may create a
conflict of interest by influencing the broker-dealer or other financial intermediary and your salesperson to recommend the fund over another investment. Ask your salesperson or visit your financial intermediarys website for more information.
|
|
|
12
|
|
Schwab Total Stock Market Index Fund
®
|
Schwab International Index
Fund
®
Ticker Symbol: SWISX
Investment objective
The funds goal is to track the performance of a benchmark index that measures the total return of large, publicly traded
non-U.S. companies
from
countries with developed equity markets outside of the United States.
Fund fees and expenses
This table describes the fees and expenses you may pay if you buy and hold shares of the fund.
|
|
|
|
|
Shareholder fees
(fees paid
directly from your investment)
|
|
Redemption fee (as a % of the amount sold or exchanged within 30 days of purchase)
|
|
|
2.00
|
|
|
|
|
|
|
Annual fund operating expenses
(expenses that you pay each year
as a % of the value of your investment)
|
|
Management fees
|
|
|
0.15
|
|
Distribution
(12b-1)
fees
|
|
|
None
|
|
Other expenses
|
|
|
0.08
|
|
|
|
|
|
|
Total annual fund operating expenses
|
|
|
0.23
|
|
Less expense reduction
|
|
|
(0.04
|
)
|
|
|
|
|
|
Total annual fund operating expenses after expense
reduction
1
|
|
|
0.19
|
|
|
|
|
|
|
1
|
The investment adviser and its affiliates have agreed to limit the total annual fund operating expenses (excluding interest, taxes and certain
non-routine
expenses) of the fund to 0.19% for so long as the investment adviser serves as the adviser to the fund. This agreement may only be amended or terminated with the approval of the funds Board of
Trustees.
|
This example is intended to help you compare the cost of investing in the fund with the cost of investing in other mutual funds. The example assumes that you invest $10,000 in the fund for the time
periods indicated and then redeem all of your shares at the end of those time periods. The example also assumes that your investment has a 5% return each year and that the funds operating expenses remain the same. The figures are based on
total annual fund operating expenses after expense reduction. The expenses would be
the same whether you stayed in the fund or sold your shares at the end of each period. Your actual costs may be higher or lower.
|
Expenses on a $10,000 investment
|
|
|
|
|
|
|
|
1 year
|
|
3 years
|
|
5 years
|
|
10 years
|
$19
|
|
$61
|
|
$107
|
|
$243
|
The fund pays transaction costs, such as commissions, when it buys and sells securities (or turns over its portfolio). A higher portfolio turnover may indicate higher transaction costs and may
result in higher taxes when fund shares are held in a taxable account. These costs, which are not reflected in the annual fund operating expenses or in the example, affect the funds performance. During the most recent fiscal year, the
funds portfolio turnover rate was 5% of the average value of its portfolio.
Principal investment strategies
To pursue its goal, the fund generally invests in stocks that are included in the MSCI EAFE Index.
1
It is the funds policy that under normal circumstances it will
invest at least 80% of its net assets in these stocks; typically, the actual percentage is considerably higher. The fund will notify its shareholders at least 60 days before changing this policy.
The fund generally gives the same weight to a given stock as the index does. However, when the investment adviser believes it is in the best interest of
the fund, such as to avoid purchasing
odd-lots
(
i.e.
, purchasing less than the usual number of shares traded for a security), for tax considerations, or to address liquidity considerations with
respect to a stock, the investment adviser may cause the funds weighting of a stock to be more or less than the indexs weighting of the stock. The fund may sell securities that are represented in the index in anticipation of their
removal from the index, or buy securities that are not yet represented in the index in anticipation of their addition to the index. The fund does not hedge its exposure to foreign currencies. However, the fund may use forward contracts to lock in
exchange rates for the portfolio securities purchased or sold, but awaiting settlement. These
1
|
Index ownership MSCI EAFE is a registered mark of MSCI Inc. (MSCI) and has been licensed for use by the Schwab International Index
Fund. The Schwab International Index Fund is not sponsored, endorsed, sold or promoted by MSCI and MSCI bears no liability with respect to the fund. The Statement of Additional Information contains a more detailed description of the limited
relationship MSCI has with the fund.
|
|
|
|
|
|
Schwab International Index Fund
®
|
|
|
13
|
|
transactions establish a rate of exchange that can be expected to be received upon settlement of the securities.
The MSCI EAFE Index includes stocks from Europe, Australasia and the Far East, and as of December 31, 2013, it consisted of the following 21 developed market country indices: Australia, Austria, Belgium,
Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the United Kingdom.
The fund may invest in derivatives, principally futures contracts, and lend its securities to minimize the gap in performance that naturally exists
between any index fund and its corresponding index. This gap occurs mainly because, unlike the index, the fund incurs expenses and must keep a small portion of its assets in cash for business operations. By using futures, the fund potentially can
offset a portion of the gap attributable to its cash holdings. In addition, any income realized through securities lending may help reduce the portion of the gap attributable to expenses.
The fund may concentrate its investments in an industry or group of industries to the extent that its comparative index is also so concentrated.
Principal risks
The fund is subject to risks, any of which could cause an investor to lose
money. The funds principal risks include:
Market Risk.
Equity markets rise and fall daily. As with any investment whose
performance is tied to these markets, the value of your investment in the fund will fluctuate, which means that you could lose money.
Equity Risk.
The prices of equity securities rise and fall daily. These price movements may result from factors affecting individual
companies, industries or the securities market as a whole. In addition, equity markets tend to move in cycles, which may cause stock prices to fall over short or extended periods of time.
Investment Style Risk.
The fund primarily follows the performance of a mix of international
large-cap
stocks, as measured by the index. It follows these
stocks during upturns as well as downturns. Because of its indexing strategy, the fund does not take steps to reduce market exposure or to lessen the effects of a declining market. In addition, because of the funds expenses, the funds
performance may be below that of the index.
A significant percentage of the index may be composed of securities in a single industry or sector
of the economy. If the fund is focused in an industry or sector, it may present more risks than if it were broadly diversified over numerous industries and sectors of the economy.
Geographic Risk.
To the extent the funds investments in a single country or a limited number of countries represent a higher percentage of the funds assets, the fund assumes the risk
that economic, political and social conditions in those countries will have a significant impact on its investment performance and it may be subject to increased price volatility.
Large-Cap
Risk.
Large-cap
stocks tend to go in and out of favor based on market and economic conditions. During a period when these stocks fall behind other types of investments bonds or
mid-
or
small-cap
stocks, for instance the funds performance also will lag those investments.
Tracking Error Risk.
As an index fund, the fund seeks to track the performance of its comparative index, although it may not be successful in doing so. The divergence between the performance
of the fund and its index, positive or negative, is called tracking error. Tracking error can be caused by many factors and it may be significant. For example, the fund may not invest in certain securities in the index, or match the
securities weightings to the index, due to regulatory, operational, custodial or liquidity constraints; corporate transactions; asset valuations; transaction costs and timing; tax considerations; and index rebalancing, which may result in
tracking error.
Foreign Investment Risk.
The funds investments in securities of foreign issuers may involve certain risks
that are greater than those associated with investments in securities of U.S. issuers. These include risks of adverse changes in foreign economic, political, regulatory and other conditions; changes in currency exchange rates or exchange
control regulations (including limitations on currency movements and exchanges); differing accounting, auditing, financial reporting and legal standards and practices; differing securities market structures; and higher transaction costs.
Concentration Risk.
To the extent that the funds or the indexs portfolio is concentrated in the securities of issuers in a
particular market, industry, group of industries, sector, country or asset class, the fund may be adversely affected by the performance of those securities, may be subject to increased price volatility and may be more susceptible to adverse
economic, market, political or regulatory occurrences affecting that market, industry, group of industries, sector, country or asset class.
Derivatives Risk.
The funds use of derivative instruments involves risks different from, or possibly greater than, the risks associated
with investing directly in securities and other traditional investments and could cause the fund to lose more than the principal amount invested. In addition, investments in derivatives may involve leverage, which means a small percentage of assets
invested in derivatives can have a disproportionately large impact on the fund.
Liquidity Risk.
A particular investment may be
difficult to purchase or sell. The fund may be unable to sell illiquid securities at an advantageous time or price.
Securities Lending
Risk.
Securities lending involves the risk of loss of rights in the collateral or delay in recovery of the collateral if the borrower fails to return the security loaned or becomes insolvent.
Your investment in the fund is not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government
agency.
|
|
|
14
|
|
Schwab International Index Fund
®
|
For more information on the risks of investing in the fund, please see the Fund details section
in the prospectus.
Performance
The bar chart below shows how the funds investment results have varied from year to year, and the following table shows how the funds average
annual total returns for various periods compared to that of the index. This information provides some indication of the risks of investing in the fund. All figures assume distributions were reinvested. Keep in mind that future performance (both
before and after taxes) may differ from past performance. For current performance information, please see
www.schwabfunds.com/prospectus
. On August 21, 2009, the Investor Share class and Select Share class were combined into a single
class of shares of the fund, and the fund no longer offers multiple classes of shares. The performance history of the fund, prior to August 21, 2009, is that of the funds former Select Shares.
|
Annual total returns
(%) as of
12/31
|
Best quarter: 24.57% Q2 2009
Worst quarter: (21.13%) Q4 2008
|
Average annual total returns
(%) as of
12/31/13
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1 year
|
|
|
5 years
|
|
|
10 years
|
|
Before taxes
|
|
|
21.64%
|
|
|
|
11.96%
|
|
|
|
6.83%
|
|
After taxes on distributions
|
|
|
20.90%
|
|
|
|
11.45%
|
|
|
|
6.34%
|
|
After taxes on distributions and sale of shares
|
|
|
12.83%
|
|
|
|
9.72%
|
|
|
|
5.63%
|
|
Comparative Index (reflects no deduction for expenses or taxes)
|
|
|
|
|
|
|
|
|
|
|
|
|
MSCI EAFE Index (Net)
1
|
|
|
22.78%
|
|
|
|
12.44%
|
|
|
|
6.91%
|
|
1
|
The net version of the index reflects reinvested dividends net of withholding taxes, but reflects no deductions for expenses or other taxes.
|
The
after-tax
figures reflect the highest individual federal income tax rates
in effect during the period and do not reflect the impact of state and local taxes. Your actual
after-tax
returns depend on your individual tax situation. In addition,
after-tax
returns are not relevant if you hold your fund shares through a
tax-deferred
arrangement, such as a 401(k) plan, an individual retirement account
(IRA) or other
tax-advantaged
account. In some cases, the return after taxes may exceed the return before taxes due to an assumed benefit from any losses on a sale of shares at the end of the
measurement period.
Investment adviser
Charles Schwab Investment Management, Inc.
Portfolio managers
Agnes Hong, CFA,
Managing Director and Head of Passive Equity Strategies, is responsible for the day-to-day co-management of the fund. She has
managed the fund since 2012.
Ferian Juwono, CFA,
Managing Director and Senior Portfolio Manager, is responsible for the day-to-day
co-management of the fund. He has managed the fund since 2013.
Ron Toll
, Portfolio Manager, is responsible for the day-to-day
co-management of the fund. He has managed the fund since 2011.
Purchase and sale of fund shares
The fund is open for business each day that the New York Stock Exchange (NYSE) is open. When you place orders to purchase, exchange or redeem
fund shares through an account at Charles Schwab & Co., Inc. (Schwab) or another financial intermediary, you must follow Schwabs or the other financial intermediarys transaction procedures.
Eligible Investors (as determined by the fund and which generally are limited to institutional investors) may invest directly in the fund by placing
purchase, exchange and redemption orders through the funds transfer agent. Eligible Investors must contact the transfer agent by phone or in writing to obtain an account application. Eligible Investors may contact the transfer agent:
|
|
|
by telephone at
1-800-407-0256; or
|
|
|
|
by mail to Boston Financial Data Services, Attn: Schwab Funds, P.O. Box 8283, Boston, MA 02266-8323.
|
The minimum initial investment for the fund is $100. The minimum may be waived for certain investors or in the funds sole discretion.
Tax information
Dividends and capital
gains distributions received from the fund will generally be taxable as ordinary income or capital gains, unless you are investing through an IRA, 401(k) or other
tax-advantaged
account.
Payments to financial intermediaries
If
you purchase shares of the fund through a broker-dealer or other financial intermediary (such as a bank), the fund and its related companies may pay the intermediary for the sale of fund shares and related services. These payments may create a
conflict of interest by influencing the broker-dealer or other financial intermediary and your salesperson to recommend the fund over another investment. Ask your salesperson or visit your financial intermediarys website for more information.
|
|
|
|
|
Schwab International Index Fund
®
|
|
|
15
|
|
Fund details
Investment objectives and more about principal risks
Schwab
®
S&P 500 Index Fund
Investment objective
The funds goal is to track the total return of the S&P 500
®
Index
.
Index
The S&P 500 Index includes the stocks of 500 leading U.S. publicly traded companies from a broad range of industries.
Standard & Poors, the company that maintains the index,
uses a variety of measures to determine which stocks are listed in the index. Each stock is represented in the index in proportion to its total market value.
Although the 500 companies in the index constitute only about 14% of all the publicly traded companies in the United States, they represent approximately 82% of the total value of the U.S. stock
market, as of December 31, 2013. Companies of this size are generally considered
large-cap
stocks. Their performance is widely followed, and the index itself is popularly seen as a measure of overall
U.S. stock market performance.
Because the index weights a stock according to its market capitalization (total market value of all
shares outstanding), larger stocks have more influence on the performance of the index than do the indexs smaller stocks.
More about the
funds principal investment risks
The fund is subject to risks, any of which could cause an investor to lose money.
Market Risk.
Equity markets rise and fall daily. As with any investment whose performance is tied to these markets, the value of your investment in
the fund will fluctuate, which means that you could lose money.
Equity Risk.
The prices of equity securities rise and fall daily. These
price movements may result from factors affecting individual companies, industries or the securities market as a whole. Individual companies may report poor results or be negatively affected by industry and/or economic trends and developments. The
prices of securities issued by such companies may suffer a decline in response. In addition, the equity market tends to move in cycles, which may cause stock prices to fall over short or extended periods of time.
Investment Style Risk.
The fund primarily follows the
large-cap
portion of the U.S. stock market, as
measured by the index. It follows these stocks during upturns as well as downturns. Because of its indexing strategy, the fund does not take steps to reduce market exposure or to lessen the effects of a declining market. In addition, because of the
funds expenses, the funds performance may be below that of the index.
A significant percentage of the index may be composed of
securities in a single industry or sector of the economy. If the fund is focused in an industry or sector, it may present more risks than if it were broadly diversified over numerous industries and sectors of the economy.
Tracking Error Risk.
As an index fund, the fund seeks to track the performance of its comparative index, although it may not be successful in doing
so. The divergence between the performance of the fund and its index, positive or negative, is called tracking error. Tracking error can be caused by many factors and it may be significant. For example, the fund may not invest in certain
securities in its index, match the securities weighting to the index, or the fund may invest in securities not in the index, due to regulatory, operational, custodial or liquidity constraints; corporate transactions; asset valuations;
transaction costs and timing; tax considerations; and index rebalancing, which may result in tracking error. The fund may attempt to offset the effects of not being invested in certain index securities by making substitute investments, but these
efforts may not be successful. In addition, cash flows into and out of the fund, operating expenses and trading costs all affect the ability of the fund to match the performance of its index, because the index does not have to manage cash flows and
does not incur any costs.
Large-Cap
Risk.
Although the S&P 500
®
Index encompasses stocks from many different sectors of the economy, its performance primarily reflects that of
large-cap
stocks, which tend to go in and out of favor based on market and economic conditions. As a result, during a period when these stocks fall behind other types of investments bonds or
mid-
or
small-cap
stocks, for instance the funds performance also will lag those investments.
Concentration Risk.
To the extent that the funds or the indexs portfolio is concentrated in the securities of issuers in a particular market, industry, group of industries, sector
or asset class, the fund may be adversely affected by the performance of those securities, may be subject to increased price volatility and may be more susceptible to adverse economic, market, political or regulatory occurrences affecting that
market, industry, group of industries, sector or asset class.
Derivatives Risk.
The fund may use derivatives to enhance returns or hedge against market declines.
Examples of derivatives are futures and options on futures. An option is the right to buy or sell an instrument at a specific price before a specific date. A future is an agreement to buy or sell a financial instrument at a specific price on a
specific day. The use of derivatives, subject to regulation by the Commodity Futures Trading Commission (CFTC), could cause the fund to become a commodity pool, which would require the fund to comply with certain CFTC rules.
The funds use of derivative instruments involves risks different from or possibly greater than the risks associated with investing directly in
securities and other traditional investments. Certain of these risks, such as liquidity risk and market risk, are discussed elsewhere in this section. The funds use of derivatives is also subject to lack of availability risk, credit risk,
leverage risk, valuation risk, correlation risk and tax risk. Lack of availability risk is the risk that suitable derivative transactions may not be available in all circumstances for risk management or other purposes. Credit risk is the risk that
the counterparty to a derivatives transaction may not fulfill its obligations. Leverage risk is the risk that a small percentage of assets invested in derivatives can have a disproportionately larger impact on the fund. Valuation risk is the risk
that a particular derivative may be valued incorrectly. Correlation risk is the risk that changes in the value of the derivative may not correlate perfectly with the underlying asset, rate or index. Tax risk is the risk that the use of derivatives
may cause the fund to realize higher amounts of short-term capital gain. These risks could cause the fund to lose more than the principal amount invested.
Liquidity Risk.
Liquidity risk exists when particular investments are difficult to purchase or sell. The market for certain investments may become illiquid due to specific adverse changes in the
conditions of a particular issuer or under adverse market or economic conditions independent of the issuer. The funds investments in illiquid securities may reduce the returns of the fund because it may be unable to sell the illiquid
securities at an advantageous time or price. Further, transactions in illiquid securities may entail transaction costs that are higher than those for transactions in liquid securities.
Securities Lending Risk.
The fund may lend its portfolio securities to brokers, dealers, and other financial institutions provided a number of conditions are satisfied, including that the loan is
fully collateralized. When the fund lends portfolio securities, its investment performance will continue to reflect changes in the value of the securities loaned, and the fund will also receive a fee or interest on the collateral. Securities lending
involves the risk of loss of rights in the collateral or delay in recovery of the collateral if the borrower fails to return the security loaned or becomes insolvent. The fund will also bear the risk of any decline in value of securities acquired
with cash collateral. The fund may pay lending fees to a party arranging the loan.
Schwab 1000 Index
®
Fund
Investment objective
The funds goal is to match the total return of the Schwab 1000 Index
®
.
Index
The Schwab 1000 Index includes the stocks of the largest 1,000 publicly traded companies in the United States, with size being determined by market
capitalization (total market value of all shares outstanding).
The index is designed to be a measure of the performance of
large-
and
mid-cap
U.S. stocks.
Although there are currently more than 3,600 total stocks in the United States, the companies represented by the Schwab 1000 Index
make up some 92% of the total value of all U.S. stocks, as of December 31, 2013. These
large-
and
mid-cap
stocks cover many industries and represent many sizes.
Because
large-
and
mid-cap
stocks can perform differently from each other at times, a fund that invests in both categories of stocks may have somewhat different
performance than a fund that invests only in
large-cap
stocks.
More about the funds principal
investment risks
The fund is subject to risks, any of which could cause an investor to lose money.
Market Risk.
Equity markets rise and fall daily. As with any investment whose performance is tied to these markets, the value of your investment in
the fund will fluctuate, which means that you could lose money.
Equity Risk.
The prices of equity securities rise and fall daily. These
price movements may result from factors affecting individual companies, industries or the securities market as a whole. Individual companies may report poor results or be negatively affected by industry and/or economic trends and developments. The
prices of securities issued by such companies may suffer a decline in response. In addition, the equity market tends to move in cycles, which may cause stock prices to fall over short or extended periods of time.
Investment Style Risk.
The fund primarily follows the
large-
and
mid-cap
portion of the U.S. stock market, as measured by the index. It follows these stocks during upturns as well as downturns. Because of its indexing strategy, the fund does not take steps to reduce
market exposure or to lessen the effects of a declining market. In addition, because of the funds expenses, the funds performance may be below that of the index.
A significant percentage of the index may be composed of securities in a single industry or sector of the
economy. If the fund is focused in an industry or sector, it may present more risks than if it were broadly diversified over numerous industries and sectors of the economy.
Tracking Error Risk.
As an index fund, the fund seeks to track the performance of its comparative index, although it may not be successful in doing so. The divergence between the performance of the
fund and its index, positive or negative, is called tracking error. Tracking error can be caused by many factors and it may be significant. For example, the fund may not invest in certain securities in its index, match the
securities weighting to the index, or the fund may invest in securities not in the index, due to regulatory, operational, custodial or liquidity constraints; corporate transactions; asset valuations; transaction costs and timing; tax
considerations; and index rebalancing, which may result in tracking error. The fund may attempt to offset the effects of not being invested in certain index securities by making substitute investments, but these efforts may not be successful. In
addition, cash flows into and out of the fund, operating expenses and trading costs all affect the ability of the fund to match the performance of its index, because the index does not have to manage cash flows and does not incur any costs.
Large-
and
Mid-Cap
Risk.
Many of the risks of this
fund are associated with its investment in the
large-
and
mid-cap
segments of the U.S. stock market. Both
large-
and
mid-cap
stocks tend to go in and out of favor based on market and economic conditions. However, stocks of
mid-cap
companies tend to be more volatile than those of
large-cap
companies because
mid-cap
companies tend to be more susceptible to adverse business or economic events than larger more established companies. During a period when
large-
and
mid-cap
U.S. stocks fall behind other types of investments bonds or small-cap stocks, for instance the funds performance also
will lag those investments.
Concentration Risk.
To the extent that the funds or the indexs portfolio is
concentrated in the securities of issuers in a particular market, industry, group of industries, sector or asset class, the fund may be adversely affected by the performance of those securities, may be subject to increased price volatility and may
be more susceptible to adverse economic, market, political or regulatory occurrences affecting that market, industry, group of industries, sector or asset class.
Derivatives Risk.
The fund may use derivatives to enhance returns or hedge against market declines. Examples of derivatives are futures and options on futures. An option is the right to buy or sell
an instrument at a specific price before a specific date. A future is an agreement to buy or sell a financial instrument at a specific price on a specific day. The use of derivatives, subject to regulation by the CFTC, could cause the fund to become
a commodity pool, which would require the fund to comply with certain CFTC rules.
The funds use of derivative instruments involves risks
different from or possibly greater than the risks associated with investing directly in securities and other traditional investments. Certain of these risks, such as liquidity risk and market risk, are discussed elsewhere in this section. The
funds use of derivatives is also subject to lack of availability risk, credit risk, leverage risk, valuation risk, correlation risk and tax risk. Lack of availability risk is the risk that suitable derivative transactions may not be available
in all circumstances for risk management or other purposes. Credit risk is the risk that the counterparty to a derivatives transaction may not fulfill its obligations. Leverage risk is the risk that a small percentage of assets invested in
derivatives can have a disproportionately larger impact on the fund. Valuation risk is the risk that a particular derivative may be valued incorrectly. Correlation risk is the risk that changes in the value of the derivative may not correlate
perfectly with the underlying asset, rate or index. Tax risk is the risk that the use of derivatives may cause the fund to realize higher amounts of short-term capital gain. These risks could cause the fund to lose more than the principal amount
invested.
Liquidity Risk.
Liquidity risk exists when particular investments are difficult to purchase or sell. The market for certain
investments may become illiquid due to specific adverse changes in the conditions of a particular issuer or under adverse market or economic conditions independent of the issuer. The funds investments in illiquid securities may reduce the
returns of the fund because it may be unable to sell the illiquid securities at an advantageous time or price. Further, transactions in illiquid securities may entail transaction costs that are higher than those for transactions in liquid
securities.
Securities Lending Risk.
The fund may lend its portfolio securities to brokers, dealers, and other financial institutions
provided a number of conditions are satisfied, including that the loan is fully collateralized. When the fund lends portfolio securities, its investment performance will continue to reflect changes in the value of the securities loaned, and the fund
will also receive a fee or interest on the collateral. Securities lending involves the risk of loss of rights in the collateral or delay in recovery of the collateral if the borrower fails to return the security loaned or becomes insolvent. The fund
will also bear the risk of any decline in value of securities acquired with cash collateral. The fund may pay lending fees to a party arranging the loan.
Schwab Small Cap Index Fund
®
Investment objective
The funds goal is to track the performance of a benchmark index that
measures the total return of small capitalization U.S. stocks.
Index
T
he fund seeks to achieve its investment objective by tracking the total return of the Russell 2000 Index
.
The Russell 2000 Index measures the performance of the small-cap sector of the U.S. equity market. The index is a subset of
the Russell 3000 Index, representing approximately the 2000 smallest issuers and, as of December 31, 2013, approximately 10% of the total market capitalization of the Russell 3000 Index.
Historically, the performance of
small-cap
stocks has not always paralleled that of
large-cap
stocks. For this reason, some investors use them to diversify a portfolio that invests in larger stocks.
More about the funds principal investment risks
The fund is subject to risks, any of which could cause an investor to lose money.
Market
Risk.
Equity markets rise and fall daily. As with any investment whose performance is tied to these markets, the value of your investment in the fund will fluctuate, which means that you could lose money.
Equity Risk.
The prices of equity securities rise and fall daily. These price movements may result from factors affecting individual companies,
industries or the securities market as a whole. Individual companies may report poor results or be negatively affected by industry and/or economic trends and developments. The prices of securities issued by such companies may suffer a decline in
response. In addition, the equity market tends to move in cycles, which may cause stock prices to fall over short or extended periods of time.
Investment Style Risk.
The fund primarily follows the
small-cap
portion of the U.S. stock market, as measured by the index. It follows these stocks
during upturns as well as downturns. Because of its indexing strategy, the fund does not take steps to reduce market exposure or to lessen the effects of a declining market. In addition, because of the funds expenses, the funds
performance may be below that of the index.
A significant percentage of the index may be composed of securities in a single industry or sector
of the economy. If the fund is focused in an industry or sector, it may present more risks than if it were broadly diversified over numerous industries and sectors of the economy.
Tracking Error Risk.
As an index fund, the fund seeks to track the performance of its comparative index, although it may not be successful in doing so. The divergence between the performance of the
fund and its index, positive or negative, is called tracking error. Tracking error can be caused by many factors and it may be significant. For example, the fund may not invest in certain securities in its index, match the
securities weighting to the index, or the fund may invest in securities not in the index, due to regulatory, operational, custodial or liquidity constraints; corporate transactions; asset valuations; transaction costs and timing; tax
considerations; and index rebalancing, which may result in tracking error. The fund may attempt to offset the effects of not being invested in certain index securities by making substitute investments, but these efforts may not be successful. In
addition, cash flows into and out of the fund, operating expenses and trading costs all affect the ability of the fund to match the performance of its index, because the index does not have to manage cash flows and does not incur any costs.
Small-Cap Risk.
Historically, small-cap stocks have been riskier than large- and mid-cap stocks. Stock prices of smaller companies
may be based in substantial part on future expectations rather than current achievements and may move sharply, especially during market upturns and downturns. Small-cap companies themselves may be more vulnerable to adverse business or economic
events than larger, more established companies. During a period when small-cap stocks fall behind other types of investments large-cap and mid-cap stocks, for instance the funds performance also will lag those investments.
Concentration Risk.
To the extent that the funds or the indexs portfolio is concentrated in the securities of
issuers in a particular market, industry, group of industries, sector or asset class, the fund may be adversely affected by the performance of those securities, may be subject to increased price volatility and may be more susceptible to adverse
economic, market, political or regulatory occurrences affecting that market, industry, group of industries, sector or asset class.
Derivatives Risk.
The fund may use derivatives to enhance returns or hedge against market declines. Examples of derivatives are futures and options
on futures. An option is the right to buy or sell an instrument at a specific price before a specific date. A future is an agreement to buy or sell a financial instrument at a specific price on a specific day. The use of derivatives, subject to
regulation by the CFTC, could cause the fund to become a commodity pool, which would require the fund to comply with certain CFTC rules.
The
funds use of derivative instruments involves risks different from or possibly greater than the risks associated with investing directly in securities and other traditional investments. Certain of these risks, such as liquidity risk and market
risk, are discussed elsewhere in this section. The funds use of derivatives is also subject to lack of availability risk, credit risk, leverage risk, valuation risk, correlation risk and tax risk. Lack of availability risk is the risk that
suitable derivative transactions may not be available in all circumstances for risk management or other purposes. Credit risk is the risk that the counterparty to a derivatives transaction may not fulfill its obligations. Leverage risk is the risk
that a small percentage of assets invested in derivatives can have a disproportionately larger impact on the fund. Valuation risk is the risk that a particular derivative may be valued incorrectly. Correlation risk is the risk that changes in the
value of the derivative may not correlate perfectly with the underlying asset, rate or index. Tax risk is the risk that the use of derivatives may cause the fund to realize higher amounts of short-term capital gain. These risks could cause the fund
to lose more than the principal amount invested.
Liquidity Risk.
Liquidity risk exists when particular investments are difficult to purchase or sell.
The market for certain investments may become illiquid due to specific adverse changes in the conditions of a particular issuer or under adverse market or economic conditions independent of the issuer. The funds investments in illiquid
securities may reduce the returns of the fund because it may be unable to sell the illiquid securities at an advantageous time or price. Further, transactions in illiquid securities may entail transaction costs that are higher than those for
transactions in liquid securities.
Securities Lending Risk.
The fund may lend its portfolio securities to brokers, dealers, and other
financial institutions provided a number of conditions are satisfied, including that the loan is fully collateralized. When the fund lends portfolio securities, its investment performance will continue to reflect changes in the value of the
securities loaned, and the fund will also receive a fee or interest on the collateral. Securities lending involves the risk of loss of rights in the collateral or delay in recovery of the collateral if the borrower fails to return the security
loaned or becomes insolvent. The fund will also bear the risk of any decline in value of securities acquired with cash collateral. The fund may pay lending fees to a party arranging the loan.
Schwab Total Stock Market Index Fund
®
Investment objective
The
funds goal is to track the total return of the entire U.S. stock market, as measured by The Dow Jones U.S. Total Stock Market Index
SM
.
Index
The funds comparative index includes all publicly traded stocks of companies headquartered in the United States for which
pricing information is readily available 3,600 stocks, as of December 31, 2013.
The index is a float-adjusted market capitalization weighted index that reflects the shares of securities actually available to investors in the
marketplace.
The U.S. stock market is commonly divided into three segments, based on market capitalization.
Mid-
and
small-cap
stocks are the most numerous, but make up only about
one-third
of the total value of the market. In contrast,
large-cap
stocks are relatively few in number but make up approximately
two-thirds
of the markets total value. In fact, the largest 1,000 of the markets listed
stocks represent about 93% of its total value, as of December 31, 2013.
In terms of performance, these segments can behave somewhat
differently from each other, over the short-term as well as the long-term. For that reason, the performance of the overall stock market can be seen as a blend of the performance of all three segments.
More about the funds principal investment risks
The fund is subject to risks, any of which could cause an investor to lose money.
Market
Risk.
Equity markets rise and fall daily. As with any investment whose performance is tied to these markets, the value of your investment in the fund will fluctuate, which means that you could lose money.
Equity Risk.
The prices of equity securities rise and fall daily. These price movements may result from factors affecting individual companies,
industries or the securities market as a whole. Individual companies may report poor results or be negatively affected by industry and/or economic trends and developments. The prices of securities issued by such companies may suffer a decline in
response. In addition, the equity market tends to move in cycles, which may cause stock prices to fall over short or extended periods of time.
Investment Style Risk.
The fund follows the U.S. stock market, as measured by the index. It follows these stocks during upturns as well as
downturns. Because of its indexing strategy, the fund does not take steps to reduce market exposure or to lessen the effects of a declining market. In addition, because of the funds expenses, the funds performance may be below that of
the index.
A significant percentage of the index may be composed of securities in a single industry or sector of the economy. If the fund is
focused in an industry or sector, it may present more risks than if it were broadly diversified over numerous industries and sectors of the economy.
Tracking Error Risk.
As an index fund, the fund seeks to track the performance of its comparative index, although it may not be successful in doing so. The divergence between the performance of the
fund and its index, positive or negative, is called tracking error. Tracking error can be caused by many factors and it may be significant. For example, the fund may not invest in all of the securities in its index or may invest in
securities not in the index, because the manager may use a sampling technique that is designed to balance the risk of tracking error against the negative effects of transaction costs associated with certain investments. Similarly, the fund may not
invest in certain securities in its index, or match the securities weighting to the index, due to regulatory, operational, custodial or liquidity constraints; corporate transactions; asset valuations; transaction costs and timing; tax
considerations; and index rebalancing, which may result in tracking error. The fund may attempt to offset the effects of not being invested in certain index securities by making substitute investments, but these efforts may not be successful. In
addition, cash flows into and out of the fund, operating expenses and trading costs all affect the ability of the fund to match the performance of its index, because the index does not have to manage cash flows and does not incur any costs.
Sampling Index Tracking Risk.
The fund does not fully replicate its comparative index and may hold securities not included in the
index. As a result, the fund is subject to the risk that the investment advisers investment strategy, the implementation of which is subject to a number
of constraints, may not produce the intended results. Because the fund utilizes a sampling approach, it may not track the return of the index as well as it would if the fund purchased all of the
securities in the index.
Concentration Risk.
To the extent that the funds or the indexs portfolio is concentrated in
the securities of issuers in a particular market, industry, group of industries, sector or asset class, the fund may be adversely affected by the performance of those securities, may be subject to increased price volatility and may be more
susceptible to adverse economic, market, political or regulatory occurrences affecting that market, industry, group of industries, sector or asset class.
Large-
and
Mid-Cap
Risk.
Many of the risks of this fund are associated with its investment in the
large-
and
mid-cap
segments of the U.S. stock market. Both
large-
and
mid-cap
stocks tend
to go in and out of favor based on market and economic conditions. However, stocks of
mid-cap
companies tend to be more volatile than those of
large-cap
companies
because
mid-cap
companies tend to be more susceptible to adverse business or economic events than larger more established companies. During a period when
large-
and
mid-cap
U.S. stocks fall behind other types of investments bonds or
small-cap
stocks, for instance the funds performance also will lag
those investments.
Small-Cap
Risk.
Historically,
small-cap
stocks have been riskier than
large-
and
mid-cap
stocks. Stock prices of smaller companies may be based in substantial
part on future expectations rather than current achievements and may move sharply, especially during market upturns and downturns.
Small-cap
companies themselves may be more vulnerable to adverse business or
economic events than larger, more established companies. During a period when
small-cap
stocks fall behind other types of investments
large-
and mid-cap
stocks, for instance the funds performance also will lag those investments.
Derivatives Risk.
The fund may use
derivatives to enhance returns or hedge against market declines. Examples of derivatives are futures and options on futures. An option is the right to buy or sell an instrument at a specific price before a specific date. A future is an agreement to
buy or sell a financial instrument at a specific price on a specific day. The use of derivatives, subject to regulation by the CFTC, could cause the fund to become a commodity pool, which would require the fund to comply with certain CFTC rules.
The funds use of derivative instruments involves risks different from or possibly greater than the risks associated with investing
directly in securities and other traditional investments. Certain of these risks, such as liquidity risk and market risk, are discussed elsewhere in this section. The funds use of derivatives is also subject to lack of availability risk,
credit risk, leverage risk, valuation risk, correlation risk and tax risk. Lack of availability risk is the risk that suitable derivative transactions may not be available in all circumstances for risk management or other purposes. Credit risk is
the risk that the counterparty to a derivatives transaction may not fulfill its obligations. Leverage risk is the risk that a small percentage of assets invested in derivatives can have a disproportionately larger impact on the fund. Valuation risk
is the risk that a particular derivative may be valued incorrectly. Correlation risk is the risk that changes in the value of the derivative may not correlate perfectly with the underlying asset, rate or index. Tax risk is the risk that the use of
derivatives may cause the fund to realize higher amounts of short-term capital gain. These risks could cause the fund to lose more than the principal amount invested.
Liquidity Risk.
Liquidity risk exists when particular investments are difficult to purchase or sell. The market for certain investments may become illiquid due to specific adverse changes in the
conditions of a particular issuer or under adverse market or economic conditions independent of the issuer. The funds investments in illiquid securities may reduce the returns of the fund because it may be unable to sell the illiquid
securities at an advantageous time or price. Further, transactions in illiquid securities may entail transaction costs that are higher than those for transactions in liquid securities.
Securities Lending Risk.
The fund may lend its portfolio securities to brokers, dealers, and other financial institutions provided a number of conditions are satisfied, including that the loan is
fully collateralized. When the fund lends portfolio securities, its investment performance will continue to reflect changes in the value of the securities loaned, and the fund will also receive a fee or interest on the collateral. Securities lending
involves the risk of loss of rights in the collateral or delay in recovery of the collateral if the borrower fails to return the security loaned or becomes insolvent. The fund will also bear the risk of any decline in value of securities acquired
with cash collateral. The fund may pay lending fees to a party arranging the loan.
Schwab International Index
Fund
®
Investment objective
The funds goal is to track the performance of a benchmark index that measures the total return of large, publicly traded
non-U.S. companies
from countries with developed equity markets outside of the United States.
Index
T
he fund seeks to achieve its investment objective by tracking the total return of the MSCI EAFE
Index.
The MSCI EAFE Index includes
stocks from Europe, Australasia and the Far East, and as of December 31, 2013, it consisted of the following 21 developed market country indices: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy,
Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the United Kingdom.
Over the past decades, foreign stock markets have grown rapidly. The market value of the index captures
approximately 37% of the worlds total market capitalization, as of December 31, 2013.
For some investors, an international index
fund represents an opportunity for
low-cost
access to a variety of world markets in one fund. Others turn to international stocks to diversify a portfolio of U.S. investments, because international stock
markets historically have performed somewhat differently from the U.S. market.
More about the funds principal investment risks
The fund is subject to risks, any of which could cause an investor to lose money.
Market Risk.
Equity markets rise and fall daily. As with any investment whose performance is tied to these markets, the value of your investment in the fund will fluctuate, which means that you
could lose money.
Equity Risk.
The prices of equity securities rise and fall daily. These price movements may result from factors
affecting individual companies, industries or the securities market as a whole. Individual companies may report poor results or be negatively affected by industry and/or economic trends and developments. The prices of securities issued by such
companies may suffer a decline in response. In addition, the equity market tends to move in cycles, which may cause stock prices to fall over short or extended periods of time.
Investment Style Risk.
The fund primarily follows the performance of a mix of international
large-cap
stocks, as measured by the index. It follows these
stocks during upturns as well as downturns. Because of its indexing strategy, the fund does not take steps to reduce market exposure or to lessen the effects of a declining market. In addition, because of the funds expenses, the funds
performance may be below that of the index.
A significant percentage of the index may be composed of securities in a single industry or sector
of the economy. If the fund is focused in an industry or sector, it may present more risks than if it were broadly diversified over numerous industries and sectors of the economy.
Geographic Risk.
To the extent the funds investments in a single country or a limited number of countries represent a higher percentage of the funds assets, the fund assumes the risk
that economic, political and social conditions in those countries will have a significant impact on its investment performance and it may be subject to increased price volatility.
Large-Cap
Risk.
Large-cap
stocks tend to go in and out of favor based on market and economic conditions. During
a period when these stocks fall behind other types of investments bonds or
mid-
or
small-cap
stocks, for instance the funds performance
also will lag those investments.
Tracking Error Risk.
As an index fund, the fund seeks to track the performance of its comparative
index, although it may not be successful in doing so. The divergence between the performance of the fund and its index, positive or negative, is called tracking error. Tracking error can be caused by many factors and it may be
significant. For example, the fund may not invest in certain securities in its index, match the securities weighting to the index, or the fund may invest in securities not in the index, due to regulatory, operational, custodial or liquidity
constraints; corporate transactions; asset valuations; transaction costs and timing; tax considerations; and index rebalancing, which may result in tracking error. In addition, the fund may not invest in issuers located in certain countries due to
these considerations. The fund may attempt to offset the effects of not being invested in certain index securities by making substitute investments, but these efforts may not be successful. In certain circumstances, the fund may value securities
based on fair value developed using methods approved by the funds board of trustees. To the extent the fund calculates its net asset value (NAV) based on fair value prices, the funds performance may diverge from its index. In
addition, cash flows into and out of the fund, operating expenses and trading costs all affect the ability of the fund to match the performance of its index, because the index does not have to manage cash flows and does not incur any costs.
Foreign Investment Risk.
The funds investments in securities of foreign issuers may involve certain risks that are greater than
those associated with investments in securities of U.S. issuers. These include risks of adverse changes in foreign economic, political, regulatory and other conditions; changes in currency exchange rates or exchange control regulations
(including limitations on currency movements and exchanges); differing accounting, auditing, financial reporting and legal standards and practices; differing securities market structures; and higher transaction costs. In certain countries, legal
remedies available to investors may be more limited than those available with respect to investments in the United States. The securities of some foreign companies may be less liquid and, at times, more volatile than securities of comparable U.S.
companies. The fund may also experience more rapid or extreme changes in value as compared to a fund that invests solely in securities of U.S. companies because the securities markets of many foreign countries are relatively small, with a limited
number of companies representing a small number of industries. These risks may be heightened in connection with investments in emerging markets.
Currency Risk.
As a result of the funds investments in securities denominated in, and/or receiving revenues in, foreign currencies, the fund will be subject to currency risk. This is the
risk that those currencies will decline in value relative to the U.S. dollar, or, in the case of hedging positions, that the U.S. dollar will decline in value relative to the currency hedged. In either event, the dollar value of an investment in the
fund would be adversely affected. Currency exchange rates may fluctuate in response to factors extrinsic to that countrys economy, which makes the forecasting of currency market movements difficult. Currency rates in foreign countries may
fluctuate significantly over short
periods of time for a number of reasons, including changes in interest rates, intervention (or failure to intervene) by
governments, central banks or supranational entities such as the
International Monetary Fund (IMF), or by the imposition of currency controls or other political developments in the United States or abroad. These can result in losses to the fund if it is unable to deliver or receive currency or monies
in settlement of obligations and could also cause hedges it has entered into to be rendered useless, resulting in full currency exposure as well as incurring transactions costs.
Concentration Risk.
To the extent that the funds or the indexs portfolio is concentrated in the securities of issuers in a particular market, industry, group of industries, sector,
country or asset class, the fund may be adversely affected by the performance of those securities, may be subject to increased price volatility and may be more susceptible to adverse economic, market, political or regulatory occurrences affecting
that market, industry, group of industries, sector, country or asset class.
Derivatives Risk.
The fund may use derivatives to enhance
returns or hedge against market declines. Examples of derivatives are futures and options on futures. An option is the right to buy or sell an instrument at a specific price before a specific date. A future is an agreement to buy or sell a financial
instrument at a specific price on a specific day. The use of derivatives, subject to regulation by the CFTC, could cause the fund to become a commodity pool, which would require the fund to comply with certain CFTC rules.
The funds use of derivative instruments involves risks different from or possibly greater than the risks associated with investing directly in
securities and other traditional investments. Certain of these risks, such as liquidity risk and market risk, are discussed elsewhere in this section. The funds use of derivatives is also subject to lack of availability risk, credit risk,
leverage risk, valuation risk, correlation risk and tax risk. Lack of availability risk is the risk that suitable derivative transactions may not be available in all circumstances for risk management or other purposes. Credit risk is the risk that
the counterparty to a derivatives transaction may not fulfill its obligations. Leverage risk is the risk that a small percentage of assets invested in derivatives can have a disproportionately larger impact on the fund. Valuation risk is the risk
that a particular derivative may be valued incorrectly. Correlation risk is the risk that changes in the value of the derivative may not correlate perfectly with the underlying asset, rate or index. Tax risk is the risk that the use of derivatives
may cause the fund to realize higher amounts of short-term capital gain. These risks could cause the fund to lose more than the principal amount invested.
Liquidity Risk.
Liquidity risk exists when particular investments are difficult to purchase or sell. The market for certain investments may become illiquid due to specific adverse changes in the
conditions of a particular issuer or under adverse market or economic conditions independent of the issuer. The funds investments in illiquid securities may reduce the returns of the fund because it may be unable to sell the illiquid
securities at an advantageous time or price. Further, transactions in illiquid securities may entail transaction costs that are higher than those for transactions in liquid securities.
Securities Lending Risk.
The fund may lend its portfolio securities to brokers, dealers, and other financial institutions provided a number of conditions are satisfied, including that the loan is
fully collateralized. When the fund lends portfolio securities, its investment performance will continue to reflect changes in the value of the securities loaned, and the fund will also receive a fee or interest on the collateral. Securities lending
involves the risk of loss of rights in the collateral or delay in recovery of the collateral if the borrower fails to return the security loaned or becomes insolvent. The fund will also bear the risk of any decline in value of securities acquired
with cash collateral. The fund may pay lending fees to a party arranging the loan.
Portfolio holdings
A description of the funds policies and procedures with respect to the disclosure of a funds portfolio securities is available in the
Statement of Additional Information (SAI).
Financial highlights
This section provides further details about each funds financial history for the past five years. Certain information reflects financial results for a single fund share. Total return
shows the percentage that an investor in the fund would have earned or lost during a given period, assuming all distributions were reinvested. The funds independent registered public accounting firm, PricewaterhouseCoopers LLP
(PwC), audited these figures. PwCs full report is included in each funds annual report (see back cover).
Schwab
®
S&P
500 Index Fund
On September 9, 2009, the Investor Share class, Select Share class, and e.Shares class were combined into a single class
of shares of the fund, and the fund no longer offered multiple classes of shares. The performance and financial history of the fund, prior to September 9, 2009, is that of the funds former Select Shares.
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11/1/12
10/31/13
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11/1/11
10/31/12
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11/1/10
10/31/11
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11/1/09
10/31/10
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11/1/08
10/31/09
1
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Per-Share Data ($)
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Net asset value at beginning of period
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|
22.35
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|
|
|
19.82
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|
|
|
18.70
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|
|
|
16.28
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|
|
|
15.28
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Income (loss) from investment operations:
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Net investment income (loss)
|
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|
0.52
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|
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0.44
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|
0.39
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|
0.35
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|
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|
0.20
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Net realized and unrealized gains (losses)
|
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|
5.40
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2.49
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1.09
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2.31
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1.22
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Total from investment operations
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5.92
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|
|
|
2.93
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|
|
|
1.48
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|
2.66
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|
1.42
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Less distributions:
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Distributions from net investment income
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(0.49
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)
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(0.40
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)
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(0.36
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)
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(0.24
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)
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(0.42
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)
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Net asset value at end of period
|
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27.78
|
|
|
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22.35
|
|
|
|
19.82
|
|
|
|
18.70
|
|
|
|
16.28
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Total return (%)
|
|
|
27.06
|
|
|
|
15.09
|
|
|
|
7.97
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|
|
|
16.50
|
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9.81
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|
Ratios/Supplemental Data (%)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ratios to average net assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net operating expenses
|
|
|
0.09
|
|
|
|
0.09
|
|
|
|
0.09
|
|
|
|
0.09
|
|
|
|
0.13
|
2
|
|
|
|
|
Gross operating expenses
|
|
|
0.09
|
|
|
|
0.10
|
|
|
|
0.10
|
|
|
|
0.10
|
|
|
|
0.16
|
|
|
|
|
|
Net investment income (loss)
|
|
|
2.10
|
|
|
|
2.09
|
|
|
|
1.96
|
|
|
|
1.97
|
|
|
|
2.09
|
|
|
|
|
|
Portfolio turnover rate
|
|
|
1
|
|
|
|
2
|
|
|
|
3
|
|
|
|
2
|
|
|
|
3
|
3
|
|
|
|
|
Net assets, end of period ($ x 1,000,000)
|
|
|
17,121
|
|
|
|
12,687
|
|
|
|
10,909
|
|
|
|
10,007
|
|
|
|
8,718
|
|
|
|
|
|
1
|
Effective September 9, 2009, the Investor Share class, the e.Share class and the Select Share class were combined into a single class of shares of the fund.
The financial history as shown in the financial highlights is that of the former Select Shares.
|
2
|
Effective May 5, 2009, the net operating expense limitation was lowered. The ratio presented for period ended 10/31/09 is a blended ratio.
|
3
|
Portfolio turnover excludes the impact of investment activity resulting from a merger with another fund.
|
Schwab 1000
Index
®
Fund
On
September 18, 2009, the Investor Share class and Select Share class were combined into a single class of shares of the fund, and the fund no longer offered multiple classes of shares. The performance and financial history of the fund, prior to
September 18, 2009, is that of the funds former Investor Shares.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
11/1/12
10/31/13
|
|
|
11/1/11
10/31/12
|
|
|
11/1/10
10/31/11
|
|
|
11/1/09
10/31/10
|
|
|
11/1/08
10/31/09
1
|
|
|
|
|
|
Per-Share Data ($)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net asset value at beginning of period
|
|
|
40.23
|
|
|
|
37.44
|
|
|
|
35.79
|
|
|
|
31.00
|
|
|
|
28.69
|
|
|
|
|
|
|
|
|
|
Income (loss) from investment operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment income (loss)
|
|
|
0.81
|
2
|
|
|
0.71
|
2
|
|
|
0.62
|
2
|
|
|
0.57
|
2
|
|
|
0.54
|
2
|
|
|
|
|
Net realized and unrealized gains (losses)
|
|
|
9.74
|
|
|
|
4.32
|
|
|
|
2.07
|
|
|
|
4.80
|
|
|
|
2.41
|
|
|
|
|
|
|
|
|
|
Total from investment operations
|
|
|
10.55
|
|
|
|
5.03
|
|
|
|
2.69
|
|
|
|
5.37
|
|
|
|
2.95
|
|
|
|
|
|
Less distributions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distributions from net investment income
|
|
|
(0.81
|
)
|
|
|
(0.72
|
)
|
|
|
(0.57
|
)
|
|
|
(0.58
|
)
|
|
|
(0.64
|
)
|
|
|
|
|
Distributions from net realized gains
|
|
|
(1.66
|
)
|
|
|
(1.52
|
)
|
|
|
(0.47
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total distributions
|
|
|
(2.47
|
)
|
|
|
(2.24
|
)
|
|
|
(1.04
|
)
|
|
|
(0.58
|
)
|
|
|
(0.64
|
)
|
|
|
|
|
|
|
|
|
Net asset value at end of period
|
|
|
48.31
|
|
|
|
40.23
|
|
|
|
37.44
|
|
|
|
35.79
|
|
|
|
31.00
|
|
|
|
|
|
|
|
|
|
Total return (%)
|
|
|
27.85
|
|
|
|
14.38
|
|
|
|
7.60
|
|
|
|
17.51
|
|
|
|
10.72
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ratios/Supplemental Data (%)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ratios to average net assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net operating expenses
|
|
|
0.29
|
|
|
|
0.29
|
|
|
|
0.29
|
|
|
|
0.29
|
|
|
|
0.38
|
3
|
|
|
|
|
Gross operating expenses
|
|
|
0.34
|
|
|
|
0.34
|
|
|
|
0.34
|
|
|
|
0.35
|
|
|
|
0.44
|
|
|
|
|
|
Net investment income (loss)
|
|
|
1.87
|
|
|
|
1.85
|
|
|
|
1.64
|
|
|
|
1.71
|
|
|
|
1.96
|
|
|
|
|
|
Portfolio turnover rate
|
|
|
4
|
|
|
|
4
|
|
|
|
5
|
|
|
|
5
|
|
|
|
4
|
|
|
|
|
|
Net assets, end of period ($ x 1,000,000)
|
|
|
5,887
|
|
|
|
4,848
|
|
|
|
4,552
|
|
|
|
4,575
|
|
|
|
4,279
|
|
|
|
|
|
1
|
Effective September 18, 2009, the Select Share class and the Investor Share class were combined into a single class of shares of the fund. The financial
history as shown in the financial highlights is that of the former Investor Shares.
|
2
|
Calculated based on the average shares outstanding during the period.
|
3
|
Effective May 5, 2009, the net operating expense limitation was lowered. The ratio presented for period ended 10/31/09 is a blended ratio.
|
Schwab
Small-Cap
Index Fund
®
On August 21,
2009, the Investor Share class and Select Share class were combined into a single class of shares of the fund, and the fund no longer offered multiple classes of shares. The performance and financial history of the fund, prior to August 21, 2009, is
that of the funds former Select Shares.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
11/1/12
10/31/13
|
|
|
11/1/11
10/31/12
|
|
|
11/1/10
10/31/11
|
|
|
11/1/09
10/31/10
|
|
|
11/1/08
10/31/09
1
|
|
|
|
|
|
Per-Share Data ($)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net asset value at beginning of period
|
|
|
21.26
|
|
|
|
20.55
|
|
|
|
19.18
|
|
|
|
15.14
|
|
|
|
13.85
|
|
|
|
|
|
|
|
|
|
Income (loss) from investment operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment income (loss)
|
|
|
0.42
|
2
|
|
|
0.33
|
2
|
|
|
0.25
|
2
|
|
|
0.22
|
2
|
|
|
0.18
|
2
|
|
|
|
|
Net realized and unrealized gains (losses)
|
|
|
6.94
|
|
|
|
1.89
|
|
|
|
1.37
|
|
|
|
3.97
|
|
|
|
1.40
|
|
|
|
|
|
|
|
|
|
Total from investment operations
|
|
|
7.36
|
|
|
|
2.22
|
|
|
|
1.62
|
|
|
|
4.19
|
|
|
|
1.58
|
|
|
|
|
|
Less distributions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distributions from net investment income
|
|
|
(0.50
|
)
|
|
|
(0.35
|
)
|
|
|
(0.20
|
)
|
|
|
(0.15
|
)
|
|
|
(0.29
|
)
|
|
|
|
|
Distributions from net realized gains
|
|
|
(0.50
|
)
|
|
|
(1.16
|
)
|
|
|
(0.05
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total distributions
|
|
|
(1.00
|
)
|
|
|
(1.51
|
)
|
|
|
(0.25
|
)
|
|
|
(0.15
|
)
|
|
|
(0.29
|
)
|
|
|
|
|
|
|
|
|
Net asset value at end of period
|
|
|
27.62
|
|
|
|
21.26
|
|
|
|
20.55
|
|
|
|
19.18
|
|
|
|
15.14
|
|
|
|
|
|
|
|
|
|
Total return (%)
|
|
|
36.23
|
|
|
|
11.87
|
|
|
|
8.45
|
|
|
|
27.85
|
|
|
|
11.98
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ratios/Supplemental Data (%)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ratios to average net assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net operating expenses
|
|
|
0.17
|
|
|
|
0.17
|
|
|
|
0.19
|
|
|
|
0.19
|
|
|
|
0.28
|
3
|
|
|
|
|
Gross operating expenses
|
|
|
0.20
|
|
|
|
0.21
|
|
|
|
0.19
|
|
|
|
0.20
|
|
|
|
0.33
|
|
|
|
|
|
Net investment income (loss)
|
|
|
1.76
|
|
|
|
1.63
|
|
|
|
1.18
|
|
|
|
1.23
|
|
|
|
1.41
|
|
|
|
|
|
Portfolio turnover rate
|
|
|
11
|
|
|
|
41
|
4
|
|
|
26
|
|
|
|
33
|
|
|
|
26
|
|
|
|
|
|
Net assets, end of period ($ x 1,000,000)
|
|
|
2,351
|
|
|
|
1,675
|
|
|
|
1,502
|
|
|
|
1,406
|
|
|
|
1,142
|
|
|
|
|
|
1
|
Effective August 21, 2009, the Investor Share class and the Select Share class were combined into a single class of shares of the fund. The financial
history as shown in the financial highlights is that of the former Select Shares.
|
2
|
Calculated based on the average shares outstanding during the period.
|
3
|
Effective May 5, 2009, the net operating expense limitation was lowered. The ratio presented for period ended 10/31/09 is a blended ratio.
|
4
|
Portfolio turnover rate increase was mainly the result of trading activities in connection with the change in primary benchmark index effective
December 14, 2011.
|
Schwab Total Stock Market Index
Fund
®
On
September 18, 2009, the Investor Share class and Select Share class were combined into a single class of shares of the fund, and the fund no longer offered multiple classes of shares. The performance and financial history of the fund, prior to
September 18, 2009, is that of the funds former Select Shares.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
11/1/12
10/31/13
|
|
|
11/1/11
10/31/12
|
|
|
11/1/10
10/31/11
|
|
|
11/1/09
10/31/10
|
|
|
11/1/08
10/31/09
1
|
|
|
|
|
|
Per-Share Data ($)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net asset value at beginning of period
|
|
|
25.80
|
|
|
|
22.92
|
|
|
|
21.57
|
|
|
|
18.50
|
|
|
|
17.08
|
|
|
|
|
|
|
|
|
|
Income (loss) from investment operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment income (loss)
|
|
|
0.57
|
|
|
|
0.47
|
|
|
|
0.41
|
|
|
|
0.37
|
|
|
|
0.24
|
|
|
|
|
|
Net realized and unrealized gains (losses)
|
|
|
6.70
|
|
|
|
2.83
|
|
|
|
1.33
|
|
|
|
3.02
|
|
|
|
1.55
|
|
|
|
|
|
|
|
|
|
Total from investment operations
|
|
|
7.27
|
|
|
|
3.30
|
|
|
|
1.74
|
|
|
|
3.39
|
|
|
|
1.79
|
|
|
|
|
|
Less distributions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distributions from net investment income
|
|
|
(0.54
|
)
|
|
|
(0.42
|
)
|
|
|
(0.39
|
)
|
|
|
(0.32
|
)
|
|
|
(0.37
|
)
|
|
|
|
|
|
|
|
|
Net asset value at end of period
|
|
|
32.53
|
|
|
|
25.80
|
|
|
|
22.92
|
|
|
|
21.57
|
|
|
|
18.50
|
|
|
|
|
|
|
|
|
|
Total return (%)
|
|
|
28.76
|
|
|
|
14.71
|
|
|
|
8.14
|
|
|
|
18.53
|
|
|
|
10.92
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ratios/Supplemental Data (%)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ratios to average net assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net operating expenses
|
|
|
0.09
|
|
|
|
0.09
|
|
|
|
0.09
|
|
|
|
0.09
|
|
|
|
0.21
|
2
|
|
|
|
|
Gross operating expenses
|
|
|
0.10
|
|
|
|
0.10
|
|
|
|
0.11
|
|
|
|
0.11
|
|
|
|
0.28
|
|
|
|
|
|
Net investment income (loss)
|
|
|
2.02
|
|
|
|
2.02
|
|
|
|
1.79
|
|
|
|
1.85
|
|
|
|
2.02
|
|
|
|
|
|
Portfolio turnover rate
|
|
|
2
|
|
|
|
3
|
|
|
|
1
|
|
|
|
3
|
|
|
|
5
|
|
|
|
|
|
Net assets, end of period ($ x 1,000,000)
|
|
|
3,183
|
|
|
|
2,240
|
|
|
|
1,747
|
|
|
|
1,470
|
|
|
|
1,205
|
|
|
|
|
|
1
|
Effective September 18, 2009, the Investor Share class and the Select Share class were combined into a single class of shares of the fund. The financial
history as shown in the financial highlights is that of the former Select Shares.
|
2
|
Effective May 5, 2009, the net operating expense limitation was lowered. The ratio presented for period ended 10/31/09 is a blended ratio.
|
Schwab International Index Fund
®
On August 21, 2009, the Investor Share class and
Select Share class were combined into a single class of shares of the fund, and the fund no longer offered multiple classes of shares. The performance and financial history of the fund, prior to August 21, 2009, is that of the funds former
Select Shares.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
11/1/12
10/31/13
|
|
|
11/1/11
10/31/12
|
|
|
11/1/10
10/31/11
|
|
|
11/1/09
10/31/10
|
|
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11/1/08
10/31/09
1
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Per-Share Data ($)
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Net asset value at beginning of period
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16.32
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16.02
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17.31
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16.26
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13.95
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Income (loss) from investment operations:
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Net investment income (loss)
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0.49
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0.57
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0.57
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0.48
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0.37
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Net realized and unrealized gains (losses)
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3.69
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0.33
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(1.38
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)
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1.01
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2.58
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Total from investment operations
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4.18
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0.90
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(0.81
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)
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1.49
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2.95
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Less distributions:
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Distributions from net investment income
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(0.58
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)
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(0.60
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)
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(0.48
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)
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(0.44
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)
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(0.64
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Net asset value at end of period
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19.92
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16.32
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16.02
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17.31
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16.26
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Total return (%)
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26.40
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6.07
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(4.83
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)
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9.31
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22.55
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Ratios/Supplemental Data (%)
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Ratios to average net assets:
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Net operating expenses
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0.19
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0.19
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0.19
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0.19
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0.32
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2
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Gross operating expenses
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0.23
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0.23
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0.21
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0.22
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0.41
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Net investment income (loss)
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2.88
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3.66
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3.26
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2.88
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2.92
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Portfolio turnover rate
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5
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31
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3
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10
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13
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21
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Net assets, end of period ($ x 1,000,000)
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2,205
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1,415
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1,375
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1,471
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1,369
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1
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Effective August 21, 2009, the Investor Share class and the Select Share class were combined into a single class of shares of the fund. The financial
history as shown in the financial highlights is that of the former Select Shares.
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2
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Effective May 5, 2009, the net operating expense limitation was lowered. The ratio presented for period ended 10/31/09 is a blended ratio.
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3
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Portfolio turnover rate increase was mainly the result of trading activities in connection with the change in primary benchmark index effective
December 20, 2011.
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Fund management
The investment adviser for the funds is Charles Schwab Investment Management, Inc. (CSIM), 211 Main Street,
San Francisco, CA 94105. Founded in 1989, the firm today serves as investment adviser for all of the Schwab
Funds
®
, Schwab ETFs
®
and Laudus Funds
®
. As of
December 31, 2013, CSIM managed approximately $248 billion in assets.
As the investment adviser, CSIM oversees
the asset management and administration of the funds. As compensation for these services, CSIM receives a management fee from each fund. For the 12 months ended October 31, 2013, these fees were 0.06% for the Schwab
®
S&P 500 Index Fund, 0.18% for the Schwab 1000 Index
®
Fund, 0.12% for the Schwab
Small-Cap
Index Fund
®
, 0.05% for the Schwab Total Stock Market Index Fund
®
, and 0.11% for the Schwab International Index Fund
®
. These figures, which are expressed as a percentage of each funds average daily net assets, represent the actual amounts paid, including the effects of
reductions.
A discussion regarding the basis for the Board of Trustees approval of each funds investment advisory agreement is
available in each funds 2013 annual report, which covers the period of 11/1/12 through 10/31/13.
Agnes Hong, CFA,
Managing
Director and Head of Passive Equity Strategies, leads the portfolio management teams of Schwabs index mutual funds and equity ETFs. She also has overall responsibility for all aspects of the management of the funds. Prior to joining CSIM
in 2009, Ms. Hong spent five years as a portfolio manager at Barclays Global Investors (subsequently acquired by BlackRock), where she managed institutional index funds and quantitative active funds. Prior to that, Ms.
Hong worked in management consulting and product management, servicing global financial services clients.
Ferian Juwono,
CFA,
Managing Director and Senior Portfolio Manager, is responsible for the day-to-day co-management of the funds. Prior to joining CSIM in 2010, Mr. Juwono worked at BlackRock (formerly Barclays Global Investors), where he spent over three
years as a portfolio manager, managing equity index funds for institutional clients, and nearly two years as a senior business analyst. Prior to that, Mr. Juwono worked for over four years as a senior financial analyst with Union Bank of California.
Ron Toll
, Portfolio Manager, is responsible for the day-to-day co-management of each of the funds, except for the Schwab Total
Stock Market Index Fund. Mr. Toll has been a portfolio manager with CSIM since 2007, and has held a number of positions at the firm since beginning his tenure in 1998. His previous roles include serving as a manager in Portfolio Operations, and as a
manager in Portfolio Operations and Analytics.
Additional information about the portfolio managers compensation, other accounts managed
by the portfolio managers and the portfolio managers ownership of securities in each fund is available in the funds Statement of Additional Information (SAI).
Investing in the funds
In this section, you will find information on buying, selling and exchanging shares. You may invest in a fund through an intermediary by placing orders through your brokerage account at Schwab or an
account with another broker/dealer, investment adviser, 401(k) plan, employee benefit plan, administrator, bank, or other financial intermediary (intermediary) that is authorized to accept orders on behalf of the fund (intermediary orders). Eligible
Investors (as defined herein) may invest directly in a fund by placing orders through the funds transfer agent (direct orders). You also will see how to choose a distribution option for your investment. Helpful information on taxes is included
as well.
Investing through a financial intermediary
Placing orders through your intermediary
When you place orders through Schwab or other intermediary, you
are not placing your orders directly with a fund, and you must follow Schwabs or the other intermediarys transaction procedures. Your intermediary may impose different or additional conditions than the fund on purchases, redemptions and
exchanges of fund shares. These differences may include initial, subsequent and maintenance investment requirements, exchange policies, fund choices,
cut-off
times for investment and trading restrictions. Your
intermediary may independently establish and charge its customers transaction fees, account fees and other fees in addition to the fees charged by the fund. These additional fees may vary over time and would increase the cost of your investment and
lower investment returns. You should consult your intermediary directly for information regarding these conditions and fees. The fund is not responsible for the failure of your intermediary to carry out its responsibilities.
Only certain intermediaries are authorized to accept orders on behalf of a fund. If your fund shares are no longer held by an authorized intermediary, the
fund may impose restrictions on your ability to manage or maintain your shares. For example, you will not be able to place orders to purchase additional shares. To remove these restrictions, you have two options. First, you may move your shares to
Schwab or another intermediary that is authorized to accept fund orders. Second, you may maintain a direct account with the fund if you meet the eligibility requirements for placing direct orders and your completed account application and supporting
documentation is returned to and accepted by the funds transfer agent, Boston Financial Data Services (transfer agent). The eligibility requirements and instructions for submitting an account application are set forth in the Investing
directly with the funds section of the prospectus. If you do not exercise one of these options within ninety days, the fund reserves the right to redeem your shares.
Buying, selling and exchanging shares through an intermediary
To purchase, redeem or exchange shares held
in your Schwab account or in your account at another intermediary, you must place your orders with the intermediary that holds your shares. You may not purchase, redeem or exchange shares held in your intermediary account directly with the fund.
When selling or exchanging shares, you should be aware of the following fund policies:
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The fund may take up to seven days to pay sale proceeds.
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The fund reserves the right to honor redemptions in liquid portfolio securities instead of cash when your redemptions over a
90-day
period exceed $250,000 or 1% of the funds assets, whichever is less. You may incur transaction expenses in converting these securities to cash.
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Exchange orders are limited to other Schwab Funds
®
that are not Sweep
Investments
®
or Laudus MarketMasters Funds
®
and must meet the minimum investment and other requirements for the fund and share class into which you are exchanging.
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You must obtain and read the prospectus for the fund into which you are exchanging prior to placing your order.
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Investing directly with the funds
Investor eligibility requirements for placing direct orders
Only Eligible Investors (as defined below) may
purchase shares directly from the funds transfer agent, Boston Financial Data Services. Eligible Investors include, but are not limited to, qualified and
non-qualified
employee benefit plans (including
but not limited to defined benefit plans, defined contribution plans, 401(k) plans), foundations and endowments, banks, trusts, investment companies and corporate capital and cash management accounts. Eligible Investors may also be shareholders who
receive shares of a Schwab Fund as a result of a reorganization of a fund. The funds reserve the right to determine which potential investors qualify as Eligible Investors. Shares held by a
non-Eligible
Investor directly with a fund are subject to involuntary redemption by the fund.
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30
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Investing in the funds
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Opening an account to place direct orders
You must satisfy the investor eligibility requirements for direct order clients in order to place direct orders for a funds shares. Eligible Investors must open an account with the fund through the
funds transfer agent prior to placing direct orders. You may obtain an account application by calling the transfer agent at
1-800-407-0256.
Your completed application and supporting documents must be returned to, and accepted by, the transfer agent
before you can place direct orders. You cannot place direct orders through your Schwab account or through your account at another intermediary.
Initial
and additional direct purchases by wire
Subject to acceptance by the fund, you may make your initial purchase and any additional purchases of
shares by wiring federal funds to the transfer agent. If you have not yet opened an account with the fund, you must fax a signed, hard copy of the completed account application and all supporting documents to the transfer agent at
1-816-218-0490.
You must call the transfer agent at
1-800-407-0256
prior to the close of the fund (generally 4:00 p.m. Eastern time or the close of the NYSE, whichever is earlier) to place your order and to receive wire instructions. Orders
received by the transfer agent in good order on or prior to the close of the fund will be processed at the net asset value per share of the fund for that day. Your wired funds must be received and accepted by the transfer agent prior to
6:00 p.m. Eastern time or the deadline for the Fedwire Funds Service for initiating third party transfers, whichever is earlier, on the day your purchase order is placed. Please call the transfer agent at
1-800-407-0256
if you have any questions or need additional information.
Initial and additional direct purchases by mail
Subject
to acceptance by a fund, you may open an account and make your initial purchase and any additional purchases of the funds shares by mail. To open an account by mail, complete and sign the account application and mail the account application,
all supporting documents and a check for the desired purchase amount to the transfer agent at Boston Financial Data Services, Attn: Schwab Funds, PO Box 8283, Boston, MA 02266-8323. Additional investments may be made at any time by mailing
a check (payable to Schwab Funds) to the transfer agent at the address above. Be sure to include your account number on your check.
Subject to
acceptance by the fund, payment for the purchase of shares received by mail will be credited to a shareholders account at the net asset value per share of the fund next determined after receipt, even though the check may not yet have been
converted into federal funds. For purposes of calculating the purchase price of fund shares, a purchase order is received by the fund on the day that it is in good order unless it is rejected by the funds transfer agent. For a cash purchase
order of fund shares to be in good order on a particular day, a check must be received on or before the close of the fund (generally 4:00 p.m. Eastern time or the close of the NYSE, whichever is earlier) on that day. If the payment is received
by the fund after the deadline, the purchase price of fund shares will be based upon the next determination of net asset value of fund shares. No currency, third party checks, foreign checks, starter checks, credit card checks, travelers
checks or money orders will be accepted by the fund.
Direct redemptions and exchanges
When selling or exchanging shares directly, you should be aware of the following fund policies:
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The fund may take up to seven days to pay sale proceeds.
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The fund reserves the right to honor redemptions in liquid portfolio securities instead of cash when your redemptions over a
90-day
period exceed $250,000 or 1% of the funds assets, whichever is less. You may incur transaction expenses in converting these securities to cash.
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Exchange orders are limited to other Schwab Funds
®
that are not Sweep
Investments
®
or Laudus MarketMasters Funds
®
and must meet the minimum investment and other requirements for the fund and share class into which you are exchanging.
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If you are selling shares that were recently purchased by check, the proceeds may be delayed until the check for purchase clears; this may take up to
15 days from the date of purchase.
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You must obtain and read the prospectus for the fund into which you are exchanging prior to placing your order.
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Direct redemptions by telephone
If you authorized the
telephone redemption option in the account application, you may place a redemption order by calling the transfer agent at
1-800-407-0256
and requesting that the redemption proceeds be wired per the authorized instructions in the account application or
mailed to the primary registration address. Your redemption order will be processed at the net asset value per share of the fund next determined after receipt of your telephone redemption order by the transfer agent. Please note that the transfer
agent may only act on telephone instructions believed by the transfer agent to be genuine. The transfer agents records of such instructions are binding on the shareholder. The funds and their service providers (including the transfer agent,
Schwab and CSIM) are not responsible for any losses or costs that may arise from following telephone instructions that the transfer agent reasonably believes to be genuine. The transfer agent will employ reasonable procedures to confirm that
instructions communicated are genuine. These procedures include tape recording of telephone instructions and requiring some form of personal identification prior to acting upon instructions received by telephone.
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Investing in the funds
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31
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Direct redemptions by mail
You may redeem your fund shares by mail by sending a request letter to the funds transfer agent at Boston Financial Data Services, Attn: Schwab Funds, PO Box 8283, Boston, MA 02266-8323.
Your redemption request will be processed by the fund at the net asset value per share of the fund next determined after the request is received in good order. To be in good order, the redemption request must include the name of the fund and the
number of shares or the dollar amount to be redeemed, all required signatures and authorizations and any required signature guarantees.
Additional
direct redemption information
To protect you, the funds and their service providers from fraud, signature guarantees may be required to enable
the transfer agent to verify the identity of the person who has authorized a redemption from an account. Signature guarantees are required for (1) redemptions where the proceeds are to be sent to someone other than the registered shareholder(s)
at the registered address, (2) redemptions if your account address has changed within the last 10 business days, (3) share transfer requests, and (4) redemptions where the proceeds are wired in connection with bank instructions not
already on file with the transfer agent. Signature guarantees may be obtained from certain eligible financial institutions, including, but not limited to, the following: U.S. banks, trust companies, credit unions, securities brokers and
dealers, savings and loan associations and participants in the Securities and Transfer Association Medallion Program (STAMP), the Stock Exchange Medallion Program (SEMP) or the New York Stock Exchange Medallion Signature
Program (MSP). Signature guarantees from
non-U.S. banks
that do not include a stamp may require a U.S. consulate stamp. You may contact the transfer agent at
1-800-407-0256
for further details.
Direct exchange privileges
Upon request, and subject
to certain limitations, shares of the funds may be exchanged into shares of any other Schwab Fund that is not a Sweep Investment or Laudus MarketMasters Fund. In order to exchange your shares to another fund, you must meet the minimum investment and
other requirements for the fund and share class into which you are exchanging. Further, you must obtain and read the prospectus for the fund into which you are exchanging prior to placing your order. A new account opened by exchange must be
established with the same name(s), address(es) and tax identification number(s) as the existing account. All exchanges will be made based on the respective net asset values next determined following receipt of the request by the fund containing the
information indicated below.
The funds reserve the right to suspend or terminate the privilege of exchanging shares of the funds by mail
or by telephone at any time.
Direct exchanges by telephone
If you authorized the telephone redemption option in the account application, you may exchange fund shares by telephone by calling the funds transfer agent at
1-800-407-0256.
Please be prepared to provide the following information: (a) the account number, tax identification number and account registration; (b) the
class of shares to be exchanged (if applicable); (c) the name of the fund from which and the fund into which the exchange is to be made; and (d) the dollar or share amount to be exchanged. Please note that the transfer agent may act only
on telephone instructions believed by the transfer agent to be genuine. Please see the section entitled Direct redemptions by telephone for more information regarding transacting with the funds transfer agent via telephone.
Direct exchanges by mail
To exchange
fund shares by mail, simply send a letter of instruction to the funds transfer agent at Boston Financial Data Services, Attn: Schwab Funds, PO Box 8283, Boston, MA 02266-8323. The letter of instruction must include: (a) your
account number; (b) the class of shares to be exchanged (if applicable); (c) the fund from and the fund into which the exchange is to be made; (d) the dollar or share amount to be exchanged; and (e) the signatures of all
registered owners or authorized parties.
Share price
The funds are open for business each day that the NYSE is open. Each fund calculates its share price each business day as of the close of the NYSE (generally 4 p.m. Eastern time). A funds share
price is its net asset value per share, or NAV, which is the funds net assets divided by the number of its shares outstanding. Orders to buy, sell or exchange shares that are received by a fund in good order on or prior to the close of the
fund (generally 4 p.m. Eastern time) will be executed at the next share price calculated that day.
When you place an order through your
Schwab account or an account at another intermediary, please consult with your intermediary to determine when your order will be executed. Generally, you will receive the share price next calculated after the fund receives your order from your
intermediary. However, some intermediaries, such as Schwab, may arrange with the fund for you to receive the share price next calculated after your intermediary has received your order. Some intermediaries may require that they receive orders prior
to a specified
cut-off
time.
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32
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Investing in the funds
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In valuing its securities, a fund uses market quotes or official closing prices if they are readily
available. In cases where quotes are not readily available or the adviser deems them unreliable, a fund may value securities based on fair values developed using methods approved by the funds Board of Trustees.
Shareholders of the Schwab International Index Fund should be aware that because foreign markets are often open on weekends and other days when the fund
is closed, the value of the funds portfolio may change on days when it is not possible to buy or sell shares of the fund.
Additional policies affecting your investment
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Minimum initial investment
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$100
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The minimum may be waived for certain retirement plans and plan participants, and for certain investment programs, or in a
funds sole discretion.
Choose an option for fund distributions.
If you are an Eligible Investor placing direct orders with a
fund, you will have one of the three options described below for fund distributions. If you dont indicate a choice, you will receive the first option. If you are placing orders through an intermediary, you will select from the options for fund
distributions provided by your intermediary, which may be different than those provided by the funds to Eligible Investors. You should consult with your financial intermediary to discuss available options.
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Option
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Feature
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Reinvestment
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All dividends and capital gain distributions are invested automatically in shares of your fund.
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Cash/reinvestment mix
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You receive payment for dividends, while any capital gain distributions are invested in shares of your fund.
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Cash
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You receive payment for all dividends and capital gain distributions.
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Each fund reserves certain rights, including the following:
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To materially modify or terminate the exchange privilege upon 60 days written notice to shareholders.
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To change or waive a funds investment minimums.
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To suspend the right to sell shares back to the fund, and delay sending proceeds, during times when trading on the NYSE is restricted or halted, or
otherwise as permitted by the SEC.
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To withdraw or suspend any part of the offering made by this prospectus.
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Payments by the investment adviser or its affiliates
The investment adviser or its affiliates may make cash
payments out of their own resources, or provide products and services at a discount, to certain brokerage firms, banks, retirement plan service providers and other financial intermediaries that perform shareholder, recordkeeping,
sub-accounting
and other administrative services in connection with investments in fund shares. These payments or discounts are separate from, and may be in addition to, any shareholder service fees or other
administrative fees the funds may pay to those intermediaries. The investment adviser or its affiliates may also make cash payments out of their own resources, or provide products and services at a discount, to certain financial intermediaries that
perform distribution, marketing, promotional or other distribution-related services. The payments or discounts described by this paragraph may be substantial; however, distribution-related services provided by such intermediaries are paid by the
investment adviser or its affiliates, not by the funds or their shareholders.
Shareholder servicing plan
The Board of Trustees has adopted a Shareholder Servicing Plan (the Plan) on behalf of the funds. The Plan enables each fund to bear expenses
relating to the provision by service providers, including Schwab, of certain account maintenance, customer liaison and shareholder services to the current shareholders of the funds. Schwab serves as the funds paying agent under the Plan for
making payments of the shareholder service fee due to the service providers (other than Schwab) under the Plan. All shareholder service fees paid by the funds to Schwab in its capacity as the funds paying agent will be passed through to the
service providers, and Schwab will not retain any portion of such fees.
Pursuant to the Plan, each funds shares are subject to an annual
shareholder servicing fee up to the amount set forth in the table below. The shareholder servicing fee paid to a particular service provider is made pursuant to its written agreement with Schwab (or, in the case of payments made to Schwab, pursuant
to Schwabs written agreement with the funds). Payments under the Plan are made as described above regardless of Schwabs or the service providers actual cost of providing the services. If the cost of providing the services under the
Plan is less than the payments received, the unexpended portion of the fees may be retained as profit by Schwab or the service provider.
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Investing in the funds
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33
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Fund
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Shareholder Servicing Fee
|
|
Schwab S&P 500 Index Fund
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0.02%
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Schwab 1000 Index Fund
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0.10%
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Schwab
Small-Cap
Index Fund
|
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0.02%
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Schwab Total Stock Market Index Fund
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0.02%
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Schwab International Index Fund
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0.02%
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Policy regarding short-term or excessive trading
The funds are intended for long-term investment and not for short-term or excessive trading (collectively market timing). Market timing may adversely impact the funds performance by
disrupting the efficient management of the funds, increasing fund transaction costs and taxes, causing the funds to maintain higher cash balances, and diluting the value of the funds shares.
In order to discourage market timing, the funds Board of Trustees has adopted policies and procedures that are reasonably designed to reduce the
risk of market timing by fund shareholders. Each fund seeks to deter market timing through several methods. These methods may include: fair value pricing, imposition of redemption fees and trade activity monitoring. Fair value pricing and redemption
fees are discussed more thoroughly in the subsequent pages of this prospectus and are considered to be key elements of the funds policy regarding short term or excessive trading. Trade activity monitoring is risk based and seeks to identify
patterns of activity in amounts that might be detrimental to the funds.
Although these methods are designed to discourage market timing, there
can be no guarantee that the funds will be able to identify and restrict investors that engage in such activities. In addition, some of these methods are inherently subjective and involve judgment in their application. Each fund and its service
providers seek to make these judgments and applications uniformly and in a manner that they believe is consistent with interests of the funds long-term shareholders. The funds may amend these policies and procedures in response to changing
regulatory requirements or to enhance the effectiveness of the program.
Each fund or its service providers maintain risk-based surveillance
procedures designed to detect market timing in fund shares in amounts that might be detrimental to the fund. Under these procedures, the funds have requested that service providers to the funds monitor transactional activity in amounts and frequency
determined by each fund to be significant to the fund and in a pattern of activity that potentially could be detrimental to the fund. If a fund, in its sole discretion based on these or other factors, determines that a shareholder has engaged in
market timing, it may refuse to process future purchases or exchanges into the fund by that shareholder. These procedures may be modified from time to time as appropriate to improve the detection of market timing and to comply with applicable laws.
If trades are effected through a financial intermediary, each fund or its service providers will work with the intermediary to monitor
possible market timing activity. The funds reserve the right to contact the intermediary to provide certain shareholder transaction information and may require the intermediary to restrict the shareholder from future purchases or exchanges in the
funds. Transactions by fund shareholders investing through intermediaries may also be subject to the restrictions of the intermediarys own frequent trading policies, which may differ from those of the funds. Each fund may defer to an
intermediarys frequent trading policies with respect to those shareholders who invest in the fund through such intermediary. Each fund will defer to an intermediarys policies only after the fund determines that the intermediarys
frequent trading policies are reasonably designed to deter transactional activity in amounts and frequency that are deemed to be significant to the fund and in a pattern of activity that potentially could be detrimental to the fund. Shareholders
should consult with their intermediary to determine if additional frequent trading restrictions apply to their fund transactions.
The funds
reserve the right to restrict, reject or cancel within a reasonable time, without prior notice, any purchase or exchange order for any reason.
Fair
value pricing
The Board of Trustees has adopted procedures to fair value the funds securities when market prices are not readily
available or are unreliable. For example, a fund may fair value a security when a security is
de-listed
or its trading is halted or suspended; when a securitys primary pricing source is unable or
unwilling to provide a price; when a securitys primary trading market is closed during regular market hours; or when a securitys value is materially affected by events occurring after the close of the securitys primary trading
market.
By fair valuing securities whose prices may have been affected by events occurring after the close of trading, the funds seek to
establish prices that investors might expect to realize upon the current sales of these securities. This methodology is designed to deter arbitrage market timers, who seek to exploit delays between the change in the value of a
funds portfolio holdings and the net asset value of the funds shares, and seeks to help ensure that the prices at which the funds shares are purchased and redeemed are fair and do not result in dilution of shareholder interest or
other harm to shareholders.
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Each fund makes fair value determinations in good faith in accordance with the funds valuation
procedures. Due to the subjective and variable nature of fair value pricing, there can be no assurance that a fund could obtain the fair value assigned to the security upon the sale of such security.
Redemption fee
Shares redeemed or exchanged within
30 days of purchase, which shall be calculated to include the 30th day, will be subject to a fee of 2%, which is intended to limit short-term trading in the funds, or to the extent that short-term trading persists, to impose the costs of
that type of activity on the shareholders who engage in it. Each fund treats shares that have been held the longest as being redeemed first. Each fund retains the redemption fees for the benefit of the remaining shareholders. Fund shares purchased
with reinvested dividends are not subject to redemption fees. Each fund reserves the right, in its sole discretion, to waive such fee when, in its judgment, such waiver would be in the best interests of the fund and its long-term shareholders. A
fund may waive the redemption fee for retirement plans, wrap or
fee-based
programs, charitable giving funds, unregistered separate accounts, redemptions pursuant to rebalancing programs or systematic
withdrawal plans established by the fund or financial intermediaries, and registered investment companies and redemptions initiated by the fund. In addition, certain financial intermediaries may use criteria and methods for tracking, applying and
calculating the fees that are different from a funds but which the fund, in its discretion, may determine are in the best interests of the fund and its long-term shareholders. While the funds discourage mutual fund market timing and maintain
procedures designed to provide reasonable assurances that such activity will be identified and terminated, including the imposition of the redemption fee described above, no policy or procedure can guarantee that all such activity will in fact be
identified or that such activity can be completely eliminated. The funds reserve the right to modify or eliminate the redemption fees or waivers at any time.
Large shareholder redemptions
Certain accounts or Schwab affiliates may from time to time own (beneficially
or of record) or control a significant percentage of a funds shares. Redemptions by these shareholders of their holdings in a fund may impact a funds liquidity and NAV. These redemptions may also force a fund to sell securities, which
may negatively impact a funds brokerage costs.
Customer identification and verification and anti-money laundering program
Federal law requires all financial institutions to obtain, verify and record information that identifies each person who opens an account. When you open
your account, you will have to provide your name, address, date of birth, identification number and other information that will allow the fund or your financial intermediary to identify you. This information is subject to verification to ensure the
identity of all persons opening an account.
Each fund or your financial intermediary is required by law to reject your new account application
if the required identifying information is not provided. The fund or your financial intermediary may contact you in an attempt to collect any missing information required on the application, and your application may be rejected if they are unable to
obtain this information. In certain instances, the fund or your financial intermediary is required to collect documents, which will be used solely to establish and verify your identity.
The funds will accept investments and your order will be processed at the NAV next determined after receipt of your application in proper form (or upon receipt of all identifying information required on
the application). The funds, however, reserve the right to close and/or liquidate your account at the then-current days price if the funds or your financial intermediary are unable to verify your identity. As a result, you may be subject to a
gain or loss on fund shares and will be subject to corresponding tax consequences.
Customer identification and verification is part of the
funds overall obligation to deter money laundering under U.S. federal law. Each fund has adopted an Anti-Money Laundering Compliance Program designed to prevent the fund from being used for money laundering or the financing of terrorist
activities. In this regard, the funds reserve the right to (i) refuse, cancel or rescind any purchase or exchange order; (ii) freeze any account and/or suspend account services; or (iii) involuntarily close your account in cases of
threatening conduct or suspected fraudulent or illegal activity. These actions will be taken when, in the sole discretion of fund management, they are deemed to be in the best interest of the fund or in cases when the fund is requested or compelled
to do so by governmental or law enforcement authority. If your account is closed at the request of governmental or law enforcement authority, you may not receive proceeds of the redemption if the fund is required to withhold such proceeds.
Distributions and taxes
Any investment in a fund typically involves several tax considerations. The information below is meant as a general summary for U.S. citizens and residents. Please see the Funds SAI for
additional information. Because each persons tax situation is different, you should consult your tax advisor about the tax implications of your investment in the fund. You also can visit the Internal Revenue Service (IRS) web site at
www.irs.gov.
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As a shareholder, you are entitled to your share of the dividends and gains a fund earns. Every year, each
fund distributes to its shareholders substantially all of its net investment income and net capital gains, if any. These distributions typically are paid in December to all shareholders of record. During the fourth quarter of the year, typically in
early November, an estimate of each funds capital gain distribution, if any, may be made available on the funds website: www.schwab.com/schwabfunds.
Unless you are investing through an IRA, 401(k) or other
tax-advantaged
retirement account, your fund distributions generally have tax consequences. Each
funds net investment income and short-term capital gains are distributed as dividends and will be taxable as ordinary income or qualified dividend income. Other capital gain distributions are taxable as long-term capital gains, regardless of
how long you have held your shares in a fund. The maximum individual rate applicable to qualified dividend income and long-term capital gains depends on whether the individuals income exceeds certain threshold amounts. The maximum
rate is generally 15% for taxpayers whose income is equal to or less than $400,000 (individual filers) or $450,000 (married filing jointly), and 20% for taxpayers whose income exceeds the foregoing thresholds. Distributions generally are taxable in
the tax year in which they are declared, whether you reinvest them or take them in cash.
Generally, any sale or exchange of your shares is a
taxable event. For tax purposes, an exchange of your shares for shares of another Schwab Fund or Laudus MarketMasters Fund is treated the same as a sale. A sale may result in a capital gain or loss for you. The gain or loss generally will be treated
as short term if you held the shares for one year or less, long term if you held the shares longer. The maximum individual rate applicable to long-term capital gains depends on whether the individuals income exceeds certain threshold amounts.
The maximum rate is generally 15% for taxpayers whose income is equal to or less than $400,000 (individual filers) or $450,000 (married filing jointly), and 20% for taxpayers whose income exceeds the foregoing thresholds. Any loss realized upon a
taxable disposition of shares held for six months or less will be treated as long-term, rather than short-term, to the extent of any long-term capital gain distributions received (or deemed received) by you with respect to the shares. All or a
portion of any loss realized upon a taxable disposition of shares will be disallowed if you purchase other substantially identical shares within 30 days before or after the disposition. In such a case, the basis of the newly purchased shares
will be adjusted to reflect the disallowed loss.
An additional 3.8% Medicare tax is imposed on certain net investment income (including
ordinary dividends and capital gain distributions received from a fund and net gains from redemptions or other taxable dispositions of fund shares) of U.S. individuals, estates and trusts to the extent that such persons modified adjusted
gross income (in the case of an individual) or adjusted gross income (in the case of an estate or trust) exceeds a threshold amount.
Shareholders in a fund which invests in
non-U.S. securities
may have additional tax considerations as a result of foreign tax payments made by the fund.
Typically, these payments will reduce the funds dividends but if eligible, the fund may elect for these payments to be included in your taxable income. In such event, you may be able to claim a tax credit or deduction for your portion of
foreign taxes paid by the fund, however.
At the beginning of every year, each fund provides shareholders with information detailing the tax
status of any distributions the fund paid during the previous calendar year. Schwab customers also receive information on distributions and transactions in their monthly account statements.
Prior to January 1, 2012 when shareholders sold fund shares from a taxable account, they typically received information on their tax forms that calculated
their gain or loss using the average cost method. This information was not previously reported to the IRS, and shareholders had the option of calculating gains or losses using an alternative IRS permitted method. However, in accordance with
legislation passed by Congress in 2008, each fund began reporting cost basis information to the IRS for shares purchased on or after January 1, 2012 and sold thereafter. Each fund permits shareholders to elect their preferred cost basis method. In
the absence of an election, a fund will use an average cost basis method. Please consult your tax adviser to determine the appropriate cost basis method for your particular tax situation and to learn more about how the new cost basis reporting laws
apply to you and your investments, including investments made prior January 1, 2012 and sold thereafter.
A fund may be required to
withhold U.S. federal income tax on all taxable distributions and redemption proceeds payable to shareholders if the shareholders fail to provide the fund with their correct taxpayer identification number or to make required certifications, or
if they have been notified by the IRS that they are subject to backup withholding. Backup withholding is not an additional tax. Any amounts withheld may be credited against U.S. federal income tax liability.
Foreign shareholders may be subject to different U.S. federal income tax treatment, including withholding tax at the rate of 30% (unless a lower
treaty rate applies) on amounts treated as ordinary dividends from the funds, as discussed in more detail in the SAI. Furthermore, effective July 1, 2014, the funds will be required to withhold U.S. tax (at a 30% rate) on payments of taxable
dividends and (effective January 1, 2017) redemption proceeds and certain capital gain dividends made to certain non-U.S. entities that fail to comply (or be deemed compliant) with extensive new reporting and withholding requirements
designed to inform the U.S. Department of the Treasury of
U.S.-owned
foreign investment accounts. Shareholders may be requested to provide additional information to the funds to enable the funds to determine
whether withholding is required.
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Notes
To learn more
This prospectus contains important information on the funds and should be read and kept for reference. You also can obtain more information from the following sources:
Annual and semi-annual reports, which are mailed to current fund investors, contain more information about the funds holdings and detailed financial
information about the funds. Annual reports also contain information from the funds managers about strategies, recent market conditions and trends and their impact on fund performance.
The Statement of Additional Information (SAI) includes a more detailed discussion of investment policies and the risks associated with various investments. The SAI is incorporated by reference into the prospectus,
making it legally part of the prospectus.
For a free copy of any of these documents or to request other information or ask
questions about the funds, call Schwab Funds
®
at
1-800-435-4000.
In addition, you may visit Schwab Funds web site at www.schwabfunds.com/prospectus for a free copy of a
prospectus, SAI or an annual or semi-annual report.
The SAI, the funds annual and semi-annual reports and other related materials are available
from the EDGAR Database on the SECs web site (http://www.sec.gov). You can obtain copies of this information, after paying a duplicating fee, by sending a request by
e-mail
to publicinfo@sec.gov or by
writing the Public Reference Section of the SEC, Washington, D.C. 20549-1520. You can also review and copy information about the funds, including the funds SAI, at the SECs Public Reference Room in Washington, D.C. Call
1-202-551-8090
for information on the operation of the SECs Public Reference Room.
SEC File Numbers
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Schwab
®
S&P 500 Index Fund
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811-7704
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Schwab 1000 Index
®
Fund
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811-6200
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Schwab
Small-Cap
Index
Fund
®
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811-7704
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Schwab Total Stock Market Index Fund
®
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811-7704
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Schwab International Index Fund
®
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811-7704
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REG13644FLT-22
Schwab Equity Index Funds
Prospectus
February 28, 2014
STATEMENT OF ADDITIONAL INFORMATION
SCHWAB CAPITAL TRUST
SCHWAB INVESTMENTS
Schwab
®
S&P 500 Index Fund: SWPPX
Schwab 1000 Index
®
Fund: SNXFX
Schwab Small-Cap Index Fund
®
: SWSSX
Schwab Total Stock Market Index Fund
®
: SWTSX
Schwab International Index Fund
®
: SWISX
February 28, 2014
The
Statement of Additional Information (SAI) is not a prospectus. It should be read in conjunction with the funds prospectus dated February 28, 2014 (as amended from time to time).
The audited financial statements from the funds annual report for the fiscal year ended October 31, 2013 are incorporated by reference into this
SAI. A copy of the funds 2013 annual report is delivered with the SAI.
For a free copy of these documents or to request other information or
ask questions about the funds, call Schwab Funds
®
at 1-800-435-4000. For TDD service call 1-800-345-2550. In addition, you may visit Schwab Funds web site at
http://www.schwabfunds.com/prospectus for a free copy of a prospectus, SAI or an annual or semi-annual report.
Each fund, except for the Schwab 1000
Index Fund, is a series of Schwab Capital Trust, and the Schwab 1000 Index Fund is a series of Schwab Investments (each, a trust, and collectively, the trusts). The funds are part of the Schwab complex of funds (Schwab
Funds).
Each funds shareholder report includes a summary portfolio schedule. Each funds 2013
annual full portfolio
schedule on Form N-CSR is a separate document delivered with, and incorporated by reference into, this SAI.
TABLE OF CONTENTS
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Page
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INVESTMENT OBJECTIVES
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2
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INVESTMENT STRATEGIES, SECURITIES AND RISKS
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6
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INVESTMENT LIMITATIONS AND RESTRICTIONS
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23
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MANAGEMENT OF THE FUNDS
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26
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CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES
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36
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INVESTMENT ADVISORY AND OTHER SERVICES
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36
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BROKERAGE ALLOCATION AND OTHER PRACTICES
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42
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DESCRIPTION OF THE TRUSTS
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48
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PURCHASE, REDEMPTION, DELIVERY OF SHAREHOLDER DOCUMENTS AND PRICING OF SHARES
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49
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TAXATION
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52
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APPENDIX PRINCIPAL HOLDERS OF SECURITIES
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57
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APPENDIX PROXY VOTING POLICY AND PROCEDURES
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REG72271-01
INVESTMENT OBJECTIVES
The
Schwab S&P 500 Index Fund
seeks to track the total return of the Standard & Poors 500 Composite Stock Price Index (S&P
500
®
).
The
Schwab 1000
Index
®
Fund
seeks to match the total return of the Schwab 1000 Index
®
, an index created to represent performance of publicly traded
equity securities of the 1,000 largest U.S. companies.
The
Schwab Small-Cap Index Fund
®
seeks to track the performance of a benchmark index that measures total return of small capitalization U.S. stocks.
The
Schwab Total Stock Market
Index Fund
®
seeks to track the total return of the entire U.S. stock market, as measured by The Dow Jones U.S. Total Stock Market Index.
The
Schwab International Index Fund
®
seeks to track the performance of a benchmark index that
measures the total return of large, publicly traded non-U.S. companies from countries with developed equity markets outside of the United States.
The
Schwab S&P 500 Index Fund, Schwab 1000 Index Fund, Schwab Small-Cap Index Fund, Schwab Total Stock Market Index Fund, and Schwab International Index Fund are collectively referred to as the
Equity Index Funds
.
Change of Investment Objective
The
investment objective for each fund may be changed only by vote of a majority of its outstanding voting shares. A majority of the outstanding voting shares of a fund means the affirmative vote of the lesser of: (a) 67% or more of the voting
shares represented at the meeting, if more than 50% of the outstanding voting shares of the fund are represented at the meeting or (b) more than 50% of the outstanding voting shares of a fund. There is no guarantee a fund will achieve its
investment objective.
Change to Investment Policy of Certain Funds
The Schwab S&P 500 Index Fund
will, under normal circumstances, invest at least 80% of its net assets in securities included in the S&P 500.
The fund will notify its shareholders at least 60 days before changing this policy. For purposes of this policy, net assets mean net assets plus the amount of any borrowings for investment purposes.
The S&P 500 is, generally, representative of the performance of the U.S. stock market. The index consists of 500 stocks chosen for market size, liquidity
and industry group representation. It is a market value weighted index (stock price times number of shares outstanding), with each stocks weight in the index proportionate to its market value. The S&P 500 does not contain the 500 largest
stocks, as measured by market capitalization. Although many of the stocks in the index are among the largest, it also includes some relatively small companies. Those companies, however, generally are established companies within their industry
group. Standard & Poors (S&P) identifies important industry groups within the U.S. economy and then allocates a representative sample of stocks with each group to the S&P 500. There are four major industry sectors
within the index: industrials, utilities, financials and transportation. The fund may purchase securities of companies with which it is affiliated to the extent these companies are represented in its index.
The Schwab S&P 500 Index Fund is not sponsored, endorsed, sold or promoted by S&P. S&P makes no representation or warranty, express or implied, to
the shareholders of the Schwab S&P 500 Index Fund or any member of the public regarding the advisability of investing in securities generally or in the funds particularly or the ability of the S&P 500 Index to track general stock market
performance. S&Ps only relationship to the Schwab S&P 500 Index Fund is the licensing of certain trademarks and trade names of S&P and of the S&P 500 Index, which is determined, composed and calculated by S&P without regard
to the fund. S&P has no obligation to take the needs of the Schwab S&P 500 Index Fund or its shareholders into consideration in determining,
2
composing or calculating the S&P 500 Index. S&P is not responsible for and has not participated in the determination of the prices and amount of shares in the Schwab S&P 500 Index
Fund or in the determination or calculation of the equation by which the funds shares are to be converted into cash. S&P has no obligation or liability in connection with the administration, marketing or trading of the funds shares.
S&P does not guarantee the accuracy and /or the completeness of the S&P 500 Index or any data included therein, and S&P shall have no
liability for any errors, omissions or interruptions therein. S&P makes no warranty, express or implied, as to results to be obtained by the Schwab S&P 500 Index Fund, its shareholders or any other person or entity from the use of the
S&P 500
®
Index or any data therein. S&P makes no express or implied warranties and expressly disclaims all warranties of merchantability or fitness for a particular purpose or use with
respect to the S&P 500 Index or any data included therein. Without limiting any of the foregoing, in no event shall S&P have any liability for any special, punitive, indirect or consequential damages (including lost profits), even if
notified of the possibility of such damages.
The Schwab 1000 Index
®
Fund
will, under
normal circumstances, invest at least 80% of its net assets in securities included in the Schwab 1000 Index. The fund will notify its shareholders at least 60 days before changing this policy. For purposes of this policy, net assets mean net assets
plus the amount of any borrowings for investment purposes.
To be included in the Schwab 1000 Index, a company must satisfy all of the following
criteria: (1) it must be an operating company (i.e., not an investment company) or real estate investment trust incorporated in the United States, its territories or possessions; (2) a liquid market for its common shares must
exist on the New York Stock Exchange (NYSE), American Stock Exchange or the NASDAQ/NMS; and (3) its market value must place it among the top 1,000 such companies as measured by market capitalization (share price times the number of
shares outstanding). The fund may purchase securities of companies with which it is affiliated to the extent these companies are represented in its index.
As of December 31, 2013
, the aggregate market capitalization of the stocks included in the Schwab 1000 Index was approximately $19 trillion. This
represents approximately 92% of the total market value of all publicly-traded U.S. companies, as represented by the Dow Jones US Total Stock Market Index.
The Schwab Small-Cap Index Fund
®
will, under normal circumstances, invest at least 80% of its
net assets in securities included in the Russell 2000
®
Index. The fund will notify its shareholders at least 60 days before changing this policy. For purposes of this policy, net assets mean
net assets plus the amount of any borrowings for investment purposes.
The Russell 2000 Index is an established index that measures the performance of
the small-cap sector of the U.S. equity market. The Russell 2000 Index is a subset of the Russell 3000
®
Index, representing approximately the 2,000 smallest issuers and, as of
December 31, 2013
, approximately 10% of the total market capitalization of the Russell 3000 Index. The fund may purchase securities of companies with which it is affiliated to the extent these companies are represented in its index.
Charles Schwab Investment Management, Inc. (CSIM), the funds investment adviser, has entered into an agreement with Russell Investment
Group (Russell), pursuant to which, CSIM has been granted a license to certain of the Russell indexes and the Russell trademarks, which has in turn been sublicensed to the fund. Under the sublicensing agreement between CSIM and the fund,
the fund pays all applicable licensing fees.
The Schwab Small-Cap Index Fund is not promoted, sponsored or endorsed by, nor in any way affiliated with
Russell. Russell is not responsible for and has not reviewed the Schwab Small-Cap Index Fund nor any associated literature or publications and Russell makes no representation or warranty, express or implied, as to their accuracy, or completeness, or
otherwise.
3
Russell reserves the right, at any time and without notice, to alter, amend, terminate or in any way change the
Russell indexes. Russell has no obligation to take the needs of any particular fund or its participants or any other product or person into consideration in determining, composing or calculating any of the Russell indexes.
Russells publication of the Russell indexes in no way suggests or implies an opinion by Russell as to the attractiveness or appropriateness of
investment in any or all securities upon which the Russell indexes are based. Russell makes no representation, warranty, or guarantee as to the accuracy, completeness, reliability, or otherwise of the Russell indexes or any data included in the
Russell indexes. Russell makes no representation, warranty or guarantee regarding the use, or the results of use, of the Russell indexes or any data included therein, or any security (or combination thereof) comprising the Russell indexes. Russell
makes no other express or implied warranty, and expressly disclaims any warranty, of any kind, including without limitation, any warranty of merchantability or fitness for a particular purpose with respect to the Russell index(es) or any data or any
security (or combination thereof) included therein.
The Schwab Total Stock Market Index
Fund
®
will, under normal circumstances, invest at least 80% of its net assets in securities included in the benchmark index. The fund will notify its shareholders at least 60 days before
changing this policy. For purposes of this policy, net assets mean net assets plus the amount of any borrowings for investment purposes.
In pursuing
its objective, the fund uses the Dow Jones US Total Stock Market Index to measure the total return of the U.S. stock market. The Dow Jones U.S. Total Stock Market Index is representative of the performance of the entire U.S. stock market. The index
measures the performance of all U.S. headquartered equity securities with readily available pricing data. It is a market-value weighted index currently consisting of more than 3,600 stocks as of December 31, 2013. The fund may purchase
securities of companies with which it is affiliated to the extent these companies are represented in its index.
Index ownership
Dow Jones and The Dow Jones U.S. Broad Stock Market Index
sm
are service marks of Dow Jones Trademark Holdings, LLC, (Dow Jones), have been licensed to CME
Group Index Services LLC (CME), and sublicensed for use for certain purposes by CSIM, the funds investment adviser. Fees payable under the license are paid by CSIM. The Schwab Total Stock Market Index Fund, based on The Dow Jones
U.S. Broad Stock Market Index
sm
, is not sponsored, endorsed, sold or promoted by Dow Jones or CME and neither makes any representation regarding the advisability of trading in such product.
Because it would be too expensive to buy all of the stocks included in the index, the investment adviser may use statistical sampling techniques in an
attempt to replicate the total return of the U.S. stock market using a smaller number of securities. These techniques use a smaller number of index securities than that included in the index, which, when taken together, are expected to perform
similarly to the index. These techniques are based on a variety of factors, including capitalization, dividend yield, price/earnings ratio, and industry factors.
The Schwab International Index Fund
will, under normal circumstances, invest at least 80% of its net assets in securities included in the MSCI EAFE
Index. The fund will notify its shareholders at least 60 days before changing this policy. For purposes of this policy, net assets mean net assets plus the amount of any borrowings for investment purposes.
The MSCI EAFE Index is an industry-recognized index composed of MSCI country indices representing developed markets outside of North AmericaEurope,
Australasia, and the Far East. The MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US and Canada. As
of December 31, 2013, the MSCI EAFE Index consisted of the following 21 developed market country indices: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand,
Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the United Kingdom. The fund may purchase securities of companies with which it is affiliated to the extent these companies are represented in its index.
4
The Schwab International Index Fund is not sponsored, endorsed, sold or promoted by MSCI Inc. (MSCI),
any of its affiliates, any of its information providers or any other third party involved in, or related to, compiling, computing or creating any MSCI index (collectively, the MSCI Parties). The MSCI indexes are the exclusive property of
MSCI. MSCI and the MSCI index names are service mark(s) of MSCI or its affiliates and have been licensed for use for certain purposes by CSIM, the funds investment adviser, which has in turn been sublicensed to the fund. Under the sublicensing
agreement between CSIM and the fund, the fund pays all applicable licensing fees.
None of the MSCI Parties makes any representation or warranty, express
or implied, to the issuer or owners of the fund or any other person or entity regarding the advisability of investing in funds generally or in the fund particularly or the ability of any MSCI index to track corresponding stock market performance.
MSCI or its affiliates are the licensors of certain trademarks, service marks and trade names and of the MSCI indexes which are determined, composed and calculated by MSCI without regard to the fund or the issuer or owners of the fund or any other
person or entity. None of the MSCI Parties has any obligation to take the needs of the issuer or owners of the fund or any other person or entity into consideration in determining, composing or calculating the MSCI indexes. None of the MSCI Parties
is responsible for or has participated in the determination of the timing of, prices at, or quantities of the fund to be issued or in the determination or calculation of the equation by or the consideration into which the fund is redeemable.
Further, none of the MSCI Parties has any obligation or liability to the issuer or owners of the fund or any other person or entity in connection with the administration, marketing or offering of the fund.
Although MSCI shall obtain information for inclusion in or for use in the calculation of the MSCI indexes from sources that MSCI considers reliable, none of
the MSCI Parties warrants or guarantees the originality, accuracy and/or the completeness of any MSCI index or any data included therein. None of the MSCI Parties makes any warranty, express or implied, as to results to be obtained by the issuer of
the fund, owners of the fund, or any other person or entity, from the use of any MSCI index or any data included therein. None of the MSCI Parties shall have any liability for any errors, omissions or interruptions of or in connection with any MSCI
index or any data included therein. Further, none of the MSCI Parties makes any express or implied warranties of any kind, and the MSCI Parties hereby expressly disclaim all warranties of merchantability and fitness for a particular purpose, with
respect to each MSCI index and any data included therein. Without limiting any of the foregoing, in no event shall any of the MSCI Parties have any liability for any direct, indirect, special, punitive, consequential or any other damages (including
lost profits) even if notified of the possibility of such damages.
Description of Schwab Index.
The Schwab 1000 Index
®
was developed and is maintained by Schwab. Schwab receives no compensation from the fund for maintaining the index. Schwab reviews and, as necessary, revises the list of companies whose
securities are included in the index, usually annually. Companies known by Schwab to meet or no longer meet the inclusion criteria may be added or deleted as appropriate. Schwab also will modify the index as necessary to account for corporate
actions (e.g., new issues, repurchases, stock dividends/splits, tenders, mergers, stock swaps, spinoffs or bankruptcy filings made because of a companys inability to continue operating as a going concern).
Schwab may change the Schwab 1000 Index inclusion criteria if it determines that doing so would cause the index to be more representative of the domestic
equity market. The Board of Trustees may select another index for the Schwab 1000 Index
®
Fund, subject to shareholder approval, should it decides that taking such action would be in the best
interest of the funds shareholders.
A particular stocks weighting in the Schwab 1000 Index is based on its relative total market
value (i.e., its market price per share times the number of shares outstanding), divided by the total market capitalization of the index.
5
INVESTMENT STRATEGIES, SECURITIES AND RISKS
The different types of investments that the funds typically may invest in, the investment techniques they may use and the risks normally associated with these
investments are discussed below. The following investment strategies, risks and limitations supplement those set forth in the prospectus and may be changed without shareholder approval, unless otherwise noted. Also, policies and limitations that
state a maximum percentage of assets that may be invested in a security or other asset, or that set forth a quality standard, shall be measured immediately after and as a result of a funds acquisition of such security or asset unless otherwise
noted. Thus, any subsequent change in values, net assets or other circumstances does not require a fund to sell an investment if it could not then make the same investment. Not all investment securities or techniques discussed below are eligible
investments for each fund.
Borrowing.
A fund may borrow for temporary or emergency purposes; for example, a fund may borrow at times to meet
redemption requests rather than sell portfolio securities to raise the necessary cash. A funds borrowings will be subject to interest costs. Borrowing can also involve leveraging when securities are purchased with the borrowed money.
Leveraging creates interest expenses that can exceed the income from the assets purchased with the borrowed money. In addition, leveraging may magnify changes in the net asset value of a funds shares and in its portfolio yield. A fund will
earmark or segregate assets to cover such borrowings in accordance with positions of the Securities and Exchange Commission (SEC). If assets used to secure a borrowing decrease in value, a fund may be required to pledge additional collateral to
avoid liquidation of those assets.
A fund may establish lines-of-credit (lines) with certain banks by which it may borrow funds for temporary or
emergency purposes. A borrowing is presumed to be for temporary or emergency purposes if it is repaid by a fund within 60 days and is not extended or renewed. Each fund may use the lines to meet large or unexpected redemptions that would otherwise
force a fund to liquidate securities under circumstances which are unfavorable to a funds remaining shareholders. Each fund will pay fees to the banks for using its lines.
Concentration
means that substantial amounts of assets are invested in a particular industry or group of industries. Concentration increases investment
exposure to industry risk. For example, the automobile industry may have a greater exposure to a single factor, such as an increase in the price of oil, which may adversely affect the sale of automobiles and, as a result, the value of the
industrys securities. Each of the funds will not concentrate its investments in a particular industry or group of industries, unless the index it is designed to track is so concentrated.
Debt Securities
are obligations issued by domestic and foreign entities, including governments and corporations, in order to raise money. They are
basically IOUs, but are commonly referred to as bonds or money market securities. These securities normally require the issuer to pay a fixed, variable or floating rate of interest on the amount of money borrowed (the
principal) until it is paid back upon maturity.
Debt securities experience price changes when interest rates change. For example,
when interest rates fall, the prices of debt securities generally rise. Conversely, when interest rates rise, the prices of debt securities generally fall. Certain debt securities have call features that allow issuers to redeem their outstanding
debts prior to final maturity. Depending on the call feature, an issuer may pre-pay its outstanding debts and issue new ones paying lower interest rates. This is more likely to occur in a falling interest rate environment; and it is especially true
for bonds with sinking fund provisions, which commit the issuer to set aside a certain amount of money to cover timely repayment of principal and typically allow the issuer to annually repurchase certain of its outstanding bonds from the open market
or at a pre-set call price.
In a rising interest rate environment, prepayment on outstanding debt securities is less likely to occur. This is
known as extension risk and may cause the value of debt securities to depreciate as a result of the higher market interest rates. Typically, longer-maturity securities react to interest rate changes more severely than shorter-term securities (all
things being equal), but generally offer greater rates of interest.
A change in the Federal Reserves monetary policy (or that of other
central banks) or improving economic conditions may lead to an increase in interest rates, which could significantly impact the value of debt securities in which a fund invests. Some debt securities are more sensitive to interest rate changes than
others and may experience an immediate and considerable reduction in value if interest rates rise. Longer duration securities tend to be more volatile than shorter duration securities. As the values of debt securities in a funds portfolio
adjust to a rise in interest rates, a funds share price may fall. In the event that a fund holds a large portion of its portfolio in longer duration securities when interest rates increase, the share price of the fund may fall significantly.
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Debt securities also are subject to the risk that the issuers will not make timely interest and/or principal
payments or fail to make them at all. This is called credit risk. Corporate debt securities (bonds) tend to have higher credit risk generally than U.S. government debt securities. Debt securities also may be subject to price volatility due to market
perception of future interest rates, the creditworthiness of the issuer and general market liquidity (market risk). Investment-grade debt securities are considered medium- and/or high-quality securities, although some still possess varying degrees
of speculative characteristics and risks. Debt securities rated below investment-grade are riskier, but may offer higher yields. These securities are sometimes referred to as high yield securities or junk bonds.
Corporate bonds are debt securities issued by corporations. Although a higher return is expected from corporate bonds, these securities, while subject to the
same general risks as U.S. government securities, are subject to greater credit risk than U.S. government securities. Their prices may be affected by the perceived credit quality of their issuer.
Certain debt securities have provisions that allow the issuer to redeem or call a bond before its maturity at a price below or above its current
market value. Issuers are most likely to call these securities during periods of falling interest rates. When this happens, a fund may have to replace these securities with lower yielding securities, which could result in a lower return.
Depositary Receipts
include American Depositary Receipts (ADRs) as well as other hybrid forms of ADRs, including European Depositary
Receipts (EDRs) and Global Depositary Receipts (GDRs), and are certificates evidencing ownership of shares of a foreign issuer. Depositary receipts may be sponsored or unsponsored. These certificates are issued by depository banks and generally
trade on an established market in the United States or elsewhere. The underlying shares are held in trust by a custodian bank or similar financial institution in the issuers home country. The depository bank may not have physical custody of
the underlying securities at all times and may charge fees for various services, including forwarding dividends and interest and corporate actions. ADRs are alternatives to directly purchasing the underlying foreign securities in their national
markets and currencies. However, ADRs continue to be subject to many of the risks associated with investing directly in foreign securities.
Investments in the securities of foreign issuers may subject a fund to investment risks that differ in some respects from those related to investments in
securities of U.S. issuers. Such risks include future adverse political and economic developments, withholding taxes on income, or possible imposition of withholding taxes on income, possible seizure, nationalization or expropriation of foreign
deposits, possible establishment of exchange controls or taxation at the source or greater fluctuation in value due to changes in exchange rates. Foreign issuers of securities often engage in business practices different from those of domestic
issuers of similar securities, and there may be less information publicly available about foreign issuers. In addition, foreign issuers are, generally speaking, subject to less government supervision and regulation and different accounting treatment
than are those in the United States.
Although the two types of depositary receipt facilities (unsponsored or sponsored) are similar, there are
differences regarding a holders rights and obligations and the practices of market participants. A depository may establish an unsponsored facility without participation by (or acquiescence of) the underlying issuer; typically, however, the
depository requests a letter of non-objection from the underlying issuer prior to establishing the facility. Holders of unsponsored depositary receipts generally bear all the costs of the facility. The depository usually charges fees upon the
deposit and withdrawal of the underlying securities, the conversion of dividends into U.S. dollars or other currency, the disposition of non-cash distributions, and the performance of other services. The depository of an unsponsored facility
frequently is under no obligation to distribute shareholder communications received from the underlying issuer or to pass through voting rights to depositary receipt holders with respect to the underlying securities.
7
Sponsored depositary receipt facilities are created in generally the same manner as unsponsored facilities,
except that sponsored depositary receipts are established jointly by a depository and the underlying issuer through a deposit agreement. The deposit agreement sets out the rights and responsibilities of the underlying issuer, the depository, and the
depositary receipt holders. With sponsored facilities, the underlying issuer typically bears some of the costs of the depositary receipts (such as dividend payment fees of the depository), although most sponsored depositary receipts holders may bear
costs such as deposit and withdrawal fees. Depositories of most sponsored depositary receipts agree to distribute notices of shareholder meetings, voting instructions, and other shareholder communications and information to the depositary receipt
holders at the underlying issuers request.
Derivative Instruments
are commonly defined to include securities or contracts whose values
depend on (or derive from) the value of one or more other assets such as securities, currencies, or commodities. These other assets are commonly referred to as underlying assets. The funds may use derivatives,
principally futures contracts, primarily to seek returns on a funds otherwise uninvested cash assets.
A derivative instrument generally consists
of, is based upon, or exhibits characteristics similar to options or forward contracts. Options and forward contracts are considered to be the basic building blocks of derivatives. For example, forward-based derivatives include forward
contracts, as well as exchange-traded futures. Option-based derivatives include privately negotiated, over-the-counter (OTC) options (including caps, floors, collars, and options on forward and swap contracts) and exchange-traded options on futures.
Diverse types of derivatives may be created by combining options or forward contracts in different ways, and applying these structures to a wide range of underlying assets.
Risk management strategies include investment techniques designed to facilitate the sale of portfolio securities, manage the average duration of the portfolio
or create or alter exposure to certain asset classes, such as equity, other debt or foreign securities.
In addition to the derivative instruments and
strategies described in this SAI, the investment adviser expects to discover additional derivative instruments and other investment, hedging or risk management techniques. The investment adviser may utilize these new derivative instruments and
techniques to the extent that they are consistent with a funds investment objective and permitted by a funds investment limitations, operating policies, and applicable regulatory authorities.
The Commodity Futures Trading Commission (CFTC) regulates the trading of commodity interests, including certain futures contracts, options, and
swaps in which a fund may invest. A fund that invests in commodity interests is subject to certain CFTC regulatory requirements, including certain limits on its trades in futures contracts, options and swaps to qualify for certain exclusions or
exemptions from registration requirements. The trusts, on behalf of each fund, have filed a notice of eligibility for exclusion from the definition of the term commodity pool operator (CPO) under the Commodity Exchange Act,
as amended (CEA), with respect to each funds operation. Therefore, each fund and its investment adviser are not subject to regulation as a commodity pool or CPO under the CEA and the investment adviser is not subject to
registration as a CPO. If a fund were no longer able to claim the exclusion, the funds investment adviser may be required to register as a CPO and the fund and its investment adviser would be subject to regulation as a commodity pool or CPO
under the CEA. If a fund or its investment adviser is subject to CFTC regulation, it may incur additional expenses.
Futures Contracts
are
instruments that represent an agreement between two parties that obligates one party to buy, and the other party to sell, specific instruments at an agreed-upon price on a stipulated future date. In the case of futures contracts relating to an index
or otherwise not calling for physical delivery at the close of the transaction, the parties usually agree to deliver the final cash settlement price of the contract. A fund may purchase and sell futures contracts based on securities, securities
indices and foreign currencies, interest rates, or any other futures contracts traded on U.S. exchanges or boards of trade that the CFTC licenses and regulates on foreign exchanges. Although positions are usually marked to market on a daily basis
with an intermediary (executing broker), there remains a credit risk with the futures exchange.
8
A fund must maintain a small portion of its assets in cash to process shareholder transactions and to pay its
expenses. To reduce the effect this otherwise uninvested cash would have on its performance, a fund may purchase futures contracts. Such transactions allow a funds cash balance to produce a return similar to that of the underlying security or
index on which the futures contract is based. Also, a fund may purchase or sell futures contracts on a specified foreign currency to fix the price in U.S. dollars of the foreign security it has acquired or sold or expects to acquire or
sell. A fund may enter into futures contracts for other reasons as well.
When buying or selling futures contracts, a fund must place a deposit with its
broker equal to a fraction of the contract amount. This amount is known as initial margin and must be in the form of liquid debt instruments, including cash, cash-equivalents and U.S. government securities. Subsequent payments to and
from the broker, known as variation margin may be made daily, if necessary, as the value of the futures contracts fluctuate. This process is known as marking-to-market. The margin amount will be returned to a fund upon
termination of the futures contracts assuming all contractual obligations are satisfied. Because margin requirements are normally only a fraction of the amount of the futures contracts in a given transaction, futures trading can involve a great deal
of leverage. In order to avoid this, a fund will earmark or segregate assets for any outstanding futures contracts as may be required under the federal securities laws.
While a fund may purchase and sell futures contracts in order to simulate full investment, there are risks associated with these transactions. Adverse market
movements could cause a fund to experience substantial losses when buying and selling futures contracts. Of course, barring significant market distortions, similar results would have been expected if a fund had instead transacted in the underlying
securities directly. There also is the risk of losing any margin payments held by a broker in the event of its bankruptcy. Additionally, a fund incurs transaction costs (e.g., brokerage fees) when engaging in futures trading. To the extent a fund
also invests in futures in order to simulate full investment, these same risks apply.
When interest rates are rising or securities prices are falling, a
fund may seek, through the sale of futures contracts, to offset a decline in the value of its current portfolio securities. When rates are falling or prices are rising, a fund, through the purchase of futures contracts, may attempt to secure better
rates or prices than might later be available in the market when they effect anticipated purchases. Similarly, a fund may sell futures contracts on a specified currency to protect against a decline in the value of that currency and its portfolio
securities that are denominated in that currency. A fund may purchase futures contracts on a foreign currency to fix the price in U.S. dollars of a security denominated in that currency that a fund has acquired or expects to acquire.
Futures contracts normally require actual delivery or acquisition of an underlying security or cash value of an index on the expiration date of the contract.
In most cases, however, the contractual obligation is fulfilled before the date of the contract by buying or selling, as the case may be, identical futures contracts. Such offsetting transactions terminate the original contracts and cancel the
obligation to take or make delivery of the underlying securities or cash. There may not always be a liquid secondary market at the time a fund seeks to close out a futures position. If a fund is unable to close out its position and prices move
adversely, a fund would have to continue to make daily cash payments to maintain its margin requirements. If a fund had insufficient cash to meet these requirements it may have to sell portfolio securities at a disadvantageous time or incur extra
costs by borrowing the cash. Also, a fund may be required to make or take delivery and incur extra transaction costs buying or selling the underlying securities. A fund seeks to reduce the risks associated with futures transactions by buying and
selling futures contracts that are traded on national exchanges or for which there appears to be a liquid secondary market.
With respect to futures
contracts that are not legally required to cash settle, a fund may cover the open position by setting aside or earmarking liquid assets in an amount equal to the market value of the futures contracts. With respect to futures contracts
that are required to cash settle, however, a fund is permitted to set aside or earmark liquid assets in an amount equal to the funds daily marked to market (net) obligation, if any, (in other words, the funds daily net
liability, if any) rather than the market value of the futures contracts. By setting aside assets or earmarking equal to only its net obligation under cash-settled futures, a fund will have the ability to employ leverage to a greater extent than if
the fund were required to set aside or earmark assets equal to the full market value of the futures contract.
9
Diversification
involves investing in a wide range of securities and thereby spreading and reducing the
risks of investment. Each fund is a series of an open-end investment management company. Each fund is a diversified mutual fund.
Emerging or
Developing Markets
exist in countries that are considered to be in the initial stages of industrialization. The risks of investing in these markets are similar to the risks of international investing in general, although the risks are greater in
emerging and developing markets. Countries with emerging or developing securities markets tend to have economic structures that are less stable than countries with developed securities markets. This is because their economies may be based on only a
few industries and their securities markets may trade a small number of securities. Prices on these exchanges tend to be volatile, and securities in these countries historically have offered greater potential for gain (as well as loss) than
securities of companies located in developed countries.
A funds investments in emerging markets can be considered speculative, and therefore may
offer higher potential for gains and losses than investments in developed markets of the world. With respect to an emerging country, there may be a greater potential for nationalization, expropriation or confiscatory taxation, political changes,
government regulation, social instability or diplomatic developments (including war) which could affect adversely the economies of such countries or investments in such countries. The economies of developing countries generally are heavily dependent
upon international trade and, accordingly, have been and may continue to be adversely affected by trade barriers, exchange or currency controls, managed adjustments in relative currency values and other protectionist measures imposed or negotiated
by the countries with which they trade.
In addition to the risks of investing in emerging market country debt securities, a funds investment in
government or government-related securities of emerging market countries and restructured debt instruments in emerging markets are subject to special risks, including the inability or unwillingness to repay principal and interest, requests to
reschedule or restructure outstanding debt, and requests to extend additional loan amounts. A fund may have limited recourse in the event of default on such debt instruments.
Equity Securities
represent ownership interests in a company, and are commonly called stocks. Equity securities historically have
outperformed most other securities, although their prices can fluctuate based on changes in a companys financial condition, market conditions and political, economic or even company-specific news. When a stocks price declines, its market
value is lowered even though the intrinsic value of the company may not have changed. Sometimes factors, such as economic conditions or political events, affect the value of stocks of companies of the same or similar industry or group of industries,
and may affect the entire stock market.
Types of equity securities include common stocks, preferred stocks, convertible securities, rights and
warrants, depositary receipts, and interests in real estate investment trusts and business development companies. (For more information on real estate investment trusts, REITs, see the section entitled Real Estate Investment
Trusts, for more information on depositary receipts, see the section entitled Depositary Receipts, and for more information on business development companies, see the section entitled Business Development Companies).
Common stocks
, which are probably the most recognized type of equity security, represent an equity or ownership interest in an issuer and
usually entitle the owner to voting rights in the election of the corporations directors and any other matters submitted to the corporations shareholders for voting, as well as to receive dividends on such stock. The market value of
common stock can fluctuate widely, as it reflects increases and decreases in an issuers earnings. In the event an issuer is liquidated or declares bankruptcy, the claims of bond owners, other debt holders and owners of preferred stock take
precedence over the claims of common stock owners. Common stocks are typically categorized by their market capitalization as large-, mid- or small-cap.
10
Small-cap stocks
include common stocks issued by operating companies with market capitalizations that
place them at the lower end of the stock market, as well as the stocks of companies that are determined to be small based on several factors, including the capitalization of the company and the amount of revenues. Historically, small-cap company
stocks have been riskier than stocks issued by large- or mid-cap companies for a variety of reasons. Small-cap companies may have less certain growth prospects and are typically less diversified and less able to withstand changing economic
conditions than larger capitalized companies. Small-cap companies also may have more limited product lines, markets or financial resources than companies with larger capitalizations, and may be more dependent on a relatively small management group.
In addition, small-cap companies may not be well known to the investing public, may not have institutional ownership and may have only cyclical, static or moderate growth prospects. Most small-cap company stocks pay low or no dividends.
These factors and others may cause sharp changes in the value of a small-cap companys stock, and even cause some small-cap companies to fail.
Additionally, small-cap stocks may not be as broadly traded as large- or mid-cap stocks, and a funds positions in securities of such companies may be substantial in relation to the market for such securities. Accordingly, it may be difficult
for a fund to dispose of securities of these small-cap companies at prevailing market prices in order to meet redemptions. This lower degree of liquidity can adversely affect the value of these securities. For these reasons and others, the value of
a funds investments in small-cap stocks is expected to be more volatile than other types of investments, including other types of stock investments. While small-cap stocks are generally considered to offer greater growth opportunities for
investors, they involve greater risks and the share price of a fund that invests in small-cap stocks may change sharply during the short term and long term.
Convertible securities
are typically preferred stocks or bonds that are exchangeable for a specific number of another form of security
(usually the issuers common stock) at a specified price or ratio. A convertible security generally entitles the holder to receive interest paid or accrued on bonds or the dividend paid on preferred stock until the convertible security matures
or is redeemed, converted or exchanged. A corporation may issue a convertible security that is subject to redemption after a specified date, and usually under certain circumstances. A holder of a convertible security that is called for redemption
would be required to tender it for redemption to the issuer, convert it to the underlying common stock or sell it to a third party. The convertible structure allows the holder of the convertible bond to participate in share price movements in the
companys common stock. The actual return on a convertible bond may exceed its stated yield if the companys common stock appreciates in value and the option to convert to common stocks becomes more valuable. Convertible securities
typically pay a lower interest rate than nonconvertible bonds of the same quality and maturity because of the convertible feature. Convertible securities are also rated below investment grade (high yield) or are not rated, and are
subject to credit risk.
Prior to conversion, convertible securities have characteristics and risks similar to nonconvertible debt and equity
securities. In addition, convertible securities are often concentrated in economic sectors, which, like the stock market in general, may experience unpredictable declines in value, as well as periods of poor performance, which may last for several
years. There may be a small trading market for a particular convertible security at any given time, which may adversely impact market price and a funds ability to liquidate a particular security or respond to an economic event, including
deterioration of an issuers creditworthiness.
Convertible preferred stocks are nonvoting equity securities that pay a fixed dividend. These
securities have a convertible feature similar to convertible bonds, but do not have a maturity date. Due to their fixed income features, convertible securities provide higher income potential than the issuers common stock, but typically are
more sensitive to interest rate changes than the underlying common stock. In the event of a companys liquidation, bondholders have claims on company assets senior to those of shareholders; preferred shareholders have claims senior to those of
common shareholders.
Convertible securities typically trade at prices above their conversion value, which is the current market value of the common stock
received upon conversion, because of their higher yield potential than the underlying common stock. The difference between the conversion value and the price of a convertible security will vary depending on the value of the underlying common stock
and interest rates. When the underlying value of the common stocks declines, the price of the issuers convertible securities will tend not to fall as much because the convertible
11
securitys income potential will act as a price support. While the value of a convertible security also tends to rise when the underlying common stock value rises, it will not rise as much
because its conversion value is more narrow. The value of convertible securities also is affected by changes in interest rates. For example, when interest rates fall, the value of convertible securities may rise because of their fixed income
component.
Preferred stocks
represent an equity or ownership interest in an issuer but do not ordinarily carry voting rights, though they may
carry limited voting rights. Preferred stocks normally have preference over the corporations assets and earnings, however. For example, preferred stocks have preference over common stock in the payment of dividends. Preferred stocks normally
pay dividends at a specified rate. However, preferred stock may be purchased where the issuer has omitted, or is in danger of omitting, payment of its dividend. Such investments would be made primarily for their capital appreciation potential. In
the event an issuer is liquidated or declares bankruptcy, the claims of bond owners take precedence over the claims of preferred and common stock owners. Certain classes of preferred stock are convertible into shares of common stock of the issuer.
By holding convertible preferred stock, a fund can receive a steady stream of dividends and still have the option to convert the preferred stock to common stock. Preferred stock is subject to many of the same risks as common stock and debt
securities.
Real Estate Investment Trusts (REITs)
are pooled investment vehicles, which invest primarily in income producing real
estate or real estate related loans or interests and, in some cases, manage real estate. REITs are sometimes referred to as equity REITs, mortgage REITs or hybrid REITs. An equity REIT invests primarily in properties and generates income from rental
and lease properties and, in some cases, from the management of real estate. Equity REITs also offer the potential for growth as a result of property appreciation and from the sale of appreciated property. Mortgage REITs invest primarily in real
estate mortgages, which may secure construction, development or long-term loans, and derive income for the collection of interest payments. Hybrid REITs may combine the features of equity REITs and mortgage REITs. REITs are generally organized as
corporations or business trusts, but are not taxed as a corporation if they meet certain requirements of Subchapter M of the Internal Revenue Code of 1986, as amended (Internal Revenue Code). To qualify, a REIT must, among other things,
invest substantially all of its assets in interests in real estate (including other REITs), cash and government securities, distribute at least 90% of its taxable income to its shareholders and receive at least 75% of that income from rents,
mortgages and sales of property.
Like any investment in real estate, a REITs performance depends on many factors, such as its ability to find
tenants for its properties, to renew leases, and to finance property purchases and renovations. In general, REITs may be affected by changes in underlying real estate values, which may have an exaggerated effect to the extent a REIT concentrates its
investment in certain regions or property types. For example, rental income could decline because of extended vacancies, increased competition from nearby properties, tenants failure to pay rent, or incompetent management. Property values
could decrease because of overbuilding, environmental liabilities, uninsured damages caused by natural disasters, a general decline in the neighborhood, losses due to casualty or condemnation, increases in property taxes, or changes in zoning laws.
Ultimately, a REITs performance depends on the types of properties it owns and how well the REIT manages its properties.
In general, during periods
of rising interest rates, REITs may lose some of their appeal for investors who may be able to obtain higher yields from other income-producing investments, such as long-term bonds. Higher interest rates also mean that financing for property
purchases and improvements is more costly and difficult to obtain. During periods of declining interest rates, certain mortgage REITs may hold mortgages that mortgagors elect to prepay, which can reduce the yield on securities issued by mortgage
REITs. Mortgage REITs may be affected by the ability of borrowers to repay debts to the REIT when due and equity REITs may be affected by the ability of tenants to pay rent.
Like small-cap stocks in general, certain REITs have relatively small market capitalizations and their securities can be more volatile thanand at times
will perform differently fromlarge-cap stocks. In addition, because small-cap stocks are typically less liquid than large-cap stocks, REIT stocks may sometimes experience greater share-price fluctuations than the stocks of larger companies.
Further, REITs are dependent upon specialized
12
management skills, have limited diversification, and are therefore subject to risks inherent in operating and financing a limited number of projects. By investing in REITs indirectly through a
fund, a shareholder will bear indirectly a proportionate share of the REITs expenses in addition to their proportionate share of a funds expenses. Finally, REITs could possibly fail to qualify for tax-free pass-through of income under
the Internal Revenue Code or to maintain their exemptions from registration under the Investment Company Act of 1940 (the 1940 Act) and CFTC regulations.
Rights and Warrants.
Rights and warrants are types of securities that entitle the holder to purchase a proportionate amount of common stock at a
specified price for a specific period of time. Rights allow a shareholder to buy more shares directly from the company, usually at a price somewhat lower than the current market price of the outstanding shares. Warrants are usually issued with bonds
and preferred stock. Rights and warrants can trade on the market separately from the companys stock. The prices of rights and warrants do not necessarily move parallel to the prices of the underlying common stock. Rights usually expire within
a few weeks of issuance, while warrants may not expire for several years. If a right or warrant is not exercised within the specified time period, it will become worthless and a fund will lose the purchase price it paid for the right or warrant and
the right to purchase the underlying security.
Initial Public Offering.
A fund may purchase shares issued as part of, or a short period after, a
companys initial public offering (IPOs), and may at times dispose of those shares shortly after their acquisition. A funds purchase of shares issued in IPOs exposes it to the risks associated with companies that have little
operating history as public companies, as well as to the risks inherent in those sectors of the market where these new issuers operate. The market for IPO issuers has been volatile, and share prices of newly-public companies have fluctuated
significantly over short periods of time.
Master Limited Partnerships
(MLPs). MLPs are limited partnerships in which the common units
are publicly traded. MLP common units are freely traded on a securities exchange or in the over-the-counter market and are generally registered with the SEC. MLPs often own several properties or businesses (or own interests) that are related to real
estate development and oil and gas industries, but they also may finance motion pictures, research and development and other projects. MLPs generally have two classes of owners, the general partner and limited partners. The general partner is
typically owned by a major energy company, an investment fund, the direct management of the MLP or is an entity owned by one or more of such parties. The general partner may be structured as a private or publicly traded corporation or other entity.
The general partner typically controls the operations and management of the MLP through an up to 2% equity interest in the MLP plus, in many cases, ownership of common units and subordinated units. Limited partners own the remainder of the
partnership, through ownership of common units, and have a limited role, if any, in the partnerships operations and management.
MLPs are typically
structured such that common units and general partner interests have first priority to receive quarterly cash distributions up to an established minimum amount (minimum quarterly distributions). Common and general partner interests also
accrue arrearages in distributions to the extent the minimum quarterly distribution is not paid. Once common and general partner interests have been paid, subordinated units receive distributions of up to the minimum quarterly distribution; however,
subordinated units do not accrue arrearages. Distributable cash in excess of the minimum quarterly distribution paid to both common and subordinated units is distributed to both common and subordinated units generally on a pro rata basis. The
general partner is also eligible to receive incentive distributions if the general partner operates the business in a manner which results in distributions paid per common unit surpassing specified target levels. As the general partner increases
cash distributions to the limited partners, the general partner receives an increasingly higher percentage of the incremental cash distributions. A common arrangement provides that the general partner can reach a tier where it receives 50% of every
incremental dollar paid to common and subordinated unit holders. These incentive distributions are intended to encourage the general partner to streamline costs, increase capital expenditures and acquire assets in order to increase the
partnerships cash flow and raise the quarterly cash distribution in order to reach higher tiers. Such results are intended to benefit all security holders of the MLP, however, such incentive distribution payments give rise to potential
conflicts of interest between the common unit holders and the general partner.
13
MLP common units represent a limited partnership interest in the MLP. Common units are listed and traded on U.S.
securities exchanges or over-the-counter, with their value fluctuating predominantly based on prevailing market conditions and the success of the MLP. The funds may purchase common units in market transactions as well as directly from the MLP or
other parties in private placements. Unlike owners of common stock of a corporation, owners of common units have limited voting rights and have no ability to annually elect directors. MLPs generally distribute all available cash flow (cash flow from
operations less maintenance capital expenditures) in the form of quarterly distributions. Common units along with general partner units, have first priority to receive quarterly cash distributions up to the minimum quarterly distribution and have
arrearage rights. In the event of liquidation, common units have preference over subordinated units, but not debt or preferred units, to the remaining assets of the MLP.
MLP subordinated units are typically issued by MLPs to their original sponsors, such as their founders, corporate general partners of MLPs, entities that sell
assets to the MLP, and investors. Subordinated units may be purchased directly from these persons as well as newly-issued subordinated units from MLPs themselves. Subordinated units have similar voting rights as common units and are generally not
publicly traded. Once the minimum quarterly distribution on the common units, including any arrearages, has been paid, subordinated units receive cash distributions up to the minimum quarterly distribution prior to any incentive payments to the
MLPs general partner. Unlike common units, subordinated units do not have arrearage rights. In the event of liquidation, common units and general partner interests have priority over subordinated units. Subordinated units are typically
converted into common units on a one-to-one basis after certain time periods and/or performance targets have been satisfied. The purchase or sale price of subordinated units is generally tied to the common unit price less a discount. The size of the
discount varies depending on the likelihood of conversion, the length of time remaining to conversion, the size of the block purchased relative to trading volumes, and other factors, including smaller capitalization partnerships or companies
potentially having limited product lines, markets or financial resources, lacking management depth or experience, and being more vulnerable to adverse general market or economic development than larger more established companies.
General partner interests of MLPs are typically retained by an MLPs original sponsors, such as its founders, corporate partners, entities that sell
assets to the MLP and investors. A holder of general partner interests can be liable under certain circumstances for amounts greater than the amount of the holders investment in the general partner interest. General partner interests often
confer direct board participation rights and in many cases, operating control, over the MLP. These interests themselves are not publicly traded, although they may be owned by publicly traded entities. General partner interests receive cash
distributions, typically 2% of the MLPs aggregate cash distributions, which are contractually defined in the partnership agreement. In addition, holders of general partner interests typically hold incentive distribution rights, which provide
them with a larger share of the aggregate MLP cash distributions as the distributions to limited partner unit holders are increased to prescribed levels. General partner interests generally cannot be converted into common units. The general partner
interest can be redeemed by the MLP if the MLP unitholders choose to remove the general partner, typically with a supermajority vote by limited partner unitholders.
Additional risks involved with investing in an MLP are risks associated with the specific industry or industries in which the partnership invests, such as the
risks of investing in real estate, or oil and gas industries.
Certain MLPs are dependent on their parent companies or sponsors for a majority of their
revenues. Any failure by an MLPs parents or sponsors to satisfy their payments or obligations would impact the MLPs revenues and cash flows and ability to make distributions.
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Exchange Traded Funds
(ETFs) such as Standard and Poors Depositary Receipts (SPDRs)
Trust, are investment companies that typically are registered under the 1940 Act as open-end funds or unit investment trusts (UITs). ETFs are actively traded on national securities exchanges and are generally based on specific domestic and foreign
market indices. Shares of an ETF may be bought and sold throughout the day at market prices, which may be higher or lower than the shares net asset value. An index-based ETF seeks to track the performance of an index holding in its
portfolio either the contents of the index or a representative sample of the securities in the index. Because ETFs are based on an underlying basket of stocks or an index, they are subject to the same market fluctuations as these types of securities
in volatile market swings. ETFs, like mutual funds, have expenses associated with their operation, including advisory fees. When a fund invests in an ETF, in addition to directly bearing expenses associated with its own operations, it will bear a
pro rata portion of the ETFs expenses. As with any exchange listed security, ETF shares purchased in the secondary market are subject to customary brokerage charges. Pursuant to an exemptive order issued by the SEC to iShares and procedures
approved by the funds Board of Trustees, each fund may invest in iShares beyond the limits set forth in Section 12(d)(1)(A) of the 1940 Act but not to exceed 25% of the funds total assets, provided that the fund has described ETF
investments in its prospectus and otherwise complies with the conditions of the exemptive order and other applicable investment limitations. Neither the iShares
®
Funds nor their investment
adviser make any representations regarding the advisability of investing in a fund.
Business Development Companies (BDCs)
are
closed-end investment companies that have elected to be BDCs under the 1940 Act and are taxed as regulated investment companies (RICs) under the Internal Revenue Code. BDCs operate as venture capital companies and typically invest in,
lend capital to, and provide significant managerial assistance to developing private companies or thinly-traded public companies. Under the 1940 Act, BDCs are required to invest at least 70% of their total assets primarily in securities of
privately-held U.S. companies or thinly-traded U.S. public companies, cash, cash equivalents, U.S. government securities and high quality debt investments that mature in one year or less. In addition, a BDC may only incur indebtedness in amounts
such that the BDCs coverage ratio of total assets to total senior securities equals at least 200% after such incurrence.
BDCs generally
invest in debt securities that are not rated by a credit rating agency and are considered below investment grade quality (junk bonds). Little public information generally exists for the type of companies in which a BDC may invest and,
therefore, there is a risk that investors may not be able to make a fully informed evaluation of the BDC and its portfolio of investments. In addition, investments made by BDCs are typically illiquid and are difficult to value for purposes of
determining a BDCs net asset value.
Foreign Currency Transactions.
A fund may invest in foreign currency-denominated securities, may
purchase and sell foreign currency options and foreign currency futures contracts and related options and may engage in foreign currency transactions either on a spot (cash) basis at the rate prevailing in the currency exchange market at the time or
through forward currency contracts (forwards) with terms generally of less than one year. A fund may engage in these transactions in order to protect against uncertainty in the level of future foreign exchange rates in the purchase and
sale of securities.
A fund may also use foreign currency options and foreign currency forward contracts to increase exposure to a foreign currency or to
shift exposure to foreign currency fluctuations from one country to another. A fund will earmark or segregate assets for any open positions in forwards used for non-hedging purposes and mark to market daily as may be required under the federal
securities laws.
A forward involves an obligation to purchase or sell 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. These contracts may be bought or sold to protect a fund against a possible loss resulting from an adverse change in the relationship between foreign
currencies and the U.S. dollar or to increase exposure to a particular foreign currency. Many foreign securities markets do not settle trades within a time frame that would be considered customary in the U.S. stock market. Therefore, a fund may
engage in forward foreign currency exchange contracts in order to secure exchange rates for fund securities purchased or sold, but awaiting settlement. These transactions do not seek to eliminate any fluctuations in the underlying prices of the
securities involved. Instead, the transactions simply establish a rate of exchange that can be expected when a fund settles its securities transactions in the future. Forwards involve certain risks. For example, if the counterparties to the
contracts are unable to meet the terms of the contracts or if the value of the foreign currency changes unfavorably, a fund could sustain a loss.
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A fund may engage in forward foreign currency exchange contracts to protect the value of specific portfolio
positions, which is called position hedging. When engaging in position hedging, a fund may enter into forward foreign currency exchange transactions to protect against a decline in the values of the foreign currencies in which portfolio
securities are denominated (or against an increase in the value of currency for securities that a fund expects to purchase).
Buying and selling foreign
currency exchange contracts involves costs and may result in losses. The ability of a fund to engage in these transactions may be limited by tax considerations. Although these techniques tend to minimize the risk of loss due to declines in the value
of the hedged currency, they tend to limit any potential gain that might result from an increase in the value of such currency. Transactions in these contracts involve certain other risks. Unanticipated fluctuations in currency prices may result in
a poorer overall performance for a fund than if it had not engaged in any such transactions. Moreover, there may be imperfect correlation between a funds holdings of securities denominated in a particular currency and forward contracts into
which a fund enters. Such imperfect correlation may cause a fund to sustain losses, which will prevent it from achieving a complete hedge or expose it to risk of foreign exchange loss.
Suitable hedging transactions may not be available in all circumstances and there can be no assurance that a fund will engage in such transactions at any
given time or from time to time. Also, such transactions may not be successful and may eliminate any chance for a fund to benefit from favorable fluctuations in relevant foreign currencies.
Forwards will be used primarily to adjust the foreign exchange exposure of a fund with a view to protecting the outlook, and a fund might be expected to enter
into such contracts under the following circumstances:
Lock In
.
When the investment adviser desires to lock in the U.S. dollar price
on the purchase or sale of a security denominated in a foreign currency.
Cross Hedge
.
If a particular currency is expected to
decrease against another currency, a fund may sell the currency expected to decrease and purchase a currency which is expected to increase against the currency sold in an amount approximately equal to some or all of a funds portfolio holdings
denominated in the currency sold.
Direct Hedge
.
If the investment adviser wants to eliminate substantially all of the risk of owning
a particular currency, and/or if the investment adviser thinks that a fund can benefit from price appreciation in a given countrys bonds but does not want to hold the currency, it may employ a direct hedge back into the U.S. dollar. In either
case, a fund would enter into a forward contract to sell the currency in which a portfolio security is denominated and purchase U.S. dollars at an exchange rate established at the time it initiated the contract. The cost of the direct hedge
transaction may offset most, if not all, of the yield advantage offered by the foreign security, but a fund would benefit from an increase in value of the bond.
Proxy Hedge
.
The investment adviser might choose to use a proxy hedge, which may be less costly than a direct hedge. In this case, a
fund, having purchased a security, will sell a currency whose value is believed to be closely linked to the currency in which the security is denominated. Interest rates prevailing in the country whose currency was sold would be expected to be
closer to those in the U.S. and lower than those of securities denominated in the currency of the original holding. This type of hedging entails greater risk than a direct hedge because it is dependent on a stable relationship between the two
currencies paired as proxies and the relationships can be very unstable at times.
Costs of Hedging
.
When a fund purchases a foreign
bond with a higher interest rate than is available on U.S. bonds of a similar maturity, the additional yield on the foreign bond could be substantially reduced or lost if a fund were to enter into a direct hedge by selling the foreign currency and
purchasing the U.S. dollar. This is what is known as the cost of hedging. Proxy hedging attempts to reduce this cost through an indirect hedge back to the U.S. dollar. It is important to note that hedging costs are treated as capital
transactions and are not, therefore, deducted from a funds dividend distribution and are not reflected in its yield. Instead such costs will, over time, be reflected in a funds net asset value per share.
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Tax Consequences of Hedging
.
Under applicable tax law, a fund may be required to limit its
gains from hedging in foreign currency forwards, futures, and options. Although a fund is expected to comply with such limits, the extent to which these limits apply is subject to tax regulations as yet unissued. Hedging may also result in the
application of the mark-to-market and straddle provisions of the Internal Revenue Code. Those provisions could result in an increase (or decrease) in the amount of taxable dividends paid by a fund and could affect whether dividends paid by a fund
are classified as capital gains or ordinary income.
Foreign Securities.
Investments in foreign securities involve additional risks, including
foreign currency exchange rate risks, because they are issued by foreign entities, including foreign governments, banks and corporations or because they are traded principally overseas. Foreign securities in which a fund may invest include foreign
entities that are not subject to uniform accounting, auditing and financial reporting standards, practices and requirements comparable to those applicable to U.S. corporations. In addition, there may be less publicly available information about
foreign entities. Foreign economic, political and legal developments, as well as fluctuating foreign currency exchange rates and withholding taxes, could have more dramatic effects on the value of foreign securities. For example, conditions within
and around foreign countries, such as the possibility of expropriation or confiscatory taxation, political or social instability, diplomatic developments, change of government or war could affect the value of foreign investments. Moreover,
individual foreign economies may differ favorably or unfavorably from the U.S. economy in such respects as growth of gross national product, rate of inflation, capital reinvestment, resource self-sufficiency and balance of payments position.
Foreign securities typically have less volume and are generally less liquid and more volatile than securities of U.S. companies. Fixed commissions on
foreign securities exchanges are generally higher than negotiated commissions on U.S. exchanges, although a fund will endeavor to achieve the most favorable overall results on portfolio transactions. There is generally less government supervision
and regulation of foreign securities exchanges, brokers, dealers and listed companies than in the United States, thus increasing the risk of delayed settlements of portfolio transactions or loss of certificates for portfolio securities. There may be
difficulties in obtaining or enforcing judgments against foreign issuers as well. Bankruptcy laws in some foreign countries are sometimes biased to the borrowers and against the creditors. These factors and others may increase the risks with respect
to the liquidity of a fund, and its ability to meet a large number of shareholder redemption requests.
Foreign markets also have different clearance
and settlement procedures and, in certain markets, there have been times when settlements have been unable to keep pace with the volume of securities transactions, making it difficult to conduct such transactions. Such delays in settlement could
result in temporary periods when a portion of the assets of a fund is uninvested and no return is earned thereon. The inability to make intended security purchases due to settlement problems could cause a fund to miss attractive investment
opportunities. Losses to a fund arising out of the inability to fulfill a contract to sell such securities also could result in potential liability for a fund.
Investments in the securities of foreign issuers may be made and held in foreign currencies. In addition, a fund may hold cash in foreign currencies. These
investments may be affected favorably or unfavorably by changes in currency rates and in exchange control regulations, and may cause a fund to incur costs in connection with conversions between various currencies. The rate of exchange between the
U.S. dollar and other currencies is determined by the forces of supply and demand in the foreign exchange market as well as by political and economic factors. Changes in the foreign currency exchange rates also may affect the value of dividends and
interest earned, gains and losses realized on the sale of securities, and net investment income and gains, if any, to be distributed to shareholders by a fund.
Financial markets in the eurozone have experienced volatility over the past few years due, in part, to concerns about rising levels of government debt and the
prevalence of increased budget deficits. Delays by politicians and regulators to address structural and policy issues in the eurozone have added to instability in the region. The
17
implementation of austerity measures in Spain, Italy, Greece, Portugal and Ireland at a time when the eurozone is experiencing higher unemployment and slowing economic activity has raised the
possibility of a prolonged recession in the region. However, recent policy actions by leaders of the European Union (EU) and the European Central Bank have significantly reduced the possibility of default by a eurozone government and
have reduced market volatility.
The severity and prolonged nature of the eurozone crisis caused certain individuals and institutions to question the
continued viability of the euro as a unit of currency. It is possible individual EU member countries that have already adopted the euro may abandon that currency and revert to a national currency or otherwise exit the EU. It is also possible that
the euro will cease to exist as a single unit of currency in its current form. The precise effects of any such outcome on regional or global financial markets are impossible to predict. However, the abandonment of the euro or the exit of any country
out of the EU would likely have an extremely destabilizing effect on all EU member countries and their economies, which would likely impact the global economy.
As the funds may hold certain investments of issuers located in the eurozone, any material negative developments in the region could have a negative impact on
the investments held by the funds, which could hurt their overall performance.
Foreign Institutions
involve additional risks. The funds may
invest in U.S. dollar-denominated securities issued by foreign institutions or securities that are subject to credit or liquidity enhancements provided by foreign institutions. Foreign institutions may not be subject to uniform accounting, auditing
and financial reporting standards, practices and requirements that are comparable to those applicable to U.S. corporations. In addition, there may be less publicly available information about foreign entities. Foreign economic, political and legal
developments could have effects on the value of securities issued or supported by foreign institutions. For example, conditions within and around foreign countries, such as the possibility of expropriation or confiscatory taxation, political or
social instability, diplomatic developments, change of government or war could affect the value of these securities. In addition, there may be difficulties in obtaining or enforcing judgments against foreign institutions that issue or support
securities in which a fund may invest. These factors and others may increase the risks with respect to the liquidity of a fund, and its ability to meet a large number of shareholder redemption requests.
Illiquid Securities
generally are any securities that cannot be disposed of promptly and in the ordinary course of business at approximately the amount
at which a fund has valued the instruments. The liquidity of a funds investments is monitored under the supervision and direction of the Board of Trustees. Investments currently not considered liquid include repurchase agreements not maturing
within seven days and certain restricted securities.
Indexing Strategies
involve tracking the securities represented in, and therefore the
performance of, an index. Each fund normally will invest primarily in the securities of its index. Moreover, each fund invests so that its portfolio performs similarly to that of its index. Each fund tries to generally match its holdings in a
particular security to its weight in the index. Each fund will seek a correlation between its performance and that of its index of 0.90 or better, over time. A perfect correlation of 1.0 is unlikely as the index funds incur operating and trading
expenses unlike their indices. Each fund may rebalance its holdings in order to track its index more closely. In the event its intended correlation is not achieved, the Board of Trustees will consider alternative arrangements for each fund.
There can be no guarantee that the performance of a fund will achieve a high degree of correlation with that of its index. A number of factors may affect a
funds ability to achieve a high correlation with its index, including the degree to which a fund utilizes a sampling technique. The correlation between the performance of a fund and its index may also diverge due to transaction costs, asset
valuations, corporate actions (such as mergers and spin-offs), timing variances, and differences between a funds portfolio and the index resulting from legal restrictions such as diversification requirements) that apply to a fund but not to
the index.
Interfund Borrowing and Lending.
The SEC has granted an exemption to the Schwab Funds that permits the funds to borrow money from
and/or lend money to other Schwab Funds. All loans are for temporary or emergency purposes and the interest rates to be charged will be the average of the overnight repurchase agreement rate and the short term bank loan rate. All loans are subject
to numerous conditions designed to ensure fair and equitable treatment of all participating funds/portfolios. The interfund lending facility is subject to the oversight and periodic review of the Board of Trustees of the Schwab Funds.
18
Money Market Securities
are high-quality, short term debt securities that may be issued by entities such
as the U.S. government, corporations and financial institutions (like banks). Money market securities include commercial paper, certificates of deposit, bankers acceptances, notes and time deposits. Certificates of deposit and time deposits
are issued against funds deposited in a banking institution for a specified period of time at a specified interest rate. Bankers acceptances are credit instruments evidencing a banks obligation to pay a draft drawn on it by a customer.
These instruments reflect the obligation both of the bank and of the drawer to pay the full amount of the instrument upon maturity. Commercial paper consists of short term, unsecured promissory notes issued to finance short term credit needs.
Money market securities pay fixed, variable or floating rates of interest and are generally subject to credit and interest rate risks. The maturity date or
price of and financial assets collateralizing a security may be structured in order to make it qualify as or act like a money market security. These securities may be subject to greater credit and interest rate risks than other money market
securities because of their structure. Money market securities may be issued with puts or sold separately, sometimes called demand features or guarantees, which are agreements that allow the buyer to sell a security at a specified price and time to
the seller or put provider. When a fund buys a put, losses could occur as a result of the costs of the put or if it exercises its rights under the put and the put provider does not perform as agreed. Standby commitments are types of
puts.
A fund may keep a portion of its assets in cash for business operations. A fund may invest in money market securities to reduce the effect this
otherwise uninvested cash would have on its performance. A fund may also invest in money market securities to the extent it is consistent with its investment objective.
Bankers Acceptances or Notes
are credit instruments evidencing a banks obligation to pay a draft drawn on it by a customer. These
instruments reflect the obligation both of the bank and of the drawer to pay the full amount of the instrument upon maturity. A fund will invest only in bankers acceptances of banks that have capital, surplus and undivided profits in excess of
$100 million.
Certificates of Deposit or Time Deposits
are issued against funds deposited in a banking institution for a specified period of
time at a specified interest rate. A fund will invest only in certificates of deposit of banks that have capital, surplus and undivided profits, in aggregate, in excess of $100 million.
Commercial Paper
consists of short-term, promissory notes issued by banks, corporations and other institutions to finance short-term credit needs.
These securities generally are discounted but sometimes may be interest bearing. Commercial paper, which also may be unsecured, is subject to credit risk.
Repurchase Agreements
are instruments under which a buyer acquires ownership of certain securities (usually U.S. government securities) from a seller
who agrees to repurchase the securities at a mutually agreed-upon time and price, thereby determining the yield during the buyers holding period. Any repurchase agreements a fund enters into will involve a fund as the buyer and banks or
broker-dealers as sellers. The period of repurchase agreements is usually shortfrom overnight to one week, although the securities collateralizing a repurchase agreement may have longer maturity dates. Default by the seller might cause a fund
to experience a loss or delay in the liquidation of the collateral securing the repurchase agreement. A fund also may incur disposition costs in liquidating the collateral. In the event of a bankruptcy or other default of a repurchase
agreements seller, a fund might incur expenses in enforcing its rights, and could experience losses, including a decline in the value of the underlying securities and loss of income. A fund will make payment under a repurchase agreement only
upon physical delivery or evidence of book entry transfer of the collateral to the account of its custodian bank.
Non-Publicly Traded Securities and
Private Placements.
A fund may invest in securities that are neither listed on a stock exchange nor traded over-the-counter, including privately placed securities. Such unlisted securities may involve a higher degree of business and financial
risk that can result in substantial losses. As a result of the
19
absence of a public trading market for these securities, they may be less liquid than publicly traded securities. Although these securities may be resold in privately negotiated transactions, the
prices realized from these sales could be less than those originally paid by a fund or less than what may be considered the fair value of such securities. Furthermore, companies whose securities are not publicly traded may not be subject to the
disclosure and other investor protection requirements which might be applicable if their securities were publicly traded. If such securities are required to be registered under the securities laws of one or more jurisdictions before being sold, a
fund may be required to bear the expenses of registration.
Restricted Securities
are securities that are subject to legal restrictions on
their sale. Difficulty in selling restricted securities may result in a loss or be costly to a fund. Restricted securities generally can be sold in privately negotiated transactions, pursuant to an exemption from registration under the Securities
Act of 1933 (the 1933 Act), or in a registered public offering. Where registration is required, the holder of a registered security may be obligated to pay all or part of the registration expense and a considerable period may elapse
between the time it decides to seek registration and the time it may be permitted to sell a security under an effective registration statement. If, during such a period, adverse market conditions were to develop, the holder might obtain a less
favorable price than prevailed when it decided to seek registration of the security. Certain restricted securities, such as Section 4(a)(2) commercial paper and Rule 144A securities under the 1933 Act, may be considered to be liquid if they
meet the criteria for liquidity established by the Board. To the extent a fund invests in restricted securities that are deemed liquid, the general level of illiquidity in the funds portfolio may be increased if such securities become
illiquid.
Securities Lending
of portfolio securities is a common practice in the securities industry. A fund may engage in security
lending arrangements. For example, a fund may receive cash collateral and may invest it in short-term, interest-bearing obligations, but will do so only to the extent that it will not lose the tax treatment available to regulated investment
companies. Lending portfolio securities involves risks that the borrower may fail to return the securities or provide additional collateral. Also, voting rights with respect to the loaned securities may pass with the lending of the securities and
efforts to call such securities promptly may be unsuccessful, especially for foreign securities. Securities lending involves the risk of loss of rights in the collateral, or delay in recovery of the collateral, if the borrower fails to return the
security loaned or becomes insolvent. A fund will also bear the risk of any decline in value of securities acquired with cash collateral.
A
fund may loan portfolio securities to qualified broker-dealers or other institutional investors provided: (1) the loan is secured continuously by collateral consisting of U.S. government securities, letters of credit, cash or cash equivalents
or other appropriate instruments maintained on a daily marked-to-market basis in an amount at least equal to the current market value of the securities loaned; (2) a fund may at any time call the loan and obtain the return of the securities
loaned; (3) a fund will receive any interest or dividends paid on the loaned securities; and (4) the aggregate market value of securities loaned will not at any time exceed one-third of the total assets of a fund, including collateral
received from the loan (at market value computed at the time of the loan).
Although voting rights with respect to loaned securities pass to the borrower,
the lender retains the right to recall a security (or terminate a loan) for the purpose of exercising the securitys voting rights. Efforts to recall such securities promptly may be unsuccessful, especially for foreign securities or thinly
traded securities such as small-cap stocks. In addition, because recalling a security may involve expenses to a fund, it is expected that a fund will do so only where the items being voted upon are, in the judgment of the investment adviser, either
material to the economic value of the security or threaten to materially impact the issuers corporate governance policies or structure.
20
Securities of Other Investment Companies.
Investment companies generally offer investors the
advantages of diversification and professional investment management, by combining shareholders money and investing it in securities such as stocks, bonds and money market instruments. Investment companies include: (1) open-end funds
(commonly called mutual funds) that issue and redeem their shares on a continuous basis; (2) business development companies that generally invest in, and provide services to, privately-held companies or thinly-traded public companies (see the
sub-section entitled Business Development Companies for more information); (3) closed-end funds that offer a fixed number of shares, and are usually listed on an exchange; and (4) unit investment trusts that generally offer a
fixed number of redeemable shares. Certain open-end funds, closed-end funds and unit investment trusts are traded on exchanges (see the section entitled Exchange Traded Funds for more information).
To the extent a fund invests, or has invested, in shares of other investment companies, including BDCs, during its prior fiscal year, the fund, pursuant to
SEC rules, must disclose any material fees and expenses indirectly incurred by the fund as a result of such investments. These indirect fees and expenses, to the extent incurred, will appear in the fee table of the funds prospectus as a
separate line item captioned Acquired fund fees and expenses. Unlike securities of other investments companies, BDCs may be included in various indices by index providers. As a result, particularly to the extent a fund seeks to track the
total return of its index by replicating the index (rather than employing statistical sampling techniques), a fund may hold securities of BDCs and may be required to disclose acquired fund fees and expenses.
Investment companies may make investments and use techniques designed to enhance their performance. These may include delayed-delivery and when-issued
securities transactions; swap agreements; buying and selling futures contracts, illiquid, and/or restricted securities and repurchase agreements; and borrowing or lending money and/or portfolio securities. The risks of investing in a particular
investment company will generally reflect the risks of the securities in which it invests and the investment techniques it employs. Also, investment companies charge fees and incur expenses.
The funds may buy securities of other investment companies, including those of foreign issuers, in compliance with the requirements of federal law or any SEC
exemptive order. A fund may invest in investment companies that are not registered with the SEC or in privately placed securities of investment companies (which may or may not be registered), such as hedge funds and offshore funds. Unregistered
funds are largely exempt from the regulatory requirements that apply to registered investment companies. As a result, unregistered funds may have a greater ability to make investments, or use investment techniques, that offer a higher potential
investment return (for example, leveraging), but which may carry high risk. Unregistered funds, while not regulated by the SEC like registered funds, may be indirectly supervised by the financial institutions (e.g., commercial and investment banks)
that may provide them with loans or other sources of capital. Investments in unregistered funds may be difficult to sell, which could cause a fund selling an interest in an unregistered fund to lose money. For example, many hedge funds require their
investors to hold their investments for at least one year.
Federal law restricts the ability of one registered investment company to invest in another.
As a result, the extent to which a fund may invest in another investment company may be limited. With respect to investments in other mutual funds, the SEC has granted the funds an exemption from the limitations of the 1940 Act that restrict the
amount of securities of underlying mutual funds a fund may hold, provided that certain conditions are met. The conditions requested by the SEC were designed to address certain abuses perceived to be associated with funds of funds, including
unnecessary costs (such as sales loads, advisory fees and administrative costs), and undue influence by a fund of funds over the underlying fund. The conditions apply only when a fund and its affiliates in the aggregate own more than 3% of the
outstanding shares of any one underlying fund.
Under the terms of the exemptive order, each fund and its affiliates may not control a non-affiliated
underlying fund. Under the 1940 Act, any person who owns beneficially, either directly or through one or more controlled companies, more than 25% of the voting securities of a company is assumed to control that company. This limitation is measured
at the time the investment is made. The funds do not currently intend to take advantage of this exemptive order because the funds are not funds of funds.
21
Short Sales
may be used by a fund as part of its overall portfolio management strategies or to offset
(hedge) a potential decline in the value of a security. A fund may engage in short sales that are either against the box or uncovered. A short sale is against the box if at all times during which the short
position is open, a fund owns at least an equal amount of the securities or securities convertible into, or has the right to acquire, at no added cost, the securities of the same issue as the securities that are sold short. A short sale against the
box is a taxable transaction to a fund with respect to the securities that are sold short. Uncovered short sales are transactions under which a fund sells a security it does not own. To complete such transaction, a fund may borrow the
security through a broker to make delivery to the buyer and, in doing so, a fund becomes obligated to replace the security borrowed by purchasing the security at the market price at the time of the replacement. A fund also may have to pay a fee to
borrow particular securities, which would increase the cost of the security. In addition, a fund is often obligated to pay any accrued interest and dividends on the securities until they are replaced. The proceeds of the short sale position will be
retained by the broker until a fund replaces the borrowed securities.
A fund will incur a loss if the price of the security sold short increases between
the time of the short sale and the time the fund replaces the borrowed security and, conversely, the fund will realize a gain if the price declines. Any gain will be decreased, and any loss increased, by the transaction costs described above. A
short sale creates the risk of an unlimited loss, as the price of the underlying securities could theoretically increase without limit, thus increasing the cost of buying those securities to cover the short position. If a fund sells securities short
against the box, it may protect unrealized gains, but will lose the opportunity to profit on such securities if the price rises. The successful use of short selling as a hedging strategy may be adversely affected by imperfect correlation
between movements in the price of the security sold short and the securities being hedged.
A funds obligation to replace the securities borrowed in
connection with a short sale will be secured by collateral deposited with the broker that consists of cash or other liquid securities. In addition, a fund will earmark cash or liquid assets or place in a segregated account an amount of cash or other
liquid assets equal to the difference, if any, between (1) the market value of the securities sold short, marked-to-market daily, and (2) any cash or other liquid securities deposited as collateral with the broker in connection with the
short sale.
Stock Substitution Strategy
is a strategy, whereby each fund may, in certain circumstances, substitute a similar stock for a security
in its index.
U.S. Government Securities
are issued by the U.S. Treasury or issued or guaranteed by the U.S. government or any of its agencies
or instrumentalities. Not all U.S. government securities are backed by the full faith and credit of the United States. Some U.S. government securities, such as those issued by the Federal National Mortgage Association (Fannie Mae), Federal Home Loan
Mortgage Corporation (Freddie Mac), the Student Loan Marketing Association (Sallie Mae), and the Federal Home Loan Banks, are supported by a line of credit the issuing entity has with the U.S. Treasury. Others are supported solely by the credit of
the issuing agency or instrumentality such as obligations issued by the Federal Farm Credit Banks Funding Corporation. There can be no assurance that the U.S. government will provide financial support to U.S. government securities of its agencies
and instrumentalities if it is not obligated to do so under law. U.S. government securities, including U.S. Treasury securities, are among the safest securities, however, not unlike other debt securities, they are still sensitive to interest rate
changes, which will cause their yields and prices to fluctuate.
On September 7, 2008, the U.S. Treasury announced a federal takeover of
Fannie Mae and Freddie Mac, placing the two federal instrumentalities in conservatorship. Under the takeover, the U.S. Treasury agreed to acquire $1 billion of senior preferred stock of each instrumentality and obtained warrants for the purchase of
common stock of each instrumentality. Under these Senior Preferred Stock Purchase Agreements (SPAs), the U.S. Treasury has pledged to provide up to $100 billion per instrumentality as needed, including the contribution of cash capital to the
instrumentalities in the event their liabilities exceed their assets. On May 6, 2009, the U.S. Treasury increased its maximum commitment to each instrumentality under the SPAs to $200 billion per instrumentality. On December 24, 2009, the
U.S. Treasury further amended the SPAs to allow the cap on Treasurys funding commitment to increase as necessary to accommodate any cumulative reduction in Fannie Maes and Freddie Macs net worth through the end of 2012.
22
On August 17, 2012, the U.S. Treasury announced that it was again amending the SPAs to terminate the requirement that Fannie Mae and Freddie Mac each pay a 10% dividend annually on all
amounts received under the funding commitment. Instead, they will transfer to the U.S. Treasury on a quarterly basis all profits earned during a quarter that exceed a capital reserve amount of $3 billion. It is anticipated that the new amendment
would put Fannie Mae and Freddie Mac in a better position to service their debt. At the start of 2013, the unlimited support the U.S. Treasury extended to the two companies expired Fannie Maes bailout is capped at $125 billion and
Freddie Mac has a limit of $149 billion.
The actions of the U.S. Treasury are intended to ensure that Fannie Mae and Freddie Mac maintain a positive
net worth and meet their financial obligations preventing mandatory triggering of receivership. No assurance can be given that the U.S. Treasury initiatives will be successful.
On August 5, 2011, Standard & Poors Financial Services LLC (S&P) lowered the long-term sovereign credit rating assigned to
the United States to AA+ with a negative outlook. On August 8, 2011, S&P downgraded the long-term senior debt rating of Fannie Mae and Freddie Mac to AA+ with a negative outlook. The long-term impacts of any future downgrades are unknown.
However, any future downgrades could have a material adverse impact on global financial markets and worldwide economic conditions, and could negatively impact a fund.
INVESTMENT LIMITATIONS AND RESTRICTIONS
The following investment limitations may be changed only by vote of a majority of each funds outstanding voting shares:
Each of the Schwab
®
S&P 500 Index Fund, Schwab 1000 Index
®
Fund, Schwab Small-Cap Index Fund
®
, and Schwab International Index Fund
®
may not:
(1)
|
Borrow money, except to the extent permitted under the 1940 Act, the rules or regulations thereunder or any exemption therefrom, as such statute, rules or regulations may be amended or interpreted from time to time.
|
(2)
|
Make loans to other persons, except to the extent permitted under the 1940 Act, the rules or regulations thereunder or any exemption therefrom, as such statute, rules or regulations may be amended or interpreted from
time to time.
|
(3)
|
Issue senior securities, except to the extent permitted under the 1940 Act, the rules or regulations thereunder or any exemption therefrom, as such statute, rules or regulations may be amended or interpreted from time
to time.
|
(4)
|
Purchase securities of an issuer, except as consistent with the maintenance of its status as an open-end diversified company under the 1940 Act, the rules or regulations thereunder or any exemption therefrom, as such
statute, rules or regulations may be amended or interpreted from time to time.
|
(5)
|
Concentrate investments in a particular industry or group of industries, as concentration is defined under the 1940 Act, the rules or regulations thereunder or any exemption therefrom, as such statute, rules or
regulations may be amended or interpreted from time to time.
|
(6)
|
Purchase or sell commodities or real estate, except to the extent permitted under the 1940 Act, the rules or regulations thereunder or any exemption therefrom, as such statute, rules or regulations may be amended or
interpreted from time to time.
|
23
(7)
|
Underwrite securities issued by other persons, except to the extent permitted under the 1940 Act, the rules or regulations thereunder or any exemption therefrom, as such statute, rules or regulations may be amended or
interpreted from time to time.
|
In addition, each of the Schwab
®
S&P 500
Index Fund, Schwab Small-Cap Index Fund
®
and Schwab International Index Fund
®
may not:
(1)
|
Purchase securities of other investment companies, except as permitted by the 1940 Act, including any exemptive relief granted by the SEC.
|
In addition, the Schwab
®
S&P 500 Index Fund may not:
(1)
|
Pledge, mortgage or hypothecate any of its assets, except as permitted under the 1940 Act, the rules or regulations thereunder or any exemption therefrom, as such statute, rules or regulations may be amended or
interpreted from time to time.
|
In addition, the Schwab 1000 Index
®
Fund may
not:
(1)
|
Purchase securities of other investment companies, except as permitted by the 1940 Act.
|
The Schwab Total
Stock Market Index Fund
®
may not:
(1)
|
Purchase securities of any issuer, except as consistent with the maintenance of its status as a diversified company under the 1940 Act.
|
(2)
|
Concentrate investments in a particular industry or group of industries, except as permitted under the 1940 Act, or the rules or regulations thereunder.
|
(3)
|
(i) Purchase or sell commodities, commodities contracts, futures or real estate; (ii) lend or borrow money; (iii) issue senior securities; (iv) underwrite securities; or (v) pledge, mortgage or
hypothecate any of its assets, except as permitted by the 1940 Act, or the rules or regulations thereunder.
|
The following are
non-fundamental investment policies and restrictions, and may be changed by the Board of Trustees.
Each fund may not:
(1)
|
Sell securities short unless it owns the security or the right to obtain the security or equivalent securities, or unless it covers such short sale as required by current SEC rules and interpretations (transactions in
futures contracts, options and other derivative instruments are not considered selling securities short).
|
(2)
|
Purchase securities on margin, except such short-term credits as may be necessary for the clearance of purchases and sales of securities and provided that margin deposits in connection with futures contracts, options on
futures or other derivative instruments shall not constitute purchasing securities on margin.
|
(3)
|
Borrow money except that the fund may (i) borrow money from banks or through an interfund lending facility, if any, only for temporary or emergency purposes (and not for leveraging) and (ii) engage in reverse
repurchase agreements with any party; provided that (i) and (ii) in combination do not exceed 33 1/3% of its total assets (any borrowings that come to exceed this amount will be reduced to the extent necessary to comply with the limitation
within three business days).
|
(4)
|
Lend any security or make any other loan if, as a result, more than 33 1/3% of its total assets would be lent to other parties (this restriction does not apply to purchases of debt securities or repurchase agreements).
|
24
(5)
|
Purchase securities (other than securities issued or guaranteed by the U.S. government, its agencies or instrumentalities) if, as a result of such purchase, 25% or more of the value of its total assets would be invested
in any industry or group of industries (except that each fund may purchase securities to the extent that its index is also so concentrated).
|
(6)
|
Purchase or sell commodities, commodity contracts or real estate, including interests in real estate limited partnerships, provided that each fund may (i) purchase securities of companies that deal in real estate
or interests therein (including REITs); (ii) purchase or sell futures contracts, options contracts, equity index participations and index participation contracts; and (iii) purchase securities of companies that deal in precious metals or
interests therein.
|
(7)
|
Invest more than 15% of its net assets in illiquid securities.
|
In addition, the Schwab Small-Cap Index
Fund
®
(1)
|
Intends to achieve its investment objective by tracking the price and dividend performance (total return) of the Russell 2000
®
Index.
|
In addition, the Schwab International Index Fund
®
(1)
|
Intends to achieve its investment objective by tracking the price and dividend performance (total return) of the MSCI EAFE Index.
|
In addition, the Schwab Total Stock Market Index Fund
®
may not:
(1)
|
Purchase securities of other investment companies, except as permitted by the 1940 Act, the rules or regulations thereunder or any exemption therefrom, as such statute, rules or regulations may be amended or interpreted
from time to time.
|
The following descriptions of the 1940 Act may assist investors in understanding the above policies and
restrictions.
Borrowing
. The 1940 Act restricts an investment company from borrowing (including pledging, mortgaging or hypothecating assets)
in excess of 33 1/3% of its total assets (not including temporary borrowings not in excess of 5% of its total assets). Transactions that are fully collateralized in a manner that does not involve the prohibited issuance of a senior
security within the meaning of Section 18(f) of the 1940 Act, shall not be regarded as borrowings for the purposes of a funds investment restriction.
Concentration.
The SEC has defined concentration as investing 25% or more of an investment companys total assets in an industry or group of
industries, with certain exceptions.
Diversification.
Under the 1940 Act and the rules, regulations and interpretations thereunder, a
diversified company, as to 75% of its total assets, may not purchase securities of any issuer (other than obligations of, or guaranteed by, the U.S. government or its agencies, or instrumentalities or securities of other investment
companies) if, as a result, more than 5% of its total assets would be invested in the securities of such issuer, or more than 10% of the issuers voting securities would be held by the fund.
25
Lending
. Under the 1940 Act, an investment company may only make loans if expressly permitted by its
investment policies.
Real Estate.
The 1940 Act does not directly restrict an investment companys ability to invest in real estate, but does
require that every investment company have a fundamental investment policy governing such investments. Each fund has adopted a fundamental policy that would permit direct investment in real estate. However, each fund has a non-fundamental investment
limitation that prohibits it from investing directly in real estate. This non-fundamental policy may be changed only by vote of a funds Board of Trustees.
Senior Securities.
Senior securities may include any obligation or instrument issued by an investment company evidencing indebtedness. The 1940 Act
generally prohibits each fund from issuing senior securities, although it provides allowances for certain borrowings and certain other investments, such as short sales, reverse repurchase agreements, firm commitment agreements and standby
commitments, when such investments are covered or with appropriate earmarking or segregation of assets to cover such obligations.
Underwriting.
Under the 1940 Act, underwriting securities involves an investment company purchasing securities directly from an issuer for the purpose
of selling (distributing) them or participating in any such activity either directly or indirectly. Under the 1940 Act, a diversified fund may not make any commitment as underwriter, if immediately thereafter the amount of its outstanding
underwriting commitments, plus the value of its investments in securities of issuers (other than investment companies) of which it owns more than 10% of the outstanding voting securities, exceeds 25% of the value of its total assets. The foregoing
restriction does not apply to non-diversified funds.
Policies and investment limitations that state a maximum percentage of assets that may be
invested in a security or other asset, or that set forth a quality standard shall be measured immediately after and as a result of a funds acquisition of such security or asset, unless otherwise noted. Except with respect to limitations on
borrowing and futures and option contracts, any subsequent change in total assets or net assets, as applicable, or other circumstances does not require a fund to sell an investment if it could not then make the same investment. With respect to the
limitation on illiquid securities, in the event that a subsequent change in net assets or other circumstances cause a fund to exceed its limitation, the fund will take steps to bring the aggregate amount of illiquid instruments back within the
limitations as soon as reasonably practicable.
MANAGEMENT OF THE FUNDS
The funds are overseen by a Board of Trustees. The trustees are responsible for protecting shareholder interests. The trustees regularly meet to review the
investment activities, contractual arrangements and the investment performance of each fund. The trustees met 6 times during the most recent fiscal year.
Certain trustees are interested persons. A trustee is considered an interested person of a trust under the 1940 Act if he or she is an officer,
director, or an employee of Charles Schwab Investment Management, Inc. (CSIM or the investment adviser) or Charles Schwab & Co., Inc. (Schwab or the funds distributor). A trustee also
may be considered an interested person of a trust under the 1940 Act if he or she owns stock of The Charles Schwab Corporation, a publicly traded company and the parent company of the funds investment adviser and distributor.
As used herein the terms Fund Complex and Family of Investment Companies each refer collectively to The Charles Schwab Family of
Funds, Schwab Investments, Schwab Annuity Portfolios, Schwab Capital Trust, Schwab Strategic Trust, Laudus Trust, and Laudus Institutional Trust which, as of January 31, 2014, included 99 funds.
26
Each of the officers and/or trustees also serves in the same capacity as described for the trusts, for The
Charles Schwab Family of Funds, Schwab Annuity Portfolios, Laudus Trust and Laudus Institutional Trust. The tables below provide information about the trustees and officers for the trusts, which includes funds in this SAI. The address of each
individual listed below is 211 Main Street, San Francisco, California 94105.
|
|
|
|
|
|
|
NAME, YEAR OF BIRTH, AND
POSITION(S) WITH THE TRUST;
(TERM OF OFFICE AND
LENGTH OF TIME SERVED
1
)
|
|
PRINCIPAL OCCUPATIONS
DURING THE PAST FIVE YEARS
|
|
NUMBER OF
PORTFOLIOS
IN FUND
COMPLEX
OVERSEEN
BY THE
TRUSTEE
|
|
OTHER
DIRECTORSHIPS
DURING THE
PAST
FIVE
YEARS
|
INDEPENDENT TRUSTEES
|
Mariann Byerwalter
1960
Trustee
(Trustee of The Charles Schwab Family of Funds, Schwab
Investments, Schwab Capital Trust and Schwab Annuity Portfolios since 2000; Laudus Trust and Laudus Institutional Trust since 2004)
|
|
Chairman of JDN Corporate Advisory LLC (advisory services firm) (Oct. 2001 Present).
|
|
76
|
|
Director, WageWorks, Inc. (2010 present)
Director, Redwood Trust, Inc. (1998 present)
Director, PMI Group Inc. (2001 2009)
|
|
|
|
|
John F. Cogan
1947
Trustee
(Trustee of The Charles Schwab Family of Funds, Schwab
Investments, Schwab Capital Trust and Schwab Annuity Portfolios since 2008; Laudus Trust and Laudus Institutional Trust since 2010)
|
|
Senior Fellow, The Hoover Institution at Stanford University (Oct. 1979 present); Senior Fellow Stanford Institute for Economic Policy Research; Professor of Public Policy, Stanford University (Sept. 2000
present).
|
|
76
|
|
Director, Gilead Sciences, Inc. (2005 present)
Director, Monaco Coach Corporation (2005 2009)
|
27
|
|
|
|
|
|
|
NAME, YEAR OF BIRTH, AND
POSITION(S) WITH THE TRUST;
(TERM OF OFFICE AND
LENGTH OF TIME SERVED
1
)
|
|
PRINCIPAL OCCUPATIONS
DURING THE PAST FIVE
YEARS
|
|
NUMBER OF
PORTFOLIOS
IN FUND
COMPLEX
OVERSEEN
BY THE
TRUSTEE
|
|
OTHER
DIRECTORSHIPS
DURING THE PAST FIVE
YEARS
|
David L. Mahoney
1954
Trustee
(Trustee of The Charles Schwab Family of Funds, Schwab
Investments, Schwab Capital Trust and Schwab Annuity Portfolios, Laudus Trust and Laudus Institutional Trust since 2011)
|
|
Private Investor.
|
|
76
|
|
Director, Symantec Corporation (2003 present)
Director, Corcept Therapeutics Incorporated (2004 present)
|
|
|
|
|
Kiran M. Patel
1948
Trustee
(Trustee of The Charles Schwab Family of Funds, Schwab
Investments, Schwab Capital Trust and Schwab Annuity Portfolios, Laudus Trust and Laudus Institutional Trust since 2011)
|
|
Retired. Executive Vice President and General Manager of Small Business Group, Intuit, Inc. (financial software and services firm for consumers and small businesses) (Dec. 2008 Sept. 2013)
|
|
76
|
|
Director, KLA-Tencor Corporation (2008 present)
|
|
|
|
|
Gerald B. Smith
1950
Trustee
(Trustee of The Charles Schwab Family of Funds, Schwab
Investments, Schwab Capital Trust and Schwab Annuity Portfolios since 2000; Laudus Trust and Laudus Institutional Trust since 2010)
|
|
Chairman, Chief Executive Officer and Founder of Smith Graham & Co. (investment advisors) (1990 present).
|
|
76
|
|
Director, Eaton (2012- present)
Director and Chairman of the Audit Committee, Oneok Partners LP (2003 2013)
Director, Oneok, Inc. (2009 2013)
Lead Independent Director, Board of Cooper Industries (2002 2012)
|
|
|
|
|
Joseph H. Wender
1944
Trustee
(Trustee of The Charles Schwab Family of Funds, Schwab
Investments, Schwab Capital Trust and Schwab Annuity Portfolios since 2008; Laudus Trust and Laudus Institutional Trust since 2010)
|
|
Senior Consultant, Goldman Sachs & Co., Inc. (investment banking and securities firm) (Jan. 2008- present); Partner, Colgin Partners, LLC (vineyards) (February 1998 present).
|
|
76
|
|
Board Member and Chairman of the Audit Committee, Isis Pharmaceuticals (1994 present)
|
28
|
|
|
|
|
|
|
NAME, YEAR OF BIRTH, AND
POSITION(S) WITH THE TRUST;
(TERM OF OFFICE AND
LENGTH OF TIME SERVED
1
)
|
|
PRINCIPAL OCCUPATIONS
DURING THE PAST FIVE YEARS
|
|
NUMBER OF
PORTFOLIOS
IN FUND
COMPLEX
OVERSEEN
BY THE
TRUSTEE
|
|
OTHER
DIRECTORSHIPS
DURING THE PAST
FIVE
YEARS
|
INTERESTED TRUSTEES
|
Charles R. Schwab
2
1937
Chairman and Trustee
(Chairman and Trustee of The Charles Schwab Family of Funds since 1989; Schwab Investments since 1991; Schwab Capital Trust since 1993; Schwab Annuity
Portfolios since 1994; Laudus Trust and Laudus Institutional Trust since 2010)
|
|
Chairman and Director, The Charles Schwab Corporation, Charles Schwab & Co., Inc., Charles Schwab Investment Management, Inc., Charles Schwab Bank, N. A.; Chairman and Chief Executive Officer, Schwab (SIS) Holdings Inc. I,
Schwab International Holdings, Inc.; Chief Executive Officer, Schwab Holdings, Inc.; Through June 2007, Director, U.S. Trust Company, N. A., U.S. Trust Corporation, United States Trust Company of New York. Until October 2008, Chief Executive
Officer, The Charles Schwab Corporation, Charles Schwab & Co., Inc.
|
|
76
|
|
None.
|
|
|
|
|
Walter W. Bettinger II
2
1960
Trustee
(Trustee of The Charles Schwab Family of Funds, Schwab Investments, Schwab Capital Trust and Schwab Annuity Portfolios since 2008; Laudus Trust and Laudus
Institutional Trust since 2010)
|
|
As of October 2008, President and Chief Executive Officer, Charles Schwab & Co., Inc. and The Charles Schwab Corporation. Since October 2008, Director, The Charles Schwab Corporation. Since May 2008, Director, Charles Schwab
& Co., Inc. and Schwab Holdings, Inc. Since 2006, Director, Charles Schwab Bank. Until October 2008, President and Chief Operating Officer, Charles Schwab & Co., Inc. and The Charles Schwab Corporation. From 2004 through 2007, Executive Vice
President and President, Schwab Investor Services. From 2004 through 2005, Executive Vice President and Chief Operating Officer, Individual Investor Enterprise, and from 2002 through 2004, Executive Vice President, Corporate Services.
|
|
99
|
|
None.
|
29
|
|
|
NAME, YEAR OF BIRTH, AND
POSITION(S) WITH THE TRUST;
(TERM OF OFFICE AND LENGTH OF TIME
SERVED
3
)
|
|
PRINCIPAL OCCUPATIONS DURING THE PAST FIVE
YEARS
|
OFFICERS
|
Marie Chandoha
1961
President and Chief Executive Officer
(Officer of The Charles
Schwab Family of Funds, Schwab Investments, Schwab Capital Trust, Schwab Annuity Portfolios, Laudus Trust and Laudus Institutional Trust since 2010)
|
|
Executive Vice President, Charles Schwab & Co., Inc. (Sept. 2010 present); Director, President and Chief Executive Officer (Dec. 2010 present), Chief Investment Officer (Sept. 2010 Oct. 2011), Charles Schwab
Investment Management, Inc.; President, Chief Executive Officer (Dec. 2010 present), and Chief Investment Officer (Sept. 2010 Oct. 2011), Schwab Funds, Laudus Funds and Schwab ETFs; Global Head of Fixed Income Business Division,
BlackRock, Inc. (formerly Barclays Global Investors) (March 2007 August 2010.
|
|
|
George Pereira
1964
Treasurer and Principal Financial Officer, Schwab Funds
Treasurer
and Chief Financial Officer, Laudus Funds
(Officer of The Charles Schwab Family of Funds, Schwab Investments, Schwab Capital Trust and Schwab Annuity
Portfolios since 2004; Laudus Trust and Laudus Institutional Trust since 2006)
|
|
Senior Vice President and Chief Financial Officer (Nov. 2004 present), Chief Operating Officer (Jan. 2011 present), Charles Schwab Investment Management, Inc. ; Treasurer and Chief Financial Officer, Laudus Funds (2006
present); Treasurer and Principal Financial Officer, Schwab Funds (Nov. 2004 present) and Schwab ETFs (Oct. 2009 present); Director, Charles Schwab Worldwide Fund, PLC and Charles Schwab Asset Management (Ireland) Limited (April
2005 present).
|
|
|
Omar Aguilar
1970
Senior Vice President and Chief Investment Officer Equities
(Officer of The Charles Schwab Family of Funds, Schwab Investments, Schwab Capital Trust, Schwab Annuity Portfolios, Laudus Trust and Laudus Institutional
Trust since 2011)
|
|
Senior Vice President and Chief Investment OfficerEquities, Charles Schwab Investment Management, Inc. (April 2011 present); Senior Vice President and Chief Investment OfficerEquities, Schwab Funds and Laudus
Funds (June 2011 present); Head of the Portfolio Management Group and Vice President of Portfolio Management, Financial Engines, Inc. (May 2009 April 2011); Head of Quantitative Equity, ING Investment Management (July 2004 Jan.
2009).
|
|
|
Brett Wander
1961
Senior Vice President and Chief Investment Officer Fixed Income
(Officer of The Charles Schwab Family of Funds, Schwab Investments, Schwab Capital Trust, Schwab Annuity Portfolios, Laudus Trust and Laudus Institutional
Trust since 2011)
|
|
Senior Vice President and Chief Investment Officer Fixed Income, Charles Schwab Investment Management, Inc. (April 2011 present); Senior Vice President and Chief Investment Officer Fixed Income, Schwab Funds and
Laudus Funds (June 2011 present); Senior Managing Director, Global Head of Active Fixed-Income Strategies, State Street Global Advisors (Jan. 2008 Oct. 2010); Director of Alpha Strategies Loomis, Sayles & Company (April 2006
Jan. 2008).
|
|
|
David Lekich
1964
Chief Legal Officer and Secretary, Schwab Funds
Vice President
and Assistant Clerk, Laudus Funds (Officer of The Charles Schwab Family of Funds, Schwab Investments, Schwab Capital Trust, Schwab Annuity Portfolios, Laudus Trust and Laudus Institutional Trust since 2011)
|
|
Senior Vice President (Sept. 2011 present), Vice President (March 2004 Sept. 2011), Charles Schwab & Co., Inc.; Senior Vice President and Chief Counsel (Sept. 2011 present), Vice President (Jan. 2011
Sept. 2011), Charles Schwab Investment Management, Inc.; Secretary (April 2011 present) and Chief Legal Officer (Dec. 2011 present), Schwab Funds;
Vice President and Assistant Clerk, Laudus Funds (April 2011 present);
Secretary (May 2011 present) and Chief Legal Officer (Nov. 2011 present), Schwab ETFs.
|
|
|
Catherine MacGregor
1964
Vice President and Assistant Secretary, Schwab Funds
Chief Legal
Officer, Vice President and Clerk, Laudus Funds
(Officer of The Charles Schwab Family of Funds, Schwab Investments, Schwab Capital Trust and Schwab Annuity
Portfolios since 2005; Laudus Trust and Laudus Institutional Trust since 2005)
|
|
Vice President, Charles Schwab & Co., Inc., Charles Schwab Investment Management, Inc. (July 2005-present); Vice President (Dec. 2005-present), Chief Legal Officer and Clerk (March 2007-present), Laudus Funds; Vice President
(Nov. 2005 present) and Assistant Secretary (June 2007 present), Schwab Funds; Vice President and Assistant Secretary, Schwab ETFs (Oct. 2009-present).
|
30
1
|
Trustees remain in office until they resign, retire or are removed by shareholder vote. The Schwab and Laudus Funds retirement policy requires that independent trustees retire at age 72 or after twenty years as a
trustee, whichever comes first. In addition, the retirement policy requires any independent trustee of Schwab Funds or Laudus Funds to retire from all Boards upon their required retirement date from either Board.
|
2
|
Mr. Schwab and Mr. Bettinger are Interested Trustees because they own stock of The Charles Schwab Corporation, the parent company of the investment adviser.
|
3
|
The President, Treasurer and Secretary/Clerk hold office until their respective successors are chosen and qualified or until he or she sooner dies, resigns, is removed or becomes disqualified. Each of the other officers
serves at the pleasure of the Boards.
|
Board Leadership Structure
The Chairman of the Board of Trustees, Charles R. Schwab, is Chairman of the Board of Directors of The Charles Schwab Corporation and an interested person of
the trusts as that term is defined in the 1940 Act. The trusts do not have a single lead independent trustee. The Board is comprised of a super-majority (75 percent) of trustees who are not interested persons of the trusts (i.e., Independent
Trustees). There are three primary committees of the Board: the Audit and Compliance Committee; the Governance Committee; and the Investment Oversight Committee. Each of the Committees is chaired by an Independent Trustee, and each Committee
is comprised solely of Independent Trustees. The Committee chairs preside at Committee meetings, participate in formulating agendas for those meetings, and coordinate with management to serve as a liaison between the Independent Trustees and
management on matters within the scope of the responsibilities of each Committee as set forth in its Board-approved charter. The Board has determined that this leadership structure is appropriate given the specific characteristics and circumstances
of the trusts. The Board made this determination in consideration of, among other things, the fact that the Independent Trustees of the trusts constitute a super-majority of the Board, the fact that Committee chairs are Independent Trustees, the
number of funds (and classes) overseen by the Board, and the total number of trustees on the Board.
Board Oversight of Risk
Management
Like most mutual funds, fund management and its other service providers have responsibility for day-to-day risk management for the funds.
The Boards duties, as part of its risk oversight of the trusts, consist of monitoring risks identified during regular and special reports to the Committees of the Board, as well as regular and special reports to the full Board. In addition to
monitoring such risks, the Committees and the Board oversee efforts of fund management and service providers to manage risks to which the funds of the trusts may be exposed. For example, the Investment Oversight Committee meets with portfolio
managers and receives regular reports
31
regarding investment risk and credit risk of a funds portfolio. The Audit and Compliance Committee meets with the funds Chief Compliance Officer and Chief Financial Officer and
receives regular reports regarding compliance risks
,
operational risks and risks related to the valuation and liquidity of portfolio securities. From its review of these reports and discussions with management, each Committee receives
information about the material risks of the funds of the trusts and about how management and service providers mitigate those risks, enabling the independent Committee chairs and other independent members of the Committees to discuss these risks
with the full Board.
The Board recognizes that not all risks that may affect the funds can be identified nor can processes and controls be developed to
eliminate or mitigate the occurrence or effects of certain risks; some risks are simply beyond the reasonable control of the funds, their management, and service providers. Although the risk oversight functions of the Board, and the risk management
policies of fund management and fund service providers, are designed to be effective, there is no guarantee that they will eliminate or mitigate all risks. In addition, it may be necessary to bear certain risks (such as investment-related risks) to
achieve each funds investment objective. As a result of the foregoing and other factors, the funds ability to manage risk is subject to significant limitations.
Individual Trustee Qualifications
The
Board has concluded that each of the trustees should initially and continue to serve on the Board because of (i) his or her ability to review and understand information about the trusts provided to them by management, to identify and request
other information they may deem relevant to the performance of their duties, to question management regarding material factors bearing on the management of the trusts, and to exercise their business judgment in a manner that serves the best
interests of the trusts shareholders and (ii) the trustees experience, qualifications, attributes or skills as described below.
The
Board has concluded that Mr. Bettinger should serve as trustee of the trusts because of the experience he gained as president and chief executive officer of The Charles Schwab Corporation, his knowledge of and experience in the financial
services industry, and the experience he has gained serving as trustee of the Schwab Funds since 2008.
The Board has concluded that Ms. Byerwalter
should serve as trustee of the trusts because of the experience she gained as chairman of her own corporate advisory and consulting firm and as former chief financial officer of a university and a bank, the experience she has gained serving as
trustee of the Schwab Funds since 2000 and the Laudus Funds since 2004, and her service on other public company and mutual insurance company boards.
The
Board has concluded that Mr. Cogan should serve as trustee of the trusts because of the experience he has gained serving as a senior fellow and professor of public policy at a university and his former service in government, the experience he
has gained serving as trustee of the Schwab Funds since 2008, and his service on other public company boards.
The Board has concluded that
Mr. Mahoney should serve as trustee of the trusts because of the experience he gained as co-chief executive officer of a healthcare services company, and his service on other public company boards.
The Board has concluded that Mr. Patel should serve as trustee of the trusts because of the experience he gained as executive vice president, general
manager and chief financial officer of a software company, and his service on other public company boards.
32
The Board has concluded that Mr. Schwab should serve as trustee of the trusts because of the experience he
has gained as founder and chairman of the board of Schwab, and subsequently its parent corporation, The Charles Schwab Corporation, his experience in and knowledge of the financial services industry, the experience he has gained serving as Chairman
of the Board of Trustees of the Schwab Funds since their inception, and his former service on other public company boards.
The Board has concluded that
Mr. Smith should serve as trustee of the trusts because of the experience he has gained as managing partner of his own investment advisory firm, the experience he has gained serving as trustee of the Schwab Funds since 2000, his service on
other public company boards, and his experience serving as Chair of the trusts Investment Oversight Committee.
The Board has concluded that
Mr. Wender should serve as trustee of the trusts because of the experience he gained serving as former partner and chairman of the finance committee of an investment bank, the experience he has gained serving as trustee of the Schwab Funds
since 2008, and his service on other public company boards.
Trustee Committees
The Board of Trustees has established certain committees and adopted Committee charters with respect to those committees, each as described below:
|
|
|
The Audit and Compliance Committee reviews the integrity of the trusts financial reporting processes and compliance policies, procedures and processes, and the trusts overall system of internal controls. The
Audit and Compliance Committee also reviews and evaluates the qualifications, independence and performance of the trusts independent auditors. This Committee is comprised of at least three Independent Trustees and currently has the following
members: Kiran M. Patel (Chairman), Mariann Byerwalter, and John F. Cogan. The charter directs that the Committee must meet four times annually, with additional meetings as the Committee deems appropriate. The Committee met 4 times during the most
recent fiscal year.
|
|
|
|
The Governance Committee reviews and makes recommendations to the Board regarding trust governance-related matters, including but not limited to Board compensation practices, retirement policies and term limits, Board
self-evaluations, the effectiveness and allocation of assignments and functions by the Board, the composition of Committees of the Board, and the training of Trustees. The Governance Committee is also responsible for selecting and nominating
candidates to serve as Trustees. The Governance Committee does not have a policy with respect to consideration of candidates for Trustee submitted by shareholders. However, if the Governance Committee determined that it would be in the best
interests of the trusts to fill a vacancy on the Board of Trustees, and a shareholder submitted a candidate for consideration by the Board of Trustees to fill the vacancy, the Governance Committee would evaluate that candidate in the same manner as
it evaluates nominees identified by the Governance Committee. Nominee recommendations may be submitted to the Secretary of the trusts at the trusts principal business address. This Committee is comprised of at least three Independent Trustees
and currently has the following members: Mariann Byerwalter (Chairman), John F. Cogan and Joseph H. Wender. The charter directs that the Committee meets at such times and with such frequency as is deemed necessary or appropriate by the Committee.
The Committee met 5 times during the most recent fiscal year.
|
33
|
|
|
The Investment Oversight Committee reviews the investment activities of the trusts and the performance of the Funds investment advisers. This Committee is comprised of at least three Trustees (at least two-thirds
of whom shall be Independent Trustees) and currently has the following members: Gerald B. Smith (Chairman), David L. Mahoney and Joseph H. Wender. The charter directs that the Committee meet at such times and with such frequency as is deemed
necessary or appropriate by the Committee. The Committee met 4 times during the most recent fiscal year.
|
Trustee
Compensation
The following table provides trustee compensation for the fiscal year ended October 31, 2013.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Name of Trustee
|
|
Aggregate Compensation
From:
|
|
|
Pension or
Retirement
Benefits
Accrued as Part
of Fund
Expenses
|
|
|
Total
Compensation
from Funds
and Fund
Complex
|
|
|
|
The Funds that are a
series of Schwab
Capital Trust
|
|
|
The Fund that
is a series of
Schwab Investments
|
|
|
|
|
|
|
|
Interested Trustees
|
|
Charles R. Schwab
|
|
|
0
|
|
|
|
0
|
|
|
|
N/A
|
|
|
|
0
|
|
Walter W. Bettinger II
|
|
|
0
|
|
|
|
0
|
|
|
|
N/A
|
|
|
|
0
|
|
Independent Trustees
|
|
Mariann Byerwalter
|
|
$
|
19,843
|
|
|
$
|
7,397
|
|
|
|
N/A
|
|
|
$
|
244,000
|
|
John F. Cogan
|
|
$
|
19,039
|
|
|
$
|
7,116
|
|
|
|
N/A
|
|
|
$
|
234,000
|
|
William A. Hasler*
|
|
$
|
19,843
|
|
|
$
|
7,397
|
|
|
|
N/A
|
|
|
$
|
244,000
|
|
David L. Mahoney
|
|
$
|
18,504
|
|
|
$
|
7,116
|
|
|
|
N/A
|
|
|
$
|
232,000
|
|
Kiran M. Patel
|
|
$
|
19,039
|
|
|
$
|
7,116
|
|
|
|
N/A
|
|
|
$
|
234,000
|
|
Gerald B. Smith
|
|
$
|
19,843
|
|
|
$
|
7,397
|
|
|
|
N/A
|
|
|
$
|
244,000
|
|
Joseph H. Wender
|
|
$
|
19,039
|
|
|
$
|
7,116
|
|
|
|
N/A
|
|
|
$
|
234,000
|
|
*
|
Mr. Hasler retired effective December 31, 2013.
|
34
Securities Beneficially Owned By Each Trustee
The following table provides each trustees equity ownership of the funds and ownership of all registered investment companies overseen by each trustee
in the Family of Investment Companies as of December 31, 2013.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Name of Trustee
|
|
Dollar Range of Trustee Ownership of:
|
|
|
Aggregate
Dollar Range of
Trustee
Ownership in the
Family of
Investment
Companies
|
|
|
|
Schwab S&P 500
Index Fund
|
|
|
Schwab
1000
Index
Fund
|
|
|
Schwab
Small-
Cap
Index
Fund
|
|
|
Schwab Total
Stock Market
Index Fund
|
|
|
Schwab
International
Index Fund
|
|
|
|
|
Interested Trustees
|
|
Charles R. Schwab
|
|
|
Over $100,000
|
|
|
|
None
|
|
|
|
None
|
|
|
|
Over $100,000
|
|
|
|
Over $100,000
|
|
|
|
Over $100,000
|
|
Walter W. Bettinger II
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
Over $100,000
|
|
Independent Trustees
|
|
Mariann Byerwalter
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
Over $100,000
|
|
John F. Cogan
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
Over $100,000
|
|
|
|
None
|
|
|
|
Over $100,000
|
|
David L. Mahoney
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
Over $100,000
|
|
Kiran M. Patel
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
Over $100,000
|
|
Gerald B. Smith
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
Over $100,000
|
|
Joseph H. Wender
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
Over $100,000
|
|
35
Deferred Compensation Plan
Independent Trustees may enter into a fee deferral plan. Under this plan, deferred fees will be credited to an account established by a trust as of the date
that such fees would have been paid to the trustee. The value of this account will equal the value that the account would have if the fees credited to the account had been invested in the shares of Schwab Funds
®
selected by the trustee. Currently, none of the Independent Trustees has elected to participate in this plan.
Code of Ethics
The funds, the investment
adviser and Schwab have adopted a Code of Ethics as required under the 1940 Act. Subject to certain conditions or restrictions, the Code of Ethics permits the trustees, directors, officers or advisory representatives of the funds or the investment
adviser or the directors or officers of Schwab to buy or sell directly or indirectly securities for their own accounts. This includes securities that may be purchased or held by the funds. Securities transactions by some of these individuals may be
subject to prior approval of the investment advisers Chief Compliance Officer or alternate. Most securities transactions are subject to quarterly reporting and review requirements.
CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES
As of February 20, 2014, the officers and trustees of the trust, as a group owned of record, directly or beneficially, less than 1% of the outstanding
voting securities of each of the funds.
Persons who owned of record or beneficially more than 25% of a funds outstanding shares may be deemed
to control the fund within the meaning of the 1940 Act. Shareholders controlling the fund could have the ability to vote a majority of the shares of the fund on any matter requiring the approval of shareholders of the fund.
As of February 1, 2014, Appendix Principal Holders of Securities, lists persons or entities that owned, of record or beneficially, more than 5% of
the outstanding voting securities of the funds.
INVESTMENT ADVISORY AND OTHER SERVICES
Investment Adviser
CSIM, a wholly owned
subsidiary of The Charles Schwab Corporation, 211 Main Street, San Francisco, CA 94105, serves as the funds investment adviser and administrator pursuant to Investment Advisory and Administration Agreements (Advisory Agreement) between it and
each trust. Schwab is an affiliate of the investment adviser and is the trusts distributor and shareholder services paying agent. Charles R. Schwab is the founder, Chairman and Director of The Charles Schwab Corporation. As a result of his
ownership of and interests in The Charles Schwab Corporation, Mr. Schwab may be deemed to be a controlling person of the investment adviser and Schwab.
Advisory Agreement
The continuation of a
funds Advisory Agreement must be specifically approved at least annually (1) by the vote of the trustees or by a vote of the shareholders of the fund, and (2) by the vote of a majority of the trustees who are not parties to the
investment advisory agreement or interested persons of any party (the Independent Trustees), cast in person at a meeting called for the purpose of voting on such approval.
36
Each year, the Board of Trustees calls and holds a meeting to decide whether to renew the Advisory Agreement
between the trusts and CSIM with respect to existing funds in the trusts. In preparation for the meeting, the Board requests and reviews a wide variety of materials provided by the funds investment adviser, as well as extensive data provided
by third parties, and the Independent Trustees receive advice from counsel to the Independent Trustees.
As described below, the investment adviser is
entitled to receive from each fund an annual fee, payable monthly, for its advisory and administrative services to each fund.
The table below sets forth
the advisory fees paid by the funds to the investment adviser for the past three fiscal years or, if shorter, the period of the funds operations. The figures in the net fees paid row represent the actual amounts paid to the
investment adviser, which include the effect of any reductions due to the application of a funds expense limitation (expense cap). The figures in the gross fees reduced by row represent the amount, if any, the advisory
fees payable to the investment adviser were reduced due to the application of a funds expense cap.
The expense cap is not intended to cover all
fund expenses, and a funds expenses may exceed the expense cap. For example, the expense cap does not cover investment-related expenses, such as brokerage commissions, interest, taxes and the fees and expenses of pooled investment vehicles,
such as ETFs, REITs, and other investment companies, that are held by the funds, nor does it cover extraordinary or non-routine expenses, such as shareholder meeting costs.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fund and Advisory Fee
Schedule
|
|
|
|
|
2013
|
|
|
2012
|
|
|
2011
|
|
|
Expense Cap
|
|
Schwab S&P 500 Index Fund
0.06% of the funds average daily net assets
|
|
|
Net fees paid:
|
|
|
$
|
8,610,499
|
|
|
$
|
6,917,377
|
|
|
$
|
6,247,021
|
|
|
|
0.09
|
%
|
|
|
Gross fees
reduced by:
|
|
|
$
|
268,898
|
|
|
$
|
249,973
|
|
|
$
|
273,761
|
|
|
|
|
|
Schwab 1000 Index Fund
0.30% of the funds average daily net assets not in excess of $500 million, 0.22% of such net assets over $500
million but not in excess of $5 billion, 0.20% of such net assets over $5 billion but not in excess of $10 billion and 0.18% of such net assets over $10 billion.
|
|
|
Net fees paid:
|
|
|
$
|
9,543,783
|
|
|
$
|
8,430,384
|
|
|
$
|
8,370,948
|
|
|
|
0.29
|
%
|
|
|
Gross fees
reduced by:
|
|
|
$
|
2,483,335
|
|
|
$
|
2,421,907
|
|
|
$
|
2,465,463
|
|
|
|
|
|
Schwab Small-Cap Index Fund
0.15% of the funds average daily net assets
|
|
|
Net fees paid:
|
|
|
|
2,376,853
|
|
|
$
|
1,803,421
|
|
|
$
|
2,314,129
|
|
|
|
0.17
|
%
|
|
|
Gross fees
reduced by:
|
|
|
$
|
609,547
|
|
|
$
|
579,058
|
|
|
$
|
31,588
|
|
|
|
|
|
Schwab Total Stock Market Index Fund
0.06% of the funds average daily net assets
|
|
|
Net fees paid:
|
|
|
$
|
1,371,848
|
|
|
$
|
990,933
|
|
|
$
|
821,138
|
|
|
|
0.09
|
%
|
|
|
Gross fees
reduced by:
|
|
|
$
|
204,765
|
|
|
$
|
189,293
|
|
|
$
|
203,065
|
|
|
|
|
|
Schwab International Index Fund
0.15% of the funds average daily net assets
|
|
|
Net fees paid:
|
|
|
$
|
2,027,623
|
|
|
$
|
1,539,461
|
|
|
$
|
1,960,674
|
|
|
|
0.19
|
%
|
|
|
Gross fees
reduced by:
|
|
|
$
|
599,104
|
|
|
$
|
494,152
|
|
|
$
|
283,055
|
|
|
|
|
|
37
Distributor
Pursuant to separate Amended and Restated Distribution Agreements between Schwab and each trust, Schwab, located at 211 Main Street, San Francisco, California
94105, is the principal underwriter for shares of the funds and is the trusts agent for the purpose of the continuous offering of the funds shares. The funds pay for prospectuses and shareholder reports to be prepared and delivered to
existing shareholders. Schwab pays such costs when the described materials are used in connection with the offering of shares to prospective investors and for supplemental sales literature and advertising. Schwab receives no fee under the
Distribution Agreement.
Shareholder Servicing Plan
Each trusts Board of Trustees has adopted a Shareholder Servicing Plan (the Plan) on behalf of certain funds of such trust. The Plan enables
these funds, directly or indirectly through Schwab, to bear expenses relating to the provision by service providers, including Schwab, of certain shareholder services to the current shareholders of the funds. The trusts have appointed Schwab to act
as their shareholder servicing fee paying agent under the Plan for the purpose of making payments to the service providers (other than Schwab) under the Plan. Pursuant to the Plan, each of the funds is subject to an annual shareholder servicing fee,
up to the amount set forth below:
|
|
|
|
|
Fund
|
|
Shareholder Servicing Fee
|
|
Schwab S&P 500 Index Fund
|
|
|
0.02
|
%
|
Schwab 1000 Index Fund
|
|
|
0.10
|
%
|
Schwab Small-Cap Index Fund
|
|
|
0.02
|
%
|
Schwab Total Stock Market Index Fund
|
|
|
0.02
|
%
|
Schwab International Index Fund
|
|
|
0.02
|
%
|
Pursuant to the Plan, the funds (or Schwab as paying agent) may pay Schwab or service providers that, pursuant to written
agreements with Schwab, provide certain account maintenance, customer liaison and shareholder services to fund shareholders. Schwab and the other service providers may provide fund shareholders with the following shareholder services, among other
shareholder services: (i) maintaining records for shareholders that hold shares of a fund; (ii) communicating with shareholders, including the mailing of regular statements and confirmation statements, distributing fund-related materials,
mailing prospectuses and reports to shareholders, and responding to shareholder inquiries; (iii) communicating and processing shareholder purchase, redemption and exchange orders; (iv) communicating mergers, splits or other reorganization
activities to fund shareholders; and (v) preparing and filing tax information, returns and reports.
The shareholder servicing fee paid to a
particular service provider is calculated at the annual rate set forth in the chart above and is based on the average daily net asset value of the fund shares owned by shareholders holding shares through such service provider. Payments under the
Plan are made as described above regardless of Schwabs or the service providers actual cost of providing the services. If the cost of providing the services under the Plan is less than the payments received, the unexpended portion of the
fees may be retained as profit by Schwab or the service provider.
The Plan shall continue in effect for a fund for so long as its continuance is
specifically approved at least annually by a vote of the majority of both (i) the Board of Trustees of the trust and (ii) the Trustees of the trust who are not interested persons of the trust and who have no direct or indirect financial
interest in the operation of the Plan or any agreements related to it (the Qualified Trustees). The Plan requires that Schwab or any person authorized
38
to direct the disposition of monies paid or payable by the funds pursuant to the Plan furnish quarterly written reports of amounts spent under the Plan and the purposes of such expenditures to
the Board of Trustees of the trusts for review. All material amendments to the Plan must be approved by votes of the majority of both (i) the Board of Trustees and (ii) the Qualified Trustees.
Transfer Agent
Boston Financial Data
Services, Inc. (BFDS), 2000 Crown Colony Drive, Quincy, Massachusetts 02169-0953, serves as the funds transfer agent. As part of these services, the firm maintains records pertaining to the sale, redemption and transfer of the
funds shares.
Custodians and Fund Accountant
Brown Brothers Harriman & Co.(BBH), 50 Post Office Square, Boston, Massachusetts, 02110 serves as custodian for the following funds:
|
Schwab S&P 500 Index Fund
|
Schwab Small-Cap Index Fund
|
Schwab Total Stock Market Index Fund
|
Schwab International Index Fund
|
State Street Bank and Trust Company (State Street), One Lincoln Street, Boston, Massachusetts, 02111, serves
as custodian for the following fund:
State Street also serves as fund accountant for each of the funds.
The custodians are responsible for the daily safekeeping of securities and cash held or sold by the funds. The fund accountant maintains all books and records
related to the funds transactions.
Independent Registered Public Accounting Firm
The funds independent registered public accounting firm, PricewaterhouseCoopers LLP (PwC), Three Embarcadero Center, San Francisco, CA
94111-4004, audits and reports on the annual financial statements of the funds and reviews certain regulatory reports and each funds federal income tax return. PwC also performs other professional, accounting, auditing, tax and advisory
services when engaged to do so by the trusts.
PORTFOLIO MANAGERS
Other Accounts.
In addition to the funds, each portfolio manager (collectively referred to as the Portfolio Managers) is responsible
for the day-to-day management of certain other accounts, as listed below. The accounts listed below are not subject to a performance-based advisory fee. The information below is provided as of October 31, 2013.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Name
|
|
Registered Investment
Companies
(this amount includes the funds
in this SAI*)
|
|
|
Other Pooled
Investment
Vehicles
|
|
|
Other Accounts
|
|
|
Number
of
Accounts
|
|
|
Total Assets
|
|
|
Number
of
Accounts
|
|
|
Total
Assets
|
|
|
Number
of
Accounts
|
|
|
Total
Assets
|
|
Agnes Hong
|
|
|
28
|
|
|
$
|
49,728,163,648
|
|
|
|
0
|
|
|
$
|
0
|
|
|
|
0
|
|
|
$
|
0
|
|
Ferian
Juwono
|
|
|
22
|
|
|
$
|
49,608,889,525
|
|
|
|
0
|
|
|
$
|
0
|
|
|
|
0
|
|
|
$
|
0
|
|
Ron Toll
|
|
|
11
|
|
|
$
|
35,938,103,838
|
|
|
|
0
|
|
|
$
|
0
|
|
|
|
0
|
|
|
$
|
0
|
|
*
|
The assets of the funds in this SAI are $30,742,097,523.
|
39
Conflicts of Interest.
A Portfolio Managers management of other accounts may give rise to
potential conflicts of interest in connection with its management of a funds investments, on the one hand, and the investments of the other accounts, on the other. The other accounts include separate accounts and other mutual funds advised by
CSIM (collectively, the Other Managed Accounts). The Other Managed Accounts might have similar investment objectives as a fund, track the same index a fund tracks or otherwise hold, purchase, or sell securities that are eligible to be
held, purchased, or sold by a fund. While the Portfolio Managers management of Other Managed Accounts may give rise to the potential conflicts of interest listed below, CSIM does not believe that the conflicts, if any, are material or, to the
extent any such conflicts are material, CSIM believes it has adopted policies and procedures that are designed to manage those conflicts in an appropriate way.
Knowledge of the Timing and Size of Fund Trades.
A potential conflict of interest may arise as a result of the Portfolio Managers
day-to-day management of the funds. Because of their positions with the funds, the Portfolio Managers know the size, timing, and possible market impact of fund trades. It is theoretically possible that the Portfolio Managers could use this
information to the advantage of the Other Managed Accounts they manage and to the possible detriment of a fund. However, CSIM has adopted policies and procedures reasonably designed to allocate investment opportunities on a fair and equitable basis
over time. Moreover, with respect to index funds, which seek to track their respective benchmark indexes, much of this information is publicly available. When it is determined to be in the best interest of both accounts, the Portfolio Managers may
aggregate trade orders for the Other Managed Accounts, excluding Schwab Personal Portfolio Managed Accounts, with those of a fund. All aggregated orders are subject to CSIMs aggregation and allocation policy and procedures, which provide,
among other things, that (i) a Portfolio Manager will not aggregate orders unless he or she believes such aggregation is consistent with his or her duty to seek best execution; (ii) no account will be favored over any other account;
(iii) each account that participates in an aggregated order will participate at the average security price with all transaction costs shared on a pro-rata basis; and (iv) if the aggregated order cannot be executed in full, the partial
execution is allocated pro-rata among the participating accounts in accordance with the size of each accounts order.
Investment
Opportunities.
A potential conflict of interest may arise as a result of the Portfolio Managers management of a fund and Other Managed Accounts which, in theory, may allow them to allocate investment opportunities in a way that
favors the Other Managed Accounts over a fund, which conflict of interest may be exacerbated to the extent that CSIM or the Portfolio Managers receive, or expect to receive, greater compensation from their management of the Other Managed Accounts
than the fund. Notwithstanding this theoretical conflict of interest, it is CSIMs policy to manage each account based on its investment objectives and related restrictions and, as discussed above, CSIM has adopted policies and procedures
reasonably designed to allocate investment opportunities on a fair and equitable basis over time and in a manner consistent with each accounts investment objectives and related restrictions. For example, while the Portfolio Managers may buy
for an Other Managed Account securities that differ in identity or quantity from securities bought for a fund or refrain from purchasing securities for an Other Managed Account that they are otherwise buying for a fund in an effort to outperform its
specific benchmark, such an approach might not be suitable for a fund given its investment objectives and related restrictions.
Compensation.
During the most recent fiscal year, each Portfolio Managers compensation consisted of a fixed annual (base)
salary and a discretionary bonus. The base salary is determined considering compensation payable for a similar position across the investment management industry and an evaluation of the individual Portfolio Managers overall performance such
as the Portfolio Managers contribution to the investment process, good corporate citizenship, risk management and mitigation, and functioning as an active contributor to the firms success. The discretionary bonus is determined
in accordance with the CSIM Equity and Fixed Income Portfolio Manager Incentive Plan (the Plan) as follows:
40
There are two independent funding components for the Plan:
|
|
|
75% of the funding is based on equal weighting of Investment Fund Performance and Risk Management and Mitigation
|
|
|
|
25% of the funding is based on Corporate results
|
Investment Fund Performance and Risk Management and
Mitigation (75% weight)
Investment Fund Performance:
At the close of the year, each funds performance will be determined by its 1-year, 1 and 2-year, or 1 and 3-year percentile standing (based on pre-tax
return before expenses) within its designated benchmark, peer group, or category, depending on the strategy of the fund (i.e., whether the fund is passively or actively managed) using standard statistical methods approved by CSIM senior management.
Investment Fund Performance measurements may be changed or modified at the discretion of the CSIM President and CSIM Chief Operating Officer. As each participant may manage and/or support a number of funds, there may be several funds considered in
arriving at the incentive compensation funding.
Risk Management and Mitigation:
Risk Management and Mitigation will be rated by CSIMs Chief Investment Officer, CSIMs Head of Investment Risk, CSIMs Chief Legal Officer,
CSIMs Chief Compliance Officer and CSIMs Head of Operations Risk (or individuals with comparable responsibilities). Factors they will consider will include, but are not limited to:
|
|
|
Balancing safety of fund principal with appropriate limits that provide investment flexibility given existing market conditions
|
|
|
|
Making timely sell recommendations to avoid significant deterioration of value resulting from the weakening condition of the issuer
|
|
|
|
Escalating operating events and errors for prompt resolution
|
|
|
|
Identifying largest risks and actively discussing with management
|
|
|
|
Accurately validating fund information disseminated to the public (e.g., Annual and Semi-Annual reports, fund fact sheets, fund prospectus)
|
|
|
|
Executing transactions timely and without material trade errors that result in losses to the funds
|
|
|
|
Ensuring ongoing compliance with prospectus and investment policy guidelines
|
|
|
|
Minimizing fund compliance exceptions
|
|
|
|
Actively following up and resolving compliance exceptions
|
Corporate Performance (25% weight)
The Corporate Bonus Plan is an annual bonus plan that provides discretionary awards based on the financial performance of The Charles Schwab Corporation
(CSC) during the annual performance period. Quarterly advances may be paid for the first three quarters. Allocations are discretionary and aligned with CSC and individual performance. Funding for the Plan is determined at the conclusion
of the calendar year. Funding will be capped at 200% of target.
41
At year-end, the full-year funding for both components of the Plan will be pooled together. The total pool is
allocated to Plan participants by CSIM senior management based on their assessment of a variety of performance factors.
Factors considered in CSIM senior
managements allocation process will include objective and subjective factors that will take into consideration total performance and will include, but are not limited to:
|
|
|
Fund performance relative to performance measure
|
|
|
|
Risk management and mitigation
|
|
|
|
Individual performance against key objectives
|
|
|
|
Contribution to overall group results
|
|
|
|
Functioning as an active contributor to the firms success
|
|
|
|
Collaboration between Analysts and Portfolio Managers
|
|
|
|
Regulatory/Compliance management.
|
The Portfolio Managers compensation is not based on the value of the
assets held in a funds portfolio.
Ownership of Fund Shares.
The following table shows the dollar amount range of the Portfolio
Managers beneficial ownership of shares of the funds they manage as of October 31, 2013. Dollar amount ranges disclosed are established by the SEC. Beneficial ownership is determined in accordance with Rule
16a-1(a)(2) under the Securities Exchange Act of 1934, as amended (the 1934 Act).
|
|
|
Agnes Hong
|
|
|
|
|
None
|
Ferian Juwono
|
|
|
|
|
None
|
Ron Toll
|
|
|
Schwab S&P 500 Index Fund
|
|
$10,001-$50,000
|
Schwab Small-Cap Index Fund
|
|
$10,001-$50,000
|
BROKERAGE ALLOCATION AND OTHER PRACTICES
Portfolio Turnover
For reporting
purposes, a funds portfolio turnover rate is calculated by dividing the value of purchases or sales of portfolio securities for the fiscal year, whichever is less, by the monthly average value of portfolio securities the fund owned during the
fiscal year. When making the calculation, all securities whose maturities at the time of acquisition were one year or less (short-term securities) are excluded.
A 100% portfolio turnover rate would occur, for example, if all portfolio securities (aside from short-term securities) were sold and either repurchased or
replaced once during the fiscal year.
Typically, funds with high turnover (such as 100% or more) tend to generate higher capital gains and transaction
costs, such as brokerage commissions.
42
Variations in turnover rate may be due to a fluctuating volume of shareholder purchase and redemption orders,
market conditions, and/or changes in the investment advisers investment outlook.
The portfolio turnover rate for each of the funds for the past two
fiscal years is as follows.
|
|
|
|
|
|
|
|
|
Fund
|
|
2013
|
|
|
2012
|
|
Schwab S&P 500 Index Fund
|
|
|
1
|
%
|
|
|
2
|
%
|
Schwab 1000 Index Fund
|
|
|
4
|
%
|
|
|
4
|
%
|
Schwab Small-Cap Index Fund
|
|
|
11
|
%
|
|
|
41
|
%
|
Schwab Total Stock Market Index Fund
|
|
|
2
|
%
|
|
|
3
|
%
|
Schwab International Index Fund
|
|
|
5
|
%
|
|
|
31
|
%
|
Portfolio Holdings Disclosure
Each trusts Board of Trustees (the Board) has approved policies and procedures that govern the timing and circumstances regarding the
disclosure of fund portfolio holdings information to shareholders and third parties. These policies and procedures are designed to ensure that disclosure of information regarding the funds portfolio securities is in the best interests of fund
shareholders, and include procedures to address conflicts between the interests of the funds shareholders, on the one hand, and those of the funds investment adviser, principal underwriter or any affiliated person of a fund, its
investment adviser or its principal underwriter, on the other. Pursuant to such procedures, the Board has authorized the President of the trust to authorize the release of the funds portfolio holdings, as necessary, in conformity with the
foregoing principles.
The Board exercises on-going oversight of the disclosure of fund portfolio holdings by overseeing the implementation and
enforcement of the funds policies and procedures by the Chief Compliance Officer and by considering reports and recommendations by the Chief Compliance Officer concerning any material compliance matters. The Board will receive periodic
updates, at least annually, regarding entities which were authorized to be provided early disclosure (as defined below) of the funds portfolio holdings information and will periodically review any agreements that the trust has
entered into to selectively disclose portfolio holdings.
A complete list of the funds portfolio holdings is published on the Schwab Funds
website at www.schwabfunds.com/prospectus, under Prospectuses & Reports, typically 60-80 days after the end of a funds fiscal quarter. The portfolio holdings information available on the funds website is the same
that is filed with the SEC on Form N-Q or Form N-CSR. In addition, the funds provide on the website quarterly information regarding certain attributes of a funds portfolio, such as a funds top ten holdings, sector weightings,
composition, credit quality and duration and maturity, as applicable. This information is generally updated within 20-30 days after the end of the fiscal quarter. The information on the website is publicly available to all categories of persons.
Each funds top ten holdings list is posted on schwab.com monthly, typically with a 10-day lag. In addition to the top ten holdings
information, the funds also provide monthly information regarding certain attributes of a funds portfolio, such as sector weightings, composition, credit quality, duration and maturity, as applicable. This information is available publicly to
all persons.
Each fund may disclose portfolio holdings information to certain persons and entities prior to and more frequently than the public
disclosure of such information (early disclosure). The President of the trusts may authorize early disclosure of portfolio holdings information to such parties at differing times and/or with different lag times provided that (a) the
President of the trusts determines that the disclosure is in the best interests of the funds and that there are no conflicts of interest between the funds shareholders and funds adviser and distributor; and (b) the recipient is,
either by contractual agreement or otherwise by law, required to maintain the confidentiality of the information.
43
Portfolio holdings may be made available on a selective basis to ratings agencies, certain industry
organizations, consultants and other qualified financial professionals when the President of the trusts determines such disclosure meets the requirements noted above and serves a legitimate business purpose. Agreements entered into with such
entities will describe the permitted use of portfolio holdings and provide that, among other customary confidentiality provisions: (i) the portfolio holdings will be kept confidential; (ii) the person will not trade on the basis of any
material non-public information; and (iii) the information will be used only for the purpose described in the agreement.
The funds
service providers including, without limitation, the investment adviser, the distributor, the custodian, fund accountant, transfer agent, auditor, proxy voting service provider, pricing information vendors, publisher, printer and mailing agent may
receive disclosure of portfolio holdings information as frequently as daily in connection with the services they perform for the funds. The names of those service providers to whom the funds selectively disclose portfolio holdings information will
be disclosed in this SAI. CSIM, Glass Lewis, and State Street and/or BBH, , as service providers to the funds, are currently receiving this information on a daily basis. RR Donnelley, as a service provider to the funds, is currently receiving this
information on a quarterly basis. PwC, BFDS and Schwab, as service providers to the funds, receive this information on an as-needed basis. Service providers are subject to a duty of confidentiality with respect to any portfolio holdings information
they receive whether imposed by the confidentiality provisions of the service providers agreements with the trusts or by the nature of its relationship with the trust. Although certain of the service providers are not under formal
confidentiality obligations in connection with disclosure of portfolio holdings, a fund will not continue to conduct business with a service provider who the fund believes is misusing the disclosed information.
To the extent that a fund invests in an ETF, the trusts will, in accordance with exemptive orders issued by the SEC to ETF sponsors and the procedures adopted
by the Board, promptly notify the ETF in writing of any purchase or acquisition of shares of the ETF that causes the fund to hold (i) 5% or more of such ETFs total outstanding voting securities, and (ii) 10% or more of such
ETFs total outstanding voting securities. In addition, CSIM will, upon causing a fund to acquire more than 3% of an open-end ETFs outstanding shares, notify the open-end ETF of the investment.
The funds policies and procedures prohibit the funds, the funds investment adviser or any related party from receiving any compensation or other
consideration in connection with the disclosure of portfolio holdings information.
The funds may disclose non-material information including
commentary and aggregate information about the characteristics of a fund in connection with or relating to a fund or its portfolio securities to any person if such disclosure is for a legitimate business purpose, such disclosure does not effectively
result in the disclosure of the complete portfolio securities of any fund (which can only be disclosed in accordance with the above requirements), and such information does not constitute material non-public information. Such disclosure does not
fall within the portfolio securities disclosure requirements outlined above.
Whether the information constitutes material non-public information
will be made on a good faith determination, which involves an assessment of the particular facts and circumstances. In most cases, commentary or analysis would be immaterial and would not convey any advantage to a recipient in making a decision
concerning a fund. Commentary and analysis include, but are not limited to, the allocation of a funds portfolio securities and other investments among various asset classes, sectors, industries and countries, the characteristics of the stock
components and other investments of a fund, the attribution of fund returns by asset class, sector, industry and country, and the volatility characteristics of a fund.
44
Portfolio Transactions
The investment adviser makes decisions with respect to the purchase and sale of portfolio securities on behalf of the funds. The investment adviser is
responsible for implementing these decisions, including the negotiation of commissions and the allocation of principal business and portfolio brokerage. Purchases and sales of securities on a stock exchange or certain riskless principal transactions
placed on NASDAQ are typically effected through brokers who charge a commission for their services. Purchases and sales of fixed income securities may be transacted with the issuer, the issuers underwriter, or a dealer. The funds do not
usually pay brokerage commissions on purchases and sales of fixed income securities, although the price of the securities generally includes compensation, in the form of a spread or a mark-up or mark-down, which is not disclosed separately. The
prices the funds pay to underwriters of newly-issued securities usually include a commission paid by the issuer to the underwriter. Transactions placed through dealers who are serving as primary market makers reflect the spread between the bid and
asked prices. The money market securities in which the funds may invest are traded primarily in the over-the-counter market on a net basis and do not normally involve either brokerage commissions or transfer taxes. It is expected that the cost of
executing portfolio securities transactions of the funds will primarily consist of dealer spreads and brokerage commissions.
The investment adviser seeks
to obtain the best execution for the funds portfolio transactions. The investment adviser may take a number of factors into account in selecting brokers or dealers to execute these transactions. Such factors may include, without limitation,
the following: execution price; brokerage commission or dealer spread; size or type of the transaction; nature or character of the markets; clearance or settlement capability; reputation; financial strength and stability of the broker or dealer;
efficiency of execution and error resolution; block trading capabilities; willingness to execute related or unrelated difficult transactions in the future; order of call; ability to facilitate short selling; provision of additional brokerage or
research services or products; whether a broker guarantees that a fund will receive, on aggregate, prices at least as favorable as the closing prices on a given day when adherence to market-on-close pricing aligns with fund objectives;
or whether a broker guarantees that a fund will receive the volume-weighted average price (VWAP) for a security for a given trading day (or portion thereof) when the investment adviser believes that VWAP execution is in a funds best interest.
In addition, the investment adviser may have incentive sharing arrangements with certain unaffiliated brokers who guarantee market-on-close pricing: on a day when such a broker executes transactions at prices better, on aggregate, than
market-on-close prices, that broker may receive, in addition to his or her standard commission, a portion of the net difference between the actual execution prices and corresponding market-on-close prices for that day.
The investment adviser may cause a fund to pay a higher commission than otherwise obtainable from other brokers or dealers in return for brokerage or research
services or products if the investment adviser believes that such commission is reasonable in relation to the services provided. In addition to agency transactions, the investment adviser may receive brokerage and research services or products in
connection with certain riskless principal transactions, in accordance with applicable SEC and other regulatory guidelines. In both instances, these services or products may include: company financial data and economic data (e.g., unemployment,
inflation rates and GDP figures), stock quotes, last sale prices and trading volumes, research reports analyzing the performance of a particular company or stock, narrowly distributed trade magazines or technical journals covering specific
industries, products, or issuers, seminars or conferences registration fees which provide substantive content relating to eligible research, quantitative analytical software and software that provides analyses of securities portfolios, trading
strategies and pre/post trade analytics, discussions with research analysts or meetings with corporate executives which provide a means of obtaining oral advice on securities, markets or particular issuers, short-term custody related to effecting
particular transactions and clearance and settlement of those trades, lines between the broker-dealer and order management systems operated by a third party vendor, dedicated lines between the broker-dealer and the investment advisers order
management system, dedicated lines providing direct dial-up service between the investment adviser and the trading desk at the broker-dealer, message services used to transmit orders to broker-dealers for execution, electronic communication of
allocation instructions between institutions and broker-dealers, comparison services required by the SEC or another regulator (e.g., use of electronic confirmation and affirmation of institutional trades), exchange of messages among broker-dealers,
45
custodians, and institutions related to a trade, post-trade matching of trade information, routing settlement instructions to custodian banks and broker-dealers clearing agents, software
that provides algorithmic trading strategies, and trading software operated by a broker-dealer to route orders to market centers or direct market access systems. The investment adviser may use research services furnished by brokers or dealers in
servicing all client accounts, and not all services may necessarily be used in connection with the account that paid commissions or spreads to the broker or dealer providing such services.
The investment adviser may receive a service from a broker or dealer that has both a research and a non-research use. When this
occurs, the investment adviser will make a good faith allocation, under all the circumstances, between the research and non-research uses of the service. The percentage of the service that is used for research purposes may be paid for with client
commissions or spreads, while the investment adviser will use its own funds to pay for the percentage of the service that is used for non-research purposes. In making this good faith allocation, the investment adviser faces a potential conflict of
interest, but the investment adviser believes that the costs of such services may be appropriately allocated to their anticipated research and non-research uses.
The investment adviser may purchase for the funds, new issues of securities in a fixed price offering. In these situations, the seller may be a member of the
selling group that will, in addition to selling securities, provide the investment adviser with research services, in accordance with applicable rules and regulations permitting these types of arrangements. Generally, the seller will provide
research credits in these situations at a rate that is higher than that which is available for typical secondary market transactions. These arrangements may not fall within the safe harbor of Section 28(e) of the 1934 Act.
The investment adviser may place orders directly with electronic communications networks or other alternative trading systems. Placing orders with electronic
communications networks or other alternative trading systems may enable funds to trade directly with other institutional holders. At times, this may allow funds to trade larger blocks than would be possible trading through a single market maker.
The investment adviser may aggregate securities sales or purchases among two or more funds. The investment adviser will not aggregate transactions unless
it believes such aggregation is consistent with its duty to seek best execution for each affected fund and is consistent with the terms of the investment advisory agreement for such fund. In any single transaction in which purchases and/or sales of
securities of any issuer for the account of a fund are aggregated with other accounts managed by the investment adviser, the actual prices applicable to the transaction will be averaged among the accounts for which the transaction is effected,
including the account of the fund.
In determining when and to what extent to use Schwab or any other affiliated broker-dealer as its broker for executing
orders for the funds on securities exchanges, the investment adviser follows procedures, adopted by the funds Board of Trustees, that are designed to ensure that affiliated brokerage commissions (if relevant) are reasonable and fair in
comparison to unaffiliated brokerage commissions for comparable transactions. The Board reviews the procedures annually and approves and reviews transactions involving affiliated brokers quarterly.
PROXY VOTING
The Board has delegated
the responsibility for voting proxies to CSIM, pursuant to the Advisory Agreement between each trust and CSIM. The Board has adopted CSIMs Proxy Voting Policy and Procedures with respect to proxies voted on behalf of the various Schwab
Funds portfolios. A description of CSIMs Proxy Voting Policy and Procedures is included in Appendix Proxy Voting Policy and Procedures.
The trusts are required to disclose annually a funds complete proxy voting record on Form N-PX. A funds proxy voting record for the most recent 12
month period ended June 30
th
is available by visiting the Schwab website at www.schwabfunds.com/prospectus. A funds Form N-PX will also be available on the SECs website at
www.sec.gov.
46
Brokerage Commissions
For each of the last three fiscal years, the funds paid the following brokerage commissions. Variances in brokerage commissions paid by a fund from year to
year are due to increases and decreases in portfolio turnover in response to asset flows.
|
|
|
|
|
|
|
|
|
|
|
|
|
Funds
|
|
2013
|
|
|
2012
|
|
|
2011
|
|
Schwab S&P 500 Index Fund
|
|
$
|
320,077
|
|
|
$
|
273,056
|
|
|
$
|
240,008
|
|
Schwab 1000 Index
®
Fund
|
|
$
|
143,778
|
|
|
$
|
210,696
|
|
|
$
|
210,575
|
|
Schwab Small-Cap Index Fund
|
|
$
|
116,295
|
|
|
$
|
644,540
|
|
|
$
|
529,257
|
|
Schwab Total Stock Market Index Fund
|
|
$
|
130,345
|
|
|
$
|
144,750
|
|
|
$
|
96,548
|
|
Schwab International Index Fund
|
|
$
|
135,367
|
|
|
$
|
266,869
|
|
|
$
|
82,984
|
|
Regular Broker-Dealers
A funds regular broker-dealers during its most recent fiscal year are: (1) the ten broker-dealers that received the greatest dollar amount of
brokerage commissions from the fund; (2) the ten broker-dealers that engaged as principal in the largest dollar amount of portfolio transactions; and (3) the ten broker-dealers that sold the largest dollar amount of the funds shares.
As of October 31, 2013, certain of the funds held securities issued by their respective regular broker-dealers as indicated below.
Schwab
®
S&P 500 Index Fund
|
|
|
|
|
Regular Broker-Dealer
|
|
Value of Holdings
|
|
WELLS FARGO SECURITIES LLC
|
|
$
|
230,044,036
|
|
SG AMERICAS SECURITIES, LLC
|
|
$
|
214,723,131
|
|
SKANDINAVISKA ENSKILDA BANKEN
|
|
$
|
190,701,794
|
|
MERRILL LYNCH PIERCE, FENNER & SMITH, INC.
|
|
$
|
159,822,610
|
|
CITIGROUP GLOBAL MARKETS INC.
|
|
$
|
158,083,639
|
|
BANK OF NEW YORK MELLON CORP.
|
|
$
|
38,912,801
|
|
CHARLES SCHWAB & CO., INC.
|
|
$
|
27,913,430
|
|
Schwab 1000 Index
®
Fund
|
|
|
|
|
Regular Broker-Dealer
|
|
Value of Holdings
|
|
MERRILL LYNCH, PIERCE, FENNER & SMITH, INC.
|
|
$
|
48,727,952
|
|
GOLDMAN SACHS & CO.
|
|
$
|
21,769,506
|
|
MORGAN STANLEY & CO., INC.
|
|
$
|
13,073,529
|
|
BANK OF NEW YORK MELLON CORP.
|
|
$
|
11,851,733
|
|
CHARLES SCHWAB & CO., INC.
|
|
$
|
8,314,022
|
|
47
Schwab Small-Cap Index Fund
®
|
|
|
|
|
Regular Broker-Dealer
|
|
Value of Holdings
|
|
DNB MARKETS, INC.
|
|
$
|
70,794,629
|
|
MITSUBISHI UFJ SECURITIES (USA), INC.
|
|
$
|
17,919,737
|
|
STIFEL, NICOLAUS & CO., INC.
|
|
$
|
3,710,971
|
|
Schwab Total Stock Market Index Fund
®
|
|
|
|
|
Regular Broker-Dealer
|
|
Value of Holdings
|
|
AUSTRALIA & NEW ZEALAND BANKING GROUP LTD.
|
|
$
|
73,797,969
|
|
WELLS FARGO SECURITIES LLC
|
|
$
|
32,525,767
|
|
CITIGROUP GLOBAL MARKETS INC.
|
|
$
|
23,391,376
|
|
BANK OF NEW YORK MELLON CORP.
|
|
$
|
5,766,421
|
|
CHARLES SCHWAB & CO., INC.
|
|
$
|
4,129,684
|
|
STIFEL, NICOLAUS & CO., INC.
|
|
$
|
355,651
|
|
SUSQUEHANNA TRUST & INVESTMENT CO.
|
|
$
|
324,889
|
|
Schwab International Index Fund
®
|
|
|
|
|
Regular Broker-Dealer
|
|
Value of Holdings
|
|
DNB MARKETS, INC.
|
|
$
|
44,639,307
|
|
HSBC SECURITIES (USA), INC.
|
|
$
|
33,596,547
|
|
AUSTRALIA & NEW ZEALAND BANKING GROUP LTD.
|
|
$
|
24,861,963
|
|
MITSUBISHI UFJ SECURITIES (USA), INC.
|
|
$
|
13,353,032
|
|
BNP PARIBAS SECURITIES CORP.
|
|
$
|
12,064,490
|
|
DEUTSCHE BANK SECURITIES, INC.
|
|
$
|
8,107,787
|
|
CREDIT SUISSE SECURITIES (USA) LLC
|
|
$
|
7,669,726
|
|
SG AMERICAS SECURITIES, LLC
|
|
$
|
6,527,758
|
|
SKANDINAVISKA ENSKILDA BANKEN
|
|
$
|
3,023,269
|
|
MACQUARIE CAPITAL (USA) INC.
|
|
$
|
2,445,479
|
|
RBS SECURITIES, INC.
|
|
$
|
2,090,222
|
|
CREDIT AGRICOLE SECURITIES (USA), INC.
|
|
$
|
2,030,920
|
|
CITIGROUP GLOBAL MARKETS INC.
|
|
$
|
208,071
|
|
DESCRIPTION OF THE TRUSTS
Each fund, except the Schwab 1000 Index
®
Fund, is a series of Schwab Capital Trust, an
open-end management investment company organized as a Massachusetts business trust on May 7, 1993. The Schwab 1000 Index Fund is a series of Schwab Investments, an open-end investment management company organized as a Massachusetts business
trust on October 26, 1990.
48
The funds may hold special shareholder meetings, which may cause the funds to incur non-routine expenses. These
meetings may be called for purposes such as electing trustees, changing fundamental policies and amending management contracts. Shareholders are entitled to one vote for each share owned and may vote by proxy or in person. Proxy materials will be
mailed to shareholders prior to any meetings, and will include a voting card and information explaining the matters to be voted upon.
The bylaws of each
trust provide that a majority of shares entitled to vote shall be a quorum for the transaction of business at a shareholders meeting, except that where any provision of law, or of the Declaration of Trust or of the bylaws permits or requires
that (1) holders of any series shall vote as a series, then a majority of the aggregate number of shares of that series entitled to vote shall be necessary to constitute a quorum for the transaction of business by that series, or
(2) holders of any class shall vote as a class, then a majority of the aggregate number of shares of that class entitled to vote shall be necessary to constitute a quorum for the transaction of business by that class. Any lesser number shall be
sufficient for adjournments. Any adjourned session or sessions may be held, within a reasonable time after the date set for the original meeting, without the necessity of further notice. Each Declaration of Trust specifically authorizes the Board of
Trustees to terminate the trust (or any of its funds) by notice to the shareholders without shareholder approval.
Under Massachusetts law, shareholders
of a Massachusetts business trust could, under certain circumstances, be held personally liable for the trusts obligations. Each Declaration of Trust, however, disclaims shareholder liability for the trusts acts or obligations and
requires that notice of such disclaimer be given in each agreement, obligation or instrument entered into or executed by the trust or the trustees. In addition, each Declaration of Trust provides for indemnification out of the property of an
investment portfolio in which a shareholder owns or owned shares for all losses and expenses of such shareholder or former shareholder if he or she is held personally liable for the obligations of the trust solely by reason of being or having been a
shareholder. Moreover, each trust will be covered by insurance, which the trustees consider adequate to cover foreseeable tort claims. Thus, the risk of a shareholder incurring financial loss on account of shareholder liability is considered remote,
because it is limited to circumstances in which a disclaimer is inoperative and the trust itself is unable to meet its obligations. There is a remote possibility that a fund could become liable for a misstatement in the prospectus or SAI about
another fund.
As more fully described in each Declaration of Trust, the trustees may each year, or more frequently, distribute to the shareholders of
each series accrued income less accrued expenses and any net realized capital gains less accrued expenses. Distributions of each years income of each series shall be distributed pro rata to shareholders in proportion to the number of shares of
each series held by each of them. Distributions will be paid in cash or shares or a combination thereof as determined by the trustees. Distributions paid in shares will be paid at the net asset value as determined in accordance with the bylaws.
Any series of a trust may reorganize or merge with one or more other series of the trusts or of another investment company. Any such reorganization
or merger shall be pursuant to the terms and conditions specified in an agreement and plan of reorganization authorized and approved by the trustees and entered into by the relevant series in connection therewith. In addition, such
reorganization or merger may be authorized by vote of a majority of the trustees then in office and, to the extent permitted by applicable law and the applicable Declaration of Trust, without the approval of shareholders of any series.
PURCHASE, REDEMPTION, DELIVERY OF SHAREHOLDER DOCUMENTS AND PRICING OF SHARES
Purchasing and Redeeming Shares of the Funds
The funds are open each day that the NYSE is open (business days). The NYSEs trading session is normally conducted from 9:30 a.m. until 4:00 p.m.
Eastern time, Monday through Friday, although some days, such as in advance of and following holidays, the NYSEs trading session closes early. The following holiday closings are currently scheduled for 2014-2015: New Years Day, Martin
Luther King Jr.s Birthday, Presidents Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day. Only orders that are received in good order by a funds transfer agent no
49
later than the close of the NYSEs trading session will be executed that day at the funds share price calculated that day. On any day that the NYSE closes early, the funds reserve the
right to advance the time by which purchase, redemption and exchange orders must be received by the funds transfer agent that day in order to be executed that day at that days share price.
The funds have authorized one or more brokers to accept on their behalf purchase and redemption orders. Such brokers have also been authorized to designate
other intermediaries to accept purchase and redemption orders on the funds behalf. The funds will be deemed to have received a purchase or redemption order when an authorized broker or, if applicable, a brokers authorized designee,
receives such order. Such orders will be priced at the respective funds net asset value per share next determined after such orders are received by an authorized broker or the brokers authorized designee.
As long as the funds or Schwab follow reasonable procedures to confirm that an investors telephone or Internet order is genuine, they will not be liable
for any losses the investor may experience due to unauthorized or fraudulent instructions. These procedures may include requiring a form of personal identification or other confirmation before acting upon any telephone or Internet order, providing
written confirmation of telephone or Internet orders and tape recording all telephone orders.
Share certificates will not be issued in order to avoid
additional administrative costs, however, share ownership records are maintained by Schwab, other authorized financial intermediaries or, for direct shareholders, by the funds transfer agent.
Each trusts Declaration of Trust provides that shares may be automatically redeemed if held by a shareholder in an amount less than the minimum required
by each fund. Each funds minimum initial investments and minimum balance requirements, if any, are set forth in the prospectus. The minimums may be changed without prior notice.
As explained in more detail in the funds prospectus, each fund that charges a redemption fee reserves the right to waive its early redemption fee for
certain tax-advantaged retirement plans or charitable giving funds, certain fee-based or wrap programs, or in other circumstances when the funds officers determine that such a waiver is in the best interest of a fund and its shareholders.
Each of the funds has made an election with the SEC to pay in cash all redemptions requested by any shareholder of record limited in amount during any 90-day
period to the lesser of $250,000 or 1% of its net assets at the beginning of such period. This election is irrevocable without the SECs prior approval. Redemption requests in excess of these limits may be paid, in whole or in part, in
investment securities or in cash, as the Board of Trustees may deem advisable. Payment will be made wholly in cash unless the Board of Trustees believes that economic or market conditions exist that would make such payment a detriment to the best
interests of a fund. If redemption proceeds are paid in investment securities, such securities will be valued as set forth in Pricing of Shares. A redeeming shareholder would normally incur transaction costs if he or she were to convert
the securities to cash.
Each fund is designed for long-term investing. Because short-term trading activities can disrupt the smooth management of a fund
and increase its expenses, each fund reserves the right, in its sole discretion, to refuse any purchase or exchange order, or large purchase or exchange orders, including any purchase or exchange order which appears to be associated with short-term
trading activities or market timing. Because market timing decisions to buy and sell securities typically are based on an individual investors market outlook, including such factors as the perceived strength of the economy or the
anticipated direction of interest rates, it is difficult for a fund to determine in advance what purchase or exchange orders may be deemed to be associated with market timing or short-term trading activities. The funds and Schwab reserve the right
to refuse any purchase or exchange order, including large orders that may negatively impact their operations. More information regarding the funds policies regarding market timing is included in the funds prospectus.
50
In certain circumstances, shares of a fund may be purchased in kind (i.e., in exchange for
securities, rather than for cash). The securities tendered as part of an in-kind purchase must be liquid securities that are not restricted as to transfer and have a value that is readily ascertainable as evidenced by a listing on the American Stock
Exchange, the NYSE, or NASDAQ. Securities accepted by the fund will be valued, as set forth in the funds prospectus, as of the time of the next determination of net asset value after such acceptance. The shares of the fund that are issued to
the shareholder in exchange for the securities will be determined as of the same time. All dividend, subscription, or other rights that are reflected in the market price of accepted securities at the time of valuation become the property of the fund
and must be delivered to the fund by the investor upon receipt from the issuer. A fund will not accept securities in exchange for its shares unless such securities are, at the time of the exchange, eligible to be held by the fund and satisfy such
other conditions as may be imposed by the funds investment adviser.
Exchanging Shares of the Funds
Methods to purchase and redeem shares of a fund are set forth in the funds prospectus. An exchange order involves the redemption of all or a portion of
the shares of one Schwab Fund or Laudus MarketMasters Fund and the simultaneous purchase of shares of another Schwab Fund or Laudus MarketMasters Fund. Exchange orders must meet the minimum investment and any other requirements of the fund or class
purchased. Exchange orders may not be executed between shares of Sweep Investments
®
and shares of non-Sweep Investments. Shares of Sweep Investments may be bought and sold automatically
pursuant to the terms and conditions of your Schwab account agreement or by direct order as long as you meet the minimums for direct investments. In addition, different exchange policies may apply to Schwab Funds
®
that are bought and sold through third-party investment providers and the exchange privilege between Schwab Funds may not be available through third-party investment providers.
The funds and Schwab reserve certain rights with regard to exchanging shares of the funds. These rights include the right to: (i) refuse any purchase or
exchange order that may negatively impact a funds operations; (ii) refuse orders that appear to be associated with short-term trading activities; and (iii) materially modify or terminate the exchange privilege upon 60 days
written notice to shareholders.
Delivery of Shareholder Documents
Typically once a year, an updated prospectus will be mailed to shareholders describing each funds investment strategies, risks and shareholder policies.
Twice a year, financial reports will be mailed to shareholders describing each funds performance and investment holdings. To eliminate duplicate mailings of shareholder documents, each household may receive one copy of these documents, under
certain conditions. This practice is commonly called householding. If you want to receive multiple copies, you may write or call your fund at the address or telephone number on the front of this SAI or contact the financial intermediary
through which you hold fund shares. Your instructions will be effective within 30 days of receipt by Schwab.
Pricing of Shares
Each business day, the funds calculate their share price, or NAV, as of the close of the NYSE (generally 4 p.m. Eastern time). This means that NAVs are
calculated using the values of a funds portfolio securities as of the close of the NYSE. Such values are required to be determined in one of two ways: securities for which market quotations are readily available are required to be valued at
current market value; and securities for which market quotations are not readily available or the investment adviser deems to be unreliable are required to be valued at fair value using procedures approved by the Board of Trustees.
Shareholders of funds that invest in foreign securities should be aware that because foreign markets are often open on weekends and other days when the funds
are closed, the value of some of a funds securities may change on days when it is not possible to buy or sell shares of the fund. The funds use approved pricing sources to provide values for their portfolio securities. Current market values
are generally determined by the approved pricing sources as follows: generally securities traded on exchanges, excluding the NASDAQ National Market System, are valued at the last-quoted sales price on the exchange on which such securities are
primarily traded, or, lacking
51
any sales, at the mean between the bid and ask prices; generally securities traded in the over-the-counter market are valued at the last reported sales price that day, or, if no sales are
reported, at the mean between the bid and ask prices. Generally securities listed on the NASDAQ National Market System are valued in accordance with the NASDAQ Official Closing Price. In addition, securities that are primarily traded on foreign
exchanges are generally valued at the official closing price or last sales price on the exchange where the securities are principally traded with these values then translated into U.S. dollars at the current exchange rate. Fixed income securities
normally are valued based on valuations provided by approved pricing sources. Securities may be fair valued pursuant to procedures approved by the funds Board of Trustees when a security is de-listed or its trading is halted or suspended; when
a securitys primary pricing source is unable or unwilling to provide a price; when a securitys primary trading market is closed during regular market hours; when a securitys value is materially affected by events occurring after
the close of the securitys primary trading market; or a furnished price appears manifestly incorrect. The Board of Trustees regularly reviews fair value determinations made by the funds pursuant to the procedures.
TAXATION
Federal Tax
Information for the Funds
This discussion of U.S. federal income tax consequences is based on the Internal Revenue Code and the regulations
issued thereunder as in effect on the date of this SAI. New legislation, as well as administrative changes or court decisions, may significantly change the conclusions expressed herein, and may have a retroactive effect with respect to the
transactions contemplated herein.
It is each funds policy to qualify for taxation as a RIC by meeting the requirements of Subchapter M of
the Internal Revenue Code. By qualifying as a RIC, each fund expects to eliminate or reduce to a nominal amount the federal income tax to which it is subject. If a fund does not qualify as a RIC under the Internal Revenue Code, it will be subject to
federal income tax on its net investment income and any net realized capital gains. In addition, each fund could be required to recognize unrealized gains, pay substantial taxes and interest, and make substantial distributions before requalifying as
a RIC.
Each fund is treated as a separate entity for federal income tax purposes and is not combined with the trusts other funds. Each
fund intends to qualify as a RIC so that it will be relieved of federal income tax on that part of its income that is distributed to shareholders. In order to qualify for treatment as a RIC, a fund must, among other requirements, distribute annually
to its shareholders at least the sum of 90% of its investment company taxable income (generally, net investment income plus the excess, if any, of net short-term capital gain over net long-term capital losses) and 90% of its net tax-exempt income.
Among these requirements are the following: (i) at least 90% of a funds gross income each taxable year must be derived from dividends, interest, payments with respect to securities loans, and gains from the sale or other disposition of
stock, securities or foreign currencies, or other income derived with respect to its business of investing in such stock or securities or currencies and net income derived from an interest in a qualified publicly traded partnership; (ii) at the
close of each quarter of a funds taxable year, at least 50% of the value of its total assets must be represented by cash and cash items, U.S. government securities, securities of other RICs and other securities, with such other securities
limited, in respect of any one issuer, to an amount that does not exceed 5% of the value of a Funds assets and that does not represent more than 10% of the outstanding voting securities of such issuer; and (iii) at the close of each
quarter of a funds taxable year, not more than 25% of the value of its assets may be invested in securities (other than U.S. government securities or the securities of other RICs) of any one issuer or of two or more issuers and which are
engaged in the same, similar, or related trades or businesses if the fund owns at least 20% of the voting power of such issuers, or the securities of one or more qualified publicly traded partnerships.
Certain master limited partnerships may qualify as qualified publicly traded partnerships for purposes of the Subchapter M diversification rules
described above. In order to do so, the master limited partnership must satisfy two requirements during the taxable year. First, the interests of such partnership either must be traded on an
52
established securities market or must be readily tradable on a secondary market (or the substantial equivalent thereof). Second, less than 90% of the partnerships gross income can consist
of dividends, interest, payments with respect to securities loans, or gains from the sale or other disposition of stock or securities or foreign currencies, or other income derived with respect to its business of investing in such stock securities
or currencies.
The Internal Revenue Code imposes a non-deductible excise tax on RICs that do not distribute in a calendar year (regardless of whether
they otherwise have a non-calendar taxable year) an amount equal to 98% of their ordinary income (as defined in the Internal Revenue Code) for the calendar year plus 98.2% of their net capital gain for the one-year period ending on
October 31 of such calendar year, plus any undistributed amounts from prior years. The non-deductible excise tax is equal to 4% of the deficiency. For the foregoing purposes, a fund is treated as having distributed any amount on which it is
subject to income tax for any taxable year ending in such calendar year and certain amounts with respect to which estimated taxes are paid in such calendar year. A fund may in certain circumstances be required to liquidate fund investments to make
sufficient distributions to avoid federal excise tax liability at a time when the investment adviser might not otherwise have chosen to do so, and liquidation of investments in such circumstances may affect the ability of a fund to satisfy the
requirements for qualification as a RIC.
A funds transactions in futures contracts, forward contracts, foreign currency exchange transactions,
options and certain other investment and hedging activities may be restricted by the Internal Revenue Code and are subject to special tax rules. In a given case, these rules may accelerate income to a fund, defer its losses, cause adjustments in the
holding periods of a funds assets, convert short-term capital losses into long-term capital losses or otherwise affect the character of a funds income. These rules could therefore affect the amount, timing and character of distributions
to shareholders. Each fund will endeavor to make any available elections pertaining to these transactions in a manner believed to be in the best interest of a fund and its shareholders.
Each fund is required for federal income tax purposes to mark-to-market and recognize as income for each taxable year its net unrealized gains and losses on
certain futures contracts as of the end of the year as well as those actually realized during the year. Gain or loss from futures and options contracts on broad-based indexes required to be marked to market will be 60% long-term and 40% short-term
capital gain or loss. Application of this rule may alter the timing and character of distributions to shareholders. Each fund may be required to defer the recognition of losses on futures contracts, options contracts and swaps to the extent of any
unrecognized gains on offsetting positions held by the fund. It is anticipated that any net gain realized from the closing out of futures or options contracts will be considered gain from the sale of securities and therefore will be qualifying
income for purposes of the 90% requirement described above. Each fund distributes to shareholders at least annually any net capital gains which have been recognized for federal income tax purposes, including unrealized gains at the end of the
funds fiscal year on futures or options transactions. Such distributions are combined with distributions of capital gains realized on the funds other investments and shareholders are advised on the nature of the distributions.
With respect to investments in zero coupon securities which are sold at original issue discount and thus do not make periodic cash interest payments, a fund
will be required to include as part of its current income the imputed interest on such obligations even though the fund has not received any interest payments on such obligations during that period. Because each fund distributes all of its net
investment income to its shareholders, a fund may have to sell fund securities to distribute such imputed income which may occur at a time when the adviser would not have chosen to sell such securities and which may result in taxable gain or loss.
Federal Income Tax Information for Shareholders
The discussion of federal income taxation presented below supplements the discussion in each funds prospectus and only summarizes some of the important
federal tax considerations generally affecting shareholders of the funds. Accordingly, prospective investors (particularly those not residing or domiciled in the United States) should consult their own tax advisors regarding the consequences of
investing in the funds.
53
Any dividends declared by a fund in October, November or December and paid the following January are treated,
for tax purposes, as if they were received by shareholders on December 31 of the year in which they were declared. In general, distributions by a fund of investment company taxable income (including net short-term capital gains), if any,
whether received in cash or additional shares, will be taxable to you as ordinary income. A portion of these distributions may be treated as qualified dividend income (eligible for the reduced rates to individuals as described below) to the extent
that a fund receives qualified dividend income. Qualified dividend income is, in general, dividend income from taxable domestic corporations and certain foreign corporations (e.g., foreign corporations incorporated in a possession of the United
States or in certain countries with a comprehensive tax treaty with the United States, or the stock of which is readily tradable on an established securities market in the United States). A dividend will not be treated as qualified dividend income
to the extent that (i) the shareholder has not held the shares of the fund on which the dividend was paid for more than 60 days during the 121-day period that begins on the date that is 60 days before the date on which the shares of the fund
become ex-dividend with respect to such dividend (and the fund must also satisfy those holding period requirements with respect to the securities it holds that paid the dividends distributed to the shareholder), (ii) the shareholder is under an
obligation (whether pursuant to a short sale or otherwise) to make related payments with respect to substantially similar or related property, or (iii) the shareholder elects to treat such dividend as investment income under section
163(d)(4)(B) of the Internal Revenue Code. Dividends received by each fund from a REIT or another RIC may be treated as qualified dividend income only to the extent the dividend distributions are attributable to qualified dividend income received by
such REIT or RIC. It is expected that dividends received by a fund from a REIT and distributed to a shareholder generally will be taxable to the shareholder as ordinary income.
Distributions from net capital gain (if any) that are reported as capital gains dividends are taxable as long-term capital gains without regard to the length
of time the shareholder has held shares of a fund. However, if you receive a capital gains dividend with respect to fund shares held for six months or less, any loss on the sale or exchange of those shares shall, to the extent of the capital gains
dividend, be treated as a long-term capital loss. The maximum individual rate applicable to qualified dividend income and long-term capital gains depends on whether the taxpayers income exceeds certain threshold amounts. The
maximum rate is generally 15% for taxpayers whose income is equal to or less than $400,000 (individual filers) or $450,000 (married filing jointly), and 20% for taxpayers whose income exceeds the foregoing thresholds.
Under the Regulated Investment Company Modernization Act of 2010, net capital losses incurred by the fund in the taxable years after the effective enactment
date, December 22, 2010, will not expire. However, such losses must be utilized prior to the losses incurred in the year preceding enactment. As a result of this ordering rule, pre-enactment capital loss carryforwards may be more likely to
expire unused. Post-enactment capital losses arise in fiscal years beginning after the enactment date exclude any elective post-October capital losses deferred during the period from November 1 to the end of the funds fiscal year. In
addition, post-enactment capital losses that are carried forward will retain their character as either short-term or long-term losses rather than short-term as under previous law.
An additional 3.8% Medicare tax is imposed on certain net investment income (including ordinary dividends and capital gain distributions received from a fund
and net gains from redemptions or other taxable dispositions of fund shares) of U.S. individuals, estates and trusts to the extent that such persons modified adjusted gross income (in the case of an individual) or adjusted
gross income (in the case of an estate or trust) exceeds a threshold amount.
A fund will inform you of the amount of your ordinary income
dividends and capital gain distributions, if any, at the time they are paid and will advise you of their tax status for federal income tax purposes, including what portion of the distributions will be qualified dividend income, shortly after the
close of each calendar year. For corporate investors in a fund, dividend distributions the fund reports as dividends received from qualifying domestic corporations will be eligible for the 70% corporate dividends-received deduction to the extent
they would qualify if the fund were a regular corporation. Distributions by a fund also may be subject to state, local and foreign taxes, and their treatment under applicable tax laws may differ from the federal income tax treatment.
54
A fund will be required in certain cases to withhold at the applicable withholding rate and remit to the U.S.
Treasury the withheld amount of taxable dividends and redemption proceeds paid to any shareholder who (1) fails to provide a correct taxpayer identification number certified under penalty of perjury; (2) is subject to withholding by the
Internal Revenue Service for failure to properly report all payments of interest or dividends; (3) fails to provide a certified statement that he or she is not subject to backup withholding; or (4) fails to provide a certified
statement that he or she is a U.S. person (including a U.S. resident alien). Backup withholding is not an additional tax and any amounts withheld may be credited against the shareholders ultimate U.S. tax liability.
Foreign shareholders (i.e., nonresident alien individuals and foreign corporations, partnerships, trusts and estates) are generally subject to U.S.
withholding tax at the rate of 30% (or a lower tax treaty rate) on distributions derived from net investment income and short-term capital gains; provided, however, that for a funds taxable year beginning before January 1, 2014 (or a
later date if extended by the U.S. Congress), U.S. source interest related dividends and short-term capital gain dividends generally will not be subject to U.S. withholding taxes if a fund elects to make reports with respect to such dividends.
Distributions to foreign shareholders of such short-term capital gain dividends and long-term capital gains, and any gains from the sale or other disposition of shares of a fund, generally are not subject to U.S. taxation, unless the recipient is an
individual who either (1) meets the Internal Revenue Codes definition of resident alien or (2) is physically present in the U.S. for 183 days or more per year. Foreign shareholders may also be subject to U.S. estate taxes
with respect to shares in a fund. Different tax consequences may result if the foreign shareholder is engaged in a trade or business within the United States. In addition, the tax consequences to a foreign shareholder entitled to claim the benefits
of a tax treaty may be different than those described above. Notwithstanding the foregoing, income, if any, derived by a fund from investments in REITs that hold residual interests in real estate mortgage investment conduits (REMICs) may
be classified as excess inclusion income. With respect to foreign shareholders, no exemption or reduction in withholding tax will apply to such excess inclusion income.
Effective July 1, 2014, the funds will be required to withhold U.S. tax (at a 30% rate) on payments of dividends and (effective January 1, 2017)
redemption proceeds and certain capital gain dividend made to certain non-U.S. entities that fail to comply with extensive new reporting and withholding requirements designed to inform the U.S. Department of the Treasury of U.S.-owned foreign
investment accounts. Shareholders may be requested to provide additional information to the funds to enable the funds to determine whether withholding is required.
Certain tax-exempt shareholders, including qualified pension plans, individual retirement accounts, salary deferral arrangements, 401(k)s, and other
tax-exempt entities, generally are exempt from federal income taxation except with respect to their unrelated business taxable income (UBTI). Under current law, each fund generally serves to block UBTI from being realized by their
tax-exempt shareholders. However, notwithstanding the foregoing, a tax-exempt shareholder could realize UBTI by virtue of its investment in a fund where, for example, (i) the fund invests in REITs that hold residual interests in REMICs or
(ii) shares in the fund constitute debt-financed property in the hands of the tax-exempt shareholder within the meaning of section 514(b) of the Internal Revenue Code. Charitable remainder trusts are subject to special rules and should consult
their tax advisors. There are no restrictions preventing a fund from holding investments in REITs that hold residual interests in REMICs, and a fund may do so. The Internal Revenue Service has issued recent guidance with respect to these issues and
prospective shareholders, especially charitable remainder trusts, are strongly encouraged to consult with their tax advisors regarding these issues.
Income that the Schwab International Index Fund
®
receives from sources within various foreign
countries may be subject to foreign income taxes withheld at the source. If a fund has more than 50% of its assets invested in foreign securities at the end of its taxable year, it may elect to pass through to its shareholders the
ability to take either the foreign tax credit or the deduction for foreign taxes. Pursuant to this election, U.S.
55
shareholders must include in gross income, even though not actually received, their respective pro rata share of foreign taxes, and may either deduct their pro rata share of foreign taxes (but
not for alternative minimum tax purposes) or credit the tax against U.S. income taxes, subject to certain limitations described in Internal Revenue Code sections 901 and 904. A shareholder who does not itemize deductions may not claim a deduction
for foreign taxes. It is expected that the Schwab International Index Fund will have more than 50% of the value of its total assets at the close of its taxable year invested in foreign securities, and that it will make this election.
The Schwab International Index Fund may invest in a non-U.S. corporations, one or more of which could be treated as a passive foreign investment company
(PFIC) or become a PFIC under the Internal Revenue Code. This could result in adverse tax consequences upon the disposition of, or the receipt of excess distributions with respect to, such equity investments. To the extent a fund does
invest in a PFIC, it may be eligible to elect to treat the PFIC as a qualified electing fund or mark-to-market its investments in PFICs annually. In either case, the fund may be required to distribute amounts in excess of realized income
and gains. To the extent a fund does invest in foreign securities which are determined to be PFIC securities and is required to pay a tax on such investments, a credit for this tax would not be allowed to be passed through to the funds
shareholders. Therefore, the payment of this tax would reduce a funds economic return from its PFIC shares, and excess distributions received with respect to such shares are treated as ordinary income rather than capital gains.
Section 988 of the Internal Revenue Code contains special tax rules applicable to certain foreign currency transactions and instruments that may affect
the amount, timing and character of income, gain or loss recognized by a fund. Under these rules, foreign exchange gain or loss realized by a fund with respect to foreign currencies and certain futures and options thereon, foreign
currency-denominated debt instruments, foreign currency forward contracts, and foreign currency-denominated payables and receivables will generally be treated as ordinary income or loss, although in some cases elections may be available that would
alter this treatment. Foreign currency losses could result in distributions of ordinary income being reclassified as a return of capital for tax purposes.
Under U.S. Treasury regulations, if a shareholder recognizes a loss of $2 million or more for an individual shareholder or $10 million or more for a corporate
shareholder, the shareholder must file with the Internal Revenue Service a disclosure statement on Form 8886. Direct shareholders of portfolio securities are in many cases excepted from this reporting requirement, but under current guidance,
shareholders of a RIC such as the fund are not excepted. Future guidance may extend the current exception from this reporting requirement to shareholders of most or all RICs. The fact that a loss is reportable under these regulations does not affect
the legal determination of whether the taxpayers treatment of the loss is proper. Shareholders should consult their tax advisors to determine the applicability of these regulations in light of their individual circumstances.
Shareholders are urged to consult their tax advisors as to the state and local tax rules affecting investments in the funds.
56
APPENDIX PRINCIPAL HOLDERS OF SECURITIES
|
|
|
|
|
|
|
Fund
|
|
Customer
|
|
Percent owned
|
|
Schwab S&P 500 Index Fund
|
|
CHARLES SCHWAB & CO., INC.
|
|
|
95
|
%
|
|
|
211 MAIN STREET
|
|
|
|
|
|
|
SAN FRANCISCO CA 94105
|
|
|
|
|
|
|
CHARLES SCHWAB BANK
|
|
|
30
|
%
1
|
|
|
211 MAIN STREET
|
|
|
|
|
|
|
SAN FRANCISCO CA 94105
|
|
|
|
|
Schwab 1000 Index Fund
|
|
CHARLES SCHWAB & CO., INC.
|
|
|
97
|
%
|
|
|
211 MAIN STREET
|
|
|
|
|
|
|
SAN FRANCISCO CA 94105
|
|
|
|
|
|
|
CHARLES SCHWAB BANK
|
|
|
7
|
%
1
|
|
|
211 MAIN STREET
|
|
|
|
|
|
|
SAN FRANCISCO CA 94105
|
|
|
|
|
Schwab Small-Cap Index Fund
|
|
CHARLES SCHWAB & CO., INC.
|
|
|
97
|
%
|
|
|
211 MAIN STREET
|
|
|
|
|
|
|
SAN FRANCISCO CA 94105
|
|
|
|
|
|
|
CHARLES SCHWAB BANK
|
|
|
13
|
%
1
|
|
|
211 MAIN STREET
|
|
|
|
|
|
|
SAN FRANCISCO CA 94105
|
|
|
|
|
|
|
SCHWAB MARKETTRACK ALL EQUITY PORTFOLIO
|
|
|
6
|
%
1
|
|
|
211 MAIN STREET
|
|
|
|
|
|
|
SAN FRANCISCO CA 94105
|
|
|
|
|
|
|
SCHWAB MARKETTRACK GROWTH PORTFOLIO
|
|
|
6
|
%
1
|
|
|
211 MAIN STREET
|
|
|
|
|
|
|
SAN FRANCISCO CA 94105
|
|
|
|
|
Schwab Total Stock Market Index Fund
|
|
CHARLES SCHWAB & CO., INC.
|
|
|
95
|
%
|
|
|
211 MAIN ST
|
|
|
|
|
|
|
SAN FRANCISCO CA 94105
|
|
|
|
|
|
|
CHARLES SCHWAB BANK
|
|
|
8
|
%
1
|
|
|
211 MAIN STREET
|
|
|
|
|
|
|
SAN FRANCISCO CA 94105
|
|
|
|
|
|
|
SCHWAB CHARITABLE FUND
|
|
|
7
|
%
1
|
|
|
211 MAIN STREET
|
|
|
|
|
|
|
SAN FRANCISCO CA 94105
|
|
|
|
|
Schwab International Index Fund
|
|
CHARLES SCHWAB & CO., INC.
|
|
|
97
|
%
|
|
|
211 MAIN STREET
|
|
|
|
|
|
|
SAN FRANCISCO CA 94105
|
|
|
|
|
|
|
CHARLES SCHWAB BANK
|
|
|
15
|
%
1
|
|
|
211 MAIN STREET
|
|
|
|
|
|
|
SAN FRANCISCO CA 94105
|
|
|
|
|
|
|
SCHWAB MARKETTRACK ALL EQUITY
|
|
|
8
|
%
1
|
|
|
211 MAIN STREET
|
|
|
|
|
|
|
SAN FRANCISCO CA 94105
|
|
|
|
|
|
|
SCHWAB MARKETTRACK GROWTH PORTFOLIO
|
|
|
6
|
%
1
|
|
|
211 MAIN STREET
|
|
|
|
|
|
|
SAN FRANCISCO CA 94105
|
|
|
|
|
1
|
These shares are held within the Charles Schwab & Co., Inc. account listed elsewhere in the table.
|
57
Charles Schwab Investment Management, Inc.
The Charles Schwab Family of Funds
Schwab Investments
Schwab Capital Trust
Schwab Annuity Portfolios
Laudus Trust
Laudus
Institutional Trust
Schwab Strategic Trust
Proxy Voting Policy and Procedures
As of February 2014
Charles Schwab Investment Management, Inc. (CSIM), as an investment adviser, is generally responsible for voting proxies with
respect to the securities held in accounts of investment companies and other clients for which it provides discretionary investment management services. CSIMs Proxy Committee exercises and documents CSIMs responsibility with regard to
voting of client proxies (the Proxy Committee). The Proxy Committee is composed of representatives of CSIMs Fund Administration, Portfolio Management, and Legal Departments, and chaired by CSIMs Chief Investment Officer,
Equities or his/her delegate. The Proxy Committee reviews and, as necessary, may amend periodically these Procedures to address new or revised proxy voting policies or procedures. The policies stated in these Proxy Voting Policy and Procedures (the
CSIM Proxy Procedures) pertain to all of CSIMs clients.
The Boards of Trustees (the Trustees) of The
Charles Schwab Family of Funds, Schwab Investments, Schwab Capital Trust, and Schwab Annuity Portfolios (Schwab Funds) have delegated the responsibility for voting proxies to CSIM through their respective Investment Advisory and
Administration Agreements. In addition, the Boards of Trustees (the Trustees) of Laudus Trust and Laudus Institutional Trust (Laudus Funds) and the Schwab Strategic Trust (Schwab ETFs; collectively, the Schwab
Funds, the Laudus Funds and the Schwab ETFs are the Funds) have delegated the responsibility for voting proxies to CSIM through their respective investment advisory and administration agreements. The Trustees have adopted these Proxy
Procedures with respect to proxies voted on behalf of the various Schwab Funds, Laudus Funds, and Schwab ETFs portfolios. CSIM will present amendments to the Trustees for approval. However, there may be circumstances where the Proxy Committee deems
it advisable to amend the Proxy Procedures between regular Schwab Funds, Laudus Funds and Schwab ETFs Board meetings. In such cases, the Trustees will be asked to ratify any changes at the next regular meeting of the Board.
To assist CSIM in its responsibility for voting proxies and the overall proxy voting process, CSIM has retained Glass Lewis & Co.
(Glass Lewis) as an expert in the proxy voting and corporate governance area. The services provided by Glass Lewis include in-depth research, global issuer analysis, and voting recommendations as well as vote execution, reporting and
record keeping.
Proxy Voting Policy
For investment companies and other clients for which CSIM exercises its responsibility for voting proxies, it is CSIMs policy to vote
proxies in the manner that CSIM and the Proxy Committee believes will maximize the economic benefit to CSIMs clients. In furtherance of this policy, the Proxy Committee has received and reviewed Glass Lewis written proxy voting policies
and procedures (Glass Lewis Proxy Procedures) and has determined that Glass Lewis Proxy Procedures are consistent with the CSIM Proxy Procedures and CSIMs fiduciary duty with respect to its clients. The Proxy Committee
has also implemented custom policies as set forth below. The Proxy Committee will review any material amendments to Glass Lewis Proxy Procedures to determine whether such procedures continue to be consistent with the CSIM Proxy Voting
Procedures, and CSIMs fiduciary duty with respect to its clients.
Page 1 of 4
Except under each of the circumstances described below, the Proxy Committee will delegate to
Glass Lewis responsibility for voting proxies, including timely submission of votes, on behalf of CSIMs clients in accordance with Glass Lewis Proxy Procedures.
For proxy issues that the Proxy Committee or the applicable portfolio manager or other relevant portfolio management staff believe raise
significant concerns with respect to the accounts of CSIM clients, the Proxy Committee will review the analysis and recommendation of Glass Lewis. Examples of factors that could cause a matter to raise significant concerns include, but are not
limited to: issues whose outcome has the potential to materially affect the companys industry, or regional or national economy, and matters which involve broad public policy developments which may similarly materially affect the environment in
which the company operates. The Proxy Committee also will solicit input from the assigned portfolio manager and other relevant portfolio management staff for the particular portfolio security. After evaluating all such recommendations, the Proxy
Committee will decide how to vote the shares and will instruct Glass Lewis to vote consistent with its decision. The Proxy Committee has the ultimate responsibility for making the determination of how to vote the shares to seek to maximize the value
of that particular holding.
With respect to proxies of a Fund, the Proxy Committee will vote such proxies in the same proportion as the
vote of all other shareholders of the Fund (
i.e.
, echo vote), unless otherwise required by law. When required by law or applicable exemptive order, the Proxy Committee will also echo vote proxies of an unaffiliated
mutual fund or exchange traded fund (ETF). For example, certain exemptive orders issued to the Funds by the Securities and Exchange Commission and Section 12(d)(1)(F) of the Investment Company Act of 1940, as amended, require the
Funds, under certain circumstances, to echo vote proxies of registered investment companies that serve as underlying investments of the Funds. When not required to echo vote, the Proxy Committee will delegate to Glass Lewis
responsibility for voting proxies of an unaffiliated mutual fund or ETF in accordance with Glass Lewis Proxy Procedures, subject to the custom policies set forth below.
In addition, with respect to holdings of The Charles Schwab Corporation (CSC) (ticker symbol: SCHW), the Proxy Committee will vote
such proxies in the same proportion as the vote of all other shareholders of CSC (
i.e.
, echo vote), unless otherwise required by law.
Exceptions from Glass Lewis Proxy Procedures
: The Proxy Committee has reviewed the particular policies set forth in Glass
Lewis Proxy Procedures and has determined that the implementation of the following custom policies is consistent with CSIMs fiduciary duty to its clients:
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Independent Chairman
: With respect to shareholder proposals requiring that a company chairmans position be filled by an independent
director, the Proxy Committee has instructed Glass Lewis to vote with management on such proposals unless the company does not meet the applicable minimum total shareholder return threshold, as calculated below. In cases where a company fails to
meet the threshold, the Proxy Committee has instructed Glass Lewis to vote the shareholder proposals requiring that the chairmans position be filled by an independent director in accordance with Glass Lewis Proxy Procedures. In cases
where a company is a registered investment company, the Proxy Committee has instructed Glass Lewis to vote with management on such proposals. Additionally, with respect to the election of a director who serves as the governance committee chair (or,
in the absence of a governance committee, the chair of the nominating committee), the Proxy Committee has instructed Glass Lewis to vote for the director in cases where the company chairmans position is not filled by an independent director
and an independent lead or presiding director has not been appointed.
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Page 2 of 4
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Classified Boards
: With respect to shareholder proposals declassifying a staggered board in favor of the annual election of directors, the
Proxy Committee has instructed Glass Lewis to vote with management on such proposals unless the company does not meet the applicable minimum total shareholder return threshold, as calculated below. In cases where a company fails to meet the
threshold, the Proxy Committee has instructed Glass Lewis to vote the shareholder proposals declassifying a staggered board in favor of the annual election of directors in accordance with Glass Lewis Proxy Procedures.
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Proxy Access
: With respect to shareholder proposals requesting proxy access for shareholders, the Proxy Committee has instructed Glass Lewis
to vote with management on such proposals unless the company does not meet one of the following triggers:
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The company did not implement a shareholder proposal that was passed by shareholders at two previous shareholder meetings.
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The company nominated directors for election that did not receive a majority of shareholder support at the previous shareholder meeting.
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The company had material financial statement restatements.
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The companys board adopted a poison pill during the past year and did not put the adoption up for shareholder approval.
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In cases where a company fails to meet the threshold or one of the triggers, the Proxy Committee has
instructed Glass Lewis to vote shareholder proposals requesting proxy access in accordance with Glass Lewis Proxy Procedures.
Glass
Lewis uses a three-year total return performance methodology to calculate the applicable minimum total shareholder return threshold. If a companys total annual shareholder return is in the bottom 25% of its Global Industry Classification
Standard (GICS) industry group constituent companies total annual shareholder returns for three consecutive years, the company will be deemed not to have met the threshold.
If Glass Lewis does not provide an analysis or recommendation for voting a particular proxy measure or measures, CSIM will generally abstain,
however (1) two members of the Proxy Committee, including at least one representative from Portfolio Management, in consultation with the Chair of the Proxy Committee or his/her designee, may decide how to vote such proxy, or (2) the Proxy
Committee may meet to decide how to vote such proxy.
Conflicts of Interest
. Except as described above for proxies solicited by the
Funds or CSC and the exceptions to Glass Lewis Proxy Procedures, proxy issues that present material conflicts of interest between CSIM, and/or any of its affiliates, and CSIMs clients, CSIM will delegate to Glass Lewis responsibility for
voting such proxies in accordance with Glass Lewis Proxy Procedures.
Voting Foreign Proxies
. CSIM has arrangements with
Glass Lewis for voting proxies. However, voting proxies with respect to shares of foreign securities may involve significantly greater effort and corresponding cost than voting proxies with respect to domestic securities, due to the variety of
regulatory schemes and corporate practices in foreign countries with respect to proxy voting. Problems voting foreign proxies may include the following:
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proxy statements and ballots written in a foreign language;
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Page 3 of 4
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untimely and/or inadequate notice of shareholder meetings;
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restrictions of foreigners ability to exercise votes;
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requirements to vote proxies in person;
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requirements to provide local agents with power of attorney to facilitate CSIMs voting instructions.
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In consideration of the foregoing issues, Glass Lewis uses its best-efforts to vote foreign proxies. As part of its ongoing oversight, the
Proxy Committee will monitor the voting of foreign proxies to determine whether all reasonable steps are taken to vote foreign proxies. If the Proxy Committee determines that the cost associated with the attempt to vote outweighs the potential
benefits clients may derive from voting, the Proxy Committee may decide not to attempt to vote. In addition, certain foreign countries impose restrictions on the sale of securities for a period of time before and/or after the shareholder meeting. To
avoid these trading restrictions, the Proxy Committee instructs Glass Lewis not to vote such foreign proxies.
Securities Lending
Programs
. Certain of the Funds enter into securities lending arrangements with lending agents to generate additional revenue for their portfolios. In securities lending arrangements, any voting rights that accompany the loaned securities
generally pass to the borrower of the securities, but the lender retains the right to recall a security and may then exercise the securitys voting rights. In order to vote the proxies of securities out on loan, the securities must be recalled
prior to the established record date. CSIM will use its best efforts to recall a Funds securities on loan and vote such securities proxies if (a) the proxy relates to a special meeting of shareholders of the issuer (as opposed to
the issuers annual meeting of shareholders), or (b) the Fund owns more than 5% of the outstanding shares of the issuer. Further, it is CSIMs policy to use its best efforts to recall securities on loan and vote such securities
proxies if CSIM determines that the proxies involve a material event affecting the loaned securities. CSIM may utilize third-party service providers to assist it in identifying and evaluating whether an event is material. CSIM may also recall
securities on loan and vote such securities proxies in its discretion.
Sub-Advisory Relationships
. Where CSIM has delegated
day-to-day investment management responsibilities to an investment sub-adviser, CSIM may (but generally does not) delegate proxy voting responsibility to such investment sub-adviser. Each sub-adviser to whom proxy voting responsibility has been
delegated will be required to review all proxy solicitation material and to exercise the voting rights associated with the securities it has been allocated in the best interest of each investment company and its shareholders, or other client. Prior
to delegating the proxy voting responsibility, CSIM will review each sub-advisers proxy voting policy to determine whether it believes that each sub-advisers proxy voting policy is generally consistent with the maximization of economic
benefits to the investment company or other client.
Reporting and Record Retention
CSIM will maintain, or cause Glass Lewis to maintain, records that identify the manner in which proxies have been voted (or not voted) on
behalf of CSIM clients. CSIM will comply with all applicable rules and regulations regarding disclosure of its or its clients proxy voting records and procedures.
CSIM will retain all proxy voting materials and supporting documentation as required under the Investment Advisers Act of 1940 and the rules
and regulations thereunder.
Page 4 of 4
PROXY PAPERTM
GUIDELINES
2014 PROXY SEASON
AN OVERVIEW OF THE GLASS LEWIS APPROACH TO PROXY ADVICE
UNITED STATES
COPYRIGHT 2014 GLASS LEWIS, & CO., LLC
TABLE OF CONTENTS
I
II
III
I. OVERVIEW OF SIGNIFICANT UPDATES FOR 2014
Glass Lewis evaluates these guidelines on an ongoing basis and formally updates them on an annual basis. This year weve made noteworthy
revisions in the following areas, which are summarized below but discussed in greater detail throughout this document:
MAJORITY-APPROVED SHAREHOLDER PROPOSALS SEEKING BOARD DECLASSIFICATION
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We have updated our policy with regard to implementation of majority-approved shareholder proposals seeking board declassification. If a company
fails to implement a shareholder proposal seeking board declassification, which received majority support from shareholders (excluding abstentions and broker non-votes) at the previous years annual meeting, we will consider recommending that
shareholders vote against all nominees up for election that served throughout the previous year, regardless of their committee membership.
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POISON PILLS WITH A TERM OF ONE YEAR OR LESS
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We have refined our policy with regard to short-term poison pills (those with a term of one year or less). If a poison pill with a term of one year
or less was adopted without shareholder approval, we will consider recommending that shareholders vote against all members of the governance committee. If the board has, without seeking shareholder approval, extended the term of a poison pill by one
year or less in two consecutive years, we will consider recommending that shareholders vote against the entire board.
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DUAL-LISTED COMPANIES
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We have clarified our approach to companies whose shares are listed on exchanges in multiple countries, and which may seek shareholder approval of
proposals in accordance with varying exchange- and country-specific rules. In determining which Glass Lewis country-specific policy to apply, we will consider a number of factors, and we will apply the policy standards most relevant in each
situation.
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HEDGING AND PLEDGING OF STOCK
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We have included general discussions of our policies regarding hedging of stock and pledging of shares owned by executives.
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SEC FINAL RULES REGARDING COMPENSATION COMMITTEE MEMBER INDEPENDENCE AND COMPENSATION CONSULTANTS
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We have summarized the SEC requirements for compensation committee member independence and compensation consultant independence, and how these new
rules may affect our evaluation of compensation committee members. These requirements were mandated by Section 952 of the Dodd-Frank Act and formally adopted by the NYSE and NASDAQ in 2013. Companies listed on these exchanges were required to
meet certain basic requirements under the new rules by July 1, 2013, with full compliance by the earlier of their first annual meeting after January 15, 2014, or October 31, 2014.
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1
II. A BOARD OF DIRECTORS THAT SERVES THE INTERESTS OF SHAREHOLDERS
ELECTION OF DIRECTORS
The purpose of Glass Lewis proxy research and advice is to facilitate shareholder voting in favor of governance structures that will
drive performance, create shareholder value and maintain a proper tone at the top. Glass Lewis looks for talented boards with a record of protecting shareholders and delivering value over the medium- and long-term. We believe that a board can best
protect and enhance the interests of shareholders if it is sufficiently independent, has a record of positive performance, and consists of individuals with diverse backgrounds and a breadth and depth of relevant experience.
INDEPENDENCE
The
independence of directors, or lack thereof, is ultimately demonstrated through the decisions they make. In assessing the independence of directors, we will take into consideration, when appropriate, whether a director has a track record indicative
of making objective decisions. Likewise, when assessing the independence of directors we will also examine when a directors service track record on multiple boards indicates a lack of objective decision-making. Ultimately, we believe the
determination of whether a director is independent or not must take into consideration both compliance with the applicable independence listing requirements as well as judgments made by the director.
We look at each director nominee to examine the directors relationships with the company, the companys executives, and other
directors. We do this to evaluate whether personal, familial, or financial relationships (not including director compensation) may impact the directors decisions. We believe that such relationships make it difficult for a director to put
shareholders interests above the directors or the related partys interests. We also believe that a director who owns more than 20% of a company can exert disproportionate influence on the board and, in particular, the audit
committee.
Thus, we put directors into three categories based on an examination of the type of relationship they have with the company:
Independent Director An independent director has no material financial, familial or other current relationships
with the company, its executives, or other board members, except for board service and standard fees paid for that service. Relationships that existed within three to five years
1
before the
inquiry are usually considered current for purposes of this test.
In our view, a director who is currently
serving in an interim management position should be considered an insider, while a director who previously served in an interim management position for less than one year and is no longer serving in such capacity is considered independent. Moreover,
a director who previously served in an interim management position for over one year and is no longer serving in such capacity is considered an affiliate for five years following the date of his/her resignation or departure from the interim
management position. Glass Lewis applies a three-year look-back period to all directors who have an affiliation with the company other than former employment, for which we apply a five-year look-back.
1
|
NASDAQ originally proposed a five-year look-back period but both it and the NYSE ultimately settled on a three-year look-back prior to finalizing
their rules. A five-year standard is more appropriate, in our view, because we believe that the unwinding of conflicting relationships between former management and board members is more likely to be complete and final after five years. However,
Glass Lewis does not apply the five-year look-back period to directors who have previously served as executives of the company on an interim basis for less than one year.
|
2
Affiliated Director An affiliated director has a material financial,
familial or other relationship with the company or its executives, but is not an employee of the company.
2
This includes directors whose employers have a material financial relationship with the
company.
3
In addition, we view a director who owns or controls 20% or more of the companys voting stock as an affiliate.
4
We view 20% shareholders as affiliates because they typically have access to and involvement with the management of a company
that is fundamentally different from that of ordinary shareholders. More importantly, 20% holders may have interests that diverge from those of ordinary holders, for reasons such as the liquidity (or lack thereof) of their holdings, personal tax
issues, etc.
Definition of Material: A material relationship is one in which the dollar value exceeds:
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|
|
$50,000 (or where no amount is disclosed) for directors who are paid for a service they have agreed to perform for the company, outside of their
service as a director, including professional or other services; or
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|
|
|
$120,000 (or where no amount is disclosed) for those directors employed by a professional services firm such as a law firm, investment bank, or
consulting firm and the company pays the firm, not the individual, for services. This dollar limit would also apply to charitable contributions to schools where a board member is a professor; or charities where a director serves on the board or is
an executive;
5
and any aircraft and real estate dealings between the company and the directors firm; or
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|
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|
1% of either companys consolidated gross revenue for other business relationships (e.g., where the director is an executive officer of a
company that provides services or products to or receives services or products from the company).
6
|
Definition of Familial: Familial relationships include a persons spouse, parents, children, siblings, grandparents, uncles,
aunts, cousins, nieces, nephews, in-laws, and anyone (other than domestic employees) who shares such persons home. A director is an affiliate if: i) he or she has a family member who is employed by the company and receives more than $120,000
in annual compensation; or, ii) he or she has a family member who is employed by the company and the company does not disclose this individuals compensation.
Definition of Company: A company includes any parent or subsidiary in a group with the company or any entity that merged with, was
acquired by, or acquired the company.
Inside Director An inside director simultaneously serves as a director and as an employee of
the company. This category may include a chairman of the board who acts as an employee of the company or is paid as an employee of the company. In our view, an inside director who derives a greater amount of income as a result of affiliated
transactions with the company rather than through compensation paid by the company (i.e., salary, bonus, etc. as a company employee) faces a conflict between making decisions that are in the best interests of the company versus those in the
directors own best interests. Therefore, we will recommend voting against such a director.
2
|
If a company classifies one of its non-employee directors as non-independent, Glass Lewis will classify that director as an affiliate.
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3
|
We allow a five-year grace period for former executives of the company or merged companies who have consulting agreements with the surviving
company. (We do not automatically recommend voting against directors in such cases for the first five years.) If the consulting agreement persists after this five-year grace period, we apply the materiality thresholds outlined in the definition of
material.
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4
|
This includes a director who serves on a board as a representative (as part of his or her basic responsibilities) of an in-vestment firm with
greater than 20% ownership. However, while we will generally consider him/her to be affiliated, we will not recommend voting against unless (i) the investment firm has disproportionate board representation or (ii) the director serves on
the audit committee.
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5
|
We will generally take into consideration the size and nature of such charitable entities in relation to the companys size and industry along
with any other relevant factors such as the directors role at the charity. However, unlike for other types of related party transactions, Glass Lewis generally does not apply a look-back period to affiliated relationships involving charitable
contributions; if the relationship between the director and the school or charity ceases, or if the company discontinues its donations to the entity, we will consider the director to be independent.
|
6
|
This includes cases where a director is employed by, or closely affiliated with, a private equity firm that profits from an acquisition made by the
company. Unless disclosure suggests otherwise, we presume the director is affiliated.
|
3
VOTING RECOMMENDATIONS ON THE BASIS OF BOARD INDEPENDENCE
Glass Lewis believes a board will be most effective in protecting shareholders interests if it is at least two-thirds independent. We
note that each of the Business Roundtable, the Conference Board, and the Council of Institutional Investors advocates that two-thirds of the board be independent. Where more than one-third of the members are affiliated or inside directors, we
typically
7
recommend voting against some of the inside and/or affiliated directors in order to satisfy the two-thirds threshold.
In the case of a less than two-thirds independent board, Glass Lewis strongly supports the existence of a presiding or lead director with
authority to set the meeting agendas and to lead sessions outside the insider chairmans presence.
In addition, we scrutinize
avowedly independent chairmen and lead directors. We believe that they should be unquestionably independent or the company should not tout them as such.
COMMITTEE INDEPENDENCE
We believe that only independent directors should serve on a companys audit, compensation, nominating, and governance committees.
8
We typically recommend that shareholders vote against any affiliated or inside director seeking appointment to an audit, compensation, nominating, or governance committee, or who has served in that
capacity in the past year.
Pursuant to Section 952 of the Dodd-Frank Act, as of January 11, 2013, the SEC approved new listing
requirements for both the NYSE and NASDAQ which require that boards apply enhanced standards of independence when making an affirmative determination of the independence of compensation committee members. Specifically, when making this
determination, in addition to the factors considered when assessing general director independence, the boards considerations must include: (i) the source of compensation of the director, including any consulting, advisory or other
compensatory fee paid by the listed company to the director (the Fees Factor); and (ii) whether the director is affiliated with the listing company, its subsidiaries, or affiliates of its subsidiaries (the Affiliation
Factor).
Glass Lewis believes it is important for boards to consider these enhanced independence factors when assessing
compensation committee members. However, as discussed above in the section titled Independence, we apply our own standards when assessing the independence of directors, and these standards also take into account consulting and advisory fees paid to
the director, as well as the directors affiliations with the company and its subsidiaries and affiliates. We may recommend voting against compensation committee members who are not independent based on our standards.
INDEPENDENT CHAIRMAN
Glass Lewis believes that separating the roles of CEO (or, more rarely, another executive position) and chairman creates a better governance
structure than a combined CEO/chairman position. An executive manages the business according to a course the board charts. Executives should report to the board regarding their performance in achieving goals set by the board. This is needlessly
complicated when a CEO chairs the board, since a CEO/chairman presumably will have a significant influence over the board.
It can become
difficult for a board to fulfill its role of overseer and policy setter when a CEO/chairman controls the agenda and the boardroom discussion. Such control can allow a CEO to have an entrenched position, leading to longer-than-optimal terms, fewer
checks on management, less scrutiny of the business operation, and limitations on independent, shareholder-focused goal-setting by the board.
7
|
With a staggered board, if the affiliates or insiders that we believe should not be on the board are not up for election, we will express our
concern regarding those directors, but we will not recommend voting against the other affiliates or insiders who are up for election just to achieve two-thirds independence. However, we will consider recommending voting against the directors subject
to our concern at their next election if the concerning issue is not resolved.
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8
|
We will recommend voting against an audit committee member who owns 20% or more of the companys stock, and we believe that there should be a
maximum of one director (or no directors if the committee is comprised of less than three directors) who owns 20% or more of the companys stock on the compensation, nominating, and governance committees.
|
4
A CEO should set the strategic course for the company, with the boards approval, and
the board should enable the CEO to carry out the CEOs vision for accomplishing the boards objectives. Failure to achieve the boards objectives should lead the board to replace that CEO with someone in whom the board has confidence.
Likewise, an independent chairman can better oversee executives and set a pro-shareholder agenda without the management conflicts that a
CEO and other executive insiders often face. Such oversight and concern for shareholders allows for a more proactive and effective board of directors that is better able to look out for the interests of shareholders.
Further, it is the boards responsibility to select a chief executive who can best serve a company and its shareholders and to replace
this person when his or her duties have not been appropriately fulfilled. Such a replacement becomes more difficult and happens less frequently when the chief executive is also in the position of overseeing the board.
Glass Lewis believes that the installation of an independent chairman is almost always a positive step from a corporate governance perspective
and promotes the best interests of shareholders. Further, the presence of an independent chairman fosters the creation of a thoughtful and dynamic board, not dominated by the views of senior management. Encouragingly, many companies appear to be
moving in this directionone study even indicates that less than 12 percent of incoming CEOs in 2009 were awarded the chairman title, versus 48 percent as recently as 2002.
9
Another study
finds that 45 percent of S&P 500 boards now separate the CEO and chairman roles, up from 23 percent in 2003, although the same study found that of those companies, only 25 percent have truly independent chairs.
10
We do not recommend that shareholders vote against CEOs who chair the board. However,
we typically recommend that our clients support separating the roles of chairman and CEO whenever that question is posed in a proxy (typically in the form of a shareholder proposal), as we believe that it is in the long-term best interests of the
company and its shareholders.
PERFORMANCE
The most crucial test of a boards commitment to the company and its shareholders lies in the actions of the board and its members. We
look at the performance of these individuals as directors and executives of the company and of other companies where they have served.
VOTING RECOMMENDATIONS ON THE BASIS OF PERFORMANCE
We disfavor directors who have a record of not fulfilling their responsibilities to
shareholders at any company where they have held a board or executive position. We typically recommend voting against:
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1.
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A director who fails to attend a minimum of 75% of board and applicable committee meetings, calculated in the aggregate.
11
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2.
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A director who belatedly filed a significant form(s) 4 or 5, or who has a pattern of late filings if the late filing was the directors fault
(we look at these late filing situations on a case-by-case basis).
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9
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Ken Favaro, Per-Ola Karlsson and Gary Neilson. CEO Succession 2000-2009: A Decade of Convergence and Compression. Booz &
Company (from Strategy+Business, Issue 59, Summer 2010).
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10
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Spencer Stuart Board Index, 2013, p. 5
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11
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However, where a director has served for less than one full year, we will typically not recommend voting against for failure to attend 75% of
meetings. Rather, we will note the poor attendance with a recommendation to track this issue going forward. We will also refrain from recommending to vote against directors when the proxy discloses that the director missed the meetings due to
serious illness or other extenuating circumstances.
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5
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3.
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A director who is also the CEO of a company where a serious and material restatement has occurred after the CEO had previously certified the
pre-restatement financial statements.
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4.
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A director who has received two against recommendations from Glass Lewis for identical reasons within the prior year at different companies (the
same situation must also apply at the company being analyzed).
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5.
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All directors who served on the board if, for the last three years, the companys performance has been in the bottom quartile of the sector
and the directors have not taken reasonable steps to address the poor performance.
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BOARD RESPONSIVENESS
Glass Lewis believes that any time 25% or more of shareholders vote contrary to the recommendation of management, the board should, depending
on the issue, demonstrate some level of responsiveness to address the concerns of shareholders. These include instances when 25% or more of shareholders (excluding abstentions and broker non-votes): WITHOLD votes from (or vote AGAINST) a director
nominee, vote AGAINST a management-sponsored proposal, or vote FOR a shareholder proposal. In our view, a 25% threshold is significant enough to warrant a close examination of the underlying issues and an evaluation of whether or not a board
response was warranted and, if so, whether the board responded appropriately following the vote. While the 25% threshold alone will not automatically generate a negative vote recommendation from Glass Lewis on a future proposal (e.g. to recommend
against a director nominee, against a say-on-pay proposal, etc.), it may be a contributing factor if we recommend to vote against managements recommendation in the event we determine that the board did not respond appropriately.
As a general framework, our evaluation of board responsiveness involves a review of publicly available disclosures (e.g. the proxy statement,
annual report, 8-Ks, company website, etc.) released following the date of the companys last annual meeting up through the publication date of our most current Proxy Paper. Depending on the specific issue, our focus typically includes, but is
not limited to, the following:
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At the board level, any changes in directorships, committee memberships, disclosure of related party transactions, meeting attendance, or other
responsibilities;
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Any revisions made to the companys articles of incorporation, bylaws or other governance documents;
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Any press or news releases indicating changes in, or the adoption of, new company policies, business practices or special reports; and
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Any modifications made to the design and structure of the companys compensation program.
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Our Proxy Paper analysis will include a case-by-case assessment of the specific elements of board responsiveness that we examined along with
an explanation of how that assessment impacts our current vote recommendations.
THE ROLE OF A COMMITTEE CHAIRMAN
Glass Lewis believes that a designated committee chairman maintains primary responsibility for the actions of his or her respective committee.
As such, many of our committee-specific vote recommendations deal with the applicable committee chair rather than the entire committee (depending on the seriousness of the issue). However, in cases where we would ordinarily recommend voting against
a committee chairman but the chair is not specified, we apply the following general rules, which apply throughout our guidelines:
6
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If there is no committee chair, we recommend voting against the longest-serving committee member or, if the longest-serving committee member cannot
be determined, the longest-serving board member serving on the committee (i.e. in either case, the senior director); and
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If there is no committee chair, but multiple senior directors serving on the committee, we recommend voting against both (or all) such senior
directors.
|
In our view, companies should provide clear disclosure of which director is charged with overseeing each
committee. In cases where that simple framework is ignored and a reasonable analysis cannot determine which committee member is the designated leader, we believe shareholder action against the longest serving committee member(s) is warranted. Again,
this only applies if we would ordinarily recommend voting against the committee chair but there is either no such position or no designated director in such role.
On the contrary, in cases where there is a designated committee chair and the recommendation is to vote against the committee chair, but the
chair is not up for election because the board is staggered, we do not recommend voting against any members of the committee who are up for election; rather, we will simply express our concern with regard to the committee chair.
AUDIT COMMITTEES AND PERFORMANCE
Audit committees play an integral role in overseeing the financial reporting process because [v]ibrant and stable capital markets depend
on, among other things, reliable, transparent, and objective financial information to support an efficient and effective capital market process. The vital oversight role audit committees play in the process of producing financial information has
never been more important.
12
When assessing an audit committees
performance, we are aware that an audit committee does not prepare financial statements, is not responsible for making the key judgments and assumptions that affect the financial statements, and does not audit the numbers or the disclosures provided
to investors. Rather, an audit committee member monitors and oversees the process and procedures that management and auditors perform. The 1999 Report and Recommendations of the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit
Committees stated it best:
A proper and well-functioning system exists, therefore, when the three main groups
responsible for financial reporting the full board including the audit committee, financial management including the internal auditors, and the outside auditors form a three legged stool that supports responsible financial
disclosure and active participatory oversight. However, in the view of the Committee, the audit committee must be first among equals in this process, since the audit committee is an extension of the full board and hence the ultimate
monitor of the process.
STANDARDS FOR ASSESSING THE AUDIT COMMITTEE
For an audit committee to function effectively on investors behalf, it must include members with sufficient knowledge to diligently carry
out their responsibilities. In its audit and accounting recommendations, the Conference Board Commission on Public Trust and Private Enterprise said members of the audit committee must be independent and have both knowledge and experience in
auditing financial matters.
13
12
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Audit Committee Effectiveness What Works Best. PricewaterhouseCoopers. The Institute of Internal Auditors Research Foundation. 2005.
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13
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Commission on Public Trust and Private Enterprise. The Conference Board. 2003.
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7
We are skeptical of audit committees where there are members that lack expertise as a
Certified Public Accountant (CPA), Chief Financial Officer (CFO) or corporate controller, or similar experience. While we will not necessarily vote against members of an audit committee when such expertise is lacking, we are more likely to vote
against committee members when a problem such as a restatement occurs and such expertise is lacking.
Glass Lewis generally assesses audit
committees against the decisions they make with respect to their oversight and monitoring role. The quality and integrity of the financial statements and earnings reports, the completeness of disclosures necessary for investors to make informed
decisions, and the effectiveness of the internal controls should provide reasonable assurance that the financial statements are materially free from errors. The independence of the external auditors and the results of their work all provide useful
information by which to assess the audit committee.
When assessing the decisions and actions of the audit committee, we typically defer
to its judgment and would vote in favor of its members, but we would recommend voting against the following members under the following circumstances:
14
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1.
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All members of the audit committee when options were backdated, there is a lack of adequate controls in place, there was a resulting restatement,
and disclosures indicate there was a lack of documentation with respect to the option grants.
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2.
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The audit committee chair, if the audit committee does not have a financial expert or the committees financial expert does not have a
demonstrable financial background sufficient to understand the financial issues unique to public companies.
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3.
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The audit committee chair, if the audit committee did not meet at least 4 times during the year.
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4.
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The audit committee chair, if the committee has less than three members.
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5.
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Any audit committee member who sits on more than three public company audit committees, unless the audit committee member is a retired CPA, CFO,
controller or has similar experience, in which case the limit shall be four committees, taking time and availability into consideration including a review of the audit committee members attendance at all board and committee meetings.
15
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6.
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All members of an audit committee who are up for election and who served on the committee at the time of the audit, if audit and audit-related fees
total one-third or less of the total fees billed by the auditor.
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7.
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The audit committee chair when tax and/or other fees are greater than audit and audit-related fees paid to the auditor for more than one year in a
row (in which case we also recommend against ratification of the auditor).
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8.
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All members of an audit committee where non-audit fees include fees for tax services (including, but not limited to, such things as tax avoidance
or shelter schemes) for senior executives of the company. Such services are prohibited by the Public Company Accounting Oversight Board (PCAOB).
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9.
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All members of an audit committee that reappointed an auditor that we no longer consider to be independent for reasons unrelated to fee
proportions.
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14
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As discussed under the section labeled Committee Chairman, where the recommendation is to vote against the committee chair but the
chair is not up for election because the board is staggered, we do not recommend voting against the members of the committee who are up for election; rather, we will simply express our concern with regard to the committee chair.
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15
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Glass Lewis may exempt certain audit committee members from the above threshold if, upon further analysis of relevant factors such as the
directors experience, the size, industry-mix and location of the companies involved and the directors attendance at all the companies, we can reasonably determine that the audit committee member is likely not hindered by multiple audit
committee commitments.
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8
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10.
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All members of an audit committee when audit fees are excessively low, especially when compared with other companies in the same industry.
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11.
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The audit committee chair
16
if the committee failed to put auditor ratification on the ballot
for shareholder approval. However, if the non-audit fees or tax fees exceed audit plus audit-related fees in either the current or the prior year, then Glass Lewis will recommend voting against the entire audit committee.
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12.
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All members of an audit committee where the auditor has resigned and reported that a section
10A
17
letter has been issued.
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13.
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All members of an audit committee at a time when material accounting fraud occurred at the
company.
18
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14.
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All members of an audit committee at a time when annual and/or multiple quarterly financial statements had to be restated, and any of the following
factors apply:
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The restatement involves fraud or manipulation by insiders;
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The restatement is accompanied by an SEC inquiry or investigation;
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The restatement involves revenue recognition;
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The restatement results in a greater than 5% adjustment to costs of goods sold, operating expense, or operating cash flows; or
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The restatement results in a greater than 5% adjustment to net income, 10% adjustment to assets or shareholders equity, or cash flows from
financing or investing activities.
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15.
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All members of an audit committee if the company repeatedly fails to file its financial reports in a timely fashion. For example, the company has
filed two or more quarterly or annual financial statements late within the last 5 quarters.
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16.
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All members of an audit committee when it has been disclosed that a law enforcement agency has charged the company and/or its employees with a
violation of the Foreign Corrupt Practices Act (FCPA).
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17.
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All members of an audit committee when the company has aggressive accounting policies and/ or poor disclosure or lack of sufficient transparency in
its financial statements.
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18.
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All members of the audit committee when there is a disagreement with the auditor and the auditor resigns or is dismissed (e.g., the company
receives an adverse opinion on its financial statements from the auditor).
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19.
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All members of the audit committee if the contract with the auditor specifically limits the auditors liability to the company for damages.
19
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16
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As discussed under the section labeled Committee Chairman, in all cases, if the chair of the committee is not specified, we recommend
voting against the director who has been on the committee the longest.
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17
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Auditors are required to report all potential illegal acts to management and the audit committee unless they are clearly inconsequential in nature.
If the audit committee or the board fails to take appropriate action on an act that has been determined to be a violation of the law, the independent auditor is required to send a section 10A letter to the SEC. Such letters are rare and therefore we
believe should be taken seriously.
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18
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Recent research indicates that revenue fraud now accounts for over 60% of SEC fraud cases, and that companies that engage in fraud experience
significant negative abnormal stock price declinesfacing bankruptcy, delisting, and material asset sales at much higher rates than do non-fraud firms (Committee of Sponsoring Organizations of the Treadway Commission. Fraudulent Financial
Reporting: 1998-2007. May 2010).
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19
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The Council of Institutional Investors. Corporate Governance Policies, p. 4, April 5, 2006; and Letter from Council of
Institutional Investors to the AICPA, November 8, 2006.
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9
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20.
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All members of the audit committee who served since the date of the companys last annual meeting, and when, since the last annual meeting,
the company has reported a material weakness that has not yet been corrected, or, when the company has an ongoing material weakness from a prior year that has not yet been corrected.
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We also take a dim view of audit committee reports that are boilerplate, and which provide little or no information or transparency to
investors. When a problem such as a material weakness, restatement or late filings occurs, we take into consideration, in forming our judgment with respect to the audit committee, the transparency of the audit committee report.
COMPENSATION COMMITTEE PERFORMANCE
Compensation committees have the final say in determining the compensation of executives. This includes deciding the basis on which
compensation is determined, as well as the amounts and types of compensation to be paid. This process begins with the hiring and initial establishment of employment agreements, including the terms for such items as pay, pensions and severance
arrangements. It is important in establishing compensation arrangements that compensation be consistent with, and based on the long-term economic performance of, the businesss long-term shareholders returns.
Compensation committees are also responsible for the oversight of the transparency of compensation. This oversight includes disclosure of
compensation arrangements, the matrix used in assessing pay for performance, and the use of compensation consultants. In order to ensure the independence of the compensation consultant, we believe the compensation committee should only engage a
compensation consultant that is not also providing any services to the company or management apart from their contract with the compensation committee. It is important to investors that they have clear and complete disclosure of all the significant
terms of compensation arrangements in order to make informed decisions with respect to the oversight and decisions of the compensation committee.
Finally, compensation committees are responsible for oversight of internal controls over the executive compensation process. This includes
controls over gathering information used to determine compensation, establishment of equity award plans, and granting of equity awards. For example, the use of a compensation consultant who maintains a business relationship with company management
may cause the committee to make decisions based on information that is compromised by the consultants conflict of interests. Lax controls can also contribute to improper awards of compensation such as through granting of backdated or
spring-loaded options, or granting of bonuses when triggers for bonus payments have not been met.
Central to understanding the actions of
a compensation committee is a careful review of the Compensation Discussion and Analysis (CD&A) report included in each companys proxy. We review the CD&A in our evaluation of the overall compensation practices of a
company, as overseen by the compensation committee. The CD&A is also integral to the evaluation of compensation proposals at companies, such as advisory votes on executive compensation, which allow shareholders to vote on the compensation paid
to a companys top executives.
When assessing the performance of compensation committees, we will recommend voting against for the following:
20
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1.
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All members of the compensation committee who are up for election and served at the time of poor pay-for-performance (e.g., a company receives an F
grade in our pay-for-performance analysis) when shareholders are not provided with an advisory vote on executive compensation at the annual meeting.
21
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20
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As discussed under the section labeled Committee Chairman, where the recommendation is to vote against the committee chair and the
chair is not up for election because the board is staggered, we do not recommend voting against any members of the committee who are up for election; rather, we will simply express our concern with regard to the committee chair.
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21
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Where there are multiple CEOs in one year, we will consider not recommending against the compensation committee but will defer judgment on
compensation policies and practices until the next year or a full year after arrival of the new CEO. In addition, if a company provides shareholders with a say-on-pay proposal and receives an F grade in our pay-for-performance model, we will
recommend that shareholders only vote against the say-on-pay proposal rather than the members of the compensation committee, unless the company exhibits egregious practices. However, if the company receives successive F grades, we will then
recommend against the members of the compensation committee in addition to recommending voting against the say-on-pay proposal.
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10
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2.
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Any member of the compensation committee who has served on the compensation committee of at least two other public companies that received F grades
in our pay-for-performance model and whose oversight of compensation at the company in question is suspect.
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3.
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The compensation committee chair if the company received two D grades in consecutive years in our pay-for-performance analysis, and if during the
past year the company performed the same as or worse than its peers.
22
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4.
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All members of the compensation committee (during the relevant time period) if the company entered into excessive employment agreements and/or
severance agreements.
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5.
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All members of the compensation committee when performance goals were changed (i.e., lowered) when employees failed or were unlikely to meet
original goals, or performance-based compensation was paid despite goals not being attained.
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6.
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All members of the compensation committee if excessive employee perquisites and benefits were allowed.
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7.
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The compensation committee chair if the compensation committee did not meet during the year, but should have (e.g., because executive compensation
was restructured or a new executive was hired).
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8.
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All members of the compensation committee when the company repriced options or completed a self tender offer without shareholder
approval within the past two years.
|
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9.
|
All members of the compensation committee when vesting of in-the-money options is accelerated.
|
|
10.
|
All members of the compensation committee when option exercise prices were backdated. Glass Lewis will recommend voting against an executive
director who played a role in and participated in option backdating.
|
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11.
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All members of the compensation committee when option exercise prices were spring-loaded or otherwise timed around the release of material
information.
|
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12.
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All members of the compensation committee when a new employment contract is given to an executive that does not include a clawback provision and
the company had a material restatement, especially if the restatement was due to fraud.
|
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13.
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The chair of the compensation committee where the CD&A provides insufficient or unclear information about performance metrics and goals, where
the CD&A indicates that pay is not tied to performance, or where the compensation committee or management has excessive discretion to alter performance terms or increase amounts of awards in contravention of previously defined targets.
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22
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In cases where a company has received two consecutive D grades, or if its grade improved from an F to a D in the most recent period, and during the
most recent year the company performed better than its peers (based on our analysis), we refrain from recommending to vote against the compensation committee chair. In addition, if a company provides shareholders with a say-on-pay proposal in this
instance, we will consider voting against the advisory vote rather than the compensation committee chair unless the company exhibits unquestionably egregious practices.
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11
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14.
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All members of the compensation committee during whose tenure the committee failed to implement a shareholder proposal regarding a
compensation-related issue, where the proposal received the affirmative vote of a majority of the voting shares at a shareholder meeting, and when a reasonable analysis suggests that the compensation committee (rather than the governance committee)
should have taken steps to implement the request.
23
|
|
15.
|
All members of a compensation committee during whose tenure the committee failed to address shareholder concerns following majority shareholder
rejection of the say-on-pay proposal in the previous year. Where the proposal was approved but there was a significant shareholder vote (i.e., greater than 25% of votes cast) against the say-on-pay proposal in the prior year, if there is no evidence
that the board responded accordingly to the vote including actively engaging shareholders on this issue, we will also consider recommending voting against the chairman of the compensation committee or all members of the compensation committee,
depending on the severity and history of the compensation problems and the level of opposition.
|
NOMINATING
AND GOVERNANCE COMMITTEE PERFORMANCE
The nominating and governance committee, as an agency for the shareholders, is responsible for the
governance by the board of the company and its executives. In performing this role, the board is responsible and accountable for selection of objective and competent board members. It is also responsible for providing leadership on governance
policies adopted by the company, such as decisions to implement shareholder proposals that have received a majority vote. (At most companies, a single committee is charged with these oversight functions; at others, the governance and nominating
responsiblities are apportioned among two separate committees.)
Consistent with Glass Lewis philosophy that boards should have
diverse backgrounds and members with a breadth and depth of relevant experience, we believe that nominating and governance committees should consider diversity when making director nominations within the context of each specific company and its
industry. In our view, shareholders are best served when boards make an effort to ensure a constituency that is not only reasonably diverse on the basis of age, race, gender and ethnicity, but also on the basis of geographic knowledge, industry
experience and culture.
Regarding the committee responsible for governance, we will recommend voting against the following:
24
|
1.
|
All members of the governance committee
25
during whose tenure the board failed to implement a
shareholder proposal with a direct and substantial impact on shareholders and their rights i.e., where the proposal received enough shareholder votes (at least a majority) to allow the board to implement or begin to implement that proposal.
26
Examples of these types of shareholder proposals are majority vote to elect directors and to declassify the board.
|
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2.
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The governance committee chair,
27
when the chairman is not independent and an independent lead
or presiding director has not been appointed.
28
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23
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In all other instances (i.e., a non-compensation-related shareholder proposal should have been implemented) we recommend that shareholders vote
against the members of the governance committee.
|
24
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As discussed in the guidelines section labeled Committee Chairman, where we would recommend to vote against the committee chair but the
chair is not up for election because the board is staggered, we do not recommend voting against any members of the committee who are up for election; rather, we will simply express our concern regarding the committee chair.
|
25
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If the board does not have a committee responsible for governance oversight and the board did not implement a shareholder proposal that received
the requisite support, we will recommend voting against the entire board. If the shareholder proposal at issue requested that the board adopt a declassified structure, we will recommend voting against all director nominees up for election.
|
26
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Where a compensation-related shareholder proposal should have been implemented, and when a reasonable analysis suggests that the members of the
compensation committee (rather than the governance committee) bear the responsibility for failing to implement the request, we recommend that shareholders only vote against members of the compensation committee.
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27
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As discussed in the guidelines section labeled Committee Chairman, if the committee chair is not specified, we recommend voting against
the director who has been on the committee the longest. If the longest-serving committee member cannot be determined, we will recommend voting against the longest-serving board member serving on the committee.
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28
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We believe that one independent individual should be appointed to serve as the lead or presiding director. When such a position is rotated among
directors from meeting to meeting, we will recommend voting against as if there were no lead or presiding director.
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12
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3.
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In the absence of a nominating committee, the governance committee chair when there are less than five or the whole nominating committee when there
are more than 20 members on the board.
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4.
|
The governance committee chair, when the committee fails to meet at all during the year.
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5.
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The governance committee chair, when for two consecutive years the company provides what we consider to be inadequate related party
transaction disclosure (i.e., the nature of such transactions and/or the monetary amounts involved are unclear or excessively vague, thereby preventing a shareholder from being able to reasonably interpret the independence status of multiple
directors above and beyond what the company maintains is compliant with SEC or applicable stock exchange listing requirements).
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6.
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The governance committee chair, when during the past year the board adopted a forum selection clause (i.e., an exclusive forum provision)
29
without shareholder approval, or, if the board is currently seeking shareholder approval of a forum selection clause pursuant to a bundled bylaw amendment rather than as a separate proposal.
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Regarding the nominating committee, we will recommend voting against the following:
30
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1.
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All members of the nominating committee, when the committee nominated or renominated an individual who had a significant conflict of interest or
whose past actions demonstrated a lack of integrity or inability to represent shareholder interests.
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2.
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The nominating committee chair, if the nominating committee did not meet during the year, but should have (i.e., because new directors were
nominated or appointed since the time of the last annual meeting).
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3.
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In the absence of a governance committee, the nominating committee chair
31
when the chairman
is not independent, and an independent lead or presiding director has not been appointed.
32
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4.
|
The nominating committee chair, when there are less than five or the whole nominating committee when there are more than 20 members on the board.
33
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5.
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The nominating committee chair, when a director received a greater than 50% against vote the prior year and not only was the director not removed,
but the issues that raised shareholder concern were not corrected.
34
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29
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A forum selection clause is a bylaw provision stipulating that a certain state, typically Delaware, shall be the exclusive forum for all
intra-corporate disputes (e.g. shareholder derivative actions, assertions of claims of a breach of fiduciary duty, etc.). Such a clause effectively limits a shareholders legal remedy regarding appropriate choice of venue and related relief
offered under that states laws and rulings.
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30
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As discussed in the guidelines section labeled Committee Chairman, where we would recommend to vote against the committee chair but the
chair is not up for election because the board is staggered, we do not recommend voting against any members of the committee who are up for election; rather, we will simply express our concern regarding the committee chair.
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31
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As discussed under the section labeled Committee Chairman, if the committee chair is not specified, we will recommend voting against
the director who has been on the committee the longest. If the longest-serving committee member cannot be determined, we will recommend voting against the longest-serving board member on the committee.
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32
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In the absence of both a governance and a nominating committee, we will recommend voting against the chairman of the board on this basis, unless if
the chairman also serves as the CEO, in which case we will recommend voting against the director who has served on the board the longest.
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33
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In the absence of both a governance and a nominating committee, we will recommend voting against the chairman of the board on this basis, unless if
the chairman also serves as the CEO, in which case we will recommend voting against the director who has served on the board the longest.
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34
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Considering that shareholder discontent clearly relates to the director who received a greater than 50% against vote rather than the nominating
chair, we review the validity of the issue(s) that initially raised shareholder concern, follow-up on such matters, and only recommend voting against the nominating chair if a reasonable analysis suggests that it would be most appropriate. In rare
cases, we will consider recommending against the nominating chair when a director receives a substantial (i.e., 25% or more) vote against based on the same analysis.
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13
BOARD-LEVEL RISK MANAGEMENT OVERSIGHT
Glass Lewis evaluates the risk management function of a public company board on a strictly case-by-case basis. Sound risk management, while
necessary at all companies, is particularly important at financial firms which inherently maintain significant exposure to financial risk. We believe such financial firms should have a chief risk officer reporting directly to the board and a
dedicated risk committee or a committee of the board charged with risk oversight. Moreover, many non-financial firms maintain strategies which involve a high level of exposure to financial risk. Similarly, since many non-financial firms have complex
hedging or trading strategies, those firms should also have a chief risk officer and a risk committee.
Our views on risk oversight are
consistent with those expressed by various regulatory bodies. In its December 2009 Final Rule release on Proxy Disclosure Enhancements, the SEC noted that risk oversight is a key competence of the board and that additional disclosures would improve
investor and shareholder understanding of the role of the board in the organizations risk management practices. The final rules, which became effective on February 28, 2010, now explicitly require companies and mutual funds to describe
(while allowing for some degree of flexibility) the boards role in the oversight of risk.
When analyzing the risk management
practices of public companies, we take note of any significant losses or writedowns on financial assets and/or structured transactions. In cases where a company has disclosed a sizable loss or writedown, and where we find that the companys
board-level risk committee contributed to the loss through poor oversight, we would recommend that shareholders vote against such committee members on that basis. In addition, in cases where a company maintains a significant level of financial risk
exposure but fails to disclose any explicit form of board-level risk oversight (committee or otherwise)
35
, we will consider recommending to vote against the chairman of the board on that basis.
However, we generally would not recommend voting against a combined chairman/CEO, except in egregious cases.
EXPERIENCE
We find that a directors past conduct is often indicative of future conduct and performance. We often find directors with a history of
overpaying executives or of serving on boards where avoidable disasters have occurred appearing at companies that follow these same patterns. Glass Lewis has a proprietary database of directors serving at over 8,000 of the most widely held U.S.
companies. We use this database to track the performance of directors across companies.
Voting Recommendations on the Basis of Director Experience
We typically recommend that shareholders vote against directors who have served on boards or as executives of companies with records of poor
performance, inadequate risk oversight, excessive compensation, audit- or accounting-related issues, and/or other indicators of mismanagement or actions against the interests of shareholders.
36
Likewise, we examine the backgrounds of those who serve on key board committees to ensure that they have the required skills and diverse
backgrounds to make informed judgments about the subject matter for which the committee is responsible.
OTHER CONSIDERATIONS
In addition to the three key characteristics independence, performance, experience that we use to evaluate board members, we
consider conflict-of-interest issues as well as the size of the board of directors when making voting recommendations.
35
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A committee responsible for risk management could be a dedicated risk committee, the audit committee, or the finance committee, depending on a
given companys board structure and method of disclosure. At some companies, the entire board is charged with risk management.
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36
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We typically apply a three-year look-back to such issues and also take into account the level of support the director has received from
shareholders since the time of the failure.
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14
Conflicts of Interest
We believe board members should be wholly free of identifiable and substantial conflicts of interest, regardless of the overall level of
independent directors on the board. Accordingly, we recommend that shareholders vote against the following types of directors:
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1.
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A CFO who is on the board: In our view, the CFO holds a unique position relative to financial reporting and disclosure to shareholders. Due to the
critical importance of financial disclosure and reporting, we believe the CFO should report to the board and not be a member of it.
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2.
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A director who is on an excessive number of boards: We will typically recommend voting against a director who serves as an executive officer of any
public company while serving on more than two other public company boards and any other director who serves on more than six public company boards.
37
Academic literature suggests that one board
takes up approximately 200 hours per year of each members time. We believe this limits the number of boards on which directors can effectively serve, especially executives at other
companies.
38
Further, we note a recent study has shown that the average number of outside board seats held by CEOs of S&P 500 companies is 0.6, down from 0.7 in 2008 and 1.0 in 2003.
39
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3.
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A director, or a director who has an immediate family member, providing material consulting or other material professional services to the company:
These services may include legal, consulting, or financial services. We question the need for the company to have consulting relationships with its directors. We view such relationships as creating conflicts for directors, since they may be forced
to weigh their own interests against shareholder interests when making board decisions. In addition, a companys decisions regarding where to turn for the best professional services may be compromised when doing business with the professional
services firm of one of the companys directors.
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4.
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A director, or a director who has an immediate family member, engaging in airplane, real estate, or similar deals, including perquisite-type grants
from the company, amounting to more than $50,000. Directors who receive these sorts of payments from the company will have to make unnecessarily complicated decisions that may pit their interests against shareholder interests.
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5.
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Interlocking directorships: CEOs or other top executives who serve on each others boards create an interlock that poses conflicts that should
be avoided to ensure the promotion of shareholder interests above all else.
40
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6.
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All board members who served at a time when a poison pill with a term of longer than one year was adopted without shareholder approval within the
prior twelve months.
41
In the event a board is classified and shareholders are therefore unable to vote against all directors, we will recommend voting against the remaining directors the next
year they are up for a shareholder vote. If a poison pill with a term of one year or less was adopted without shareholder approval, and without adequate justification, we will consider recommending that shareholders vote against all members of the
governance committee. If the board has, without seeking shareholder approval, and without adequate justification, extended the term of a poison pill by one year or less in two consecutive years, we will consider recommending that shareholders vote
against the entire board.
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37
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Glass Lewis will not recommend voting against the director at the company where he or she serves as an executive officer, only at the other public
companies where he or she serves on the board.
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38
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Our guidelines are similar to the standards set forth by the NACD in its Report of the NACD Blue Ribbon Commission on Director
Professionalism, 2001 Edition, pp. 14-15 (also cited approvingly by the Conference Board in its Corporate Governance Best Practices: A Blueprint for the Post-Enron Era, 2002, p. 17), which suggested that CEOs should not serve on
more than 2 additional boards, persons with full-time work should not serve on more than 4 additional boards, and others should not serve on more than six boards.
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39
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Spencer Stuart Board Index, 2013, p. 6.
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40
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We do not apply a look-back period for this situation. The interlock policy applies to both public and private companies. We will also evaluate
multiple board interlocks among non-insiders (i.e., multiple directors serving on the same boards at other companies), for evidence of a pattern of poor oversight.
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41
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Refer to Section V. Governance Structure and the Shareholder Franchise for further discussion of our policies regarding anti-takeover measures,
including poison pills.
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15
Size of the Board of Directors
While we do not believe there is a universally applicable optimum board size, we do believe boards should have at least five directors to
ensure sufficient diversity in decision-making and to enable the formation of key board committees with independent directors. Conversely, we believe that boards with more than 20 members will typically suffer under the weight of too many
cooks in the kitchen and have difficulty reaching consensus and making timely decisions. Sometimes the presence of too many voices can make it difficult to draw on the wisdom and experience in the room by virtue of the need to limit the
discussion so that each voice may be heard.
To that end, we typically recommend voting against the chairman of the nominating committee
at a board with fewer than five directors. With boards consisting of more than 20 directors, we typically recommend voting against all members of the nominating committee (or the governance committee, in the absence of a nominating committee).
42
CONTROLLED COMPANIES
Controlled companies present an exception to our independence recommendations. The boards function is to protect shareholder interests;
however, when an individual or entity owns more than 50% of the voting shares, the interests of the majority of shareholders are the interests of that entity or individual. Consequently, Glass Lewis does not apply our usual two-thirds independence
rule and therefore we will not recommend voting against boards whose composition reflects the makeup of the shareholder population.
Independence
Exceptions
The independence exceptions that we make for controlled companies are as follows:
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1.
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We do not require that controlled companies have boards that are at least two-thirds independent. So long as the insiders and/or affiliates are
connected with the controlling entity, we accept the presence of non-independent board members.
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2.
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The compensation committee and nominating and governance committees do not need to consist solely of independent directors.
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We believe that standing nominating and corporate governance committees at controlled companies are unnecessary. Although having a committee
charged with the duties of searching for, selecting, and nominating independent directors can be beneficial, the unique composition of a controlled companys shareholder base makes such committees weak and irrelevant.
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Likewise, we believe that independent compensation committees at controlled companies are unnecessary. Although independent directors are the best
choice for approving and monitoring senior executives pay, controlled companies serve a unique shareholder population whose voting power ensures the protection of its interests. As such, we believe that having affiliated directors on a
controlled companys compensation committee is acceptable. However, given that a controlled company has certain obligations to minority shareholders we feel that an insider should not serve on the compensation committee. Therefore, Glass Lewis
will recommend voting against any insider (the CEO or otherwise) serving on the compensation committee.
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42
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The Conference Board, at p. 23 in its May 2003 report Corporate Governance Best Practices, Id., quotes one of its roundtable
participants as stating, [w]hen youve got a 20 or 30 person corporate board, its one way of assuring that nothing is ever going to happen that the CEO doesnt want to happen.
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16
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3.
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Controlled companies do not need an independent chairman or an independent lead or presiding director. Although an independent director in a
position of authority on the board such as chairman or presiding director can best carry out the boards duties, controlled companies serve a unique shareholder population whose voting power ensures the protection of its
interests.
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Size of the Board of Directors
We have no board size requirements for controlled companies.
Audit Committee Independence
We believe that
audit committees should consist solely of independent directors. Regardless of a companys controlled status, the interests of all shareholders must be protected by ensuring the integrity and accuracy of the companys financial statements.
Allowing affiliated directors to oversee the preparation of financial reports could create an insurmountable conflict of interest.
UNOFFICIALLY CONTROLLED COMPANIES AND 20-50% BENEFICIAL OWNERS
Where a shareholder group owns more than 50% of a companys voting
power but the company is not a controlled company as defined by relevant listing standards, we apply a lower independence requirement of a majority of the board but believe the company should otherwise be treated like another public
company; we will therefore apply all other standards as outlined above.
Similarly, where an individual or entity holds between 20-50% of
a companys voting power, but the company is not controlled, we believe it is reasonable to allow proportional representation on the board and committees (excluding the audit committee) based on the individual or entitys
percentage of ownership.
EXCEPTIONS FOR RECENT IPOs
We believe companies that have recently completed an initial public offering (IPO) should be allowed adequate time to fully comply
with marketplace listing requirements as well as to meet basic corporate governance standards. We believe a one-year grace period immediately following the date of a companys IPO is sufficient time for most companies to comply with all
relevant regulatory requirements and to meet such corporate governance standards. Except in egregious cases, Glass Lewis refrains from issuing voting recommendations on the basis of corporate governance best practices (e.g., board independence,
committee membership and structure, meeting attendance, etc.) during the one-year period following an IPO.
However, two specific cases
warrant strong shareholder action against the board of a company that completed an IPO within the past year:
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1.
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Adoption of a poison pill: In cases where a board implements a poison pill preceding an IPO, we will consider voting against the members of the
board who served during the period of the poison pills adoption if the board (i) did not also commit to submit the poison pill to a shareholder vote within 12 months of the IPO or (ii) did not provide a sound rationale for adopting
the pill and the pill does not expire in three years or less. In our view, adopting such an anti-takeover device unfairly penalizes future shareholders who (except for electing to buy or sell the stock) are unable to weigh in on a matter that could
potentially negatively impact their ownership interest. This notion is strengthened when a board adopts a poison pill with a five to ten year life immediately prior to having a public shareholder base so as to insulate management for a substantial
amount of time while postponing and/or avoiding allowing public shareholders the ability to vote on the pills adoption. Such instances are indicative of boards that may subvert shareholders best interests following their IPO.
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17
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2.
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Adoption of an exclusive forum provision: Consistent with our general approach to boards that adopt exclusive forum provisions without shareholder
approval (refer to our discussion of nominating and governance committee performance in Section I of the guidelines), in cases where a board adopts such a provision for inclusion in a companys charter or bylaws before the companys IPO,
we will recommend voting against the chairman of the governance committee, or, in the absence of such a committee, the chairman of the board, who served during the period of time when the provision was adopted.
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In addition, shareholders should also be wary of companies that adopt supermajority voting requirements before their IPO. Absent explicit
provisions in the articles or bylaws stipulating that certain policies will be phased out over a certain period of time (e.g. a predetermined declassification of the board, a planned separation of the chairman and CEO, etc.) long-term shareholders
could find themselves in the predicament of having to attain a supermajority vote to approve future proposals seeking to eliminate such policies.
DUAL-LISTED COMPANIES
For those companies whose shares trade on exchanges in multiple countries, and which may seek shareholder
approval of proposals in accordance with varying exchange- and country-specific rules, we will apply the governance standards most relevant in each situation. We will consider a number of factors in determining which Glass Lewis country-specific
policy to apply, including but not limited to: (i) the corporate governance structure and features of the company including whether the board structure is unique to a particular market; (ii) the nature of the proposals; (iii) the
location of the companys primary listing, if one can be determined; (iv) the regulatory/governance regime that the board is reporting against; and (v) the availability and completeness of the companys SEC filings.
MUTUAL FUND BOARDS
Mutual funds, or investment companies, are structured differently from regular public companies (i.e., operating companies). Typically, members
of a funds adviser are on the board and management takes on a different role from that of regular public companies. Thus, we focus on a short list of requirements, although many of our guidelines remain the same.
The following mutual fund policies are similar to the policies for regular public companies:
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1.
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Size of the board of directors: The board should be made up of between five and twenty directors.
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2.
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The CFO on the board: Neither the CFO of the fund nor the CFO of the funds registered investment adviser should serve on the board.
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3.
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Independence of the audit committee: The audit committee should consist solely of independent directors.
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4.
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Audit committee financial expert: At least one member of the audit committee should be designated as the audit committee financial expert.
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The following differences from regular public companies apply at mutual funds:
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1.
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Independence of the board: We believe that three-fourths of an investment companys board should be made up of independent directors. This is
consistent with a proposed SEC rule on investment company boards. The Investment Company Act requires 40% of the board to be independent, but in 2001, the SEC amended the Exemptive Rules to require that a majority of a mutual fund board be
independent. In 2005, the SEC proposed increasing the independence threshold to 75%. In 2006, a federal appeals court ordered that this rule amendment be put back out for public comment, putting it back into proposed rule status. Since
mutual fund boards play a vital role in overseeing the relationship between the fund and its investment manager, there is greater need for independent oversight than there is for an operating company board.
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2.
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When the auditor is not up for ratification: We do not recommend voting against the audit committee if the auditor is not up for ratification. Due
to the different legal structure of an investment company compared to an operating company, the auditor for the investment company (i.e., mutual fund) does not conduct the same level of financial review for each investment company as for an
operating company.
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3.
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Non-independent chairman: The SEC has proposed that the chairman of the fund board be independent. We agree that the roles of a mutual funds
chairman and CEO should be separate. Although we believe this would be best at all companies, we recommend voting against the chairman of an investment companys nominating committee as well as the chairman of the board if the chairman and CEO
of a mutual fund are the same person and the fund does not have an independent lead or presiding director. Seven former SEC commissioners support the appointment of an independent chairman and we agree with them that an independent board
chairman would be better able to create conditions favoring the long-term interests of fund shareholders than would a chairman who is an executive of the adviser. (See the comment letter sent to the SEC in support of the proposed rule at
http://www.sec.gov/news/studies/indchair.pdf)
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4.
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Multiple funds overseen by the same director: Unlike service on a public company board, mutual fund boards require much less of a time commitment.
Mutual fund directors typically serve on dozens of other mutual fund boards, often within the same fund complex. The Investment Company Institutes (ICI) Overview of Fund Governance Practices, 1994-2012, indicates that the average
number of funds served by an independent director in 2012 was 53. Absent evidence that a specific director is hindered from being an effective board member at a fund due to service on other funds boards, we refrain from maintaining a cap on
the number of outside mutual fund boards that we believe a director can serve on.
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DECLASSIFIED BOARDS
Glass Lewis favors the repeal of staggered boards and the annual election of directors. We believe staggered boards are less accountable to
shareholders than boards that are elected annually. Furthermore, we feel the annual election of directors encourages board members to focus on shareholder interests.
Empirical studies have shown: (i) companies with staggered boards reduce a firms value; and (ii) in the context of hostile
takeovers, staggered boards operate as a takeover defense, which entrenches management, discourages potential acquirers, and delivers a lower return to target shareholders.
In our view, there is no evidence to demonstrate that staggered boards improve shareholder returns in a takeover context. Research shows that
shareholders are worse off when a staggered board blocks a transaction. A study by a group of Harvard Law professors concluded that companies whose staggered boards prevented a takeover reduced shareholder returns for targets ... on the order
of eight to ten percent in the nine months after a hostile bid was announced.
43
When a staggered board negotiates
43
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Lucian Bebchuk, John Coates IV, Guhan Subramanian, The Powerful Antitakeover Force of Staggered Boards: Further Findings and a Reply to
Symposium Participants, 55 Stanford Law Review 885-917 (2002), page 1.
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19
a friendly transaction, no statistically significant difference in premiums occurs.
44
Further, one of those same professors found that charter-based staggered boards reduce the market value of a firm by 4% to 6% of its market capitalization and that staggered boards
bring about and not merely reflect this reduction in market value.
45
A subsequent study reaffirmed that classified boards reduce shareholder value, finding that the ongoing process of
dismantling staggered boards, encouraged by institutional investors, could well contribute to increasing shareholder wealth.
46
Shareholders have increasingly come to agree with this view. In 2013, 91% of S&P 500 companies had declassified boards, up from
approximately 40% a decade ago.
47
Clearly, more shareholders have supported the repeal of classified boards. Resolutions relating to the repeal of staggered boards garnered on average over 70%
support among shareholders in 2008, whereas in 1987, only 16.4% of votes cast favored board declassification.
48
Given the empirical evidence suggesting staggered boards reduce a companys value and the increasing shareholder opposition to such a
structure, Glass Lewis supports the declassification of boards and the annual election of directors.
MANDATORY DIRECTOR TERM
AND AGE LIMITS
Glass Lewis believes that director age and term limits typically are not in shareholders best interests. Too often
age and term limits are used by boards as a crutch to remove board members who have served for an extended period of time. When used in that fashion, they are indicative of a board that has a difficult time making tough decisions.
Academic literature suggests that there is no evidence of a correlation between either length of tenure or age and director performance. On
occasion, term limits can be used as a means to remove a director for boards that are unwilling to police their membership and to enforce turnover. Some shareholders support term limits as a way to force change when boards are unwilling to do so.
While we understand that age limits can be a way to force change where boards are unwilling to make changes on their own, the long-term
impact of age limits restricts experienced and potentially valuable board members from service through an arbitrary means. Further, age limits unfairly imply that older (or, in rare cases, younger) directors cannot contribute to company oversight.
In our view, a directors experience can be a valuable asset to shareholders because of the complex, critical issues that boards
face. However, we support periodic director rotation to ensure a fresh perspective in the boardroom and the generation of new ideas and business strategies. We believe the board should implement such rotation instead of relying on arbitrary limits.
When necessary, shareholders can address the issue of director rotation through director elections.
We believe that shareholders are
better off monitoring the boards approach to corporate governance and the boards stewardship of company performance rather than imposing inflexible rules that dont necessarily correlate with returns or benefits for shareholders.
However, if a board adopts term/age limits, it should follow through and not waive such limits. If the board waives its term/age limits,
Glass Lewis will consider recommending shareholders vote against the nominating and/or governance committees, unless the rule was waived with sufficient explanation, such as consummation of a corporate transaction like a merger.
44
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Id. at 2 (Examining a sample of seventy-three negotiated transactions from 2000 to 2002, we find no systematic benefits in terms of higher
premia to boards that have [staggered structures].).
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45
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Lucian Bebchuk, Alma Cohen, The Costs of Entrenched Boards (2004).
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46
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Lucian Bebchuk, Alma Cohen and Charles C.Y. Wang, Staggered Boards and the Wealth of Shareholders: Evidence from a Natural Experiment,
SSRN: http://ssrn.com/abstract=1706806 (2010), p. 26.
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47
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Spencer Stuart Board Index, 2013, p. 4
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48
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Lucian Bebchuk, John Coates IV and Guhan Subramanian, The Powerful Antitakeover Force of Staggered Boards: Theory, Evidence, and
Policy, 54 Stanford Law Review 887-951 (2002).
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REQUIRING TWO OR MORE NOMINEES PER BOARD SEAT
In an attempt to address lack of access to the ballot, shareholders sometimes propose that the board give shareholders a choice of directors
for each open board seat in every election. However, we feel that policies requiring a selection of multiple nominees for each board seat would discourage prospective directors from accepting nominations. A prospective director could not be
confident either that he or she is the boards clear choice or that he or she would be elected. Therefore, Glass Lewis generally will vote against such proposals.
PROXY ACCESS
Proxy
Access has garnered significant attention in recent years. As in 2013, we expect to see a number of shareholder proposals regarding this topic in 2014 and perhaps even some companies unilaterally adopting some elements of proxy access. However,
considering the uncertainty in this area and the inherent case-by-case nature of those situations, we refrain from establishing any specific parameters at this time.
For a discussion of recent regulatory events in this area, along with a detailed overview of the Glass Lewis approach to Shareholder Proposals
regarding Proxy Access, refer to Glass Lewis
Proxy Paper Guidelines for Shareholder Initiatives.
MAJORITY VOTE
FOR THE ELECTION OF DIRECTORS
In stark contrast to the failure of shareholder access to gain acceptance, majority voting for the election
of directors is fast becoming the de facto standard in corporate board elections. In our view, the majority voting proposals are an effort to make the case for shareholder impact on director elections on a company-specific basis.
While this proposal would not give shareholders the opportunity to nominate directors or lead to elections where shareholders have a choice
among director candidates, if implemented, the proposal would allow shareholders to have a voice in determining whether the nominees proposed by the board should actually serve as the overseer-representatives of shareholders in the boardroom. We
believe this would be a favorable outcome for shareholders.
During the first half of 2013, Glass Lewis tracked approximately 30
shareholder proposals seeking to require a majority vote to elect directors at annual meetings in the U.S. While this is roughly on par with what we have reviewed in each of the past several years, it is a sharp contrast to the 147 proposals tracked
during all of 2006. This large drop in the number of proposals being submitted in recent years compared to 2006 is a result of many companies having already adopted some form of majority voting, including approximately 84% of companies in the
S&P 500 Index, up from 56% in 2008.
49
During 2013, these proposals received, on average, 59% shareholder support (excluding abstentions and broker non-votes), up from 54% in 2008. Further,
nearly half of these resolutions received majority shareholder support.
THE PLURALITY VOTE STANDARD
Today, most US companies still elect directors by a plurality vote standard. Under that standard, if one shareholder holding only one share
votes in favor of a nominee (including himself, if the director is a shareholder), that nominee wins the election and assumes a seat on the board. The common concern among companies with a plurality voting standard is the possibility
that one or more directors would not receive a majority of votes, resulting in failed elections. This was of particular concern during the 1980s, an era of frequent takeovers and contests for control of companies.
49
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Spencer Stuart Board Index, 2013, p. 13
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21
ADVANTAGES OF A MAJORITY VOTE STANDARD
If a majority vote standard were implemented, a nominee would have to receive the support of a majority of the shares voted in order to be
elected. Thus, shareholders could collectively vote to reject a director they believe will not pursue their best interests. We think that this minimal amount of protection for shareholders is reasonable and will not upset the corporate structure nor
reduce the willingness of qualified shareholder-focused directors to serve in the future.
We believe that a majority vote standard will
likely lead to more attentive directors. Occasional use of this power will likely prevent the election of directors with a record of ignoring shareholder interests in favor of other interests that conflict with those of investors. Glass Lewis will
generally support proposals calling for the election of directors by a majority vote except for use in contested director elections.
In
response to the high level of support majority voting has garnered, many companies have voluntarily taken steps to implement majority voting or modified approaches to majority voting. These steps range from a modified approach requiring directors
that receive a majority of withheld votes to resign (e.g., Ashland Inc.) to actually requiring a majority vote of outstanding shares to elect directors (e.g., Intel).
We feel that the modified approach does not go far enough because requiring a director to resign is not the same as requiring a majority vote
to elect a director and does not allow shareholders a definitive voice in the election process. Further, under the modified approach, the corporate governance committee could reject a resignation and, even if it accepts the resignation, the
corporate governance committee decides on the directors replacement. And since the modified approach is usually adopted as a policy by the board or a board committee, it could be altered by the same board or committee at any time.
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III. TRANSPARENCY AND INTEGRITY OF FINANCIAL REPORTING
AUDITOR RATIFICATION
The auditors role as gatekeeper is crucial in ensuring the integrity and transparency of the financial information necessary for
protecting shareholder value. Shareholders rely on the auditor to ask tough questions and to do a thorough analysis of a companys books to ensure that the information provided to shareholders is complete, accurate, fair, and that it is a
reasonable representation of a companys financial position. The only way shareholders can make rational investment decisions is if the market is equipped with accurate information about a companys fiscal health. As stated in the
October 6, 2008 Final Report of the Advisory Committee on the Auditing Profession to the U.S. Department of the Treasury:
The auditor is expected to offer critical and objective judgment on the financial matters under consideration, and
actual and perceived absence of conflicts is critical to that expectation. The Committee believes that auditors, investors, public companies, and other market participants must understand the independence requirements and their objectives, and that
auditors must adopt a mindset of skepticism when facing situations that may compromise their independence.
As such,
shareholders should demand an objective, competent and diligent auditor who performs at or above professional standards at every company in which the investors hold an interest. Like directors, auditors should be free from conflicts of interest and
should avoid situations requiring a choice between the auditors interests and the publics interests. Almost without exception, shareholders should be able to annually review an auditors performance and to annually ratify a
boards auditor selection. Moreover, in October 2008, the Advisory Committee on the Auditing Profession went even further, and recommended that to further enhance audit committee oversight and auditor accountability ... disclosure in the
company proxy statement regarding shareholder ratification [should] include the name(s) of the senior auditing partner(s) staffed on the engagement.
50
On August 16, 2011, the PCAOB issued a Concept Release seeking public comment on ways that auditor independence, objectivity and
professional skepticism could be enhanced, with a specific emphasis on mandatory audit firm rotation. The PCAOB convened several public roundtable meetings during 2012 to further discuss such matters. Glass Lewis believes auditor rotation can ensure
both the independence of the auditor and the integrity of the audit; we will typically recommend supporting proposals to require auditor rotation when the proposal uses a reasonable period of time (usually not less than 5-7 years), particularly at
companies with a history of accounting problems.
VOTING RECOMMENDATIONS ON AUDITOR RATIFICATION
We generally support managements choice of auditor except when we believe the auditors independence or audit integrity has been
compromised. Where a board has not allowed shareholders to review and ratify an auditor, we typically recommend voting against the audit committee chairman. When there have been material restatements of annual financial statements or material
weaknesses in internal controls, we usually recommend voting against the entire audit committee.
50
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Final Report of the Advisory Committee on the Auditing Profession to the U.S. Department of the Treasury. p. VIII:20, October 6,
2008.
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23
Reasons why we may not recommend ratification of an auditor include:
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1.
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When audit fees plus audit-related fees total less than the tax fees and/or other non-audit fees.
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2.
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Recent material restatements of annual financial statements, including those resulting in the reporting of material weaknesses in internal controls
and including late filings by the company where the auditor bears some responsibility for the restatement or late filing.
51
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3.
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When the auditor performs prohibited services such as tax-shelter work, tax services for the CEO or CFO, or contingent-fee work, such as a fee
based on a percentage of economic benefit to the company.
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4.
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When audit fees are excessively low, especially when compared with other companies in the same industry.
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5.
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When the company has aggressive accounting policies.
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6.
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When the company has poor disclosure or lack of transparency in its financial statements.
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7.
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Where the auditor limited its liability through its contract with the company or the audit contract requires the corporation to use alternative
dispute resolution procedures without adequate justification.
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8.
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We also look for other relationships or concerns with the auditor that might suggest a conflict between the auditors interests and
shareholder interests.
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PENSION ACCOUNTING ISSUES
A pension accounting question often raised in proxy proposals is what effect, if any, projected returns on employee pension assets should have
on a companys net income. This issue often arises in the executive-compensation context in a discussion of the extent to which pension accounting should be reflected in business performance for purposes of calculating payments to executives.
Glass Lewis believes that pension credits should not be included in measuring income that is used to award performance-based
compensation. Because many of the assumptions used in accounting for retirement plans are subject to the companys discretion, management would have an obvious conflict of interest if pay were tied to pension income. In our view, projected
income from pensions does not truly reflect a companys performance.
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An auditor does not audit interim financial statements. Thus, we generally do not believe that an auditor should be opposed due to a restatement of
interim financial statements unless the nature of the misstatement is clear from a reading of the incorrect financial statements.
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IV. THE LINK BETWEEN COMPENSATION AND PERFORMANCE
Glass Lewis carefully reviews the compensation awarded to senior executives, as we believe that this is an important area in which the
boards priorities are revealed. Glass Lewis strongly believes executive compensation should be linked directly with the performance of the business the executive is charged with managing. We believe the most effective compensation arrangements
provide for an appropriate mix of performance-based short- and long-term incentives in addition to fixed pay elements.
Glass Lewis
believes that comprehensive, timely and transparent disclosure of executive pay is critical to allowing shareholders to evaluate the extent to which pay is keeping pace with company performance. When reviewing proxy materials, Glass Lewis examines
whether the company discloses the performance metrics used to determine executive compensation. We recognize performance metrics must necessarily vary depending on the company and industry, among other factors, and may include a wide variety of
financial measures as well as industry-specific performance indicators. However, we believe companies should disclose why the specific performance metrics were selected and how the actions they are designed to incentivize will lead to better
corporate performance.
Moreover, it is rarely in shareholders interests to disclose competitive data about individual salaries
below the senior executive level. Such disclosure could create internal personnel discord that would be counterproductive for the company and its shareholders. While we favor full disclosure for senior executives and we view pay disclosure at the
aggregate level (e.g., the number of employees being paid over a certain amount or in certain categories) as potentially useful, we do not believe shareholders need or will benefit from detailed reports about individual management employees other
than the most senior executives.
ADVISORY VOTE ON EXECUTIVE COMPENSATION (SAY-ON-PAY)
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act) required companies to hold an advisory vote on
executive compensation at the first shareholder meeting that occurs six months after enactment of the bill (January 21, 2011).
This
practice of allowing shareholders a non-binding vote on a companys compensation report is standard practice in many non-US countries, and has been a requirement for most companies in the United Kingdom since 2003 and in Australia since 2005.
Although say-on-pay proposals are non-binding, a high level of against or abstain votes indicates substantial shareholder concern about a companys compensation policies and procedures.
Given the complexity of most companies compensation programs, Glass Lewis applies a highly nuanced approach when analyzing advisory
votes on executive compensation. We review each companys compensation on a case-by-case basis, recognizing that each company must be examined in the context of industry, size, maturity, performance, financial condition, its historic pay for
performance practices, and any other relevant internal or external factors.
We believe that each company should design and apply specific
compensation policies and practices that are appropriate to the circumstances of the company and, in particular, will attract and retain competent executives and other staff, while motivating them to grow the companys long-term shareholder
value.
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Where we find those specific policies and practices serve to reasonably align compensation
with performance, and such practices are adequately disclosed, Glass Lewis will recommend supporting the companys approach. If, however, those specific policies and practices fail to demonstrably link compensation with performance, Glass Lewis
will generally recommend voting against the say-on-pay proposal.
Glass Lewis focuses on four main areas when reviewing say-on-pay proposals:
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The overall design and structure of the companys executive compensation program including performance metrics;
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The quality and content of the companys disclosure;
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The quantum paid to executives; and
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The link between compensation and performance as indicated by the companys current and past pay-for-performance grades.
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We also review any significant changes or modifications, and rationale for such changes, made to the companys
compensation structure or award amounts, including base salaries.
SAY-ON-PAY VOTING RECOMMENDATIONS
In cases where we find deficiencies in a companys compensation programs design, implementation or management, we will recommend
that shareholders vote against the say-on-pay proposal. Generally such instances include evidence of a pattern of poor pay-for-performance practices (i.e., deficient or failing pay for performance grades), unclear or questionable disclosure
regarding the overall compensation structure (e.g., limited information regarding benchmarking processes, limited rationale for bonus performance metrics and targets, etc.), questionable adjustments to certain aspects of the overall compensation
structure (e.g., limited rationale for significant changes to performance targets or metrics, the payout of guaranteed bonuses or sizable retention grants, etc.), and/or other egregious compensation practices.
Although not an exhaustive list, the following issues when weighed together may cause Glass Lewis to recommend voting against a say-on-pay
vote:
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Inappropriate peer group and/or benchmarking issues;
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Inadequate or no rationale for changes to peer groups;
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Egregious or excessive bonuses, equity awards or severance payments, including golden handshakes and golden parachutes;
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Targeting overall levels of compensation at higher than median without adequate justification;
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Bonus or long-term plan targets set at less than mean or negative performance levels;
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Performance targets not sufficiently challenging, and/or providing for high potential payouts;
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Performance targets lowered without justification;
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Discretionary bonuses paid when short- or long-term incentive plan targets were not met;
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Executive pay high relative to peers not justified by outstanding company performance; and
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The terms of the long-term incentive plans are inappropriate (please see Long-Term Incentives on page 28).
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In instances where a company has simply failed to provide sufficient disclosure of its
policies, we may recommend shareholders vote against this proposal solely on this basis, regardless of the appropriateness of compensation levels.
COMPANY RESPONSIVENESS
At companies that received a significant level of shareholder disapproval (25% or greater) to their say-on-pay
proposal at the previous annual meeting, we believe the board should demonstrate some level of engagement and responsiveness to the shareholder concerns behind the discontent. While we recognize that sweeping changes cannot be made to a compensation
program without due consideration and that a majority of shareholders voted in favor of the proposal, we will look for disclosure in the proxy statement and other publicly-disclosed filings that indicates the compensation committee is responding to
the prior years vote results including engaging with large shareholders to identify the concerns causing the substantial vote against. In the absence of any evidence that the board is actively engaging shareholders on these issues and
responding accordingly, we may recommend holding compensation committee members accountable for failing to adequately respond to shareholder opposition, giving careful consideration to the level of shareholder protest and the severity and history of
compensation problems.
Where we identify egregious compensation practices, we may also recommend voting against the compensation
committee based on the practices or actions of its members during the year, such as approving large one-off payments, the inappropriate, unjustified use of discretion, or sustained poor pay for performance practices.
PAY FOR PERFORMANCE
Glass Lewis believes an integral part of a well-structured compensation package is a successful link between pay and performance. Our
proprietary pay-for-performance model was developed to better evaluate the link between pay and performance of the top five executives at US companies. Our model benchmarks these executives pay and company performance against peers selected by
Equilars market-based peer groups and across five performance metrics. By measuring the magnitude of the gap between two weighted-average percentile rankings (executive compensation and performance), we grade companies from a school letter
system: A, B, F, etc. The grades guide our evaluation of compensation committee effectiveness and we generally recommend voting against compensation committee of companies with a pattern of failing our
pay-for-performance analysis.
We also use this analysis to inform our voting decisions on say-on-pay proposals. As such, if a company
receives a failing grade from our proprietary model, we are likely to recommend that shareholders vote against the say-on-pay proposal. However, there may be exceptions to this rule such as when a company makes significant enhancements to its
compensation programs that may not be reflected yet in a quantitative assessment.
SHORT-TERM INCENTIVES
A short-term bonus or incentive (STI) should be demonstrably tied to performance. Whenever possible, we believe a mix of corporate
and individual performance measures is appropriate. We would normally expect performance measures for STIs to be based on company-wide or divisional financial measures as well as non-financial factors such as those related to safety, environmental
issues, and customer satisfaction. While we recognize that companies operating in different sectors or markets may seek to utilize a wide range of metrics, we expect such measures to be appropriately tied to a companys business drivers.
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Further, the target and potential maximum awards that can be achieved under STI awards should
be disclosed. Shareholders should expect stretching performance targets for the maximum award to be achieved. Any increase in the potential maximum award should be clearly justified to shareholders.
Glass Lewis recognizes that disclosure of some measures may include commercially confidential information. Therefore, we believe it may be
reasonable to exclude such information in some cases as long as the company provides sufficient justification for non-disclosure. However, where a short-term bonus has been paid, companies should disclose the extent to which performance has been
achieved against relevant targets, including disclosure of the actual target achieved.
Where management has received significant STIs but
short-term performance over the previous year prima facie appears to be poor or negative, we believe the company should provide a clear explanation of why these significant short-term payments were made.
LONG-TERM INCENTIVES
Glass Lewis recognizes the value of equity-based incentive programs. When used appropriately, they can provide a vehicle for linking an
executives pay to company performance, thereby aligning their interests with those of shareholders. In addition, equity-based compensation can be an effective way to attract, retain and motivate key employees.
There are certain elements that Glass Lewis believes are common to most well-structured long-term incentive (LTI) plans. These
include:
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No re-testing or lowering of performance conditions;
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Performance metrics that cannot be easily manipulated by management;
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Two or more performance metrics;
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At least one relative performance metric that compares the companys performance to a relevant peer group or index;
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Performance periods of at least three years;
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Stretching metrics that incentivize executives to strive for outstanding performance while not encouraging excessive risk-taking; and
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Individual limits expressed as a percentage of base salary.
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Performance measures should be carefully selected and should relate to the specific business/industry in which the company operates and,
especially, the key value drivers of the companys business.
While cognizant of the inherent complexity of certain performance
metrics, Glass Lewis generally believes that measuring a companys performance with multiple metrics serves to provide a more complete picture of the companys performance than a single metric, which may focus too much management attention
on a single target and is therefore more susceptible to manipulation. When utilized for relative measurements, external benchmarks such as a sector index or peer group should be disclosed and transparent. The rationale behind the selection of a
specific index or peer group should also be disclosed. Internal benchmarks should also be disclosed and transparent, unless a cogent case for confidentiality is made and fully explained.
We also believe shareholders should evaluate the relative success of a companys compensation programs, particularly with regard to
existing equity-based incentive plans, in linking pay and performance in evaluating new LTI plans to determine the impact of additional stock awards. We will therefore review the companys pay-for-performance grade (see below for more
information) and specifically the proportion of total compensation that is stock-based.
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RECOUPMENT (CLAWBACK) PROVISIONS
Section 954 of the Dodd-Frank Act requires the SEC to create a rule requiring listed companies to adopt policies for recouping certain
compensation during a three-year look-back period. The rule applies to incentive-based compensation paid to current or former executives if the company is required to prepare an accounting restatement due to erroneous data resulting from material
non-compliance with any financial reporting requirements under the securities laws.
These recoupment provisions are more stringent than
under Section 304 of the Sarbanes-Oxley Act in three respects: (i) the provisions extend to current or former executive officers rather than only to the CEO and CFO; (ii) it has a three-year look-back period (rather than a
twelve-month look-back period); and (iii) it allows for recovery of compensation based upon a financial restatement due to erroneous data, and therefore does not require misconduct on the part of the executive or other employees.
HEDGING OF STOCK
Glass Lewis believes that the hedging of shares by executives in the shares of the companies where they are employed severs the alignment of
interests of the executive with shareholders. We believe companies should adopt strict policies to prohibit executives from hedging the economic risk associated with their shareownership in the company.
PLEDGING OF STOCK
Glass Lewis believes that shareholders should examine the facts and circumstances of each company rather than apply a one-size-fits-all policy
regarding employee stock pledging. Glass Lewis believes that shareholders benefit when employees, particularly senior executives have skin-in-the-game and therefore recognizes the benefits of measures designed to encourage employees to
both buy shares out of their own pocket and to retain shares they have been granted; blanket policies prohibiting stock pledging may discourage executives and employees from doing either.
However, we also recognize that the pledging of shares can present a risk that, depending on a host of factors, an executive with significant
pledged shares and limited other assets may have an incentive to take steps to avoid a forced sale of shares in the face of a rapid stock price decline. Therefore, to avoid substantial losses from a forced sale to meet the terms of the loan, the
executive may have an incentive to boost the stock price in the short term in a manner that is unsustainable, thus hurting shareholders in the long-term. We also recognize concerns regarding pledging may not apply to less senior employees, given the
latter groups significantly more limited influence over a companys stock price. Therefore, we believe that the issue of pledging shares should be reviewed in that context, as should polices that distinguish between the two groups.
Glass Lewis believes that the benefits of stock ownership by executives and employees may outweigh the risks of stock pledging, depending on
many factors. As such, Glass Lewis reviews all relevant factors in evaluating proposed policies, limitations and prohibitions on pledging stock, including:
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The number of shares pledged;
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The percentage executives pledged shares are of outstanding shares;
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The percentage executives pledged shares are of each executives shares and total assets;
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Whether the pledged shares were purchased by the employee or granted by the company;
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Whether there are different policies for purchased and granted shares;
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Whether the granted shares were time-based or performance-based;
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The overall governance profile of the company;
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The volatility of the companys stock (in order to determine the likelihood of a sudden stock price drop);
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The nature and cyclicality, if applicable, of the companys industry;
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The participation and eligibility of executives and employees in pledging;
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The companys current policies regarding pledging and any waiver from these policies for employees and executives; and
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Disclosure of the extent of any pledging, particularly among senior executives.
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COMPENSATION CONSULTANT INDEPENDENCE
As mandated by Section 952 of the Dodd-Frank Act, as of January 11, 2013, the SEC approved new listing requirements for both the NYSE
and NASDAQ which require compensation committees to consider six factors in assessing compensation advisor independence. These factors include: (1) provision of other services to the company; (2) fees paid by the company as a percentage of
the advisors total annual revenue; (3) policies and procedures of the advisor to mitigate conflicts of interests; (4) any business or personal relationships of the consultant with any member of the compensation committee;
(5) any company stock held by the consultant; and (6) any business or personal relationships of the consultant with any executive officer of the company. According to the SEC, no one factor should be viewed as a determinative
factor. Glass Lewis believes this six-factor assessment is an important process for every compensation committee to undertake.
We
believe compensation consultants are engaged to provide objective, disinterested, expert advice to the compensation committee. When the consultant or its affiliates receive substantial income from providing other services to the company, we believe
the potential for a conflict of interest arises and the independence of the consultant may be jeopardized. Therefore, Glass Lewis will, when relevant, note the potential for a conflict of interest when the fees paid to the advisor or its affiliates
for other services exceeds those paid for compensation consulting.
FREQUENCY OF SAY-ON-PAY
The Dodd-Frank Act also requires companies to allow shareholders a non-binding vote on the frequency of say-on-pay votes, i.e. every one, two
or three years. Additionally, Dodd-Frank requires companies to hold such votes on the frequency of say-on-pay votes at least once every six years.
We believe companies should submit say-on-pay votes to shareholders every year. We believe that the time and financial burdens to a company
with regard to an annual vote are relatively small and incremental and are outweighed by the benefits to shareholders through more frequent accountability. Implementing biannual or triennial votes on executive compensation limits shareholders
ability to hold the board accountable for its compensation practices through means other than voting against the compensation committee. Unless a company provides a compelling rationale or unique circumstances for say-on-pay votes less frequent than
annually, we will generally recommend that shareholders support annual votes on compensation.
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VOTE ON GOLDEN PARACHUTE ARRANGEMENTS
The Dodd-Frank Act also requires companies to provide shareholders with a separate non-binding vote on approval of golden parachute
compensation arrangements in connection with certain change-in-control transactions. However, if the golden parachute arrangements have previously been subject to a say-on-pay vote which shareholders approved, then this required vote is waived.
Glass Lewis believes the narrative and tabular disclosure of golden parachute arrangements benefits all shareholders. Glass Lewis analyzes
each golden parachute arrangement on a case-by-case basis, taking into account, among other items: the ultimate value of the payments particularly compared to the value of the transaction, the tenure and position of the executives in question, and
the type of triggers involved (single vs. double).
EQUITY-BASED COMPENSATION PLAN PROPOSALS
We believe that equity compensation awards are useful, when not abused, for retaining employees and providing an incentive for them to act in a
way that will improve company performance. Glass Lewis evaluates equity-based compensation plans using a detailed model and analytical review.
Equity-based compensation programs have important differences from cash compensation plans and bonus programs. Accordingly, our model and
analysis takes into account factors such as plan administration, the method and terms of exercise, repricing history, express or implied rights to reprice, and the presence of evergreen provisions.
Our analysis is primarily quantitative and focused on the plans cost as compared with the businesss operating metrics. We run
twenty different analyses, comparing the program with absolute limits we believe are key to equity value creation and with a carefully chosen peer group. In general, our model seeks to determine whether the proposed plan is either absolutely
excessive or is more than one standard deviation away from the average plan for the peer group on a range of criteria, including dilution to shareholders and the projected annual cost relative to the companys financial performance. Each of the
twenty analyses (and their constituent parts) is weighted and the plan is scored in accordance with that weight.
In our analysis, we
compare the programs expected annual expense with the businesss operating metrics to help determine whether the plan is excessive in light of company performance. We also compare the plans expected annual cost to the enterprise
value of the firm rather than to market capitalization because the employees, managers and directors of the firm contribute to the creation of enterprise value but not necessarily market capitalization (the biggest difference is seen where cash
represents the vast majority of market capitalization). Finally, we do not rely exclusively on relative comparisons with averages because, in addition to creeping averages serving to inflate compensation, we believe that some absolute limits are
warranted.
We evaluate equity plans based on certain overarching principles:
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Companies should seek more shares only when needed;
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Requested share amounts should be small enough that companies seek shareholder approval every three to four years (or more frequently);
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If a plan is relatively expensive, it should not grant options solely to senior executives and board members;
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Annual net share count and voting power dilution should be limited;
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Annual cost of the plan (especially if not shown on the income statement) should be reasonable as a percentage of financial results and should be
in line with the peer group;
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The expected annual cost of the plan should be proportional to the businesss value;
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The intrinsic value that option grantees received in the past should be reasonable compared with the businesss financial results;
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Plans should deliver value on a per-employee basis when compared with programs at peer companies;
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Plans should not permit re-pricing of stock options;
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Plans should not contain excessively liberal administrative or payment terms;
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Plans should not count shares in ways that understate the potential dilution, or cost, to common shareholders. This refers to inverse
full-value award multipliers;
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Selected performance metrics should be challenging and appropriate, and should be subject to relative performance measurements; and
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Stock grants should be subject to minimum vesting and/or holding periods sufficient to ensure sustainable performance and promote retention.
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OPTION EXCHANGES
Glass Lewis views option repricing plans and option exchange programs with great skepticism. Shareholders have substantial risk in owning stock
and we believe that the employees, officers, and directors who receive stock options should be similarly situated to align their interests with shareholder interests.
We are concerned that option grantees who believe they will be rescued from underwater options will be more inclined to take
unjustifiable risks. Moreover, a predictable pattern of repricing or exchanges substantially alters a stock options value because options that will practically never expire deeply out of the money are worth far more than options that carry a
risk of expiration.
In short, repricings and option exchange programs change the bargain between shareholders and employees after the
bargain has been struck.
There is one circumstance in which a repricing or option exchange program is acceptable: if macroeconomic or
industry trends, rather than specific company issues, cause a stocks value to decline dramatically and the repricing is necessary to motivate and retain employees. In this circumstance, we think it fair to conclude that option grantees may be
suffering from a risk that was not foreseeable when the original bargain was struck. In such a circumstance, we will recommend supporting a repricing only if the following conditions are true:
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Officers and board members cannot participate in the program;
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The stock decline mirrors the market or industry price decline in terms of timing and approximates the decline in magnitude;
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The exchange is value-neutral or value-creative to shareholders using very conservative assumptions and with a recognition of the adverse selection
problems inherent in voluntary programs; and
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Management and the board make a cogent case for needing to motivate and retain existing employees, such as being in a competitive employment
market.
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OPTION BACKDATING, SPRING-LOADING AND BULLET-DODGING
Glass Lewis views option backdating, and the related practices of spring-loading and bullet-dodging, as egregious actions that warrant holding
the appropriate management and board members responsible. These practices are similar to re-pricing options and eliminate much of the downside risk inherent in an option grant that is designed to induce recipients to maximize shareholder return.
Backdating an option is the act of changing an options grant date from the actual grant date to an earlier date when the market
price of the underlying stock was lower, resulting in a lower exercise price for the option. Since 2006, Glass Lewis has identified over 270 companies that have disclosed internal or government investigations into their past stock-option grants.
Spring-loading is granting stock options while in possession of material, positive information that has not been disclosed publicly.
Bullet-dodging is delaying the grants of stock options until after the release of material, negative information. This can allow option grants to be made at a lower price either before the release of positive news or following the release of
negative news, assuming the stocks price will move up or down in response to the information. This raises a concern similar to that of insider trading, or the trading on material non-public information.
The exercise price for an option is determined on the day of grant, providing the recipient with the same market risk as an investor who
bought shares on that date. However, where options were backdated, the executive or the board (or the compensation committee) changed the grant date retroactively. The new date may be at or near the lowest price for the year or period. This would be
like allowing an investor to look back and select the lowest price of the year at which to buy shares.
A 2006 study of option grants made
between 1996 and 2005 at 8,000 companies found that option backdating can be an indication of poor internal controls. The study found that option backdating was more likely to occur at companies without a majority independent board and with a
long-serving CEO; both factors, the study concluded, were associated with greater CEO influence on the companys compensation and governance practices.
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Where a company granted backdated options to an executive who is also a director, Glass Lewis will recommend voting against that
executive/director, regardless of who decided to make the award. In addition, Glass Lewis will recommend voting against those directors who either approved or allowed the backdating. Glass Lewis feels that executives and directors who either
benefited from backdated options or authorized the practice have breached their fiduciary responsibility to shareholders.
Given the
severe tax and legal liabilities to the company from backdating, Glass Lewis will consider recommending voting against members of the audit committee who served when options were backdated, a restatement occurs, material weaknesses in internal
controls exist and disclosures indicate there was a lack of documentation. These committee members failed in their responsibility to ensure the integrity of the companys financial reports.
When a company has engaged in spring-loading or bullet-dodging, Glass Lewis will consider recommending voting against the compensation
committee members where there has been a pattern of granting options at or near historic lows. Glass Lewis will also recommend voting against executives serving on the board who benefited from the spring-loading or bullet-dodging.
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Lucian Bebchuk, Yaniv Grinstein and Urs Peyer. LUCKY CEOs. November, 2006.
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DIRECTOR COMPENSATION PLANS
Glass Lewis believes that non-employee directors should receive reasonable and appropriate compensation for the time and effort they spend
serving on the board and its committees. However, a balance is required. Fees should be competitive in order to retain and attract qualified individuals, but excessive fees represent a financial cost to the company and potentially compromise the
objectivity and independence of non-employee directors. We will consider recommending supporting compensation plans that include option grants or other equity-based awards that help to align the interests of outside directors with those of
shareholders. However, equity grants to directors should not be performance-based to ensure directors are not incentivized in the same manner as executives but rather serve as a check on imprudent risk-taking in executive compensation plan design.
Glass Lewis uses a proprietary model and analyst review to evaluate the costs of equity plans compared to the plans of peer companies
with similar market capitalizations. We use the results of this model to guide our voting recommendations on stock-based director compensation plans.
EXECUTIVE COMPENSATION TAX DEDUCTIBILITY (IRS 162(M) COMPLIANCE)
Section 162(m) of the Internal Revenue Code allows companies to
deduct compensation in excess of $1 million for the CEO and the next three most highly compensated executive officers, excluding the CFO, if the compensation is performance-based and is paid under shareholder-approved plans. Companies therefore
submit incentive plans for shareholder approval to take of advantage of the tax deductibility afforded under 162(m) for certain types of compensation.
We believe the best practice for companies is to provide robust disclosure to shareholders so that they can make fully-informed judgments
about the reasonableness of the proposed compensation plan. To allow for meaningful shareholder review, we prefer that disclosure should include specific performance metrics, a maximum award pool, and a maximum award amount per employee. We also
believe it is important to analyze the estimated grants to see if they are reasonable and in line with the companys peers.
We
typically recommend voting against a 162(m) proposal where: (i) a company fails to provide at least a list of performance targets; (ii) a company fails to provide one of either a total maximum or an individual maximum; or (iii) the
proposed plan is excessive when compared with the plans of the companys peers.
The companys record of aligning pay with
performance (as evaluated using our proprietary pay-for-performance model) also plays a role in our recommendation. Where a company has a record of setting reasonable pay relative to business performance, we generally recommend voting in favor of a
plan even if the plan caps seem large relative to peers because we recognize the value in special pay arrangements for continued exceptional performance.
As with all other issues we review, our goal is to provide consistent but contextual advice given the specifics of the company and ongoing
performance. Overall, we recognize that it is generally not in shareholders best interests to vote against such a plan and forgo the potential tax benefit since shareholder rejection of such plans will not curtail the awards; it will only
prevent the tax deduction associated with them.
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V. GOVERNANCE STRUCTURE AND THE SHAREHOLDER FRANCHISE
ANTI-TAKEOVER MEASURES
POISON PILLS (SHAREHOLDER RIGHTS PLANS)
Glass Lewis believes that poison pill plans are not generally in shareholders best
interests. They can reduce management accountability by substantially limiting opportunities for corporate takeovers. Rights plans can thus prevent shareholders from receiving a buy-out premium for their stock. Typically we recommend that
shareholders vote against these plans to protect their financial interests and ensure that they have an opportunity to consider any offer for their shares, especially those at a premium.
We believe boards should be given wide latitude in directing company activities and in charting the companys course. However, on an
issue such as this, where the link between the shareholders financial interests and their right to consider and accept buyout offers is substantial, we believe that shareholders should be allowed to vote on whether they support such a
plans implementation. This issue is different from other matters that are typically left to board discretion. Its potential impact on and relation to shareholders is direct and substantial. It is also an issue in which management interests may
be different from those of shareholders; thus, ensuring that shareholders have a voice is the only way to safeguard their interests.
In
certain circumstances, we will support a poison pill that is limited in scope to accomplish a particular objective, such as the closing of an important merger, or a pill that contains what we believe to be a reasonable qualifying offer clause. We
will consider supporting a poison pill plan if the qualifying offer clause includes each of the following attributes:
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The form of offer is not required to be an all-cash transaction;
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The offer is not required to remain open for more than 90 business days;
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The offeror is permitted to amend the offer, reduce the offer, or otherwise change the terms;
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There is no fairness opinion requirement; and
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There is a low to no premium requirement.
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Where these requirements are met, we typically feel comfortable that shareholders will have the opportunity to voice their opinion on any
legitimate offer.
NOL POISON PILLS
Similarly, Glass Lewis may consider supporting a limited poison pill in the unique event that a company seeks shareholder approval of a rights
plan for the express purpose of preserving Net Operating Losses (NOLs). While companies with NOLs can generally carry these losses forward to offset future taxable income, Section 382 of the Internal Revenue Code limits companies ability
to use NOLs in the event of a change of ownership.
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In this case, a company may adopt or amend a poison pill (NOL pill) in order to prevent an inadvertent change of
ownership by multiple investors purchasing small chunks of stock at the same time, and thereby preserve the ability to carry the NOLs forward. Often such NOL pills have trigger thresholds much lower than the common 15% or 20% thresholds, with some
NOL pill triggers as low as 5%.
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Section 382 of the Internal Revenue Code refers to a change of ownership of more than 50 percentage points by one or more 5%
shareholders within a three-year period. The statute is intended to deter the trafficking of net operating losses.
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Glass Lewis evaluates NOL pills on a strictly case-by-case basis taking into consideration,
among other factors, the value of the NOLs to the company, the likelihood of a change of ownership based on the size of the holding and the nature of the larger shareholders, the trigger threshold and whether the term of the plan is limited in
duration (i.e., whether it contains a reasonable sunset provision) or is subject to periodic board review and/or shareholder ratification. However, we will recommend that shareholders vote against a proposal to adopt or amend a pill to
include NOL protective provisions if the company has adopted a more narrowly tailored means of preventing a change in control to preserve its NOLs. For example, a company may limit share transfers in its charter to prevent a change of ownership from
occurring.
Furthermore, we believe that shareholders should be offered the opportunity to vote on any adoption or renewal of a NOL pill
regardless of any potential tax benefit that it offers a company. As such, we will consider recommending voting against those members of the board who served at the time when an NOL pill was adopted without shareholder approval within the prior
twelve months and where the NOL pill is not subject to shareholder ratification.
FAIR PRICE PROVISIONS
Fair price provisions, which are rare, require that certain minimum price and procedural requirements be observed by any party that acquires
more than a specified percentage of a corporations common stock. The provision is intended to protect minority shareholder value when an acquirer seeks to accomplish a merger or other transaction which would eliminate or change the interests
of the minority stockholders. The provision is generally applied against the acquirer unless the takeover is approved by a majority of continuing directors and holders of a majority, in some cases a supermajority as high as 80%, of the
combined voting power of all stock entitled to vote to alter, amend, or repeal the above provisions.
The effect of a fair price provision
is to require approval of any merger or business combination with an interested stockholder by 51% of the voting stock of the company, excluding the shares held by the interested stockholder. An interested stockholder is generally
considered to be a holder of 10% or more of the companys outstanding stock, but the trigger can vary.
Generally, provisions are put
in place for the ostensible purpose of preventing a back-end merger where the interested stockholder would be able to pay a lower price for the remaining shares of the company than he or she paid to gain control. The effect of a fair price provision
on shareholders, however, is to limit their ability to gain a premium for their shares through a partial tender offer or open market acquisition which typically raise the share price, often significantly. A fair price provision discourages such
transactions because of the potential costs of seeking shareholder approval and because of the restrictions on purchase price for completing a merger or other transaction at a later time.
Glass Lewis believes that fair price provisions, while sometimes protecting shareholders from abuse in a takeover situation, more often act as
an impediment to takeovers, potentially limiting gains to shareholders from a variety of transactions that could significantly increase share price. In some cases, even the independent directors of the board cannot make exceptions when such
exceptions may be in the best interests of shareholders. Given the existence of state law protections for minority shareholders such as Section 203 of the Delaware Corporations Code, we believe it is in the best interests of shareholders to
remove fair price provisions.
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REINCORPORATION
In general, Glass Lewis believes that the board is in the best position to determine the appropriate jurisdiction of incorporation for the
company. When examining a management proposal to reincorporate to a different state or country, we review the relevant financial benefits, generally related to improved corporate tax treatment, as well as changes in corporate governance provisions,
especially those relating to shareholder rights, resulting from the change in domicile. Where the financial benefits are de minimis and there is a decrease in shareholder rights, we will recommend voting against the transaction.
However, costly, shareholder-initiated reincorporations are typically not the best route to achieve the furtherance of shareholder rights. We
believe shareholders are generally better served by proposing specific shareholder resolutions addressing pertinent issues which may be implemented at a lower cost, and perhaps even with board approval. However, when shareholders propose a shift
into a jurisdiction with enhanced shareholder rights, Glass Lewis examines the significant ways would the company benefit from shifting jurisdictions including the following:
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Is the board sufficiently independent?
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Does the company have anti-takeover protections such as a poison pill or classified board in place?
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Has the board been previously unresponsive to shareholders (such as failing to implement a shareholder proposal that received majority shareholder
support)?
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Do shareholders have the right to call special meetings of shareholders?
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Are there other material governance issues at the company?
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Has the companys performance matched or exceeded its peers in the past one and three years?
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How has the company ranked in Glass Lewis pay-for-performance analysis during the last three years?
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Does the company have an independent chairman?
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We note, however, that we will only support shareholder proposals to change a companys place of incorporation in exceptional
circumstances.
EXCLUSIVE FORUM PROVISIONS
Glass Lewis believes that charter or bylaw provisions limiting a shareholders choice of legal venue are not in the best interests of
shareholders. Such clauses may effectively discourage the use of shareholder derivative claims by increasing their associated costs and making them more difficult to pursue. As such, shareholders should be wary about approving any limitation on
their legal recourse including limiting themselves to a single jurisdiction (e.g. Delaware) without compelling evidence that it will benefit shareholders.
For this reason, we recommend that shareholders vote against any bylaw or charter amendment seeking to adopt an exclusive forum provision
unless the company: (i) provides a compelling argument on why the provision would directly benefit shareholders; (ii) provides evidence of abuse of legal process in other, non-favored jurisdictions; and (ii) maintains a strong record
of good corporate governance practices.
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Moreover, in the event a board seeks shareholder approval of a forum selection clause
pursuant to a bundled bylaw amendment rather than as a separate proposal, we will weigh the importance of the other bundled provisions when determining the vote recommendation on the proposal. We will nonetheless recommend voting against the
chairman of the governance committee for bundling disparate proposals into a single proposal (refer to our discussion of nominating and governance committee performance in Section I of the guidelines).
AUTHORIZED SHARES
Glass Lewis believes that adequate capital stock is important to a companys operation. When analyzing a request for additional shares, we
typically review four common reasons why a company might need additional capital stock:
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Stock Split We typically consider three metrics when evaluating whether we think a stock split is likely or necessary: The historical stock
pre-split price, if any; the current price relative to the companys most common trading price over the past 52 weeks; and some absolute limits on stock price that, in our view, either always make a stock split appropriate if desired by
management or would almost never be a reasonable price at which to split a stock.
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Shareholder Defenses Additional authorized shares could be used to bolster takeover defenses such as a poison pill. Proxy filings often
discuss the usefulness of additional shares in defending against or discouraging a hostile takeover as a reason for a requested increase. Glass Lewis is typically against such defenses and will oppose actions intended to bolster such defenses.
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Financing for Acquisitions We look at whether the company has a history of using stock for acquisitions and attempt to determine what levels
of stock have typically been required to accomplish such transactions. Likewise, we look to see whether this is discussed as a reason for additional shares in the proxy.
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Financing for Operations We review the companys cash position and its ability to secure financing through borrowing or other means. We
look at the companys history of capitalization and whether the company has had to use stock in the recent past as a means of raising capital.
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Issuing additional shares can dilute existing holders in limited circumstances. Further, the availability of additional shares, where the
board has discretion to implement a poison pill, can often serve as a deterrent to interested suitors. Accordingly, where we find that the company has not detailed a plan for use of the proposed shares, or where the number of shares far exceeds
those needed to accomplish a detailed plan, we typically recommend against the authorization of additional shares. Similar concerns may also lead us to recommend against a proposal to conduct a reverse stock split if the board does not state that it
will reduce the number of authorized common shares in a ratio proportionate to the split.
While we think that having adequate shares to
allow management to make quick decisions and effectively operate the business is critical, we prefer that, for significant transactions, management come to shareholders to justify their use of additional shares rather than providing a blank check in
the form of a large pool of unallocated shares available for any purpose.
ADVANCE NOTICE REQUIREMENTS
We typically recommend that shareholders vote against proposals that would require advance notice of shareholder proposals or of director
nominees.
These proposals typically attempt to require a certain amount of notice before shareholders are allowed to place proposals on
the ballot. Notice requirements typically range between three to six months prior to the annual meeting. Advance notice requirements typically make it impossible for a shareholder who misses the deadline to present a shareholder proposal or a
director nominee that might be in the best interests of the company and its shareholders.
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We believe shareholders should be able to review and vote on all proposals and director
nominees. Shareholders can always vote against proposals that appear with little prior notice. Shareholders, as owners of a business, are capable of identifying issues on which they have sufficient information and ignoring issues on which they have
insufficient information. Setting arbitrary notice restrictions limits the opportunity for shareholders to raise issues that may come up after the window closes.
VOTING STRUCTURE
CUMULATIVE VOTING
Cumulative voting increases the ability of minority shareholders to elect a director by allowing shareholders to
cast as many shares of the stock they own multiplied by the number of directors to be elected. As companies generally have multiple nominees up for election, cumulative voting allows shareholders to cast all of their votes for a single nominee, or a
smaller number of nominees than up for election, thereby raising the likelihood of electing one or more of their preferred nominees to the board. It can be important when a board is controlled by insiders or affiliates and where the companys
ownership structure includes one or more shareholders who control a majority-voting block of company stock.
Glass Lewis believes that
cumulative voting generally acts as a safeguard for shareholders by ensuring that those who hold a significant minority of shares can elect a candidate of their choosing to the board. This allows the creation of boards that are responsive to the
interests of all shareholders rather than just a small group of large holders.
However, academic literature indicates that where a highly
independent board is in place and the company has a shareholder-friendly governance structure, shareholders may be better off without cumulative voting. The analysis underlying this literature indicates that shareholder returns at firms with good
governance structures are lower and that boards can become factionalized and prone to evaluating the needs of special interests over the general interests of shareholders collectively.
We review cumulative voting proposals on a case-by-case basis, factoring in the independence of the board and the status of the companys
governance structure. But we typically find these proposals on ballots at companies where independence is lacking and where the appropriate checks and balances favoring shareholders are not in place. In those instances we typically recommend in
favor of cumulative voting.
Where a company has adopted a true majority vote standard (i.e., where a director must receive a majority of
votes cast to be elected, as opposed to a modified policy indicated by a resignation policy only), Glass Lewis will recommend voting against cumulative voting proposals due to the incompatibility of the two election methods. For companies that have
not adopted a true majority voting standard but have adopted some form of majority voting, Glass Lewis will also generally recommend voting against cumulative voting proposals if the company has not adopted antitakeover protections and has been
responsive to shareholders.
Where a company has not adopted a majority voting standard and is facing both a shareholder proposal to adopt
majority voting and a shareholder proposal to adopt cumulative voting, Glass Lewis will support only the majority voting proposal. When a company has both majority voting and cumulative voting in place, there is a higher likelihood of one or more
directors not being elected as a result of not receiving a majority vote. This is because shareholders exercising the right to cumulate their votes could unintentionally cause the failed election of one or more directors for whom shareholders do not
cumulate votes.
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SUPERMAJORITY VOTE REQUIREMENTS
Glass Lewis believes that supermajority vote requirements impede shareholder action on ballot items critical to shareholder interests. An
example is in the takeover context, where supermajority vote requirements can strongly limit the voice of shareholders in making decisions on such crucial matters as selling the business. This in turn degrades share value and can limit the
possibility of buyout premiums to shareholders. Moreover, we believe that a supermajority vote requirement can enable a small group of shareholders to overrule the will of the majority shareholders. We believe that a simple majority is appropriate
to approve all matters presented to shareholders.
TRANSACTION OF OTHER BUSINESS
We typically recommend that shareholders not give their proxy to management to vote on any other business items that may properly come before
an annual or special meeting. In our opinion, granting unfettered discretion is unwise.
ANTI-GREENMAIL PROPOSALS
Glass Lewis will support proposals to adopt a provision preventing the payment of greenmail, which would serve to prevent companies from buying
back company stock at significant premiums from a certain shareholder. Since a large or majority shareholder could attempt to compel a board into purchasing its shares at a large premium, the anti-greenmail provision would generally require that a
majority of shareholders other than the majority shareholder approve the buyback.
MUTUAL FUNDS: INVESTMENT POLICIES AND
ADVISORY AGREEMENTS
Glass Lewis believes that decisions about a funds structure and/or a funds relationship with its
investment advisor or sub-advisors are generally best left to management and the members of the board, absent a showing of egregious or illegal conduct that might threaten shareholder value. As such, we focus our analyses of such proposals on the
following main areas:
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The terms of any amended advisory or sub-advisory agreement;
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Any changes in the fee structure paid to the investment advisor; and
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Any material changes to the funds investment objective or strategy.
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We generally support amendments to a funds investment advisory agreement absent a material change that is not in the best interests of
shareholders. A significant increase in the fees paid to an investment advisor would be reason for us to consider recommending voting against a proposed amendment to an investment advisory agreement. However, in certain cases, we are more inclined
to support an increase in advisory fees if such increases result from being performance-based rather than asset-based. Furthermore, we generally support sub-advisory agreements between a funds advisor and sub-advisor, primarily because the
fees received by the sub-advisor are paid by the advisor, and not by the fund.
In matters pertaining to a funds investment
objective or strategy, we believe shareholders are best served when a funds objective or strategy closely resembles the investment discipline shareholders understood and selected when they initially bought into the fund. As such, we generally
recommend voting against amendments to a funds investment objective or strategy when the proposed changes would leave shareholders with stakes in a fund that is noticeably different than when originally contemplated, and which could therefore
potentially negatively impact some investors diversification strategies.
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REAL ESTATE INVESTMENT TRUSTS
The complex organizational, operational, tax and compliance requirements of Real Estate Investment Trusts (REITs) provide for a
unique shareholder evaluation. In simple terms, a REIT must have a minimum of 100 shareholders (the 100 Shareholder Test) and no more than 50% of the value of its shares can be held by five or fewer individuals (the 5/50
Test). At least 75% of a REITs assets must be in real estate, it must derive 75% of its gross income from rents or mortgage interest, and it must pay out 90% of its taxable earnings as dividends. In addition, as a publicly traded
security listed on a stock exchange, a REIT must comply with the same general listing requirements as a publicly traded equity.
In order
to comply with such requirements, REITs typically include percentage ownership limitations in their organizational documents, usually in the range of 5% to 10% of the REITs outstanding shares. Given the complexities of REITs as an asset class, Glass
Lewis applies a highly nuanced approach in our evaluation of REIT proposals, especially regarding changes in authorized share capital, including preferred stock.
PREFERRED STOCK ISSUANCES AT REITS
Glass Lewis is generally against the authorization of preferred shares that allows the board to determine the preferences, limitations and
rights of the preferred shares (known as blank-check preferred stock). We believe that granting such broad discretion should be of concern to common shareholders, since blank-check preferred stock could be used as an antitakeover device
or in some other fashion that adversely affects the voting power or financial interests of common shareholders. However, given the requirement that a REIT must distribute 90% of its net income annually, it is inhibited from retaining capital to make
investments in its business. As such, we recognize that equity financing likely plays a key role in a REITs growth and creation of shareholder value. Moreover, shareholder concern regarding the use of preferred stock as an anti-takeover
mechanism may be allayed by the fact that most REITs maintain ownership limitations in their certificates of incorporation. For these reasons, along with the fact that REITs typically do not engage in private placements of preferred stock (which
result in the rights of common shareholders being adversely impacted), we may support requests to authorize shares of blank-check preferred stock at REITs.
BUSINESS DEVELOPMENT COMPANIES
Business Development Companies (BDCs) were created by the U.S. Congress in 1980; they are regulated under the Investment Company
Act of 1940 and are taxed as regulated investment companies (RICs) under the Internal Revenue Code. BDCs typically operate as publicly traded private equity firms that invest in early stage to mature private companies as well as small
public companies. BDCs realize operating income when their investments are sold off, and therefore maintain complex organizational, operational, tax and compliance requirements that are similar to those of REITsthe most evident of which is
that BDCs must distribute at least 90% of their taxable earnings as dividends.
AUTHORIZATION TO SELL SHARES AT A PRICE BELOW
NET ASSET VALUE
Considering that BDCs are required to distribute nearly all their earnings to shareholders, they sometimes need to offer
additional shares of common stock in the public markets to finance operations and acquisitions. However, shareholder approval is required in order for a BDC to sell shares of common stock at a price below Net Asset Value (NAV). Glass
Lewis evaluates these proposals using a case-by-case approach, but will recommend supporting such requests if the following conditions are met:
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The authorization to allow share issuances below NAV has an expiration date of one year or less from the date that shareholders approve the
underlying proposal (i.e. the meeting date);
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The proposed discount below NAV is minimal (ideally no greater than 20%);
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The board specifies that the issuance will have a minimal or modest dilutive effect (ideally no greater than 25% of the companys
then-outstanding common stock prior to the issuance); and
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A majority of the companys independent directors who do not have a financial interest in the issuance approve the sale.
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In short, we believe BDCs should demonstrate a responsible approach to issuing shares below NAV, by proactively
addressing shareholder concerns regarding the potential dilution of the requested share issuance, and explaining if and how the companys past below-NAV share issuances have benefitted the company.
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VI. COMPENSATION, ENVIRONMENTAL, SOCIAL AND GOVERNANCE SHAREHOLDER INITIATIVES
OVERVIEW
Glass Lewis typically prefers to leave decisions regarding day-to-day management and policy decisions, including those related to
social, environmental or political issues, to management and the board, except when there is a clear link between the proposal and value enhancement or risk mitigation. We feel strongly that shareholders should not attempt to micromanage the
company, its businesses or its executives through the shareholder initiative process. Rather, we believe shareholders should use their influence to push for governance structures that protect shareholders and promote director accountability.
Shareholders should then put in place a board they can trust to make informed decisions that are in the best interests of the business and its owners, and then hold directors accountable for management and policy decisions through board elections.
However, we recognize that support of appropriately crafted shareholder initiatives may at times serve to promote or protect shareholder value.
To this end, Glass Lewis evaluates shareholder proposals on a case-by-case basis. We generally recommend supporting shareholder proposals
calling for the elimination of, as well as to require shareholder approval of, antitakeover devices such as poison pills and classified boards. We generally recommend supporting proposals likely to increase and/or protect shareholder value and also
those that promote the furtherance of shareholder rights. In addition, we also generally recommend supporting proposals that promote director accountability and those that seek to improve compensation practices, especially those promoting a closer
link between compensation and performance.
For a detailed review of our policies concerning compensation, environmental, social
and governance shareholder initiatives, please refer to our comprehensive
Proxy Paper Guidelines for Shareholder Initiatives.
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DISCLAIMER
This document sets forth the proxy voting policy and guidelines of Glass, Lewis & Co., LLC. The policies included herein have been
developed based on Glass Lewis experience with proxy voting and corporate governance issues and are not tailored to any specific person. Moreover, these guidelines are not intended to be exhaustive and do not include all potential voting
issues. The information included herein is reviewed periodically and updated or revised as necessary. Glass Lewis is not responsible for any actions taken or not taken on the basis of this information. This document may not be reproduced or
distributed in any manner without the written permission of Glass Lewis.
Copyright © 2014 Glass, Lewis & Co., LLC. All Rights Reserved.
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PROXY PAPERTM
GUIDELINES
2014 PROXY SEASON
AN OVERVIEW OF THE GLASS LEWIS APPROACH TO PROXY ADVICE
INTERNATIONAL
COPYRIGHT 2014 GLASS LEWIS, & CO., LLC
TABLE OF CONTENTS
I
I. ELECTION OF DIRECTORS
Boards are put in place to represent shareholders and protect their interests. Glass Lewis seeks boards with a proven record of protecting
shareholders and delivering value over the medium- and long-term. In our view, boards working to protect and enhance the best interests of shareholders typically include some independent directors (the percentage will vary by local market practice
and regulations), boast a record of positive performance, have directors with diverse backgrounds, and appoint directors with a breadth and depth of experience.
BOARD COMPOSITION
When companies disclose sufficient relevant information, we look at each individual on the board and examine his or her relationships with the
company, the companys executives and with other board members. The purpose of this inquiry is to determine whether pre-existing personal, familial or financial relationships are likely to impact the decisions of that board member. Where the
company does not disclose the names and backgrounds of director nominees with sufficient time in advance of the shareholder meeting to evaluate their independence and performance, we will consider recommending abstaining on the directors
election.
We vote in favor of governance structures that will drive positive performance and enhance shareholder value. The most crucial
test of a boards commitment to the company and to its shareholders is the performance of the board and its members. The performance of directors in their capacity as board members and as executives of the company, when applicable, and in their
roles at other companies where they serve is critical to this evaluation.
We believe a director is independent if he or she has no
material financial, familial or other current relationships with the company, its executives or other board members except for service on the board and standard fees paid for that service. Relationships that have existed within the three-five years
prior to the inquiry are usually considered to be current for purposes of this test.
In our view, a director is affiliated if
he or she has a material financial, familial or other relationship with the company or its executives, but is not an employee of the company. This includes directors whose employers have a material financial relationship with the Company. This also
includes a director who owns or controls 10-20% or more of the companys voting stock.
We define an inside director as one who
simultaneously serves as a director and as an employee of the company. This category may include a chairman of the board who acts as an employee of the company or is paid as an employee of the company.
Although we typically vote for the election of directors, we will recommend voting against directors for the following reasons:
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A director who attends less than 75% of the board and applicable committee meetings.
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A director who is also the CEO of a company where a serious restatement has occurred after the CEO certified the pre-restatement financial
statements.
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We also feel that the following conflicts of interest may hinder a directors performance and will
therefore recommend voting against a:
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CFO who presently sits on the board.
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Director who presently sits on an excessive number of boards.
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Director, or a director whose immediate family member, provides material professional services to the company at any time during the past five
years.
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Director, or a director whose immediate family member, engages in airplane, real estate or other similar deals, including perquisite type grants
from the company.
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Director with an interlocking directorship.
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SLATE ELECTIONS
In
some countries, companies elect their board members as a slate, whereby shareholders are unable to vote on the election of each individual director, but rather are limited to voting for or against the board as a whole. If significant issues exist
concerning one or more of the nominees or in markets where directors are generally elected individually, we will recommend voting against the entire slate of directors.
BOARD COMMITTEE COMPOSITION
We believe that independent directors should serve on a companys audit, compensation, nominating and governance committees. We will
support boards with such a structure and encourage change where this is not the case.
REVIEW OF RISK MANAGEMENT CONTROLS
We believe companies, particularly financial firms, should have a dedicated risk committee, or a committee of the board charged with risk
oversight, as well as a chief risk officer who reports directly to that committee, not to the CEO or another executive. In cases where a company has disclosed a sizable loss or writedown, and where a reasonable analysis indicates that the
companys board-level risk committee should be held accountable for poor oversight, we would recommend that shareholders vote against such committee members on that basis. In addition, in cases where a company maintains a significant level of
financial risk exposure but fails to disclose any explicit form of board-level risk oversight (committee or otherwise), we will consider recommending to vote against the chairman of the board on that basis.
CLASSIFIED BOARDS
Glass Lewis favors the repeal of staggered boards in favor of the annual election of directors. We believe that staggered boards are less
accountable to shareholders than annually elected boards. Furthermore, we feel that the annual election of directors encourages board members to focus on protecting the interests of shareholders.
2
II. FINANCIAL REPORTING
ACCOUNTS AND REPORTS
Many countries require companies to submit the annual financial statements, director reports and independent auditors reports to
shareholders at a general meeting. Shareholder approval of such a proposal does not discharge the board or management. We will usually recommend voting in favor of these proposals except when there are concerns about the integrity of the
statements/reports. However, should the audited financial statements, auditors report and/or annual report not be published at the writing of our report, we will recommend that shareholders abstain from voting on this proposal.
INCOME ALLOCATION (DISTRIBUTION OF DIVIDEND)
In many countries, companies must submit the allocation of income for shareholder approval. We will generally recommend voting for such a
proposal. However, we will give particular scrutiny to cases where the companys dividend payout ratio is exceptionally low or excessively high relative to its peers and the company has not provided a satisfactory explanation.
APPOINTMENT OF AUDITORS AND AUTHORITY TO SET FEES
We believe that role of the auditor is crucial in protecting shareholder value. Like directors, auditors should be free from conflicts of
interest and should assiduously avoid situations that require them to make choices between their own interests and the interests of the shareholders.
We generally support managements recommendation regarding the selection of an auditor and support granting the board the authority to
fix auditor fees except in cases where we believe the independence of an incumbent auditor or the integrity of the audit has been compromised.
However, we recommend voting against ratification of the auditor and/or authorizing the board to set auditor fees for the following reasons:
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When audit fees added to audit-related fees total less than one-half of total fees.
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When there have been any recent restatements or late filings by the company where the auditor bears some responsibility for the restatement or late
filing (e.g., a restatement due to a reporting error).
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When the company has aggressive accounting policies.
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When the company has poor disclosure or lack of transparency in financial statements.
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When there are other relationships or issues of concern with the auditor that might suggest a conflict between the interest of the auditor and the
interests of shareholders.
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When the company is changing auditors as a result of a disagreement between the company and the auditor on a matter of accounting principles or
practices, financial statement disclosure or auditing scope or procedures.
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III. COMPENSATION
COMPENSATION REPORT/COMPENSATION POLICY
We closely review companies remuneration practices and disclosure as outlined in company filings to evaluate management-submitted
advisory compensation report and policy vote proposals. In evaluating these proposals, which can be binding or non-binding depending on the country, we examine how well the company has disclosed information pertinent to its compensation programs,
the extent to which overall compensation is tied to performance, the performance metrics selected by the company and the levels of remuneration in comparison to company performance and that of its peers.
We will usually recommend voting against approval of the compensation report or policy when the following occur:
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Gross disconnect between pay and performance;
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Performance goals and metrics are inappropriate or insufficiently challenging;
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Lack of disclosure regarding performance metrics and goals as well as the extent to which the performance metrics, targets and goals are
implemented to enhance company performance and encourage prudent risk-taking;
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Excessive discretion afforded to or exercised by management or the compensation committee to deviate from defined performance metrics and goals in
making awards;
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Ex gratia or other non-contractual payments have been made and the reasons for making the payments have not been fully explained or the explanation
is unconvincing;
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Guaranteed bonuses are established;
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There is no clawback policy; or
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Egregious or excessive bonuses, equity awards or severance payments.
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LONG TERM INCENTIVE PLANS
Glass Lewis recognizes the value of equity-based incentive programs. When used appropriately, they can provide a vehicle for linking an
employees pay to a companys performance, thereby aligning their interests with those of shareholders. Tying a portion of an employees compensation to the performance of the Company provides an incentive to maximize share value. In
addition, equity-based compensation is an effective way to attract, retain and motivate key employees.
In order to allow for meaningful
shareholder review, we believe that incentive programs should generally include: (i) specific and appropriate performance goals; (ii) a maximum award pool; and (iii) a maximum award amount per employee. In addition, the payments made
should be reasonable relative to the performance of the business and total compensation to those covered by the plan should be in line with compensation paid by the Companys peers.
PERFORMANCE-BASED EQUITY COMPENSATION
Glass Lewis believes in performance-based equity compensation plans for senior executives. We feel that executives should be compensated with
equity when their performance and that of the company warrants such rewards. While we do not believe that equity-based compensation plans for all employees need to be based on overall company performance, we do support such limitations for grants to
senior executives (although even some equity-based compensation of senior executives without performance criteria is acceptable, such as in the case of moderate incentive grants made in an initial offer of employment).
4
Boards often argue that such a proposal would hinder them in attracting talent. We believe
that boards can develop a consistent, reliable approach, as boards of many companies have, that would still attract executives who believe in their ability to guide the company to achieve its targets. We generally recommend that shareholders vote in
favor of performance-based option requirements.
There should be no retesting of performance conditions for all share- and option- based
incentive schemes. We will generally recommend that shareholders vote against performance-based equity compensation plans that allow for re-testing.
DIRECTOR COMPENSATION
Glass Lewis believes that non-employee directors should receive appropriate types and levels of compensation for
the time and effort they spend serving on the board and its committees. Director fees should be reasonable in order to retain and attract qualified individuals. In particular, we support compensation plans that include non performance-based equity
awards, which help to align the interests of outside directors with those of shareholders.
Glass Lewis compares the costs of these plans
to the plans of peer companies with similar market capitalizations in the same country to help inform its judgment on this issue.
RETIREMENT BENEFITS FOR DIRECTORS
We will typically recommend voting against proposals to grant retirement benefits to non-executive directors. Such extended payments can impair
the objectivity and independence of these board members. Directors should receive adequate compensation for their board service through initial and annual fees.
LIMITS ON EXECUTIVE COMPENSATION
As a general rule, Glass Lewis believes that shareholders should not be involved in setting executive compensation. Such matters should be left
to the boards compensation committee. We view the election of directors, and specifically those who sit on the compensation committee, as the appropriate mechanism for shareholders to express their disapproval or support of board policy on
this issue. Further, we believe that companies whose pay-for-performance is in line with their peers should be granted the flexibility to compensate their executives in a manner that drives growth and profit.
However, Glass Lewis favors performance-based compensation as an effective means of motivating executives to act in the best interests of
shareholders. Performance-based compensation may be limited if a chief executives pay is capped at a low level rather than flexibly tied to the performance of the company.
5
IV. GOVERNANCE STRUCTURE
AMENDMENTS TO THE ARTICLES OF ASSOCIATION
We will evaluate proposed amendments to a companys articles of association on a case-by-case basis. We are opposed to the practice of
bundling several amendments under a single proposal because it prevents shareholders from evaluating each amendment on its own merits. In such cases, we will analyze each change individually and will recommend voting for the proposal only when we
believe that the amendments on balance are in the best interests of shareholders.
ANTI-TAKEOVER MEASURES
POISON PILLS (SHAREHOLDER RIGHTS PLANS)
Glass Lewis believes that poison pill plans generally are not in the best interests of shareholders. Specifically, they can reduce management
accountability by substantially limiting opportunities for corporate takeovers. Rights plans can thus prevent shareholders from receiving a buy-out premium for their stock.
We believe that boards should be given wide latitude in directing the activities of the company and charting the companys course.
However, on an issue such as this where the link between the financial interests of shareholders and their right to consider and accept buyout offers is so substantial, we believe that shareholders should be allowed to vote on whether or not they
support such a plans implementation.
In certain limited circumstances, we will support a limited poison pill to accomplish a
particular objective, such as the closing of an important merger, or a pill that contains what we believe to be a reasonable qualifying offer clause.
SUPERMAJORITY VOTE REQUIREMENTS
Glass Lewis favors a simple majority voting structure. Supermajority vote requirements act as impediments to shareholder action on ballot items
that are critical to our interests. One key example is in the takeover context where supermajority vote requirements can strongly limit shareholders input in making decisions on such crucial matters as selling the business.
INCREASE IN AUTHORIZED SHARES
Glass Lewis believes that having adequate capital stock available for issuance is important to the operation of a company. We will generally
support proposals when a company could reasonably use the requested shares for financing, stock splits and stock dividends. While we think that having adequate shares to allow management to make quick decisions and effectively operate the business
is critical, we prefer that, for significant transactions, management come to shareholders to justify their use of additional shares rather than providing a blank check in the form of large pools of unallocated shares available for any purpose.
In general, we will support proposals to increase authorized shares up to 100% of the number of shares currently authorized unless, after the
increase the company would be left with less than 30% of its authorized shares outstanding.
6
ISSUANCE OF SHARES
Issuing additional shares can dilute existing holders in some circumstances. Further, the availability of additional shares, where the board
has discretion to implement a poison pill, can often serve as a deterrent to interested suitors. Accordingly, where we find that the company has not disclosed a detailed plan for use of the proposed shares, or where the number of shares requested
are excessive, we typically recommend against the issuance. In the case of a private placement, we will also consider whether the company is offering a discount to its share price.
In general, we will support proposals to issue shares (with pre-emption rights) when the requested increase is the lesser of (i) the
unissued ordinary share capital; or (ii) a sum equal to one-third of the issued ordinary share capital. This authority should not exceed five years. In some countries, if the proposal contains a figure greater than one-third, the company should
explain the nature of the additional amounts.
We will also generally support proposals to suspend pre-emption rights for a maximum of
5-20% of the issued ordinary share capital of the company, depending on the country in which the company is located. This authority should not exceed five years, or less for some countries.
REPURCHASE OF SHARES
We will recommend voting in favor of a proposal to repurchase shares when the plan includes the following provisions: (i) a maximum number
of shares which may be purchased (typically not more than 15% of the issued share capital); and (ii) a maximum price which may be paid for each share (as a percentage of the market price).
7
V. ENVIRONMENTAL AND SOCIAL RISK
We believe companies should actively evaluate risks to long-term shareholder value stemming from exposure to environmental and social risks and
should incorporate this information into their overall business risk profile. In addition, we believe companies should consider their exposure to changes in environmental or social regulation with respect to their operations as well as related legal
and reputational risks. Companies should disclose to shareholders both the nature and magnitude of such risks as well as steps they have taken or will take to mitigate those risks.
When we identify situations where shareholder value is at risk, we may recommend voting in favor of a reasonable and well-targeted proposal if
we believe supporting the proposal will promote disclosure of and/or mitigate significant risk exposure. In limited cases where a company has failed to adequately mitigate risks stemming from environmental or social practices, we will recommend
shareholders vote against: (i) ratification of board and/or management acts; (ii) approving a companys accounts and reports and/or; (iii) directors (in egregious cases).
8
DISCLAIMER
This document sets forth the proxy voting policy and guidelines of Glass, Lewis & Co., LLC. The policies included herein have been
developed based on Glass Lewis experience with proxy voting and corporate governance issues and are not tailored to any specific person. Moreover, these guidelines are not intended to be exhaustive and do not include all potential voting
issues. The information included herein is reviewed periodically and updated or revised as necessary. Glass Lewis is not responsible for any actions taken or not taken on the basis of this information. This document may not be reproduced or
distributed in any manner without the written permission of Glass Lewis.
Copyright © 2014 Glass, Lewis & Co., LLC. All Rights Reserved.
9
SAN FRANCISCO
Headquarters
Glass, Lewis & Co., LLC
One Sansome Street
Suite 3300
San Francisco, CA 94104
Tel: +1 415-678-4110
Tel: +1 888-800-7001
Fax: +1 415-357-0200
NEW YORK
Glass, Lewis & Co., LLC
48 Wall Street
15th Floor
New York, N.Y. 10005
Tel: +1 212-797-3777
Fax: +1 212-980-4716
AUSTRALIA
CGI Glass Lewis Pty Limited
Suite 8.01, Level 8,
261 George St
Sydney NSW 2000
Australia
Tel: +61 2 9299 9266
Fax: +61 2 9299 1866
IRELAND
Glass Lewis Europe, Ltd.
15 Henry Street
Limerick, Ireland
Phone: +353 61 292 800
Fax: +353 61 292 899
Schwab Investments
PEA No. 114
Part
C: Other Information
ITEM 28. EXHIBITS.
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(a)(i)
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Agreement and Declaration of Trust, dated October 25, 1990, is incorporated herein by reference to Exhibit 1 of Post-Effective Amendment No. 22, filed December 31, 1997 (PEA No. 22).
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(a)(ii)
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Amendment to the Agreement and Declaration of Trust, dated August 29, 2006, is incorporated herein by reference to Exhibit (a)(ii) of Post-Effective Amendment No. 65, filed September 14, 2006 (PEA No. 65).
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(b)
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Amended and Restated Bylaws, dated November 16, 2004, are incorporated herein by reference to Exhibit (b) of Post-Effective Amendment No. 56, filed February 25, 2005 (PEA No. 56).
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(c)(i)
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Article III, Section 5, Article V, Article VI, Article VIII, Section 4 and Article IX, Sections 1, 5 and 7 of (a) the Agreement and Declaration of Trust, which is incorporated herein by reference to Exhibit 1 of PEA No. 22, and (b)
the Amendment to the Agreement and Declaration of Trust, dated August 29, 2006, which is incorporated herein by reference to Exhibit (a)(ii) of PEA No. 65.
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(c)(ii)
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Article 9 and Article 11 of the Amended and Restated By-Laws, which are incorporated herein by reference to Exhibit (b) of PEA No. 56.
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(d)(i)
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Investment Advisory and Administration Agreement between Registrant and Charles Schwab Investment Management, Inc. (the Investment Adviser), dated June 15, 1994, is incorporated herein by reference to Exhibit 5(a) of PEA
No. 22.
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(d)(ii)
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Amendment, dated June 5, 2007, to the Investment Advisory and Administration Agreement between Registrant and Investment Adviser, dated June 15, 1994, is incorporated herein by reference to Exhibit (d)(ii) of Post-Effective
Amendment No. 75, filed November 14, 2007.
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(d)(iii)
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Amended Schedules A and D, dated March 29, 2013, to the Investment Advisory and Administration Agreement between Registrant and the Investment Adviser, dated June 15, 1994, is incorporated herein by reference to Exhibit (d)(iii) of
Post-Effective Amendment No. 112, filed December 12, 2013 (PEA No. 112).
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(d)(iv)
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Expense Limitation Agreement, dated May 2, 2007, as amended July 1, 2009, among the Investment Adviser, Charles Schwab & Co. Inc. (Schwab), and the Registrant, is incorporated herein by reference to Exhibit (d)(iv)
of Post-Effective Amendment No. 81, filed November 13, 2009 (PEA No. 81).
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(d)(v)
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Amended Schedule A, dated December 4, 2012, to the Expense Limitation Agreement, dated May 2, 2007, as amended July 1, 2009, June 15, 2011 and September 25, 2012, among Investment Adviser, Schwab and the Registrant is incorporated
herein by reference to Exhibit (d)(v) of Post-Effective Amendment No. 103, filed December 14, 2012.
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(e)
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Amended and Restated Distribution Agreement between Registrant and Schwab, dated July 1, 2009, is incorporated herein by reference to Exhibit (e) of PEA No. 81.
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(f)
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Inapplicable.
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(g)(i)
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Amended and Restated Master Custodian Agreement between Registrant and State Street Bank and Trust Company (State Street), dated October 17, 2005, is incorporated herein by reference to Exhibit (g)(xv) of Post-Effective
Amendment No. 60, filed November 14, 2005 (PEA No. 60).
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(g)(ii)
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Custodian Agreement between Registrant and Brown Brothers Harriman & Co., dated April 1, 2007, is incorporated herein by reference to Exhibit (g)(ii) of Post-Effective Amendment No. 87, filed June 23, 2010.
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(h)(i)
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Transfer Agency and Service Agreement between Registrant and Boston Financial Data Services, Inc., dated July 1, 2009, is incorporated herein by reference to Exhibit (h)(i) of PEA No.
81.
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2
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(h)(ii)
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Shareholder Servicing Plan, dated July 1, 2009, is incorporated herein by reference to Exhibit (h)(ii) of PEA No. 81.
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(h)(iii)
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Amended Schedule A, dated February 25, 2014, to Shareholder Servicing Plan is filed herein as Exhibit (h)(iii).
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(h)(iv)
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Master Fund Accounting and Services Agreement between Registrant and State Street, dated October 1, 2005, is incorporated herein by reference to Exhibit (g)(xvi) of PEA No. 60.
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(i)
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Opinion and Consent of Counsel is filed herein as Exhibit (i).
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(j)(i)
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Consent of PricewaterhouseCoopers LLP is filed herein as Exhibit (j)(i).
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(j)(ii)
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Powers of Attorney for each of Mariann Byerwalter, William A. Hasler, Gerald B. Smith, Charles R. Schwab, George Pereira, Walter W. Bettinger, II, Joseph Wender and John F. Cogan are incorporated herein by reference to
Post-Effective Amendment No. 88, filed September 24, 2010.
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(j)(iii)
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Powers of Attorney for each of David L. Mahoney and Kiran M. Patel are incorporated herein by reference to Post-Effective Amendment No. 92, filed February 25, 2011.
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(j)(iv)
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Power of Attorney for Marie Chandoha is incorporated herein by reference to Post-Effective Amendment No. 90, filed December 9, 2010.
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(k)
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Inapplicable.
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(l)(i)
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Purchase Agreement between Registrant and Schwab relating to shares of the Schwab 1000 Index Fund is incorporated herein by reference to Exhibit (l)(i) of Post-Effective Amendment No. 29, filed July 21, 1999 (PEA No.
29).
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(l)(ii)
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Purchase Agreement between Registrant and Schwab relating to shares of the Schwab Short-Term Bond Market Fund is incorporated herein by reference to Exhibit (l)(ii) of PEA No. 29.
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(l)(iii)
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Purchase Agreement between Registrant and Schwab relating to shares of the Schwab California Tax-Free Bond Fund is incorporated herein by reference to Exhibit (l)(iii) of PEA No. 29.
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(l)(iv)
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Purchase Agreement between Registrant and Schwab relating to shares of the Schwab Tax-Free Bond Fund is incorporated herein by reference to Exhibit (l)(iv) of PEA No 29.
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(l)(v)
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Purchase Agreement between Registrant and Schwab relating to shares of the Schwab Total Bond Market Fund is incorporated herein by reference to Exhibit 13 of PEA No. 22.
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(l)(vi)
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Purchase Agreement between Registrant and Schwab relating to the purchase of one share of each class of the Schwab GNMA Fund is incorporated herein by reference to Exhibit (l)(vii) of Post-Effective Amendment No. 46, filed January
24, 2003.
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(l)(vii)
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Purchase Agreement between Registrant and Schwab relating to the purchase of one share of each class of the Schwab Treasury Inflation Protected Securities Fund is incorporated herein by reference to Exhibit (l)(ix) of Post-Effective
Amendment No. 61, filed January 23, 2006.
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(l)(viii)
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Purchase Agreement between Registrant and Schwab relating to the purchase of one share of the Schwab Premier Income Fund Investor Shares, two shares of the Schwab Premier Income Fund Select Shares and three shares of the Schwab
Premier Income Fund Institutional Shares is incorporated herein by reference to Exhibit (l)(x) of Post-Effective Amendment No. 73, filed September 19, 2007.
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(l)(ix)
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Purchase Agreement between Registrant and Schwab relating to the purchase of two shares of the Schwab Global Real Estate Fund Investor Shares and one share of the Schwab Global Real Estate Fund Select Shares is incorporated herein
by reference to Exhibit (l)(xi) of Post-Effective Amendment No. 77, filed June 27, 2008.
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(m)
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Inapplicable.
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(n)
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Inapplicable.
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(o)
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Inapplicable.
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3
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(p)
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Registrant, Investment Adviser, and Schwab Code of Ethics, dated June 14, 2013 is incorporated herein by reference to Exhibit (p) of PEA No. 112.
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Item 29.
Persons Controlled by or under Common Control with the Registrant
.
The Board of Trustees of the Registrant is identical to the boards of trustees of The Charles Schwab Family of Funds, Schwab Capital Trust, Schwab Annuity
Portfolios, Laudus Trust and Laudus Institutional Trust. Each such trust has Charles Schwab Investment Management, Inc. as its investment adviser. In addition, the officers of the Registrant are also identical to those of each such other trust, with
the exception of the Chief Legal Officer and Secretary/Clerk. As a result, the above-named trusts may be deemed to be under common control with the Registrant. Nonetheless, the Registrant takes the position that it is not under common control with
such other trusts because the power residing in the respective trusts boards and officers arises as a result of an official position with each such trust.
Item 30.
Indemnification
.
Article VIII of Registrants Agreement and Declaration of Trust (Exhibit (1) hereto, which is incorporated herein by reference)
provides in effect that Registrant will indemnify its officers and trustees against all liabilities and expenses, including but not limited to amounts paid in satisfaction of judgments, in compromise, or as fines and penalties, and counsel fees
reasonably incurred by any such officer or trustee in connection with the defense or disposition of any action, suit, or other proceeding. However, in accordance with Sections 17(h) and 17(i) of the 1940 Act and its own terms, said Agreement and
Declaration of Trust does not protect any person against any liability to Registrant or its shareholders to which he or she would otherwise be subject by reason of willful misfeasance, bad faith, gross negligence or reckless disregard of the duties
involved in the conduct of his or her office. In any event, Registrant will comply with 1940 Act Releases No. 7221 and 11330 respecting the permissible boundaries of indemnification by an investment company of its officers and trustees.
Insofar as indemnification for liability arising under the Securities Act of 1933, as amended (the 1933 Act), may be
permitted to trustees, officers and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, Registrant has been advised that, in the opinion of the Securities and Exchange Commission, such indemnification is against
public policy as expressed in the 1933 Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by Registrant of expenses incurred or paid by a trustee, officer or
controlling person of Registrant in the successful defense of any action, suit or proceeding) is asserted by such trustee, officer or controlling person in connection with the securities being registered, Registrant will, unless in the opinion of
its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the 1933 Act and will be governed by the final
adjudication of such issue.
Item 31.
Business and Other Connections of Investment Manager
Registrants investment adviser, Charles Schwab Investment Management, Inc., a Delaware corporation, organized in October 1989 to serve as investment
manager to Registrant, also serves as the investment manager to The Charles Schwab Family of Funds, Schwab Capital Trust, Schwab Annuity Portfolios, Schwab Strategic Trust, Laudus Trust and Laudus Institutional Trust, each an open-end management
investment company. The principal place of business of the investment adviser is 211 Main Street, San Francisco, California 94105. The only business in which the investment adviser engages is that of investment adviser and administrator to
Registrant, The Charles Schwab Family of Funds, Schwab Capital Trust, Schwab Annuity Portfolios and Schwab Strategic Trust, investment adviser of Laudus Trust and Laudus Institutional Trust and any other investment companies that Schwab may sponsor
in the future, and an investment adviser to certain non-investment company clients.
The business, profession, vocation or employment of a substantial
nature in which each director and/or senior or executive officer of the Investment Adviser is or has been engaged during the past two fiscal years is listed below. The name of any company for which any director and/or senior or executive officer of
the investment adviser serves as director, officer, employee, partner or trustee is also listed below.
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Name and Position
with Adviser
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Name of Other Company
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Capacity
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Charles R. Schwab, Chairman and Director
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The Charles Schwab Corporation
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Chairman and Director
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Charles Schwab & Co., Inc.
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Chairman and Director
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The Charles Schwab Bank, N.A.
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Chairman, Director
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Schwab Holdings, Inc.
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Director, Chairman and Chief
Executive
Officer
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4
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Schwab International Holdings, Inc.
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Chairman and Chief Executive Officer
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Schwab (SIS) Holdings, Inc. I
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Chairman and Chief Executive Officer
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Schwab Charitable Fund
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Director
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Charles Schwab Foundation
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Director and Chairman
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JustAnswer Corp.
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Director
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Museum of American Finance
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Advisory Board
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San Francisco Museum of Modern Art
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Board of Trustees
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Charles and Helen Schwab Foundation
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Director
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University of California San Francisco
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Chancellors Executive Board
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Laudus Funds
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Chairman and Trustee
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Schwab Funds
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Chairman and Trustee
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Marie Chandoha, Director, President and Chief Executive Officer
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Charles Schwab & Co., Inc.
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Executive Vice President
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Schwab Funds
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President and Chief Executive Officer
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Schwab ETFs
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President and Chief Executive Officer
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Laudus Funds
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President and Chief Executive Officer
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Charles Schwab Worldwide Funds, PLC
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Director
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Charles Schwab Asset Management (Ireland) Limited
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Director
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David Lekich, Chief Counsel and Senior Vice President
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Charles Schwab & Co., Inc.
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Senior Vice President and Associate General Counsel
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Schwab Funds
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Secretary and Chief Legal Officer
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Schwab ETFs
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Secretary and Chief Legal Officer
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Laudus Funds
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Vice President and Assistant Clerk
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Michael Hogan, Chief Compliance Officer
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Schwab Funds
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Chief Compliance Officer
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Schwab ETFs
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Chief Compliance Officer
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Laudus Funds
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Chief Compliance Officer
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Charles Schwab & Co., Inc.
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Senior Vice President and Chief Compliance Officer
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George Pereira, Senior Vice President, Chief Financial Officer and Chief Operating Officer
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Schwab Funds
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Treasurer and Principal Financial Officer
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Schwab ETFs
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Treasurer and Principal Financial Officer
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Laudus Funds
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Treasurer and Chief Financial Officer
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Charles Schwab Worldwide Funds, PLC
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Director
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Charles Schwab Asset Management (Ireland) Limited
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Director
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Item 32.
Principal Underwriters.
(a) Schwab acts as principal underwriter and distributor of Registrants shares. Schwab also acts as principal underwriter for The Charles
Schwab Family of Funds, Schwab Capital Trust, and Schwab Annuity Portfolios and may act as such for any other investment company which Schwab may sponsor in the future.
(b) Information with respect to Schwabs directors and officers is as follows:
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Name
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Position and Offices with the Underwriter
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Position and Offices with the Registrant
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Charles R. Schwab
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Chairman
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Chairman and Trustee
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Walter W. Bettinger II
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President and Chief Executive Officer
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Trustee
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Jay Allen
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Executive Vice President, Human Resources and Employee Services
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None
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5
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Ron Carter
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Executive Vice President, Operational Services
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None
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Bernard Clark
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Executive Vice President, Advisor Services
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None
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John Clendening
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Executive Vice President, Investor Services
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None
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Carrie Dwyer
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Executive Vice President, General Counsel and Corporate Secretary
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None
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Jonathan M. Craig
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Executive Vice President and Chief Marketing Officer
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None
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G. Andrew Gill
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Executive Vice President, Schwab Investor Services
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None
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Lisa Kidd Hunt
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Executive Vice President, International Services and Special Business Development
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None
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Joseph Martinetto
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Executive Vice President and Chief Financial Officer
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None
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James McCool
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Executive Vice President, Client Solutions
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None
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Nigel J. Murtagh
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Executive Vice President, Corporate Risk
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None
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Jim McGuire
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Executive Vice President and Chief Information Officer
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None
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Leona Tang
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Executive Vice President, Internal Audit
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None
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Paul V. Woolway
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Executive Vice President and President, Charles Schwab Bank
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None
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Steve Anderson
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Executive Vice President, Schwab Retirement Plan Services
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None
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The principal business address of all directors and officers of Schwab is 211 Main Street, San Francisco, California
94105.
(c) None.
Item 33.
Location of Accounts and Records
.
All accounts, books and other documents required to be maintained pursuant to
Section 31(a) of the 1940 Act and the Rules thereunder are maintained at the offices of: Registrant and Registrants investment adviser and administrator, Charles Schwab Investment Management, Inc., 211 Main Street, San Francisco,
California 94105; Registrants principal underwriter, Charles Schwab & Co., Inc., 211 Main Street, San Francisco, California 94105; Registrants custodian for the Schwab Global Real Estate Fund, Brown Brothers Harriman &
Co., 50 Post Office Square, Boston, Massachusetts 02110, Registrants custodian for the balance of the Registrants funds, State Street Bank and Trust Company, One Lincoln Street, Boston, Massachusetts 02111; and Registrants transfer
agent, Boston Financial Data Services, Inc., 2000 Crown Colony Drive Quincy Massachusetts, 02169.
Item 34.
Management Services
.
Not applicable.
Item 35.
Undertakings.
Not applicable.
6
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended (the 1933 Act), and the Investment Company Act of 1940, as
amended, Registrant certifies that it meets all of the requirements for the effectiveness of this Post Effective Amendment No. 114 to Registrants Registration Statement on Form N-1A pursuant to Rule 485(b) under the 1933 Act and has duly
caused this Post Effective Amendment No. 114 to be signed on its behalf by the undersigned, thereto duly authorized, in the City of Washington in the District of Columbia, on the 26th day of February, 2014.
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SCHWAB INVESTMENTS
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Registrant
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Charles R. Schwab*
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Charles R. Schwab, Chairman and Trustee
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Pursuant to the requirements of the 1933 Act, this Post-Effective Amendment No. 114 to
Registrants Registration Statement on Form N-1A has been signed below by the following persons in the capacities indicated this 26th day of February, 2014.
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Signature
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Title
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Charles R. Schwab*
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Chairman and Trustee
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Charles R. Schwab
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Walter W. Bettinger, II*
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Trustee
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Walter W. Bettinger, II
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Mariann Byerwalter*
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Trustee
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Mariann Byerwalter
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John F. Cogan*
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Trustee
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John F. Cogan
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David L. Mahoney*
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Trustee
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David L. Mahoney
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Kiran M. Patel*
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Trustee
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Kiran M. Patel
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Gerald B. Smith*
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Trustee
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Gerald B. Smith
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Joseph H. Wender*
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Trustee
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Joseph H. Wender
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Marie Chandoha*
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President and Chief Executive Officer
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Marie Chandoha
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George Pereira*
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Treasurer and Principal Financial Officer
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George Pereira
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*By:
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/s/ Douglas P. Dick
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Douglas P. Dick, Attorney-in-Fact
Pursuant
to Power of Attorney
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EXHIBIT INDEX
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(h)(iii)
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Amended Schedule A, dated February 25, 2014, to Shareholder Servicing Plan
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(i)
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Opinion and Consent of Counsel.
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(j)(i)
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Consent of PricewaterhouseCoopers LLP
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