Form 497 ROYCE CAPITAL FUND
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RCF-SAI-0522
ROYCE CAPITAL FUND
STATEMENT OF ADDITIONAL INFORMATION
ROYCE CAPITAL FUND (the “Trust”), a Delaware statutory trust organized in January 1996, is an open-end management investment company registered under the Investment Company Act of 1940 (the “1940 Act”). The Trust has two portfolios or series (each, a “Fund” and together, the “Funds”), each of which is classified as “diversified” within the meaning of the 1940 Act. Additionally, each Fund has distinct investment goals and/or strategies, and a shareholder’s interest is limited to the Fund in which the shareholder beneficially owns shares. The Funds, the share classes they offer (each, a “Share Class” and collectively, the “Share Classes”), and their related ticker symbols are:
| Fund | Class and Ticker Symbol |
| Royce Micro-Cap Portfolio | Investment (RCMCX) and Service (RCMSX) |
| Royce Small-Cap Portfolio | Investment (RCPFX) and Service (RCSSX) |
Shares of the Funds are offered to life insurance companies (“Insurance Companies”) for allocation to certain separate accounts established for the purpose of funding variable annuity contracts and variable life insurance contracts (collectively, “Variable Contracts”).
This statement of additional information (this “SAI”) is not a prospectus, but should be read in conjunction with the Trust’s statutory prospectus dated May 1, 2022 (the “Prospectus”). Please retain this document for future reference. The audited financial statements included in the Funds’ Annual Reports to Shareholders for the fiscal year ended December 31, 2021 (SEC Accession No. 0000949377-22-000021) are incorporated herein by reference. To obtain an additional copy of the Prospectus or Annual Report, please call Investor Services at 1-800-221-4268 or contact your Insurance Company.
| Investment Adviser | Transfer Agent | |
| Royce Investment Partners (“Royce”)1 | DST Asset Manager Solutions, Inc. (“DST AMS”) | |
| Distributor | Custodian | |
| Royce Fund Services, LLC (“RFS”) | State Street Bank and Trust Company (“State Street”) | |
| May 1, 2022, as supplemented August 19, 2022 |
1 Royce & Associates, LP is a Delaware limited partnership that primarily conducts its business under the name Royce Investment Partners.
TABLE OF CONTENTS
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In addition to the principal investment strategies described in the Prospectus, each Fund may invest the balance of its assets as described below.
Royce Micro-Cap Portfolio - in securities of companies with stock market capitalizations greater than that of the largest company in the Russell Microcap® Index at the time of its most recent reconstitution and non-convertible preferred stocks and debt securities.
Royce Small-Cap Portfolio - in securities of companies with stock market capitalizations greater than that of the largest company in the Russell 2000® Index at the time of its most recent reconstitution, non- dividend-paying common stocks, and non-convertible preferred stocks and debt securities.
INVESTMENT POLICIES AND LIMITATIONS
The Funds’ investment objective are set for in the Prospectus. The Funds’ fundamental investment policies, limitations and operating policies are listed below. A Fund’s fundamental investment policies cannot be changed without the approval of a “majority of the outstanding voting securities” (as defined in the the1940 Act) of that Fund. The remaining investment policies and limitations described in this SAI and the Funds’ investment objectives described in the Prospectus are operating policies and may be changed by a majority vote the Board of Trustees of the Trust (the “Board”) and without shareholder approval. However, shareholders will be notified prior to any material change to the operating policies of any Fund in which they beneficially own shares.
Unless otherwise expressly noted, compliance with each Fund’s investment policies and limitations will be determined immediately after or at the time of that Fund’s acquisition of the security or relevant asset except for Fundamental Policy No. 4, which the Funds must comply with on a continuous basis. Accordingly, any subsequent change in values, net assets or other circumstances will not be considered in determining whether an investment complies with a Fund’s investment policies and limitations, except as it relates to Fundamental Policy No. 4. In the event the percentage of a Fund’s assets invested in securities for which market quotations are not readily available (i.e., illiquid securities) exceeds the applicable limit set forth in Fundamental Policy No. 7 due to a subsequent change in values, net assets, or other circumstances, the Fund will consider, based on all relevant facts and circumstances, taking appropriate measures to reduce the percentage of its assets invested in such securities in an orderly fashion. Neither Fund, however, will be required to sell securities for which market quotations are not readily available (i.e., illiquid securities) if the percentage of its assets invested in such securities exceeds the applicable limit set forth in Fundamental Policy No. 7 due to a subsequent change in values, net assets, or other circumstances.
No Fund may, as a matter of fundamental policy:
| 1. | Issue any senior securities; |
| 2. | Purchase securities on margin or write call options on its portfolio securities; |
| 3. | Sell securities short; |
| 4. | Borrow money, except from banks as a temporary measure for extraordinary or emergency purposes in an amount not exceeding 5% of its assets; |
| 5. | Underwrite the securities of other issuers; |
| 6. | Invest in repurchase agreements which mature in more than seven days; |
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| 7. | Invest more than 10% of its assets in securities for which market quotations are not readily available (i.e., illiquid securities); |
| 8. | Invest, with respect to 75% of its assets, more than 5% of its assets in the securities of any one issuer (except U.S. Government securities); |
| 9. | Invest more than 25% of its assets in any one industry; |
| 10. | Acquire more than 10% of the outstanding voting securities of any one issuer; |
| 11. | Purchase or sell real estate or real estate mortgage loans or invest in the securities of real estate companies unless such securities are publicly-traded; |
| 12. | Purchase or sell commodities or commodity contracts; |
| 13. | Make loans, except for purchases of portions of issues of publicly-distributed bonds, debentures and other securities, whether or not such purchases are made upon the original issuance of such securities, and except that the Funds may loan up to 25% of their respective assets to qualified brokers, dealers or institutions for their use relating to short sales or other securities transactions (provided that such loans are fully collateralized at all times); |
| 14. | Invest in companies for the purpose of exercising control of management; or |
| 15. | Purchase portfolio securities from or sell such securities directly to any of the Trust’s Trustees, officers, employees or investment adviser, as principal for their own accounts. |
For purposes of Fundamental Policy No. 7, the Trust looks only to whether market quotations are not readily available and not to any other indicia of liquidity.
For purposes of Fundamental Policy No. 13, the Trust does not consider repurchase agreements or the purchase of debt securities, bank certificates of deposit and other similar securities, in accordance with the Funds’ investment policies, to be loans.
Certain operating policies of the Funds are set forth below. Such operating policies may be changed by a majority vote of the Board and without shareholder approval.
Notwithstanding any Fundamental Policy set forth herein, neither Fund may, as a matter of operating policy, enter into any “derivatives transaction” within the meaning of Rule 18f-4 under the 1940 Act.
In addition, neither Fund may, as a matter of operating policy:
| 1. | Invest more than 5% of its net assets in lower-rated (high-risk) non-convertible debt securities; or |
| 2. | Invest more than 5% of its total assets in warrants and rights; or |
| 3. | Invest more than 15% of its net assets in restricted securities (i.e., securities subject to certain contractual or legal restrictions on resale); or |
| 4. | Invest more than 25% of its net assets in the securities of foreign issuers; or |
| 5. | Invest more than 5% of its net assets in securities of companies headquartered in developing countries. |
For purposes of the operating policies, the Trust does not consider foreign government securities to be the securities of foreign issuers.
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In addition, for purposes of the operating policies, the Trust does not consider securities to be “restricted” if they may be sold by a Fund without restriction in the market in which they are primarily traded, outside the United States. Restricted securities, sometimes referred to as private placements, are subject to contractual or legal restrictions on resale because they are not registered under the Securities Act of 1933 (the “Securities Act”). Such securities and are purchased directly from the issuer, a control person of the issuer or another investor holding such securities. A large institutional market has developed for these unregistered privately placed restricted securities, including foreign securities. Institutional investors depend on an efficient institutional market in which the unregistered security can be readily resold or on an issuer’s ability to honor a demand for repayment. Notwithstanding the fact that these securities may be subject to contractual or legal restrictions on resale to the general public or to certain institutions, unregistered securities that can be sold in accordance with Rule 144A under the Securities Act will not be considered illiquid securities so long as Royce determines that an adequate trading market exists for the security. Rule 144A allows an institutional trading market for securities otherwise subject to restriction on resale to the general public. An insufficient number of qualified institutional buyers interested in purchasing certain restricted securities held by the Funds, however, could adversely affect the marketability of such portfolio securities, and the Funds might be unable to dispose of such securities promptly or at reasonable prices.
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RISK FACTORS AND SPECIAL CONSIDERATIONS
Equity Securities
Each Fund invests in equity securities to the extent set forth in its Prospectus. For these purposes, “equity security” has the meaning set forth in the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Common stocks, preferred stocks, convertible securities, warrants, rights, and options are some examples of equity securities in which the Funds may invest. Generally, preferred stock has a specified dividend and ranks after bonds and before common stocks in its claim on the company’s income for purposes of receiving dividend payments and on the company’s assets in the event of liquidation. Convertible securities have characteristics of both debt securities (which is generally the form in which they are first issued) and equity securities (which is what they can be converted into).
Funds’ Rights as Stockholders
No Fund may invest in a company for the purpose of exercising control of management. However, a Fund may exercise its rights as a stockholder and communicate its views on important matters of policy to the company’s management or its board of directors and/or other stockholders if Royce or the Board determines that such matters could have a significant effect on the value of the Fund’s investment in the company. The activities that a Fund may engage in, either individually or in conjunction with others, include, among others, supporting or opposing proposed changes in a company’s corporate structure or business activities; seeking changes in a company’s board of directors or management; seeking changes in a company’s direction or policies; seeking the sale or reorganization of a company or a portion of its assets; or supporting or opposing third party takeover attempts. This area of corporate activity is increasingly prone to litigation, and it is possible that a Fund could be involved in lawsuits related to such activities. Royce will monitor such activities with a view to mitigating, to the extent possible, the risk of litigation against the Funds and the risk of actual liability if a Fund is involved in litigation. However, no guarantee can be made that litigation against a Fund will not be undertaken or expenses or liabilities incurred, which could have a negative impact on that Fund’s performance.
A Fund may, at its expense or in conjunction with others, pursue litigation or otherwise exercise its rights as a security holder to seek to protect the interests of security holders if Royce and the Board determine this to be in the best interests of a Fund’s shareholders.
Securities Lending
Each Fund may lend up to 25% of its assets to brokers, dealers and other financial institutions. Securities lending allows a Fund to retain ownership of the securities loaned and, at the same time, to earn additional income. Since there may be delays in the recovery of loaned securities or even a loss of rights in collateral supplied should the borrower fail financially, loans will be made only to parties that participate in and satisfy the requirements of the a Global Securities Lending Program organized and monitored by the Funds’ custodian, State Street. Furthermore, such loans will be made only if, in Royce’s judgment, the consideration to be earned from such loans would justify the risk. Collateral supplied from the borrower that is re-invested is subject to market and other investment-related risks.
The current view of the staff of the Securities and Exchange Commission (the “SEC”) is that a Fund may engage in such loan transactions only under the following conditions: (i) the Fund must receive 100% collateral in the form of cash or cash equivalents from the borrower; (ii) the borrower must increase the collateral whenever the market value of the securities loaned (determined on a daily basis) rises above the value of the collateral; (iii) after giving notice, the Fund must be able to terminate the loan at any time; (iv) the Fund must receive reasonable interest on the loan or a flat fee from the borrower, as well as amounts equivalent to any dividends, interest or other distributions on the securities loaned and to any increase in market value; (v) the Fund may pay only reasonable custodian fees in connection with the loan; and (vi) the Fund must be able to vote proxies on the securities loaned, either by terminating the loan or by entering into an alternative arrangement with the borrower.
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Lower-Rated (High-Risk) and Below Investment Grade Debt Securities
Each Fund may invest up to 5% of its net assets in lower-rated (high-risk) non-convertible debt securities. These speculative securities are commonly referred to as “below investment grade” securities or “junk” bonds. They may be rated from Ba to Ca by Moody’s Investors Service, Inc., from BB to D by Standard & Poor’s, or may be unrated. These securities have poor protection with respect to the payment of interest and repayment of principal and may be in default or about to be in default as to the repayment of principal or payment of interest. These securities are often considered to be speculative and involve greater risk of loss or price changes due to changes in the issuer’s capacity or perceived capacity to make timely payment of principal and interest. The market prices of lower-rated (high-risk) debt securities may fluctuate more than those of higher-rated debt securities and may decline significantly in periods of general economic difficulty, which may follow periods of rising interest rates.
The market for lower-rated (high-risk) debt securities may be thinner and less active than that for higher-rated debt securities, which can adversely affect the prices at which the former are sold. If market quotations cease to be readily available for a debt security rated “below investment grade” in which a Fund has invested, the security will then be valued in accordance with procedures established by the Board and described in the Prospectus. Judgment and other subjective factors play a greater role in the valuation of lower-rated (high-risk) debt securities than securities for which more external sources for quotations and last sale information are available. Adverse publicity and changing investor perceptions may adversely affect the value of a Fund’s investment in lower-rated (high-risk) debt securities along with its ability to dispose of that investment.
Since the risk of default is higher for “junk bonds”, Royce’s research and credit analysis play an important part in managing securities of this type for the Funds. In considering such investments for the Funds, Royce will attempt to identify those issuers of lower-rated (high-risk) debt securities whose financial condition is adequate to meet future obligations or has improved or is expected to improve in the future. Royce’s analysis may focus on relative values based on such factors as interest or dividend coverage, asset coverage, earnings prospects and the experience and managerial strength of the issuer.
Each of the Funds may also invest in non-convertible debt securities in the lowest rated category of investment grade debt. Such securities may have speculative characteristics, and adverse changes in economic conditions or other circumstances are more likely to lead to a weakened capacity to make principal and interest payments than is the case with higher grade securities.
The Funds may also invest in investment grade non-convertible debt securities. Such securities include those rated Aaa by Moody’s (which are considered to be of the highest credit quality and where the capacity to pay interest and repay principal is extremely strong), those rated Aa by Moody’s (where the capacity to repay principal is considered very strong, although elements may exist that make risks appear somewhat larger than expected with securities rated Aaa), securities rated A by Moody’s (which are considered to possess adequate factors giving security to principal and interest) and securities rated Baa by Moody’s (which are considered to have an adequate capacity to pay interest and repay principal, but may have some speculative characteristics) without regard to gradations within those ratings categories.
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Foreign Investments
Each of Royce Micro-Cap Portfolio and Royce Small-Cap Portfolio may invest up to 25% of its net assets in the securities of companies that are headquartered in foreign countries. In addition, each Fund may invest in securities of companies whose economic fortunes are linked to foreign countries but do not meet the Fund’s definition of a foreign security (i.e., a security issued by a company that is headquartered in a foreign country). To the extent a Fund invests in this manner, the percentage of the Fund’s portfolio that is exposed to foreign country risks may be greater than the percentage of the Fund’s assets that the Fund defines as representing foreign securities.
Foreign investments involve certain risks which typically are not present in securities of domestic issuers. There may be less information available about a foreign company than a domestic company; foreign companies may not be subject to accounting, auditing and reporting standards and requirements comparable to those applicable to domestic companies; and foreign markets, brokers and issuers are generally subject to less extensive government regulation than their domestic counterparts. Markets for foreign securities may be less liquid and may be subject to greater price volatility than those for domestic securities. There also may be restrictions on outside investment in certain other foreign jurisdictions, including major industry or market sector restrictions, or limitations on the total amount or type of position in any single issue. Foreign brokerage commissions and custodial fees are generally higher than those in the United States. 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, thereby making it difficult to conduct such transactions. Delays or problems with settlements might affect the liquidity of a Fund’s portfolio. Foreign investments may also be subject to heightened local economic and political risks, political, economic and social instability, confiscatory taxation, foreign exchange controls, sanctions, war, military action or other armed conflict, periods of unrest or adverse diplomatic developments, large-scale human migration, possible difficulties in obtaining and/or enforcing legal judgments in foreign courts, and possible nationalization of issuers or expropriation of their assets, which might adversely affect the value of the Fund’s foreign investments along with its ability to dispose of those investments. Investments in foreign securities also may be subject to possible difficulties in obtaining and/or enforcing legal judgments in foreign courts; restrictions or prohibitions on foreign investment, including prohibitions or restrictions on investments in specific industries or market sectors; limitations on the total amount or type of position in any single issue; and possible imposition by foreign governments of prohibitions or substantial restrictions on foreign investments in their capital markets or in certain industries. Royce may not be able to anticipate these potential events or counter their effects. Furthermore, some foreign securities are subject to brokerage taxes levied by foreign governments, which have the effect of increasing the cost of such investment and reducing the realized gain or increasing the realized loss on such securities at the time of sale.
Although changes in foreign currency rates may adversely affect the value of the Funds’ foreign investments, Royce does not expect to hedge against declines in the U.S. dollar or to lock in the value of any foreign securities it purchases on behalf of the Funds. Consequently, the risks associated with such investments may be greater than if the Funds were to engage in foreign currency hedging transactions.
Exchange control regulations in such foreign markets or sanctions against certain foreign governments or issuers may also adversely affect the value of the Funds’ foreign investments. Foreign exchange controls may also adversely affect the Funds’ ability to make certain distributions necessary to maintain their eligibility as regulated investment companies and avoid the imposition of income and excise taxes may, to that extent, be limited.
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The risk factors noted above are generally heightened for investments in developing countries. Developing countries may have relatively unstable governments, economies based on only a few industries and securities markets that trade a small number of securities.
The Funds may purchase the securities of foreign companies in the form of American Depositary Receipts (“ADRs”). ADRs are certificates held in trust by a bank or similar financial institution evidencing ownership of securities of a foreign-based issuer. Designed for use in U.S. securities markets, ADRs are alternatives to the purchase of the underlying foreign securities in their national markets and currencies.
Depositories may establish either unsponsored or sponsored ADR facilities. While ADRs issued under these two types of facilities are in some respects similar, there are distinctions between them relating to the rights and obligations of ADR holders and the practices of market participants. A depository may establish an unsponsored facility without participation by (or even necessarily the acquiescence of) the issuer of the deposited securities, although typically the depository requests a letter of non-objection from such issuer prior to the establishment of the facility. Holders of unsponsored ADRs generally bear all the costs of such facilities. The depository usually charges fees upon the deposit and withdrawal of the deposited securities, the conversion of dividends into U.S. dollars, 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 issuer of the deposited securities or to pass through voting rights to ADR holders in respect of the deposited securities. Depositories create sponsored ADR facilities in generally the same manner as unsponsored facilities, except that the issuer of the deposited securities enters into a deposit agreement with the depository. The deposit agreement sets out the rights and responsibilities of the issuer, the depository and the ADR holders.
With sponsored facilities, the issuer of the deposited securities generally will bear some of the costs relating to the facility (such as deposit and withdrawal fees). Under the terms of most sponsored arrangements, depositories agree to distribute notices of shareholder meetings and voting instructions and to provide shareholder communications and other information to the ADR holders at the request of the issuer of the deposited securities.
Developing Countries
Each of Royce Small-Cap Portfolio and Royce Micro-Cap Portfolio may not invest more than 5% of its net assets in the securities of companies that are headquartered in developing countries. Generally developing countries include every country in the world other than the United States, Canada, Japan, Australia, New Zealand, Hong Kong, Singapore, South Korea, Taiwan, Bermuda, Israel, and Western European countries (which include, Austria, Belgium, Denmark, France, Finland, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the United Kingdom). The risk factors noted above in “Foreign Investments” are generally heightened for investments in developing countries. A number of developing countries restrict, to varying degrees, foreign investment in stocks. Repatriation of investment income, capital, and the proceeds of sales by foreign investors may require governmental registration and approval in some developing countries. A number of the currencies of developing countries have experienced significant declines against the U.S. dollar in recent years, and devaluation may occur subsequent to investment in these countries by the Funds. Inflation and rapid fluctuations in inflation rates have had and may continue to have negative effects on the economies and securities markets of certain developing countries. Many of the securities markets in developing countries are relatively small or less diverse, have low trading volumes, suffer periods of relative illiquidity and are characterized by significant price volatility. Developing countries may have antiquated legal systems with existing laws and regulations that are inconsistently applied. Generally, developing countries are not subject to as extensive and frequent accounting and financial reporting requirements as in the United States.
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Transaction costs, including brokerage commissions and dealer mark-ups in developing countries may be higher than in the United States or other developed countries. Investments in developing countries also are subject to the risk that a future economic, military, or political crisis could lead to armed conflict, price controls, forced mergers of companies, expropriation or confiscatory taxation, seizure, nationalization, foreign exchange controls, sanctions, large-scale human migration, or creation of government monopolies, any of which may have a detrimental effect on the value of the Funds’ investments. In addition, each Fund may invest in securities of companies whose economic fortunes are linked to developing countries but do not meet the Fund’s definition of a developing country security. To the extent a Fund invests in this manner, the percentage of the Fund’s portfolio that is exposed to developing country risks may be greater than the percentage of the Fund’s assets that the Fund defines as representing developing country securities.
Repurchase Agreements
In a repurchase agreement, a Fund in effect makes a loan by purchasing a security and simultaneously committing to resell that security to the seller at an agreed upon price on an agreed upon date within a number of days from the date of purchase. The resale price reflects the purchase price plus an agreed upon incremental amount which is unrelated to the coupon rate or maturity of the purchased security. A repurchase agreement requires or obligates the seller to pay the agreed upon price, which obligation is in effect secured by the value (at least equal to the amount of the agreed upon resale price and marked to market daily) of the underlying security.
The Funds may engage in repurchase agreements which mature in seven days or less, provided that such agreements are collateralized by cash or securities issued by the U.S. Government or its agencies. While it does not presently appear possible to eliminate all risks from these transactions (particularly the possibility of a decline in the market value of the underlying securities, as well as delays and costs to the Funds in connection with bankruptcy proceedings), it is the policy of the Trust to enter into repurchase agreements only with recognized securities dealers, banks and the Fixed Income Clearing Corporation, a securities clearing agency registered with the SEC, each determined by Royce to represent acceptable credit risk.
Portfolio Turnover
For the years ended December 31, 2020 and December 31, 2021, Royce Small-Cap Portfolio’s portfolio turnover rates were 95% and 51%, respectively. Relatively high portfolio turnover rates may result, in part, from asset flows into and out of the Fund that were triggered by allocation adjustment programs used by certain participating insurance companies to help manage the volatility of the relevant variable contract investment options and to preserve variable contract value.
Investments in Other Investment Companies and Exchange-Traded Funds
Each Fund may purchase, sell and invest in the securities of other investment companies, including money market funds, exchange-traded funds (“ETFs”), registered open-end and closed-end funds, and unregistered funds to the extent permitted under the 1940 Act. As a result, to the extent a Fund invests in another investment company, the investment performance of the Fund will be directly impacted by the investment performance of that investment company. Likewise, a Fund will be exposed to the same risks as such investment companies in direct proportion to the allocation of its assets among those investment companies. In addition, when a Fund invests in another investment company, the Fund’s shareholders must bear not only their proportionate share of the Fund’s fees and expenses, but they also must bear indirectly the fees and expenses of the other investment company.
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ETFs are ownership interests in registered open-end funds, unit investment trusts, and other pooled investment vehicles that are traded on an exchange and that hold a portfolio of securities or other financial instruments (the “Underlying Assets”). The Underlying Assets are typically selected to correspond to the securities that comprise a particular broad based, sector or international index, or to provide exposure to a particular industry, sector or asset class. The Funds also may, from time to time, purchase ETFs that sell short a portfolio of securities or other financial assets. An investment in an ETF involves risks similar to investing directly in the Underlying Assets, including the risk that the value of the Underlying Assets may fluctuate in accordance with changes in the financial condition of their issuers, the value of securities and other financial instruments generally, and other market factors. Each Fund also may invest in ETFs that use financial derivatives or leverage in an attempt to provide a multiple of the returns of the underlying index on a daily basis or the inverse of those returns. Investment exposure to these leveraged or inverse ETFs may increase a Fund’s volatility and magnify any losses.
The performance of an ETF will be reduced by transaction and other expenses, including fees paid by the ETF to service providers. Investors in ETFs are eligible to receive their portion of dividends, if any, accumulated on the securities held in the portfolio, less fees and expenses of the ETF.
If an ETF is an investment company, unless an exemption has been obtained from the SEC, the limitations applicable to the Funds’ ability to purchase securities issued by other investment companies will apply.
Warrants, Rights and Options
Each Fund may invest up to 5% of its total assets in warrants and rights. A warrant or right entitles the holder to purchase a given security within a specified period for a specified price and does not represent an ownership interest. These securities have no voting rights, pay no dividends and have no liquidation rights. In addition, their market prices are not necessarily correlated with the market prices of the underlying securities.
The sale of warrants and rights held for more than one year generally results in a long-term capital gain or loss to a Fund, and the sale of warrants or rights held for one year or less generally results in a short-term capital gain or loss. The holding period for securities acquired upon exercise of a warrant or right, however, generally begins on the day after the date of exercise, regardless of how long the warrant or right. The securities underlying warrants and rights could include shares of common stock of a single company or securities market indices representing shares of the common stocks of a group of companies, such as the S&P Small-Cap 600 Index, an unmanaged market-weighted index.
Investing in warrants and rights on a given security allows a Fund to hold an interest in that security without having to commit assets equal to the market price of the underlying security and, in the case of securities market indices, to participate in a market without having to purchase all of the securities comprising the index. Thus, investing in warrants and rights permits a Fund to incur additional risk and/or to hedge against risk.
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Illiquid and Restricted Securities
Neither Fund may invest more than 10% of its assets in securities for which market quotations are not readily available (referred to in this sub-section as “illiquid securities”). In addition, neither Fund may invest more than 15% of its net assets in restricted securities (i.e., securities subject to certain contractual or legal restrictions on resale). Restricted securities, sometimes referred to as private placements, are subject to contractual or legal restrictions on resale because they are not registered under the Securities Act. Such securities and are purchased directly from the issuer, a control person of the issuer or another investor holding such securities. A large institutional market has developed for these unregistered privately placed restricted securities, including foreign securities. Institutional investors depend on an efficient institutional market in which the unregistered security can be readily resold or on an issuer’s ability to honor a demand for repayment. Notwithstanding the fact that these securities may be subject to contractual or legal restrictions on resale to the general public or to certain institutions, unregistered securities that can be sold in accordance with Rule 144A under the Securities Act will not be considered illiquid securities so long as Royce determines that an adequate trading market exists for the security. Rule 144A allows an institutional trading market for securities otherwise subject to restriction on resale to the general public. An insufficient number of qualified institutional buyers interested in purchasing certain restricted securities held by the Funds, however, could adversely affect the marketability of such portfolio securities, and the Funds might be unable to dispose of such securities promptly or at reasonable prices. For purposes of the operating policies relating to restricted securities, the Trust does not consider securities to be “restricted” if they may be sold by a Fund without restriction in the market in which they are primarily traded, outside the United States.
Large Redemptions; New Fund Risks; Fund Liquidations.
If one or more investors in a Fund initiate significant redemptions, the Fund may be required to dispose of assets to meet the redemption request. This can make ordinary portfolio management and rebalancing decisions more complicated to implement, can result in a Fund’s current expenses being allocated over a smaller asset base, which generally results in an increase in a Fund’s expense ratio. The impact of these transactions is likely to be greater in highly volatile markets or less liquid markets or for smaller or newer Funds or when a significant investor purchases, redeems or owns a substantial portion of a Fund’s shares. Because large redemptions (for example, $250,000 or more) can adversely affect a portfolio manager’s ability to implement a Fund’s investment strategy, each Fund also reserves the right to satisfy redemption in-kind, subject to certain conditions, rather than in cash. Funds that are new or that do not have considerable operating history also face greater risks that their investment strategies may not be successful, because the Fund may launch at an inopportune time or for other reasons. Newly organized Funds may not attract sufficient assets to achieve investment, trading, expense, or other efficiencies. In general, a Fund may be liquidated without shareholder approval and/or at a time that may not be favorable for all shareholders, which also may result in the Fund’s disposition of assets.
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Investments by Affiliated and Non-Affiliated “Funds of Funds” in the Fund
Certain affiliated and non-affiliated investment companies may invest in the Funds in accordance with the requirements of the 1940 Act and Rule 12d1-4 under the 1940 Act (“Rule 12d1-4”). These investment companies may be referred to as “funds of funds” because they invest primarily in other investment companies.
From time to time, a Fund may experience relatively large investments or redemptions, including liquidations, from a fund of funds due to an asset allocation rebalancing or other investment decision made by the investment manager of the applicable fund of funds. These asset flows may adversely affect performance by requiring the Fund to purchase or sell securities at inopportune times, including periods of reduced market liquidity, by otherwise limiting Royce’s ability to fully implement the Fund’s investment strategies, or by requiring the Fund to hold a larger portion of its assets in cash or highly liquid securities than it otherwise would hold. Asset flows initiated by a fund of funds may also result in higher portfolio turnover rates, increased payments of brokerage commissions, lower asset levels, and higher operating expense ratios for the Fund.
The Funds’ investment adviser, Royce, may be subject to potential conflicts of interest in connection with investments by affiliated funds of funds. For example, Royce may have an incentive to permit an affiliated fund of funds to become a more significant shareholder (with the potential to cause greater disruption) than would be permitted for an unaffiliated investor. Royce has committed to the Board that it will resolve any potential conflict in the best interests of the shareholders of a Fund in accordance with its fiduciary duty to the Fund and that fund of fund investments in a Fund made pursuant to Rule 12d1-4 will comply with such Rule and the Funds’ related policies and procedures.
Royce will take such actions as it deems necessary or appropriate to mitigate any potential adverse impacts from such fund of funds investments or redemptions, including redeeming Fund shares in-kind rather than in cash. See “Redemptions in Kind” in this SAI for more information.
State Insurance Restrictions
The Funds are sold to Insurance Companies in connection with Variable Contracts, and will seek to be available under Variable Contracts sold in a number of jurisdictions. Certain states have regulations or guidelines concerning concentration of investments and other investment techniques. If applied to the Funds, the Funds may be limited in their ability to engage in certain techniques and to manage their portfolios with the flexibility provided herein. In order to permit a Fund to be available under Variable Contracts sold in certain states, the Trust may make commitments for the Fund that are more restrictive than the investment policies and limitations described in this SAI and the Prospectus. If the Trust determines that such a commitment is no longer in the Fund’s best interests, the commitment may be revoked by terminating the availability of the Fund to Variable Contract owners residing in such states.
* * *
Royce believes that Royce Micro-Cap Portfolio and Royce Small-Cap Portfolio are suitable investments for those investors who are in a financial position to assume above-average investment risks in the search for long-term capital appreciation.
13
The following tables set forth certain information as to each Trustee and officer of the Trust. The Trustees have oversight responsibility for the Trust’s operations and are subject to various duties imposed on directors of registered investment companies under the 1940 Act and state law.
|
Name,
Age and of Interested Trustees |
Position(s)
|
Term of Time Served |
Principal Occupation(s) During Past 5 Years |
Number
of Fund by |
Other
Public Past 5 Years |
|
Christopher D. Clark (56) The Royce Funds 745 Fifth Avenue New York, NY 10151 |
Trustee and President |
Since 2014 |
Chief Executive Officer (since July 2016), President (since July 2014), Co-Chief Investment Officer (since January 2014), Managing Director, and Member of the Board of Managers (since June 2015) of Royce, having been employed by Royce since May 2007. |
16 |
None |
| *Each Trustee will hold office until their successors have been duly elected and qualified or until their earlier resignation or removal. All of the Trust’s Trustees are also Directors/Trustees of Royce Value Trust, Inc. (“RVT”), Royce Micro-Cap Trust, Inc. (“RMT”), Royce Global Value Trust, Inc. (“RGT”), and The Royce Fund (“TRF”) (collectively with the Trust, “The Royce Funds”). | |||||
14
Name, Age,
and Address of
|
Position(s) Held with Trust |
Term
of Office* and Length of Time Served |
Principal
Occupation(s) |
Number
of Portfolios in Fund Complex Overseen by Trustee |
Other Public Company |
Patricia W. Chadwick (73) 745 Fifth Avenue |
Trustee | Since 2009 | Consultant and President, Ravengate Partners LLC (since 2000). Formerly Director, Wisconsin Energy Corp. (until 2022). | 16 | Voya Funds |
Christopher C. Grisanti (60) 745 Fifth Avenue |
Trustee | Since 2017 | Chief Equity Strategist and Senior Portfolio Manager, MAI Capital Management LLC (investment advisory firm) (since May 2020). Formerly Co-Founder and Chief Executive Officer, Grisanti Capital Management LLC (investment advisory firm) (from 1999 to 2020); Director of Research and Portfolio Manager, Spears Benzak, Salomon & Farrell (from 1994 to 1999); and Senior Associate, Simpson, Thacher & Bartlett (law firm) (from 1988 to 1994). |
16 | None |
Cecile B. Harper (58) New York, NY 10151 |
Trustee | Since Sept. 2020 |
Chief Financial Officer and Chief Operating Officer, College Foundation at the University of Virginia (since October 2019). Formerly Board Member, Pyramid Peak Foundation (January 2012 to 2022); Board Member, Regional One Health Foundation (from June 2013 to September 2019); and Principal, Southeastern Asset Management (from December 1993 to September 2019). | 16 | None |
Arthur S. Mehlman (80) 745 Fifth Avenue |
Trustee | Since 2004 | Director, University of Maryland Foundation (non-profits). Formerly Director/Trustee, registered investment companies constituting the Legg Mason Funds (from 2002 to June 2021); Director, The League for People with Disabilities, Inc. (from June 2003 to June 2018); Director, Municipal Mortgage & Equity, LLC (from October 2004 to April 2011); Director, University of Maryland College Park Foundation (non-profit) (from 1998 to 2005); Director, Maryland Business Roundtable for Education (from July 1984 to June 2002); and Partner, KPMG LLP (international accounting firm) (from 1972 to 2002). |
16 | None |
15
Name, Age,
and Address of |
Position(s) Held with Trust |
Term
of Office* and Length of Time Served |
Principal
Occupation(s) |
Number
of Portfolios in Fund Complex Overseen by Trustee |
Other
Public Company
|
G. Peter O’Brien (76) New York, NY 10151 |
Trustee | Since 2001 | Trustee Emeritus, Colgate University (since 2005); and Emeritus Board Member, Hill House, Inc. (since 2019). Formerly Director, TICC Capital Corp. (from 2003-2017); Trustee, Colgate University (from 1996 to 2005); President, Hill House, Inc. (from 2001 to 2005); Board Member, Hill House, Inc. (from 1999 to 2019); Director, Bridges School (from 2006 to 2018); and Managing Director/Equity Capital Markets Group, Merrill Lynch & Co. (from 1971 to 1999). |
75
(Director/Trustee of The Royce Funds, consisting of 16 portfolios; Director/Trustee of the Legg Mason Family of Funds, consisting of 59 portfolios) |
None |
Michael K. Shields (63) 745 Fifth Avenue
|
Trustee | Since 2015 | President and Chief Executive Officer, Piedmont Trust Company (privately owned North Carolina trust company) (since February 2012); Chairman, UNC Charlotte Investment Fund Board (since February 2016); and Chairman, Halftime Carolinas Board (since February 2011). Formerly Owner, Shields Advisors (investment consulting firm) (from April 2010 to June 2012); President and Chief Executive Officer, Eastover Capital Management (2005-2007); President and Chief Executive Officer, Campbell, Cowperthwait & Co. (investment subsidiary of U.S. Trust Corporation) (1997-2002); and equity portfolio manager and co-manager of Quality Growth Team, Scudder, Stevens & Clark (1992-1997). | 16 | None |
| *Each Trustee will hold office until their successors have been duly elected and qualified or until their earlier resignation or removal. All of the Trust’s Trustees are also Directors/Trustees of RVT, RMT, RGT, and TRF. | |||||
16
Name, Age
and of Trust Officers |
Position(s) |
Term
of Time Served |
Principal
Occupation(s) |
Number
of Portfolios in |
Other
Public Past 5 Years |
| Peter
K. Hoglund* (56) 745 Fifth Avenue New York, NY 10151 |
Treasurer | Since 2015 | Chief Financial Officer, Chief Administrative Officer and Managing Director of Royce, having been employed by Royce since December 2014. Prior to joining Royce, Mr. Hoglund spent more than 20 years with Munder Capital Management in Birmingham, MI, serving as Managing Director and Chief Financial Officer and overseeing all financial aspects of the firm. He began his career at Munder as a portfolio manager. | N/A | None |
| Daniel
A. O’Byrne* (60) 745 Fifth Avenue New York, NY 10151 |
Vice President | Since 1994 | Principal and Vice President of Royce, having been employed by Royce since October 1986. | N/A | None |
| Francis
D. Gannon* (54) 745 Fifth Avenue New York, NY 10151 |
Vice President | Since 2014 | Co-Chief Investment Officer (since January 2014) and Managing Director of Royce, having been employed by Royce since September 2006. | N/A | None |
| John
E. Denneen* (55) 745 Fifth Avenue New York, NY 10152 |
Secretary and Chief Legal Officer | 1996-2001 and since April 2022 | General Counsel, Managing Director and, since June 2015, a member of the Board of Managers of Royce; Chief Legal and Compliance Officer and Secretary of Royce. | N/A | None |
| John
P. Schwartz* (51) 745 Fifth Avenue New York, NY 10153 |
Chief Compliance Officer | Since May 2022 | Chief Compliance Officer of The Royce Funds (since May 2022) and Associate General Counsel and Compliance Officer of Royce (since March 2013). | N/A | None |
*An “interested person” of the Trust and/or Royce under Section 2(a)(19) of the 1940 Act. **Each officer will hold office for the year ending December 31, 2022 and thereafter until their respective successors are duly elected and qualified. | |||||
Additional information about each Trustee follows (supplementing the information provided in the table above) that describes some of the specific experiences, qualifications, attributes or skills that each Trustee possesses which the Board believes has prepared them to be effective Trustees.
| ● | Christopher D. Clark – In addition to his tenure as an interested Trustee/Director of The Royce Funds, Mr. Clark serves as the Chief Executive Officer, President, Co-Chief Investment Officer, and a Member of the Board of Managers of Royce, having been employed by Royce since 2007. Mr. Clark has over 25 years of investment and business experience, including extensive experience in the financial sector. |
| ● | Patricia W. Chadwick – In addition to her tenure as an independent Trustee/Director of The Royce Funds, Ms. Chadwick is designated as an Audit Committee Financial Expert. Ms. Chadwick has over 30 years of investment and business experience, including extensive experience in the financial sector and as a consultant to business and non-profit entities. In addition, Ms. Chadwick has served on the boards of a variety of public and private companies and non-profit entities, including currently serving on the board of two public companies. |
17
| ● | Christopher C. Grisanti – In addition to his tenure as an independent Trustee/ Director of The Royce Funds, Mr. Grisanti serves as Chief Equity Strategist and Senior Portfolio Manager at MAI Capital Management LLC, an investment advisory firm. He previously co-founded and served as Chief Executive Officer of Grisanti Capital Management LLC, an investment advisory firm. Mr. Grisanti has over 20 years of investment industry experience. |
| ● | Cecile B. Harper – In addition to her tenure as an independent Trustee/Director of The Royce Funds, Ms. Harper has over 25 years of business experience in the asset management sector. In addition, Ms. Harper has served on the boards of various philanthropic entities. |
| ● | Arthur S. Mehlman – In addition to his tenure as an independent Trustee/Director of The Royce Funds, Mr. Mehlman serves as the Chairman of the Board’s Audit Committee, acting as liaison between the Boards and the Funds’ independent registered public accountants, and is designated as an Audit Committee Financial Expert. Mr. Mehlman also served as an independent Trustee/Director of the Legg Mason Funds from 2002 until June 30, 2021. Mr. Mehlman has over 35 years of business experience, including as Partner of an international accounting firm and a Director for various private companies and non-profit entities. |
| ● | G. Peter O’Brien – In addition to his tenure as an independent Trustee/Director of The Royce Funds and the Legg Mason Family of Funds, Mr. O’Brien serves as co-Chairman of the Board’s Nominating Committee. Mr. O’Brien has over 35 years of business experience, including extensive experience in the financial sector. In addition, Mr. O’Brien has served on the boards of public companies and non-profit entities. |
| ● | Michael K. Shields – In addition to his tenure as an independent Trustee/Director of The Royce Funds, Mr. Shields serves as President and Chief Executive Officer of Piedmont Trust Company, a private North Carolina trust company. Mr. Shields has over 30 years of investment and business experience, including extensive experience in the financial sector. |
The Board believes that each Trustee’s experience, qualifications, attributes and skills should be evaluated on an individual basis and in consideration of the perspective such Trustee brings to the entire Board, with no single Trustee, or particular factor, being indicative of Board effectiveness. However, the Board believes that Trustees need to have the ability to critically review, evaluate, question and discuss information provided to them, and to interact effectively with Fund management, service providers and counsel, in order to exercise effective business judgment in the performance of their duties; the Board believes that their members satisfy this standard. Experience relevant to having this ability may be achieved through a Trustee’s educational background; business, professional training or practice, public service or academic positions; experience from service as a board member (including the Board of the Fund) or as an executive of investment funds, public companies or significant private or non-profit entities or other organizations; and/or other life experiences. The charter for the Boards’ Nominating Committee contains certain other specific factors considered by the Nominating Committee in identifying and selecting Trustee candidates (as described below).
To assist them in evaluating matters under Federal and state law, the Trustees are counseled by their own independent legal counsel, who participates in Board meetings and interacts with Royce, and also may benefit from information provided by Royce’s internal counsel; both Board and Royce’s internal counsel have significant experience advising funds and fund board members. The Board and its committees have the ability to engage other experts as appropriate. The Board evaluates its performance on an annual basis.
18
Board Composition and Leadership Structure
The 1940 Act requires that at least 40% of the Trust’s Trustees not be “interested persons” (as defined in the 1940 Act) of the Trust and, as such, are not affiliated with Royce (“Independent Trustees”). To rely on certain exemptive rules under the 1940 Act, a majority of a Trust’s trustees must be Independent Trustees, and for certain important matters, such as the approval of investment advisory agreements or transactions with affiliates, the 1940 Act or the rules thereunder require the approval of a majority of the Independent Trustees. Currently, six of the Trust’s seven Trustees are Independent Trustees. The Board does not have a chair, but the President, an interested Trustee, acts as Chair at the Board meetings. The Independent Trustees have not designated a lead Independent Trustee, but the Chair of the Audit Committee, Mr. Mehlman, generally acts as chair of meetings or executive sessions of the Independent Trustees and, when appropriate, represents the views of the Independent Trustees to Royce management. The Board has determined that its leadership structure is appropriate in light of the services that Royce and its affiliates provide to the Fund and potential conflicts of interest that could arise from these relationships.
Information relating to each Trustee’s share ownership in the Funds and in the other funds in the group of registered investment companies comprising The Royce Funds that are overseen by the respective Trustee as of December 31, 2021 is set forth in the table below.
|
Trustee |
Aggregate
Dollar Range of Royce Micro-Cap Portfolio |
Aggregate Dollar Range of Royce Small-Cap Portfolio |
Aggregate Dollar Range of The Royce Funds |
| Christopher D. Clark | None | None | Over $100,000 |
| Patricia W. Chadwick | None | None | Over $100,000 |
| Christopher C. Grisanti | None | None | Over $100,000 |
| Cecile B. Harper | None | None | Over $100,000 |
| Arthur S. Mehlman | None | None | Over $100,000 |
| G. Peter O’Brien | None | None | Over $100,000 |
| Michael K. Shields | None | None | Over $100,000 |
The Board has an Audit Committee, comprised of Patricia W. Chadwick, Christopher C. Grisanti, Cecile B. Harper, Arthur S. Mehlman, G. Peter O’Brien, and Michael K. Shields. The Audit Committee is responsible for, among other things, recommending the selection and nomination of the Funds’ independent accountants and for conducting post-audit reviews of the Funds’ financial statements with such independent accountants. The Trust has adopted an Audit Committee charter. Mr. Mehlman serves as Chairman of the Audit Committee. Ms. Chadwick and Mr. Mehlman are designated as Audit Committee Financial Experts, as defined under SEC Regulations. During the year ended December 31, 2021, the Audit Committee held two meetings.
The Board also has a Nominating Committee, comprised of Patricia W. Chadwick, Christopher C. Grisanti, Cecile B. Harper, Arthur S. Mehlman, G. Peter O’Brien, and Michael K. Shields. The Nominating Committee is responsible for, among other things, identifying individuals qualified to serve as Independent Trustees of the Trust and recommending its nominees for consideration by the Board. The Trust has adopted a Nominating Committee charter. Mr. O’Brien serves as Chairman of the Nominating Committee. While the Committee is solely responsible for the selection and nomination of the Trust’s Independent Trustees, the Committee will review and consider nominations for the office of Trustee made by management and by Fund shareholders as it deems appropriate. Shareholders who wish to recommend a nominee should send their suggestions to the Secretary of the Trust, which should include biographical information and set forth their proposed nominee’s qualifications. During the year ended December 31, 2021, the Nominating Committee did not hold any meetings.
19
The Nominating Committee charter requires the Nominating Committee to identify individuals qualified to serve as Independent Trustees of the Trust and to recommend its nominees for consideration by the Board. In considering potential nominees, the Nominating Committee will take into consideration; (i) the contribution which the person can make to the Board, with consideration given to the person’s business and professional experience, education and such other factors as the Committee may consider relevant, including but not limited to whether a potential nominee’s personal and professional qualities and attributes would provide a beneficial diversity of skills, experience and/or perspective to the Board; (ii) the character and integrity of the person; (iii) whether or not the person is an “interested person” as defined in the 1940 Act and whether the person is otherwise qualified under applicable laws and regulations to serve as a Trustee or Independent Trustee of the Trust; (iv) whether or not the person has any relationships that might impair his or her independence, such as any business, financial or family relationships with Fund management, the investment adviser of the Funds, Fund service providers or their affiliates; (v) whether or not the person is financially literate pursuant to stock exchange audit committee membership standards; (vi) whether or not the person serves on boards of, or is otherwise affiliated with, competing financial service organizations or their related investment company complexes; (vii) whether or not the person is willing to serve as, and willing and able to commit the time necessary for the performance of the duties of, a Trustee of the Trust; and (viii) whether or not the selection and nomination of the person would be in the best interest of the Funds in light of the requirements of the Trust’s retirement policies. While the Nominating Committee does not have a formal policy regarding diversity, as noted above, it may consider the diversity of skills, experience and/or perspective a potential nominee will bring to the Board as part of its evaluation of the contribution such potential nominee will make to the Board. Such factors will be considered in light of the other factors described above and in the context of the Board’s existing membership at the time such potential candidate is considered.
The Board has a Distribution Committee, currently comprised of Christopher D. Clark. The Distribution Committee is responsible for, among other things, approving the Funds’ payment of dividends from net investment income and distributions from capital gains, if any, to ensure compliance with the requirements of Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”). See “Taxation.” During the year ended December 31, 2021, the Distribution Committee took action in respect of the Funds one time through the issuance of written consents.
Board’s Oversight Role in Management
The Board’s role in management of the Trust is oversight. As is the case with virtually all investment companies (as distinguished from operating companies), service providers to the Funds, primarily Royce and its affiliates, have responsibility for the day-to-day management of the Funds, which includes responsibility for risk management (including management of investment performance and investment risk, valuation risk, issuer and counterparty credit risk, compliance risk and operational risk). As part of its oversight, the Board, acting at its scheduled meetings, or the Chairman of the Audit Committee, acting between Board meetings, regularly interacts with and receives reports from senior personnel of service providers, including the Trust’s and Royce’s Chief Compliance Officer and portfolio management personnel. The Board’s Audit Committee (which consists of the six Independent Trustees) meets during its scheduled meetings, and between meetings the Chairman of the Audit Committee maintains contact with the Funds’ independent registered public accounting firm and the Trust’s Treasurer. The Board also receives periodic presentations from senior personnel of Royce or its affiliates regarding risk management generally, as well as periodic presentations regarding specific operational, compliance or investment areas including, but not limited to, business continuity, anti-money laundering, personal trading, valuation, investment research and securities lending. The Board also receives reports from counsel to Royce and the Board’s own independent legal counsel regarding regulatory compliance and governance matters. The Board’s oversight role does not make the Board a guarantor of the Funds’ investments or activities.
20
Information relating to the Trustees who received compensation from the Trust, from the other funds in the group of registered investment companies comprising The Royce Funds, and from the Fund Complex, which includes the Legg Mason Funds, for the year ended December 31, 2021 is set forth in the table below.
Name |
Aggregate Trust |
Pension or Retirement Expenses |
Total Compensation Trustees/Directors |
Total Complex* |
| Patricia W. Chadwick | $18,500 | N/A | $248,300 | $248,300 |
| Christopher C. Grisanti | $18,500 | N/A | $248,300 | $248,300 |
| Cecile B. Harper | $18,500 | N/A | $248,300 | $248,300 |
| Arthur S. Mehlman | $18,500 | N/A | $248,300 | $473,800 |
| G. Peter O’Brien | $18,500 | N/A | $248,300 | $504,050 |
| Michael K. Shields | $18,500 | N/A | $248,300 | $248,300 |
* Represents aggregate compensation paid to each Trustee during the calendar year ended December 31, 2021 from the Fund Complex. As of August 19, 2022, the Fund Complex includes the 16 portfolios of The Royce Funds and the 59 portfolios of the Legg Mason Funds. In addition to serving as Trustees/Directors of The Royce Funds during the calendar year ended December 31, 2021, Arthur S. Mehlman and G. Peter O’Brien served as Trustees/Directors of the Legg Mason Funds during the six-month period ended June 30, 2021 and the calendar year ended December 31, 2021, respectively. | ||||
For the period January 1, 2021 to December 31, 2021, each of the non-interested Trustees was paid at an annual rate of $15,500 for serving on the Board, plus $600 for each Board meeting attended. These rates will remain in effect for the period January 1, 2022 to December 31, 2022.
21
Information Concerning Royce and Franklin Resources
On October 1, 2001, Royce & Associates, Inc., the Funds’ investment adviser, became a subsidiary of Legg Mason, Inc. (“Legg Mason”). On March 31, 2002, Royce & Associates, Inc. was merged into Royce Holdings, LLC (a subsidiary of Legg Mason), which then changed its name to Royce & Associates, LLC. As a result of this merger, Royce & Associates, LLC became the Funds’ investment adviser and a subsidiary of Legg Mason. Effective March 1, 2016, Royce & Associates, LLC converted to Royce & Associates, LP, a Delaware limited partnership. Royce & Associates, LP primarily conducts its business under the name Royce Investment Partners. Royce & Associates, LP’s general partner is Royce & Associates GP, LLC (“Royce GP”). After the close of business on July 31, 2020, Franklin Resources, Inc. (“Franklin Resources”) acquired Legg Mason in an all-cash transaction. The limited partners of Royce & Associates, LP are Legg Mason Royce Holdings, LLC (“Legg Mason Royce Holdings”) and certain employees of Royce GP. Royce & Associates, LP is more than 75% owned and controlled by Legg Mason Royce Holdings. Legg Mason Royce Holdings is, in turn, 100% owned and controlled by Legg Mason. Legg Mason is, in turn, 100% owned and controlled by Franklin Resources.
Franklin Resources, whose principal executive offices are at One Franklin Parkway, San Mateo, California 94403, is a global investment management organization operating, together with its subsidiaries, as Franklin Templeton. As of March 31, 2022, Franklin Templeton had aggregate assets under management of approximately $1.48 trillion.
22
As of April 1, 2021, the following persons were known to the Trust to be the record and/or beneficial owners of 5% or more of the outstanding shares of each Fund:
| Number | Type of | Percentage of | |
| Fund | of Shares | Ownership | Outstanding Shares |
| Royce Small-Cap Portfolio Investment Class | |||
| Ohio National Life Insurance Company | 13,596,791 | Record | 75.06% |
| FBO Benefit of its Separate Accts | |||
| P.O. Box 237 | |||
| One Financial Way | |||
| Cincinnati, OH 45201-0237 | |||
| Jefferson National Life Insurance Company | 1,038,165 | Record | 5.73% |
| Attn: Separate Accounts | |||
| 10350 Ornsby Park Place, Suite 600 | |||
| Louisville, KY 40223-6175 | |||
| MetLife Insurance Co. of Connecticut (MIC) | 1,269,757 | Record | 7.01% |
| P.O. Box 990027 | |||
| Hartford, CT 06199-0027 | |||
| TIAA-CREF Life Separate Acct. VA-1 Of TIAA-CREF Life Insurance Co. | 944,309 | Record | 5.21% |
| 8500 Andrew Carnegie Blvd. | |||
| Msc E3/N6 | |||
| Charlotte, NC 28262-8500 | |||
| Royce Small-Cap Portfolio Service Class | |||
| Protective Life Insurance Co. VA | 9,754,931 | Record | 79.21% |
| P.O. Box 2606 | |||
| Birmingham, AL 35202-2606 | |||
| Protective Life Insurance Co. VUL | 1,154,469 | Record | 9.37% |
| Box 2606 | |||
| Birmingham, Al 35202-2606 |
23
| Number | Type of | Percentage of | |
| Fund | of Shares | Ownership | Outstanding Shares |
| Midland National Life Ins. Co. Separate Account C | 915,796 | Record | 7.44% |
| 8300 Mills Civic Pkwy | |||
| West Des Moines, IA 50266-3833 | |||
| Royce Micro-Cap Portfolio Investment Class | |||
| Ohio National Life Insurance Company | 4,200,144 | Record | 41.67% |
| The Benefit of its Separate Accts | |||
| P.O. Box 237 | |||
| One Financial Way | |||
| Cincinnati, OH 45201-0237 | |||
| IDS Life Insurance Company | 3,430,870 | Record | 34.04% |
| 222 Ameriprise Financial Center | |||
| Minneapolis, MN 55474-0002 | |||
| Royce Micro-Cap Portfolio Service Class | |||
| Protective Life Insurance Co. VA | 773,642 | Record | 62.15% |
| P.O. Box 2606 | |||
| Birmingham, AL 35202-2606 | |||
| Pacific Select Exec. Separate Acct. of Pacific Life Insurance Co. | 311,376 | Record | 25.01% |
| 700 Newport Center Drive | |||
| Newport Beach, CA 92660-6307 | |||
| Protective Life Insurance Co. VUL | 86,200 | Record | 6.92% |
| P.O. Box 2606 | |||
| Birmingham, AL 35202-2606 |
As of April 1, 2021, the Trustees and officers of the Trust as a group beneficially owned less than 1% of the outstanding shares of each Fund and each of its classes.
24
Services Provided by Royce
As compensation for its services under its Investment Advisory Agreement with the Trust, Royce is entitled to receive the following fees:
| Fund | Percentage Per Annum of Fund’s Average Net Assets |
| Royce Micro-Cap Portfolio | 1.25% |
| Royce Small-Cap Portfolio | 1.00% |
Such fees are payable from the assets of the relevant Fund and are allocated among each of its Share Classes based on the relative net assets of each class. Under the Investment Advisory Agreement, Royce (i) determines the composition of each Fund’s portfolio, the nature and timing of the changes in it and the manner of implementing such changes, subject to any directions it may receive from the Board; (ii) provides each Fund with investment advisory, research and related services for the investment of its funds; and (iii) pays any additional expenses incurred by the Trust in connection with promoting the sale of its shares and expenses incurred in performing its investment advisory duties under the Investment Advisory Agreement.
The Trust pays all administrative and other costs and expenses attributable to its operations and transactions, including, without limitation, transfer agent and custodian fees; legal, administrative and clerical services; rent for its office space and facilities; auditing; preparation, printing and distribution of its prospectuses to existing shareholders, proxy statements, shareholders’ reports and notices; supplies and postage; Federal and state registration fees; Federal, state and local taxes; non-affiliated Trustees’ fees; and brokerage commissions. Please see the section of this SAI entitled, “Administration Agreement” for more information.
For each of the years ended December 31, 2019, 2020 and 2021, Royce received advisory fees from each Fund as follows:
| Advisory Fees Received by Royce | Advisory Fees Waived by Royce | |
| Royce Micro-Cap Portfolio | ||
| 2019 | 1,767,274 | 82,461 |
| 2020 | 1,559,325 | 87,217 |
| 2021 | 2,280,430 | 59,011 |
| Royce Small-Cap Portfolio | ||
| 2019 | 3,083,041 | 125,890 |
| 2020 | 2,447,343 | 139,873 |
| 2021 | 3,805,765 | 59,923 |
Royce has contractually agreed, without right of termination, to waive fees and/or reimburse expenses to the extent necessary to maintain the relevant Fund and Class’s net annual operating expenses (excluding brokerage commissions, taxes, interest, litigation expenses, acquired fund fees and expenses, and other expenses not borne in the ordinary course of business) at or below the rates set forth below through April 30, 2023.
25
| CONTRACTUAL NET ANNUAL OPERATING EXPENSE RATIO CAPS | ||
| Fund | Investment Class | Service Class |
| Royce Micro-Cap Portfolio | 1.33% | 1.58% |
| Royce Small-Cap Portfolio | 1.08% | 1.33% |
The Trust, on behalf of the Funds, and Royce are parties to an Amended and Restated Administration Agreement, effective as of July 31, 2020 (the “Administration Agreement”). Under the terms of the Administration Agreement, Royce provides the Funds with, among other things, administrative, professional, compliance and clerical services; necessary personnel, office space and facilities and equipment; preparation of its prospectuses, statements of additional information and proxy statements, shareholders’ reports and notices and other reports and filings made to and with the SEC and/or other regulators; administering shareholder accounts, handling shareholder relations and such other services as Royce, subject to the Board, shall from time to time determine to be necessary or useful to perform its obligations under the terms of the Administration Agreement. Royce also, on behalf of the Funds, conducts relations with custodians, depositories, transfer agents, dividend disbursing agents, other shareholder servicing agents, accountants, attorneys, underwriters, brokers and dealers, corporate fiduciaries, insurers, banks and other such persons in any such other capacity deemed to be necessary or desirable. Royce does not receive a fee under the terms of the Administration Agreement but rather is reimbursed by the Funds for any and all costs and expenses that it may incur in providing services under the Administration Agreement, including, without limitation, the costs and expenses relating to necessary personnel, rent, telephone, technology and supplies. The timing for such reimbursements by the Funds varies depending upon the type of expense involved. Such reimbursements may be made by the Funds on a quarterly, monthly, or more frequent basis. In accordance with the Administration Agreement, for the fiscal years ended December 31, 2020 and 2021, Royce received $214,686 and $223,344, respectively, in reimbursements from the Funds.
26
The following table shows the dollar range of each Fund's shares owned beneficially and of record by the Portfolio Managers and Assistant Portfolio Manager for the Funds (each, a “Portfolio Manager” and collectively, the “Portfolio Managers”), including investments by their immediate family members sharing the same household and amounts invested through retirement and deferred compensation plans. Portfolio manager assignments in the table are provided as of May 1, 2022. Investment holdings information in the table is provided as of December 31, 2021.
Portfolio Manager Investments in Each Fund
| Fund Name |
Dollar Range of Fund Shares Beneficially Owned |
Total Ownership Interest in Fund Shares |
| Royce Capital Fund - Micro-Cap Portfolio | ||
| James P. Stoeffel (Lead Portfolio Manager) | None | None |
| Brendan J. Hartman (Portfolio Manager) | None | None |
| Royce Capital Fund - Small-Cap Portfolio | ||
| Jay S. Kaplan (Portfolio Manager) | None | None |
Description of Portfolio Manager Compensation Structure
Royce seeks to maintain a compensation program that is competitively positioned to attract and retain high-caliber investment professionals. All Portfolio Managers receive from Royce a base salary, Portfolio-Related Variable Compensation (generally the largest element of each Portfolio Manager’s compensation), Firm-Related Variable Compensation based primarily on registered investment company and other client account revenues generated by Royce and a benefits package. Portfolio Manager compensation is reviewed and may be modified from time to time as appropriate to reflect changes in the market, as well as to adjust the factors used to determine variable compensation. Except as described below, each Portfolio Manager’s compensation consists of the following elements:
| - | BASE SALARY. Each Portfolio Manager is paid a base salary. In setting the base salary, Royce seeks to be competitive in light of the particular Portfolio Manager’s experience and responsibilities. |
| - | PORTFOLIO-RELATED VARIABLE COMPENSATION. Each Portfolio Manager receives quarterly Portfolio-Related Variable Compensation that is either asset-based, or revenue-based and, therefore in part, based on the value of the net assets of the account for which the Portfolio Manager is being compensated, determined with reference to each of the registered investment company and other client accounts such person is managing. The revenue used to determine the quarterly Portfolio-Related Variable Compensation received by James P. Stoeffel and Brendan Hartman that relates to RMT is performance-based fee revenue. |
Payment of the Portfolio-Related Variable Compensation may be deferred, and any amounts deferred are forfeitable, if the Portfolio Manager is terminated by Royce with or without cause or resigns. The amount of the deferred Portfolio-Related Variable Compensation will appreciate or depreciate during the deferral period, based on the total return performance of one or more Royce-managed registered investment company accounts selected by the Portfolio Manager at the beginning of the deferral period. The amount deferred will depend on the Portfolio Manager’s total direct, indirect beneficial and deferred unvested investments in the Royce investment strategy for which he or she is receiving portfolio management compensation.
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| - | FIRM-RELATED VARIABLE COMPENSATION. Portfolio Managers receive quarterly variable compensation based on Royce’s net revenues. |
| - | BENEFIT PACKAGE. Portfolio Managers also receive benefits standard for all Royce employees, including health care and other insurance benefits, and participation in Royce’s 401(k) Plan and Money Purchase Pension Plan. Each Royce employee, including each Portfolio Manager, is also eligible to purchase shares of Franklin Resources, Inc. at a 15% discount to its closing price on certain dates in accordance with the terms and conditions of the Franklin Templeton Employee Stock Investment Plan. |
Other Portfolio Manager Accounts
The following chart contains information regarding all Royce client accounts for which each Portfolio Manager has day-to-day management responsibilities. Portfolio Manager assignments in the table are provided as of May 1, 2022. Account information in the table is provided as of December 31, 2021. Accounts are grouped into three categories: (i) registered investment companies; (ii) private pooled investment vehicles; and (iii) other accounts. To the extent that any of these accounts pay advisory fees that are based on account performance (“performance-based fees”), information on those accounts is specifically broken out.
|
Name of Portfolio |
Type of Account |
Number of Accounts Managed |
Total Assets |
Number of Accounts Managed for which Advisory Fee is Performance Based |
Value of Managed Accounts for which Advisory Fee is Performance Based |
| James P. Stoeffel | |||||
| Registered investment companies | 5 | $5,147,163,027 | 1 | $590,313,377 | |
| Private pooled investment vehicles | 4 | $89,776,415 | -- | -- | |
| Other accounts* | 1 | $989,692,708 | -- | -- | |
| Brendan J. Hartman | |||||
| Registered investment companies | 4 | $2,998,342,934 | 1 | $590,313,377 | |
| Private pooled investment vehicles | 4 | $89,776,415 | -- | -- | |
| Other accounts* | 1 | $989,692,708 | -- | -- | |
| Jay S. Kaplan | |||||
| Registered investment companies | 3 | $2,670,282,896 | -- | -- | |
| Private pooled investment vehicles | -- | -- | -- | -- | |
| Other accounts* | -- | -- | -- | -- | |
| *Other accounts include all other accounts managed by the Portfolio Manager in either a professional or personal capacity except for personal accounts subject to pre-approval and reporting requirements under the Funds’ Rule 17j-1 Code of Ethics. | |||||
Potential Conflicts of Interest
Each Portfolio Manager’s day-to-day management responsibility for more than one client account may create actual, potential or only apparent conflicts of interest. For example, the Portfolio Manager may have an opportunity to purchase securities of limited availability. In this circumstance, the Portfolio Manager is expected to review each account’s investment guidelines, restrictions, tax considerations, cash balances, liquidity needs and other factors to determine the suitability of the investment for each account and to ensure that his or her managed accounts are treated equitably.
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The Portfolio Manager may also decide to purchase or sell the same security for multiple managed accounts at approximately the same time. To address any conflicts that this situation may create, the Portfolio Manager will generally combine managed account orders (i.e., enter a “bunched” order) in an effort to obtain best execution or a more favorable commission rate. In addition, if orders to buy or sell a security for multiple accounts managed by common Portfolio Managers on the same day are executed at different prices or commission rates, the transactions will generally be allocated by Royce to each of such managed accounts at the weighted average execution price and commission. In circumstances where a pre-allocated bunched order is not completely filled, each account will normally receive a pro-rated portion of the securities based upon the account's level of participation in the order, subject to Royce’s minimum ticket size requirements. Royce may, under certain circumstances, allocate securities in a manner other than pro-rata if it determines that the allocation is fair and equitable under the circumstances and does not discriminate against any account. See “Portfolio Transactions” below.
As described above, there is a revenue-based component of each Portfolio Manager’s Performance-Related Variable Compensation, and the Portfolio Managers also receive Firm-Related Variable Compensation based on revenues (adjusted for certain imputed expenses) generated by Royce. In addition, James P. Stoeffel and Jay S. Kaplan receive variable compensation based on Royce’s retained pre-tax profits from operations. As a result, the Portfolio Managers may receive a greater relative benefit from activities that increase the value to Royce of the Funds and/or other Royce client accounts, including, but not limited to, increases in sales of Fund shares and assets under management.
Also, as described above, the Portfolio Managers generally manage more than one client account, including, among others, registered investment company accounts, separate accounts and private pooled accounts managed on behalf of institutions (e.g., pension funds, endowments and foundations) and high-net-worth individuals. The appearance of a conflict of interest may arise where Royce has an incentive, such as a performance-based management fee (or any other variation in the level of fees payable by Funds or other Royce client accounts to Royce), which relates to the management of one or more Funds or accounts with respect to which the same Portfolio Manager has day-to-day management responsibilities. Except as described herein, no Royce Portfolio Manager’s compensation is tied to performance fees earned by Royce for the management of any one client account. Although variable and other compensation derived from Royce revenues or profits is impacted to some extent, the impact is relatively minor given the small percentage of Royce firm assets under management for which Royce receives performance-based revenue. Notwithstanding the above, the Performance-Related Variable Compensation paid to James P. Stoeffel and Brendan J. Hartman, as Portfolio Managers of RMT, is based, in part, on performance-based fee revenues. RMT pays Royce a fulcrum fee that is adjusted up or down depending on the performance of the Fund relative to its benchmark index.
Finally, conflicts of interest may arise when a Portfolio Manager personally buys, holds or sells securities held or to be purchased or sold for a Fund or other Royce client account or personally buys, holds or sells the shares of one or more of The Royce Funds. To address this, Royce has adopted a written Code of Ethics designed to prevent and detect personal trading activities that may interfere or conflict with client interests (including Fund shareholders’ interests). See “Code of Ethics and Related Matters” below. Royce generally does not permit its Portfolio Managers to purchase small- or micro-cap securities in their personal investment portfolios.
Royce and The Royce Funds have adopted certain compliance procedures which are designed to address the above-described types of conflicts. However, there is no guarantee that such procedures will detect each and every situation in which a conflict arises.
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The Funds are engaged in a continuous offering of their shares. RFS, a wholly-owned subsidiary of Royce, is the distributor of each Fund’s Share Classes. RFS has its office at 745 Fifth Avenue, New York, New York 10151. RFS’s corporate predecessor was organized in November 1982. RFS is a member of the Financial Industry Regulatory Authority, Inc.
As compensation for its services and for the expenses payable by it under the Distribution Agreement with the Trust, RFS is entitled to receive, from the assets of the Fund or Share Class involved, a fee, paid monthly, equal to .25% per annum (consisting of an asset-based sales charge, personal service and/or account maintenance fee) of the average net assets of each Fund’s respective Service Class shares. Except to the extent that they may be waived by RFS, these fees are not subject to any required reductions.
Under the Distribution Agreement, RFS (i) seeks to promote the sale and/or continued holding of shares of such Funds through a variety of activities, including advertising, direct marketing and servicing investors and introducing parties on an on-going basis; (ii) pays sales commissions and other fees to those broker-dealers, investment advisers, insurance companies and others (excluding banks) who have introduced investors to such Funds (which commissions and other fees may or may not be the same amount as or otherwise comparable to the distribution fees payable to RFS); (iii) pays the cost of preparing, printing and distributing any advertising or sales literature and the cost of printing and mailing the Funds’ prospectuses to persons other than shareholders of the Funds; and (iv) pays all other expenses incurred by it in promoting the sale and/or continued holding of the shares of such Funds and in rendering such services under the Distribution Agreement. RFS also may make payments to financial intermediaries that provide personal service and recordkeeping/administrative/account maintenance services. The Trust bears the expense of registering its shares with the SEC and the cost of filing for sales of its shares under the securities laws of the various states.
The Trust entered into the Distribution Agreement with RFS pursuant to a Distribution Plan which, among other things, permits each Fund that remains covered by the Plan to pay the monthly distribution fee out of its net assets. Such distribution fee is paid to RFS regardless of whether expenses were incurred under the Plan. As required by Rule 12b-1 under the 1940 Act, the Board, including a majority of the Independent Trustees, approved the Plan. No Independent Trustee of the Trust had any direct or indirect financial interest in the operation of the Plan or the Distribution Agreement.
The Plan may be terminated as to any Fund or Share Class: (i) by the vote of a majority of the Independent Trustees or (ii) by the vote of a majority of the outstanding voting securities of such Fund or Share Class. Any change in the Plan that would materially increase the distribution cost to a Fund or Share Class requires approval by the shareholders of such Fund or Share Class; otherwise, the Trustees, including a majority of the Independent Trustees, as described above, may amend the Plan.
The Distribution Agreement may be terminated as to any Fund or Share Class at any time on 60 days’ written notice and without payment of any penalty by RFS, by the vote of a majority of the outstanding shares of such Fund or Share Class or by the vote of a majority of the Independent Trustees, if not sooner terminated in accordance with their terms, and will continue in effect for successive one-year periods, provided that each such continuance is specifically approved: (i) by the vote of a majority of the Independent Trustees and (ii) by the vote of a majority of the entire Board.
While the Plan is in effect, the selection and nomination of those Trustees who are not interested persons of the Trust will be committed to the discretion of the Independent Trustees.
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For the fiscal year ended December 31, 2021, RFS received distribution and/or service (12b-1) fees from the Funds as follows.
| Fund | Share Class | Net Distribution Fees | Distribution Fees Waived |
| Royce Micro-Cap Portfolio | Service Class | $79,614 | None |
| Royce Small-Cap Portfolio | Service Class | 537,913 | None |
For the fiscal year ended December 31, 2021, all of the amounts paid by the Funds under their Distribution Plans ($617,527) were paid to RFS. RFS used such distribution fees primarily for (i) compensation to insurance companies and other financial intermediaries; (ii) printing expenses; and (iii) state registration fees for RFS. There were no unreimbursed expenses incurred during the fiscal year ended December 31, 2021 that are being carried over to future years and the Funds do not participate in any joint distribution activities with another series or investment company.
Neither the Plan nor the Distribution Agreement authorize the imposition of initial sales charges or contingent deferred sales charges (“CDSCs”) in connection with the purchase of shares coved by this SAI. As a result, the Share Classes are not subject to initial sales charges or CDSCs.
Shares of the Funds may be held by certain financial intermediaries for the benefit of their customers. In such instances, some or all of the recordkeeping for these accounts may be performed by such financial intermediaries and the Funds may not have to maintain accounts for the customers of the financial intermediaries who have invested in the Funds. The Board has authorized the Funds to compensate financial intermediaries to the extent the services such parties render to a Fund are non distribution-related recordkeeping, account maintenance or other shareholder services. Such non distribution-related shareholder services may include (without limitation): (a) establishing and maintaining omnibus accounts with the Funds; (b) establishing and maintaining subaccounts and subaccount balances for the relevant record and/or beneficial shareholders; (c) processing orders by the relevant record and/or beneficial shareholders to purchase, redeem and exchange Fund shares promptly and in accordance with the Prospectus relating to the relevant Share Class; (d) transmitting to the Funds, on each business day, a net subscription or net redemption order reflecting subscription, redemption and exchange orders received by it with respect to the relevant record and/or beneficial shareholders; and (e) receiving and transmitting funds representing the purchase price or redemption proceeds relating to such orders. The actual services provided, and the payments made for such services, vary from firm to firm. These payments by the Funds are made out of the assets attributable to their various Share Classes and reflected as “Other Expenses” in the Funds’ fee tables and expense examples contained in the Prospectus.
RFS, Royce, and/or certain of their affiliates may make payments to financial intermediaries that provide the opportunity to distribute the Funds through their sales personnel, provide access to their selling personnel or branch offices, place the Funds on the financial intermediary’s list of offered funds, and introduce investors to the Funds. Certain of such payments may be made from the resources of Royce and/or its certain of its affiliates, which resources may include profits from their relationships with the Funds.
As of December 31, 2021, Royce anticipates that the financial intermediaries that will receive payments relating to the Funds from Royce’s own resources include the following:
| Ameriprise/RiverSource | Jefferson National Life/Inviva | Security Benefit |
| Brighthouse | Nationwide Investment Services | Symetra |
| Delaware Life | Ohio National | TIAA |
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The payments described under this heading may influence financial intermediaries to recommend or sell a Fund over other mutual funds. You may ask your financial intermediary about these differing interests and how the financial intermediary and its employees and associated persons are compensated for administering your Fund investment. Such payments may benefit Royce to the extent that the payments result in more assets, on which fees are charged by Royce, being invested in a Fund. In addition, such payments may: (i) be substantial to any given financial intermediary, (ii) be more or less than comparable payments received by a financial intermediary with respect to other mutual funds, and (iii) exceed the costs and expenses incurred by the financial intermediary in performing the applicable services and activities in respect of the Funds.
State Street is the custodian of each Fund’s securities, cash and other assets, but it does not participate in any Fund’s investment decisions. The Trust has authorized State Street to deposit certain domestic and foreign portfolio securities in several central depository systems and to use foreign sub-custodians for certain foreign portfolio securities, as allowed by Federal law. State Street’s main office is at John Adams Building, 2 North, 1776 Heritage Drive, North Quincy, MA 02171.
State Street is responsible for calculating the daily net asset value per share, maintaining the portfolio and general accounting records, and also provides certain shareholder services for each Fund and its Share Classes.
DST AMS is the transfer agent and dividend disbursement agent for each Fund’s shares, but it does not participate in any Fund’s investment decisions. All mutual fund transfer, dividend disbursing and shareholder service activities are performed by DST AMS at 330 W. 9th Street, Kansas City, Missouri 64105.
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
PricewaterhouseCoopers LLP, whose primary address is 300 Madison Avenue, New York, New York 10017-6232, is the Trust’s independent registered public accounting firm, providing audit services, tax return preparation and assistance and consultation in connection with the review of various SEC filings.
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State Street acts as the securities lending agent for the Funds (in such capacity, the “Lending Agent”). During the fiscal year ended December 31, 2021, the Lending Agent provided various services to the Funds, including locating borrowers, monitoring daily the value of the loaned securities and collateral, requiring additional collateral from borrowers as necessary, cash collateral management, qualified dividend management, negotiation of loan terms, selection of securities to be loaned, recordkeeping and account servicing, monitoring dividend activity and material proxy votes relating to loaned securities, and arranging for return of loaned securities to the Funds at loan termination. For the fiscal year ended December 31, 2021 the table below reflects the dollar amounts of income received and the compensation paid to the Lending Agent, including any share of revenue generated by the securities lending program paid to the Lending Agent (“revenue split”), related to the securities lending activities of each Fund:
|
Fund |
Gross income activities |
Fees
paid to securities |
Fees
paid for any cash included
in revenue |
Administrative
|
Indemnification fee not included in revenue split |
Rebate (paid to |
Other
fees not |
Aggregate
fees/ compensation for |
Net
income |
| Royce Micro-Cap Portfolio |
$14,560 |
$2,912 |
− |
− |
− |
− |
− |
$2,912 |
$11,648 |
| Royce Small-Cap Portfolio |
1,073 |
214 |
− |
− |
− |
− |
− |
214 |
859 |
Royce is responsible for selecting the brokers who effect the purchases and sales of each Fund’s portfolio securities. Royce does not select a broker to effect a securities transaction for a Fund unless Royce believes such broker can obtain the best execution for the security involved in the transaction. Best execution is comprised of several factors, including the liquidity of the market for the security, the commission charged, the promptness and reliability of execution, priority accorded the order and other factors affecting the overall benefit obtained from the transaction.
In addition to considering a broker’s execution capability, Royce generally considers the research and brokerage services which the broker has provided to it, including any research relating to the security involved in the transaction and/or to other securities. Royce uses commission dollars generated by agency transactions for the Funds and certain of its other client accounts to pay for such “research services.” Research services that are paid for in this manner assist Royce in carrying out its investment decision-making responsibilities. Research services may include, but are not limited to, general economic research, market and statistical information, industry and technical research, strategy and company research, advice as to the availability of securities or purchasers or sellers of a particular security, research related to performance measurement, and may be provided in writing or orally. Brokerage services that are paid for in this manner include effecting securities transactions and incidental functions such as clearance, settlement and custody.
Royce is authorized, under its Advisory Agreement with the Trust and in accordance with Section 28(e) of the Exchange Act and SEC guidance issued under the Exchange Act, to cause the Funds to pay brokerage commissions in excess of those which another broker might have charged for effecting the same transaction, in recognition of the value of research and brokerage services provided to Royce by the broker. Thus, the Funds generally pay higher commissions to those brokers who provide both such research and brokerage services than those who provide only execution services. Royce determines the overall reasonableness of brokerage commissions paid based on prevailing commission rates for similar transactions and the value it places on the research and/or brokerage services provided to it by the broker, viewed in terms of either the particular transaction or Royce’s overall responsibilities with respect to its accounts. Royce does not consider liquidity rebates or payments for order flow to be significant factors when selecting brokers and setting broker commission rates.
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Royce may use research and brokerage services furnished by brokers in connection with the effecting of securities transactions for the Funds in managing all of its client accounts, including: (i) certain discretionary client accounts that Royce reimburses to the extent commission dollars generated by agency transactions for such accounts are used to pay for such research and brokerage services and certain separately managed accounts for which Royce provides model portfolio services which do not generate commission dollars that may be used for research and brokerage services (together, the “Non-Participating Accounts”). Furthermore, the particular Fund that generated the applicable research or brokerage services is typically not the sole beneficiary (and, as to a particular service, potentially may not be a beneficiary at all); this is, in part, because some accounts regularly benefit from research or other services generated by trading by other accounts while themselves generating few or no commissions associated with such services. Royce does not attempt to allocate these kinds of benefits proportionately among its clients or, except in limited circumstances, to track the benefits of research and brokerage services to the commissions associated with a particular account or group of accounts. Royce’s receipt of these services also does not reduce the investment advisory fees payable to Royce by the Funds, even though Royce might have otherwise been required to purchase some of those services for cash. The arrangements thus present various conflicts of interest for Royce. Because research and other services paid for by the Funds can reduce Royce’s costs, Royce has an incentive both to prefer trades and brokers whose commissions pay for such services over potentially less expensive alternatives and to prefer higher volumes of trading over lower volumes. Those incentives also can be heightened when acting for clients with different trading profiles. Those client accounts with no or limited ability to generate commissions from trading (e.g., the Non-Participating Accounts or those accounts that trade less frequently) may increase the incentive for Royce to generate commissions from trading by the Funds.
In some cases Royce may receive a service from a broker that has both a “research/brokerage” and a “non- research/non-brokerage” use. When this occurs, Royce makes a good faith allocation between the research/brokerage and non-research/non-brokerage use of the service. Only the portion of the service that is used for research/brokerage purposes may be paid for with commission dollars.
Firms that provide such research and brokerage services to Royce may also promote the sale of the Funds’ shares, and Royce and/or RFS may separately compensate them for doing so. Such brokerage business is placed on the basis of brokerage and research services provided by the firm and is not based on any sales of the shares of the Funds. RFS does not effect portfolio transactions on behalf of the Funds or any other Royce-advised accounts.
Even though Royce makes investment decisions for each Fund independently from those for the other Funds and the other accounts managed by Royce, Royce frequently purchases, holds or sells securities of the same issuer for more than one Royce account because the same security may be suitable for more than one of them. When Royce is purchasing or selling the same security for more than one Royce account managed by the same primary portfolio manager on the same trading day, Royce generally seeks to average the transactions as to price and allocate them as to amount in a manner believed by Royce to be equitable to each account. Royce generally effects such purchases and sales of the same security pursuant to Royce’s Trade Allocation Guidelines and Procedures. Although Royce’s portfolio managers generally pre-allocate the majority of Royce’s purchase or sale orders to one or more of its client accounts, under such Guidelines and Procedures, Royce may place and execute unallocated orders with broker-dealers during the trading day and then allocate the securities purchased or sold in such transactions to one or more of Royce’s accounts at or shortly following the close of trading, generally using the average net price obtained by accounts with the same primary portfolio manager. Royce does such allocations based on a number of judgmental factors that it believes should result in fair and equitable treatment to those of its accounts for which the securities may be deemed suitable. In some cases, this procedure may adversely affect the price paid or received by a Fund or the size of the position obtained for a Fund. In addition, on a limited, infrequent basis, and in accordance with its written procedures, Royce may change initial allocations from one Royce client account to another when: (i) it is determined that a security is unsuitable or inappropriate for a particular Royce client account in the original allocation; (ii) there is a lack of cash in a Royce client account to whom a security is initially allocated; (iii) there is a client-imposed restriction on the purchase of the security being allocated; or (iv) the portfolio manager decides to change the initial allocation for some other reason.
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From time to time, one or more of Royce’s portfolio managers may sell short or purchase long a security for the client accounts that he manages even though one or more other portfolio managers may have or acquire an opposite position in this same security for the client accounts that they manage. In addition, from time to time, two portfolio managers with independent investment discretion over separate portions of a single Fund’s portfolio may place opposite direction trades for that Fund in the same security on the same day or within a short period of time of one another. Although Royce has taken certain steps designed to minimize the circumstances under which this will occur, it nevertheless could result in adverse tax consequences to the Funds’ taxable shareholders.
During each of the years ended December 31, 2019, 2020, and 2021, the Funds paid brokerage commissions as follows:
| Fund | 2019 | 2020 | 2021 |
| Royce Micro-Cap Portfolio | $215,864 | $170,790 | $163,588 |
| Royce Small-Cap Portfolio | 827,643 | 549,849 | 410,316 |
For the year ended December 31, 2021, the aggregate amount of brokerage transactions of each Fund having a research component and the amount of commissions paid by each Fund for such transactions were as follows:
|
Fund |
Aggregate
Amount of Brokerage a Research Component |
Commissions Paid
for Such |
| Royce Micro-Cap Portfolio | $79,367,242 | $142,168 |
| Royce Small-Cap Portfolio | 296,328,827 | 353,193 |
As of December 31, 2021, neither Fund held any securities of its regular broker-dealers or parents thereof.
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CODE OF ETHICS AND RELATED MATTERS
Royce, RFS and The Royce Funds have adopted a Code of Ethics under which directors (other than non- management directors), officers and employees of Royce and RFS (“Royce-related persons”) and interested trustees/directors, officers and employees of The Royce Funds are generally prohibited from personal trading in any security which is being purchased, sold, or considered for purchase or sale by a Fund or any other Royce- advised account. The Code of Ethics permits such persons to engage in other personal securities transactions if: (i) the securities involved are certain debt securities, money market instruments/funds, shares of non-affiliated registered open-end investment companies or shares acquired from an issuer in a rights offering or under an automatic investment plan, including, among other things, dividend reinvestment plans or employee-approved automatic payroll-deduction cash purchase plans; (ii) the transactions are either non-volitional or are effected in an account over which such person has no direct or indirect influence or control; or (iii) they first obtain permission to trade from a Royce Compliance Officer and either an executive officer or Senior Portfolio Manager of Royce. The Code of Ethics contains standards for the granting of such permission, and permission to trade will usually be granted only in accordance with such standards.
Royce’s clients include several private investment companies in which Royce, Royce-related persons and/or other Franklin Templeton affiliates have (and, therefore, may be deemed to beneficially own) a share of up to 15% of the company’s realized and unrealized net capital gains from securities transactions, but less than 25% of the company’s equity interests. The Code of Ethics does not restrict transactions effected by Royce for such private investment company accounts, and transactions for such accounts are subject to Royce’s allocation policies and procedures. See “Portfolio Transactions,” below.
As of March 31, 2022, Royce-related persons, interested trustees/directors, officers and employees of The Royce Funds and members of their immediate families beneficially owned shares of The Royce Funds having a total value of approximately $107 million and such persons beneficially owned equity interests in Royce-related private investment companies and other pooled investment vehicles totaling approximately $26 million.
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PROXY VOTING POLICIES AND PROCEDURES
Royce has adopted written proxy voting policies and procedures (the “Proxy Voting Procedures”) for itself and client accounts for which Royce is responsible for voting proxies. Royce is generally granted proxy voting authority at the inception of its management of each client account. Proxy voting authority is generally either (i) specifically authorized in the applicable investment management agreement or other instrument; or (ii) where not specifically authorized, is granted to Royce where general investment discretion is given to Royce in the applicable investment management agreement. In voting proxies, Royce is guided by general fiduciary principles. Royce’s goal is to act prudently, solely in the best interest of the beneficial owners of the accounts it manages. Royce attempts to consider all factors of its vote that could affect the value of the investment and will vote proxies in the manner it believes will be consistent with efforts to enhance and/or protect stockholder value.
Royce’s personnel are responsible for monitoring receipt of all proxies and seeking to ensure that proxies are received for all securities for which Royce has proxy voting authority. Royce is not responsible for voting proxies it does not receive. Royce divides proxies into “regularly recurring” and “non-regularly recurring” matters. Examples of regularly recurring matters include non-contested elections of directors and non-contested approvals of independent auditors. Royce’s personnel are responsible for developing and maintaining a list of matters Royce treats as “regularly recurring” and for ensuring that instructions from a Royce Co-Chief Investment Officer are followed when voting those matters on behalf of Royce clients. Non-regularly recurring matters are all other proxy matters and are brought to the attention of the relevant portfolio manager(s) for the applicable account(s). After giving consideration to advisories provided by an independent third-party research firm with respect to such non-regularly recurring matters, the portfolio manager(s) directs that such matters be voted in a way that he or she believes should better protect or enhance the value of the investment. Certain Royce portfolio managers may provide instructions that they do not want regularly recurring matters to be voted in accordance with the standing instructions for their accounts and individual voting instructions on all matters, both regularly recurring and non- regularly recurring, will be obtained from such portfolio managers.
Notwithstanding the above, all matters identified by an independent third-party research firm as being “ESG” proposals are brought to the attention of the portfolio manager(s) for the account(s) involved by Royce personnel. After giving consideration to the recommendation from the independent third-party research firm, the portfolio manager will direct that such matters be voted in a way he or she believes appropriately takes into account environmental and social issues alongside traditional financial measures to provide a more comprehensive view of the value, risk, and return potential of an investment. When Royce portfolio managers cast votes on “ESG” proposals, they take into account the risk that companies may face significant financial, legal, and reputational risks resulting from poor environmental and social practices, or negligent oversight of environmental or social issues.
Under certain circumstances, Royce may also vote against a proposal from the issuer’s board of directors or management. Royce’s portfolio managers decide these issues on a case-by-case basis. These would include, among others, excessive compensation, unusual management stock options, preferential voting, and poison pills. Royce’s portfolio managers decide these issues on a case-by-case basis. In addition, a Royce portfolio manager may, on occasion, decide to abstain from voting a proxy or a specific proxy item when such person concludes that the potential benefit of voting is outweighed by the cost or when it is not in the client’s best interest to vote. From time to time, it is also possible that one Royce portfolio manager will decide: (i) to vote shares held in client accounts he or she manages differently from the vote of another Royce portfolio manager whose client accounts hold the same security or (ii) to abstain from voting on behalf of client accounts he or she manages when another Royce portfolio manager is casting votes on behalf of other Royce client accounts.
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There may be circumstances where Royce may not be able to vote proxies in a timely manner, including, but not limited to, (i) when certain securities are out on loan at the time of a record date; (ii) when administrative or operational constraints impede Royce’s ability to cast a timely vote, such as late receipt of proxy voting information; and/or (iii) when systems, administrative or processing errors occur (including errors by Royce or third-party vendors).
To further Royce’s goal to vote proxies in the best interests of its client, Royce follows specific procedures outlined in the Proxy Voting Procedures to identify, assess and address material conflicts that may arise between Royce's interests and those of its clients before voting proxies on behalf of such clients. In the event such a material conflict of interest is identified, the proxy will be voted by Royce in accordance with the recommendation given by an independent third party research firm.
You may obtain a copy of the Proxy Voting Procedures at www.royceinvest.com or by calling 212- 508-4500. Additionally, information regarding how the Funds voted proxies relating to portfolio securities during the most recent 12-month period ended June 30 is available without charge upon request, by calling the Trust toll-free at (800) 221-4268 and on the SEC’s Internet site at http://www.sec.gov.
PORTFOLIO HOLDINGS DISCLOSURE POLICY
The Board has adopted policies and procedures with respect to the disclosure of portfolio holdings. It is the policy of the Funds to prevent the selective disclosure of non-public information concerning Fund portfolio holdings. Unless specifically authorized by the Funds’ Chief Compliance Officer, no non-public portfolio holdings information for a Fund may be provided to anyone except in accordance with the following Policy and Procedures.
Public Disclosure of Portfolio Holdings
No earlier than 15 days after the end of each calendar quarter, the Funds’ most recent complete quarter-end schedules of portfolio holdings will be posted on the Funds’ website. Such disclosure will remain accessible on the Funds’ website until the posting of the portfolio holdings schedules for the next succeeding calendar quarter-end. The Funds also distribute complete portfolio holdings information to their shareholders through semi-annual and annual reports first mailed to shareholders within sixty (60) days after period ends. Such semi-annual and annual reports are also made available to the public through postings at the same time on the Funds’ website www.royceinvest.com. Finally, the Funds’ complete portfolio holdings are also available on Exhibit F to Form N-PORT, which filings are made with the SEC within sixty (60) days of the end of the Funds’ first and third fiscal quarters. The Funds’ Form N-PORT filings are available on the SEC’s website at http://www.sec.gov.
All other portfolio holdings information must first be posted on the Funds’ website before it is provided to anyone. Complete or partial portfolio holdings information may, therefore, be included in responses to Requests for Proposal, Pitch Books or similar marketing materials, only if such information is based on the latest holdings information publicly available on the Funds’ website.
Non-Public Dissemination of Portfolio Holdings Information
From time to time, portfolio holdings information that is not publicly available may be required by the Fund’s service providers or other third parties in order to perform various services for the Funds, including, but not limited to, custodian services, pricing services, auditing, printing, legal, compliance, software support, proxy voting support and providing ratings for a Fund. Such persons may be provided with information more current than the latest publicly-available portfolio holdings only if: (i) more current information is necessary in order for the third party to complete its task and (ii) the third party has agreed in writing to keep the information confidential and to not use the information to trade securities. Non- public dissemination to a Fund service provider must be authorized by Royce’s Chief Operating Officer, Royce’s General Counsel or the Trust’s Chief Compliance Officer only after it is determined that such dissemination serves a legitimate business purpose in the best interest of shareholders.
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At the present time, the Trust has ongoing arrangements with the following service providers to provide them with non-public portfolio holdings information with respect to the Funds:
State Street Bank and Trust Company – Information is provided daily with no time lag.
PricewaterhouseCoopers LLP – Information is provided as needed with no time lag.
Sidley Austin LLP – Information is provided with Board materials with a time lag of less than one week to ten weeks and may be provided at other times as needed.
Institutional Shareholder Services, Inc. (“ISS”) – Information is provided daily with no time lag.
Broadridge Financial Solutions, Inc. – Information is provided daily with no time lag.
Allied Printing Services, Inc. – Information is generally provided with a time lag of two weeks but may be provided with no time lag.
Automated Securities Clearance, LLC – Information is provided daily with no time lag.
Charles River Systems, Inc. – Information is provided daily with no time lag.
Factset – Information is provided daily with no time lag. Bloomberg – Information is provided daily with no time lag.
William O’Neil & Co., Inc. – Information is provided daily with no time lag.
MSCI – ESG – Information is provided daily with no time lag.
ISS – ESG – Information is provided daily with no time lag.
S&P Capital IQ – ESG – Information is provided daily with no time lag.
Evestment – Information is provided quarterly with no time lag.
Certain administrative employees of Franklin Resources, Royce’s ultimate parent company, or its subsidiaries regularly have access to the Funds’ portfolio holdings. All portfolio holdings information given to these employees is subject to the Franklin Resources Code of Conduct, which has been distributed to all such employees and prohibits the disclosure of confidential information.
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Additionally, the Funds may occasionally reveal certain of their current portfolio securities to broker-dealers in connection with their executing securities transactions on behalf of the Funds. In such cases, the Funds do not enter into a formal confidentiality agreements with the broker-dealers. Also, the Board, Trust officers, and certain Royce employees, including fund accounting, legal, compliance, marketing, administrative and systems personnel, have access to the Funds’ portfolio holdings information prior to the time it is made public. All such persons are required by the Funds and Royce to keep such information confidential.
Incidental information about the portfolio holdings of the Funds (including information that a Fund no longer holds a particular security) may be provided to third parties when the extent of the information and its timeliness are such that it cannot reasonably be seen to give the recipient an advantage in trading Fund shares or to in any other way harm the Fund or its shareholders. However, information about a security holding may not be released if, in Royce’s judgment, it could be seen to interfere with the current or future purchase or sale activities of a Fund. In this respect, information about intended or ongoing transactions may not be released.
General information about a Fund’s portfolio securities holdings (not including the holdings themselves) that is derived from its holdings (that have or have not been publicly released) that do not reveal portfolio holdings are not subject to the Policy and Procedures. This would include such characteristics of a Fund as portfolio volatility, median capitalization, percentages of international and domestic securities or sector allocations.
Notwithstanding the above, no person is authorized under the Policy and Procedures to make a disclosure that is unlawful under the anti-fraud provisions of the Federal securities laws (as defined in Rule 38a-1 under the 1940 Act).
Nothing contained in the Policy and Procedures is intended to prevent the disclosure of portfolio holdings information as required by applicable law. For example, the Funds or any of their affiliates or service providers may file any report required by applicable law (such as Form N-PORT and/or Schedules 13D, 13G and 13F), respond to requests from regulators, and comply with valid subpoenas. On an annual basis, the Trust’s Chief Compliance Officer will report to the Board on the operation and effectiveness of the Policy and Procedures.
Prohibitions on Receipt of Compensation or Other Compensation
The Policies and Procedures prohibit the Funds, Royce and any other person to pay or receive any compensation or other consideration of any type for the purpose of obtaining disclosure of the Funds’ portfolio securities holdings or other investment positions. “Consideration” includes any agreement to maintain assets in a Fund or in any other investment company or account managed by Royce or by any of its affiliated persons.
PRICING OF SHARES BEING OFFERED
The purchase and redemption price of each Fund’s shares is based on the relevant Fund’s current net asset value per share. See “Net Asset Value Per Share” in the Funds’ Prospectus.
As set forth under “Net Asset Value Per Share”, State Street determines each Fund’s net asset value per share as of the close of regular trading on the New York Stock Exchange (the “NYSE”) (generally at 4:00 Eastern Time) on each day that the NYSE is open. The NYSE generally is open on all weekdays which are not holidays. Thus, the NYSE is closed on Saturdays and Sundays and on New Year’s Day, Martin Luther King Day, Presidents’ Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
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The Funds have entered into agreements that authorize one or more insurance companies or other financial intermediaries to receive purchase and redemption orders on their behalf. Such insurance companies or other financial intermediaries may be authorized to designate other intermediaries to receive 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 financial intermediary’s authorized designee, receives the order. Such orders will be priced at the Funds’ net asset value next computed after they are received by an authorized financial intermediary or the financial intermediary’s authorized designee and accepted by the Fund.
Conditions may arise in the future which would, in the judgment of the Board or Royce, make it undesirable for a Fund to pay for all redemptions in cash. The Trust reserves the right to satisfy a shareholder's redemption request under certain circumstances by effecting a redemption-in-kind through a pro rata distribution of the Fund's portfolio securities (allowing for adjustments to prevent distributions of restricted shares, fractional shares and odd-lot numbers of shares). Redemption in-kind proceeds will typically be made by delivering the selected securities to the redeeming shareholder within seven days after the receipt of a redemption request in Good Order. For these purposes, such securities will be valued at the same values assigned to them in computing the Fund's net asset value per share. If the Fund pays redemption proceeds by transferring portfolio securities in-kind to you, you may pay transaction costs to dispose of the securities, incur adverse tax consequences in connection with any such disposal, and receive less for them than the price at which they were valued for purposes of redemption. However, the Trust is obligated to redeem for cash all shares presented for redemption by any one shareholder up to $250,000 (or 1% of a Fund’s net assets if that is less) in any 90-day period.
APPLICATION OF FREQUENT TRADING POLICY TO CERTAIN INVESTORS
As described in the Prospectus, under the Trust’s frequent trading policy, the Funds may, in certain circumstances, reject an investor’s purchase or exchange of Fund shares. In accordance with Rule 22c-2 under the 1940 Act, a Fund will not permit investors to purchase shares through certain intermediaries, including brokers, that do not have shareholder information agreements with either the Trust or RFS, acting on behalf of the Trust. Such shareholder information agreements are intended to help identify investors who engage in excessive trading through intermediaries. The Funds may elect to treat an intermediary that has no shareholder information agreement concerning the Funds as an individual investor with respect to the frequent trading policy. If the Funds make this election, they will not, with respect to the frequent trading policy, consider any individual order to transact Fund shares that an investor has submitted to the intermediary, but will instead consider only single transactions submitted by the intermediary. Depending in part on an investor’s relationship with the intermediary, this may have adverse consequences to the investor, such as the rejection of a transaction in Fund shares or the imposition of a fee, that would not be borne by other investors who deal with the Funds directly or through a different intermediary.
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Shares of the Funds are offered solely to separate accounts of insurance companies that fund variable annuity contracts or life insurance policies described in Section 817(d) of the Code (the “Variable Contracts”). See the disclosure documents for the applicable Variable Contracts for a discussion of the tax consequences of owning such Variable Contracts.
Each Fund has qualified and intends to remain qualified each year for the tax treatment applicable to a regulated investment company under Subchapter M of the Code. To so qualify, a Fund must comply with certain requirements of the Code relating to, among other things, the source of its income and the diversification of its assets. If it so qualifies, a Fund will not be subject to U.S. Federal income tax to the extent that its net investment income and capital gain net income are distributed, so long as the Fund distributes, as ordinary income dividends, at least 90% of its investment company taxable income. The Funds will not be subject to the 4% Federal excise tax imposed on regulated investment companies that do not distribute substantially all of their income and gains each calendar year so long as their only shareholders are segregated asset accounts of life insurance companies held in connection with Variable Contracts.
As of December 31, 2021, neither Fund had any capital loss carryforwards.
Each Fund maintains accounts and calculates income by reference to the U.S. dollar for U.S. Federal income tax purposes. Investments calculated by reference to foreign currencies will not necessarily correspond to a Fund’s distributable income and capital gains for U.S. Federal income tax purposes as a result of fluctuations in foreign currency exchange rates. Furthermore, if any exchange control regulations were to apply to a Fund’s investments in foreign securities, such regulations could restrict that Fund’s ability to repatriate investment income or the proceeds of sales of securities, which may limit the Fund’s ability to make sufficient distributions to satisfy the 90% distribution requirement.
Income earned or received by a Fund from investments in foreign securities may be subject to foreign withholding taxes unless a withholding exemption is provided under an applicable treaty. Any such taxes would reduce that Fund’s cash available for distribution to shareholders.
If a Fund invests in stock of a so-called passive foreign investment company (“PFIC”), the Fund may be subject to U.S. Federal income tax on a portion of any “excess distribution” with respect to, or gain from the disposition of, the stock. The Fund would determine the tax by allocating such distribution or gain ratably to each day of the Fund’s holding period for the stock. The Fund would be taxed on the amount so allocated to any taxable year of the Fund prior to the taxable year in which the excess distribution or disposition occurs, at the highest marginal income tax rate in effect for such year, and the tax would be further increased by an interest charge. The Fund would include in its investment company taxable income the amount allocated to the taxable year of the distribution or disposition and, accordingly, this amount would not be taxable to the Fund to the extent distributed by the Fund as a dividend to shareholders. The Fund may make certain elections to mitigate the effect of these rules, but any such election could require the Fund to recognize taxable income or gain (which would be subject to the distribution requirements discussed above) without the concurrent receipt of cash.
If a Fund is treated as holding directly or indirectly 10% or more of the voting power or value of the stock (or other interests treated as equity for U.S. Federal income tax purposes) of a foreign corporation, and all 10% or greater U.S. shareholders collectively own more than 50% of the voting power or value of the stock of such corporation, the foreign corporation will be treated as a “controlled foreign corporation” (a “CFC”) for U.S. Federal income tax purposes. In such circumstances, the Fund would be required to report each year as ordinary income, its pro rata share of the CFC’s earnings for such year, and such income would be subject to the distribution requirements discussed above, whether or not such income is concurrently distributed to the Fund.
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Investments of a Fund in securities issued at a discount or providing for deferred interest payments or payments of interest in kind (which investments are subject to special tax rules under the Code) will affect the amount, timing and character of distributions to shareholders. For example, a Fund which acquires securities issued at a discount will be required to accrue as ordinary income each year a portion of the discount (even though the Fund may not have received cash interest payments equal to the amount included in income) and to distribute such income each year in order to maintain its qualification as a regulated investment company and to avoid income taxes. In order to generate sufficient cash to make distributions necessary to satisfy the 90% distribution requirement when the Fund recognizes non-cash “phantom” income and to avoid income and excise taxes, the Fund may have to dispose of securities that it would otherwise have continued to hold.
A Fund’s transactions in options, futures contracts, and certain other transactions will be subject to special provisions of the Code (including provisions relating to “hedging transactions,” “straddles,” “wash sales,” and “section 1256 contracts”) that, among other things, may affect the character of gains and/or losses realized by the Fund (as short-term or long-term), accelerate recognition of income to the Fund or defer the allowance of Fund losses. These rules could therefore affect the character, amount and timing of distributions to shareholders. These provisions also may: (a) require the Fund to mark-to-market certain types of the positions in its portfolio (i.e., treat them as if they were closed out at the end of each year) and (b) cause the Fund to recognize income without receiving cash with which to pay dividends or make distributions in amounts necessary to satisfy the distribution requirements for avoiding income and excise taxes.
Each Fund intends to comply with Section 817(h) of the Code and the regulations issued thereunder, which impose certain diversification requirements on segregated asset accounts investing in the Funds. These requirements, which are in addition to the diversification requirements applicable to the Funds under the 1940 Act and under the regulated investment company provisions of the Code, may limit the types and amounts of securities in which the Funds may invest. Failure to meet the requirements of Section 817(h) could result in current taxation of a holder of a Variable Contract on the income of the Variable Contract.
The foregoing is only a general summary of some of the important U.S. Federal income tax considerations generally affecting the Funds. Changes in U.S. Federal income tax law occurring after May 1, 2022 may be retroactive and may significantly affect the U.S. Federal income tax matters discussed above. No attempt is made to present a complete explanation of the Federal tax treatment of the Funds’ activities, and this discussion must be read in conjunction with the discussion in the prospectuses and/or statements of additional information for the applicable Variable Contracts. It is not intended as a substitute for careful tax planning, and does not discuss the taxation of insurance companies or the taxation of holders of Variable Contracts. Potential investors are urged to consult their own tax advisers for more detailed information and for information regarding any U.S. Federal, state, local or foreign taxes applicable to the Variable Contracts and the holders thereof.
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Trust Organization
The Trust was established as a Delaware business trust, effective January 11, 1996. A copy of the Trust’s Certificate of Trust is on file with the Secretary of State of Delaware, and a copy of its Trust Instrument, its principal governing document, is available for inspection by shareholders at the Trust’s office in New York, New York. The Trust’s business and affairs are managed under the direction of the Board.
The Trust has an unlimited authorized number of shares of beneficial interest, which the Board may divide into an unlimited number of series and/or classes without shareholder approval. (The Trust presently has two series, each of which has two Share Classes.) Shareholders are entitled to one vote per share (with proportional voting for fractional shares) on such matters as shareholders are entitled to vote. Shares vote by individual series, except as otherwise required by the 1940 Act or when the Trustees determine that the matter affects shareholders of more than one series. The shares of each Share Class represent a pari passu interest in such Fund’s investment portfolio and other assets and have the same redemption and other rights. Service Class shares of each Fund have exclusive voting rights with respect to the Rule 12b-1 Plan.
Each of the seven Trustees currently in office was elected by the Funds’ shareholders. There will normally be no meeting of shareholders for the purpose of electing Trustees unless and until such time as less than a majority of the shareholder-elected Trustees remain in office, at which time the Trustees then in office will call a shareholders’ meeting for the election of Trustees. In addition, Trustees may be removed from office by written consents signed by the holders of 662/3% of the outstanding shares of the Trust and filed with the Trust’s custodian or by a vote of the holders of 662/3% of the outstanding shares of the Trust at a meeting duly called for the purpose, which meeting will be held upon the written request of the holders of at least 10% of the Trust’s outstanding shares. Upon the written request by 10 or more shareholders of the Trust, who have been shareholders for at least 6 months and who hold shares constituting at least 1% of the Trust’s outstanding shares, stating that such shareholders wish to communicate with the Trust’s other shareholders for the purpose of obtaining the signatures necessary to demand a meeting to consider the removal of a Trustee, the Trust is required to provide lists of its shareholders or to disseminate appropriate materials (at the expense of the requesting shareholders). Except as provided above the Trustees may continue to hold office and appoint their successors.
Shares are freely transferable, are entitled to distributions as declared by the Trustees and, in liquidation of the Trust, are entitled to receive the net assets of their series. Shareholders have no preemptive rights. The Trust’s fiscal year ends on December 31.
The separate accounts of Insurance Companies and the trustees of qualified plans invested in the Funds, rather than individual contract owners or plan participants, are the shareholders of the Funds. However, each Insurance Company or qualified plan will vote such shares as required by law and interpretations thereof, as amended or changed from time to time. Under current law, an Insurance Company is required to request voting instructions from its contract owners and must vote Fund shares held by each of its separate accounts in proportion to the voting instructions received. Additional information about voting procedures is contained in the applicable separate account prospectuses.
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The Funds currently do not foresee any disadvantages to policyowners arising out of the fact that each Fund offers its shares to variable and variable life insurance separate accounts of insurance companies. Nevertheless, the Trustees intend to monitor events in order to identify any irreconcilable material conflicts that may arise due to future differences in tax treatment or other considerations and to determine what action, if any, should be taken in response to such conflicts. If a conflict occurs, the Trustees may require one or more insurance company separate accounts or plans to withdraw investments in one or more of the Funds and to substitute shares of another Fund. As a result, a Fund may be forced to sell securities at disadvantageous prices. In addition, the Trustees may refuse to sell shares of any Fund to any separate account or may suspend or terminate the offering of shares of any Fund if such action is required by law or regulatory authority or is deemed by the Trust to be in the best interests of the shareholders of the Fund.
Shareholder Liability
Generally, Trust shareholders will not be personally liable for the obligations of the Trust under Delaware law. The Delaware Statutory Trust Act provides that a shareholder of a Delaware statutory trust is entitled to the same limited liability extended to stockholders of private corporations for profit organized under the Delaware General Corporation Law. No similar statutory or other authority limiting shareholder trust shareholder liability exists in many other states. As a result, to the extent that the Trust or a shareholder of the Trust is subject to the jurisdiction of courts in those states, the courts may not apply Delaware law and may thereby subject the Trust’s shareholders to liability. To guard against this possibility, the Trust Instrument (i) requires that every written obligation of the Trust contain a statement that such obligation may be enforced only against the Trust’s assets (however, the omission of this disclaimer will not operate to create personal liability for any shareholder); and (ii) provides for indemnification out of a Fund’s property of any Fund shareholder held personally liable for the Fund’s obligations. Thus, the risk of a Fund shareholder incurring financial loss beyond its investment because of shareholder liability is limited to circumstances in which: (i) a court refuses to apply Delaware law; (ii) no contractual limitation of liability was in effect; and (iii) the Fund itself would be unable to meet its obligations. In light of Delaware law, the nature of the Trust’s business and the nature of its assets, management believes that the risk of personal liability to a shareholder is extremely remote.
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