As filed with the Securities and Exchange Commission on December 23, 2002
File Nos. 333-91282; 811-21129
================================================================================
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM N-2
(CHECK APPROPRIATE BOX OR BOXES)
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 [X]
Pre-Effective Amendment No. [1]
Post-Effective Amendment No. [ ]
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1940 [X]
Amendment No. 1
F&C/CLAYMORE PREFERRED SECURITIES INCOME FUND INCORPORATED
(Exact Name of Registrant as Specified in Charter)
301 E. Colorado Boulevard
Pasadena, California 91101
Address of Principal Executive Offices (Number, Street, City, State and Zip
Code)
(626) 795-7300
Registrant's Telephone Number, including Area Code
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Robert M. Ettinger
301 E. Colorado Boulevard
Suite 720
Pasadena, CA 91101
Name and Address (Number, Street, City, State and Zip Code) of Agent for Service
WITH COPIES TO:
Rose F. DiMartino, Esq.
Willkie Farr & Gallagher
787 Seventh Avenue
New York, New York 10019
(212) 728-8000
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Approximate Date of Proposed Public Offering: As soon as practicable after the
effective date of this Registration Statement.
If any of the securities being registered on this form will be offered on a
delayed or continuous basis in reliance on Rule 415 under the Securities Act of
1933, other than securities offered in connection with a dividend reinvestment
plan, check the following box / /
It is proposed that this filing will become effective (check appropriate box):
/ / when declared effective pursuant to Section 8(c) of the Securities Act of
1933.
If appropriate, check the following box:
/ /This post-effective amendment designates a new effective date for a previous
filed registrations statement.
/ /This Form is filed to register additional securities for an offering pursuant
to Rule 462(b) under the Securities Act and the Securities Act registration
statement number of the earlier effective registration statement for the same
offering is ____.
CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933
--------------------------------------------------------------------------------------------------------------------
PROPOSED MAXIMUM PROPOSED MAXIMUM AMOUNT OF
TITLE OF SECURITIES BEING AMOUNT BEING OFFERING PRICE PER AGGREGATE OFFERING REGISTRATION FEE
REGISTERED REGISTERED UNIT PRICE (1) (2)
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1048856.2
Common Stock, $0.01 par value per
share 2,400,000 Shares $25.00 $60,000,000 $5,520*
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(1) Estimated solely for purposes of calculating the registration fee.
(2) Transmitted prior to filing the initial registration statement on Form N-2.
* Previously paid
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES
AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE
A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT
SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE
SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING
PURSUANT TO SECTION 8(A), MAY DETERMINE.
THE UNDERSIGNED REGISTRANT HEREBY UNDERTAKES THAT: (1) FOR PURPOSES OF
DETERMINING ANY LIABILITY UNDER THE SECURITIES ACT OF 1933, THE INFORMATION
OMITTED FROM THE FORM OF PROSPECTUS FILES AS PART OF THE REGISTRATION STATEMENT
IN RELIANCE UPON THE PROSPECTUS FILED BY THE REGISTRANT PURSUANT TO RULE
424(b)(1) OR (4) OR 497(h) UNDER THE SECURITIES ACT SHALL BE DEEMED TO BE PART
OF THIS REGISTRATION STATEMENT AS OF THE TIME IT WAS DECLARED EFFECTIVE; (2) FOR
THE PURPOSE OF DETERMINING ANY LIABILITY UNDER THE SECURITIES ACT OF 1933, EACH
POST-EFFECTIVE AMENDMENT THAT CONTAINS A FORM OF PROSPECTUS SHALL BE DEEMED TO
BE A NEW REGISTRATION STATEMENT RELATING TO THE SECURITIES OFFERED THEREIN, AND
THE OFFERING OF SUCH SECURITIES AT THAT TIME SHALL BE DEEMED TO BE THE INITIAL
BONA FIDE OFFERING THEREOF.
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY
NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER
TO SELL THESE SECURITIES AND IT IS NOT SOLICITING AN OFFER TO BUY THESE
SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
SUBJECT TO COMPLETION
PRELIMINARY PROSPECTUS DATED DECEMBER 23, 2002
PROSPECTUS
[F&C LOGO] [CLAYMORE LOGO]
SHARES
F&C/CLAYMORE PREFERRED SECURITIES
INCOME FUND INCORPORATED
COMMON STOCK
$25.00 PER SHARE
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INVESTMENT OBJECTIVE. F&C/Claymore Preferred Securities Income Fund
Incorporated (the "Fund") is a newly organized, closed-end, diversified
management investment company.
The Fund's investment objective is high current income for holders of its
Common Stock consistent with preservation of capital. At least 80% of the Fund's
total assets will be invested in a diversified portfolio of preferred
securities. Under current market conditions, the Fund expects that its portfolio
of preferred securities will consist principally of "hybrid" or taxable
preferreds. At least 80% of the Fund's preferred securities will be investment
grade quality at the time of purchase. Up to 20% of the Fund's total assets may
be invested in securities rated below investment grade (but not below Ba3 or
BB-), provided the issuer has investment grade senior debt outstanding. The
Fund's investment adviser intends to pursue strategies that include, among other
things, hedging, which are generally intended to result in the Fund's income
increasing in response to significant increases in interest rates while being
relatively resistant to the impact of significant declines in interest rates.
NO PRIOR HISTORY. Prior to this offering, there has been no public market
for the Common Stock. The Common Stock has been accepted for listing on the New
York Stock Exchange, subject to notice of issuance, under the trading symbol of
"FFC." Shares of closed-end funds frequently trade at a discount from their net
asset value and initial offering prices. The risks associated with this
characteristic of closed-end investment companies may be greater for investors
expecting to sell shares of a closed-end investment company soon after the
completion of an initial public offering of the company's shares.
AN INVESTMENT IN THE FUND'S COMMON STOCK INVOLVES CERTAIN RISKS AND SPECIAL
CONSIDERATIONS. SEE "RISK FACTORS AND SPECIAL CONSIDERATIONS." THERE CAN BE NO
ASSURANCE THAT THE FUND WILL ACHIEVE ITS INVESTMENT OBJECTIVE.
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PER SHARE TOTAL
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Public offering price....................................... $25.00 $
Sales load(1)............................................... $1.125 $
Estimated offering expenses(2).............................. $.05 $
Proceeds to the Fund........................................ $23.825 $
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(1) For a description of other compensation paid to Merrill Lynch, see
"Underwriting."
(2) In addition to the sales load, the Fund will pay offering expenses,
which are estimated to total $775,887 and which will reduce the
"Proceeds to the Fund" (above). The Fund's investment adviser has
agreed to pay all organizational expenses of the Fund. The investment
adviser has also agreed to pay those offering costs of the Fund (other
than the sales load) that exceed $0.05 per share of Common Stock.
The underwriters may also purchase up to an additional shares of
Common Stock at the public offering price, less the sales load, within 45 days
of the date of this prospectus to cover over-allotments.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
The shares of Common Stock will be ready for delivery on or about January
, 2003.
----------------------------
MERRILL LYNCH & CO. RAYMOND JAMES
A.G. EDWARDS & SONS, INC. LEGG MASON WOOD WALKER RBC CAPITAL MARKETS
INCORPORATED
WACHOVIA SECURITIES WELLS FARGO SECURITIES, LLC ADVEST, INC.
BB&T CAPITAL MARKETS ROBERT W. BAIRD & CO. CLAYMORE SECURITIES, INC.
FAHNESTOCK & CO. INC. FERRIS, BAKER WATTS J.J.B. HILLIARD, W.L. LYONS, INC.
INCORPORATED
HUNTLEIGH SECURITIES CORPORATION JANNEY MONTGOMERY SCOTT LLC MCDONALD INVESTMENTS INC.
MORGAN KEEGAN & COMPANY, INC. RYAN BECK & CO. WEDBUSH MORGAN SECURITIES INC.
----------------------------
The date of this prospectus is , 2003.
INVESTMENT ADVISER. Flaherty & Crumrine Incorporated acts as investment
adviser to the Fund. The Fund's address is 301 E. Colorado Boulevard,
Suite 720, Pasadena, California 91101, and the Fund's telephone number is (626)
795-7300.
LEVERAGE. Within three months after the completion of the offering of Common
Stock described in this prospectus, the Fund intends, subject to then favorable
market conditions, to offer shares of auction rate preferred stock representing
up to approximately 36% of the Fund's capital immediately following the issuance
of such shares. The issuance of these shares, which would be senior to the
Common Stock, will result in the financial leveraging of the Common Stock.
Whether to offer shares of auction rate preferred stock and, if offered, the
terms of such shares and the timing and other terms of their offering will be
determined by the Fund's Board of Directors. The Fund anticipates that shares of
auction rate preferred stock will pay dividends based on short-term rates, and
that the net return on the Fund's portfolio, including the proceeds of the
preferred stock offering, will exceed the dividend rate on such shares. Through
leveraging, the Fund will seek to obtain a higher return for holders of Common
Stock than if the Fund did not use leverage. Leverage is a speculative technique
and investors should note that there are special risks and costs associated with
the leveraging of the Common Stock. There can be no assurance that a leveraging
strategy will be successful during any period in which it is employed. See
"Special Leverage Considerations" and "Description of Capital Stock."
You should read this prospectus, which contains important information about
the Fund, before deciding whether to invest in the Common Stock, and retain it
for future reference. You may request a free copy of any additional information
that the Fund has filed with the Securities and Exchange Commission, by calling
800-345-7999 or by writing to the Fund, or obtain the information from the
Securities and Exchange Commission's web site (http://www.sec.gov).
The Fund's Common Stock does not represent a deposit or obligation of, and
is not guaranteed or endorsed by, any bank or other insured depository
institution, and is not federally insured by the Federal Deposit Insurance
Corporation, the Federal Reserve Board or any other government agency.
TABLE OF CONTENTS
PAGE
----
Prospectus Summary................................ 4
Summary of Fund Expenses.......................... 15
The Fund.......................................... 16
Use of Proceeds................................... 16
Investment Objective and Policies................. 16
Risk Factors and Special Considerations........... 37
Special Leverage Considerations................... 41
Investment Restrictions........................... 44
Management of the Fund............................ 46
Portfolio Transactions............................ 53
Dividends and Distributions....................... 54
Net Asset Value................................... 55
Description of Capital Stock...................... 55
Taxation.......................................... 59
Repurchase of Common Stock and Tender Offers;
Conversion to Open-End Fund..................... 64
Certain Provisions of the Articles of
Incorporation................................... 65
Custodian, Transfer Agent, Dividend-Paying Agent
and Registrar................................... 67
Underwriting...................................... 68
Performance Related and Comparative Information... 70
Legal Matters..................................... 71
Reports to Shareholders........................... 71
Experts........................................... 71
Report of Independent Accountants................. 72
F&C/Claymore Preferred Securities Income Fund
Incorporated Statement of Assets and
Liabilities..................................... 73
APPENDIX A........................................ A-1
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED OR INCORPORATED BY
REFERENCE IN THIS PROSPECTUS. THE FUND HAS NOT, AND THE UNDERWRITERS HAVE NOT,
AUTHORIZED ANY OTHER PERSON TO PROVIDE YOU WITH DIFFERENT INFORMATION. IF ANYONE
PROVIDES YOU WITH DIFFERENT INFORMATION OR INCONSISTENT INFORMATION, YOU SHOULD
NOT RELY ON IT. THE FUND IS NOT, AND THE UNDERWRITERS ARE NOT, MAKING AN OFFER
TO SELL THESE SECURITIES IN ANY JURISDICTION WHERE THE OFFER OR SALE IS NOT
PERMITTED. YOU SHOULD ASSUME THAT THE INFORMATION IN THIS PROSPECTUS IS ACCURATE
ONLY AS OF THE DATE OF THIS PROSPECTUS. THE FUND'S BUSINESS, FINANCIAL CONDITION
AND PROSPECTS MAY HAVE CHANGED SINCE THAT DATE.
Until , 2003 (25 days after the date of this prospectus), all
dealers that buy, sell or trade the Common Stock, whether or not participating
in this offering, may be required to deliver a prospectus. This is in addition
to the dealers' obligation to deliver a prospectus when acting as underwriters
and with respect to their unsold allotments or subscriptions.
3
PROSPECTUS SUMMARY
THIS SUMMARY HIGHLIGHTS SELECTED INFORMATION FROM THIS PROSPECTUS. IT MAY
NOT CONTAIN ALL OF THE INFORMATION THAT IS IMPORTANT TO YOU. YOU SHOULD READ
THIS ENTIRE PROSPECTUS CAREFULLY, INCLUDING THE RISK FACTORS, TO UNDERSTAND THE
OFFERING OF THE SHARES OF COMMON STOCK FULLY. THE FOLLOWING INFORMATION IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO THE MORE DETAILED INFORMATION INCLUDED
ELSEWHERE IN THIS PROSPECTUS AND APPENDIX A HERETO.
THE FUND............ F&C/Claymore Preferred Securities Income Fund Incorporated
is a newly organized, diversified, closed-end management
investment company. See "The Fund."
THE OFFERING........ The Fund is offering shares of Common Stock through a
group of underwriters led by Merrill Lynch, Pierce,
Fenner & Smith Incorporated ("Merrill Lynch"). You must
purchase at least 100 shares of Common Stock. The
underwriters have been granted an option to purchase up to
additional shares of Common Stock to cover
over-allotments. The initial public offering price is
$25.00 per share. The Fund's investment adviser has agreed
to pay all organizational expenses of the Fund. The
investment adviser has also agreed to pay those offering
costs (other than the sales load) that exceed $0.05 per
share of Common Stock. See "Underwriting."
LISTING AND The Fund's Common Stock has been approved for listing on
SYMBOL............ the New York Stock Exchange upon notice of issuance under
the symbol "FFC."
INVESTMENT OBJECTIVE
AND POLICIES...... OBJECTIVE. The Fund's investment objective is high current
income for holders of its Common Stock consistent with
preservation of capital. The Fund's investment adviser
intends to pursue strategies that it expects generally to
result in the Fund's income increasing in response to
significant increases in interest rates while being
relatively resistant to the impact of significant declines
in interest rates. This strategy involves hedging
strategies and is described more fully below.
In seeking its objective, the Fund normally will invest at
least 80% of its total assets in a diversified portfolio
of preferred securities, some or all of which are expected
to be hedged. Under current market conditions, the Fund
expects that its portfolio of preferred securities will
consist principally of "hybrid" or taxable preferreds. The
Fund may also invest up to 20% of its total assets in debt
securities and up to 15% of its total assets in common
stocks. The portions of the Fund's assets invested in
various types of preferred, debt or equity may vary from
time to time depending on market conditions. The portion
of securities that the Fund will hedge, as well as the
types of hedge positions utilized, may also vary
significantly from time to time.
CREDIT QUALITY. At least 80% of the preferred securities
that the Fund will acquire will be rated investment grade
(at least "Baa3" by Moody's Investors Services, Inc.
("Moody's") or "BBB-" by
4
Standard & Poor's Corporation ("S&P") at the time of
investment or will be preferred securities of issuers of
investment grade senior debt, which securities are rated,
at the time of investment, at least either "Ba3" by
Moody's or "BB-" by S&P. In addition, the Fund may invest
in unrated issues that the Fund's investment adviser deems
to be comparable in quality to rated issues in which the
Fund is authorized to invest.
The Fund will limit to 20% of its total assets its
holdings of securities rated below investment grade (which
securities must be rated at least either "Ba3" by Moody's
or "BB-" by S&P) at the time of purchase or judged to be
comparable in quality at the time of purchase; however,
any such securities must be issued by an issuer having a
class of senior debt rated investment grade outstanding.
PROTECTIVE HEDGING STRATEGIES. The Fund currently
anticipates hedging some or all of the general interest
rate exposure inherent in its holdings of preferred and
debt securities. The response of the Fund's income to
changes in interest rates will be impacted by the
effectiveness of its hedging strategies. Under current
market conditions, this hedging would be accomplished
principally by one or more of the following strategies:
(1) purchasing put options (called a "long position in a
put option") on Treasury Bond and/ or Treasury Note
futures contracts, (2) entering into futures contracts to
sell Treasury Bonds and/or Treasury Notes (called a "short
position in a futures contract"), (3) entering into
interest rate swap agreements as a "fixed rate payer",
and/or (4) purchasing options to enter into interest rate
swap agreements as a "fixed rate payer" (called a "pay
fixed swaption").
The hedging positions that the Fund currently expects to
hold normally appreciate in value when interest rates rise
significantly, reflecting either the expected rise in
yields of Treasury securities or interest rate swap
yields, as applicable, and the associated decline in the
prices of underlying Treasury securities or decreased net
market value of an obligation to pay a fixed income stream
in a higher interest rate environment.
The response of the Fund's income to changes in interest
rates will be impacted by the effectiveness of its hedging
strategies. There are economic costs of hedging reflected
in the pricing of futures, interest rate swaps, options
and swaptions contracts which can be significant,
particularly when long-term interest rates are
substantially above short-term interest rates, as is the
case at present. For a more detailed discussion of futures
transactions, interest rate swaps, and related options,
and the risks associated with investing in those
instruments, See "Investment Objective and
Policies--Investment Techniques--Futures Contracts and
Options on Futures Contracts" and "Interest Rate Swaps and
Options Thereon" ("Swaptions").
PREFERRED SECURITIES. Preferred securities include
"hybrid" or taxable preferred securities and traditional
preferred/preference
5
stock whose dividends qualify for the inter-corporate
dividends received deduction ("DRD") that meet certain
criteria (as described below). Under current market
conditions, the Fund expects that its portfolio of
preferred securities will consist principally of "hybrid"
or taxable preferreds. For this reason, most of the Fund's
distributions will generally not qualify for the DRD. The
preferred securities in which the Fund invests consist
principally of fixed rate and adjustable rate, some or all
of which are expected to be hedged. See "Investment
Objective and Policies--Portfolio Investments--Adjustable
Rate Securities." Preferred securities include securities
that are commonly known as MIPs, QUIPS, TOPrS, TrUPS,
QUIBS, QUIDS, CorTS, PINES, Trust Preferred Securities or
capital securities. See "Investment Objective and
Policies--Portfolio Investments."
INDUSTRY DIVERSIFICATION. Under normal market conditions,
- The Fund intends to invest 25% or more of its total
assets in securities of companies in the utilities
industry.
- The Fund intends to invest 25% or more of its total
assets in securities of companies in the banking
industry.
The Fund's holdings of securities of companies in any
industry other than the utilities industry or the banking
industry will at all times be less than 25% of the Fund's
total assets. Consistent with the limitations described
above, the proportion of the Fund's assets invested in the
utilities, banking and other industries may vary from time
to time, depending on market conditions.
CONVERTIBLE SECURITIES AND COMMON STOCK. Certain
traditional and hybrid preferred securities are
convertible into the common stock of the associated
issuer. To the extent that such preferred securities,
because of their terms and market conditions, trade in
close relationship to the underlying common stock of the
issuer, they will be subject to the limit of 15% of total
assets, under normal market conditions, that also applies
to common stocks. Otherwise, such convertible preferred
securities will be treated by the Fund in the same manner
as non-convertible preferred securities.
See "Investment Objective and Policies" and Appendix A to
this prospectus.
INVESTMENT ADVISER
AND SERVICING
AGENT............. Flaherty & Crumrine Incorporated (the "Adviser"), a
registered investment adviser, acts as the Fund's
investment adviser. The Adviser has been active in the
management of portfolios of preferred securities,
including related hedging activities, since 1983. The
Adviser had aggregate assets under management, as of
November 30, 2002 (excluding the net assets of the Fund),
equal to approximately $890 million.
Claymore Securities, Inc. (the "Servicing Agent"), a
registered broker-dealer, acts as shareholder servicing
agent to the Fund and
6
provides oversight of the Fund's administrator. Claymore
specializes in the creation, development and distribution
of investment solutions for advisors and their valued
clients.
The Fund pays the Adviser a monthly fee for its advisory
services equal to an annual rate of 0.525% on the first
$200 million of the Fund's average weekly total managed
assets, which is reduced to 0.45% on the next $300 million
of the Fund's average weekly total managed assets and
0.40% on the Fund's average weekly total managed assets
above $500 million.
The Fund pays the Servicing Agent a monthly fee for its
servicing functions equal to an annual rate of 0.025% on
the first $200 million of the Fund's average weekly total
managed assets, 0.10% on the next $300 million of the
Fund's average weekly total managed assets and 0.15% on
the Fund's average weekly total managed assets above $500
million. Total managed assets means the total assets of
the Fund (including any assets attributable to any Fund
Preferred Shares (as defined below) that may be outstand-
ing or otherwise attributable to the use of leverage)
minus the sum of accrued liabilities (other than debt
representing financial leverage). For purposes of
determining total managed assets, the liquidation
preference of the Fund Preferred Shares is not treated as
a liability. See "Management of the Fund--Investment
Adviser."
ADMINISTRATOR....... PFPC, Inc., a member of the PNC Financial Services
Group, Inc., serves as the Fund's administrator (the
"Administrator"). The Administrator calculates the net
asset value of the Fund's shares of Common Stock and
generally assists in all aspects of the Fund's
administration and operation. As compensation for the
Administrator's services, the Fund pays the Administrator
a monthly fee at an annual rate of 0.10% of the Fund's
average weekly total managed assets, declining thereafter
at higher asset levels. The Administrator also serves as
the Fund's Common Stock servicing agent (transfer agent),
dividend-paying agent and registrar and, as compensation
for the Administrator's services as such, the Fund pays
the Administrator a monthly fee at an annual rate of 0.02%
on the Fund's average weekly net assets attributable to
the Common Stock, declining thereafter at higher asset
levels, plus certain out-of-pocket expenses.
PROPOSED OFFERING OF
SHARES OF AUCTION
RATE PREFERRED
STOCK............. Subject to market conditions and the Fund's receipt of
"Aaa" and "AAA" credit ratings on the Fund Preferred
Shares (as defined below), within three months after the
completion of this offering, the Fund intends, subject to
then favorable market conditions, to offer shares of
auction rate preferred stock in one or more series ("Fund
Preferred Shares") representing up to approximately 36% of
the Fund's capital after their issuance. The issuance of
Fund Preferred Shares will leverage common shareholders'
investment in the shares of Common Stock.
7
The fees and expenses incident to the offering and
issuance of Fund Preferred Shares will be recorded as a
reduction of capital of the Fund attributable to the
Common Stock. See "The Fund" and "Special Leverage
Considerations."
LEVERAGE The Fund anticipates that, while the Fund will pay
CONSIDERATIONS.... dividends on its Fund Preferred Shares based on
shorter-term rates, the net return on the Fund's
portfolio, including the proceeds of the Fund Preferred
Shares offering, will exceed the dividend rate on the Fund
Preferred Shares, although no assurance can be given that
the issuance of Fund Preferred Shares will result in a
higher net return to Common Stock shareholders. So long as
the Fund is able to invest the proceeds of the Fund
Preferred Share offering in securities that provide a
higher net return than a rate of return based on the then
current dividends paid on the Fund Preferred Shares
outstanding after taking into account the expenses of the
Fund Preferred Shares offering and the Fund's operating
expenses, the effect of leverage will be to cause the
Common Stock shareholders to realize a higher current rate
of return than if the Fund were not leveraged. If the
current dividend rate on the Fund Preferred Shares
outstanding were to approach the net return on the Fund's
investment portfolio after expenses, however, the benefit
of leverage to the Common Stock shareholders would be
reduced. Moreover, if the current dividend rate on the
Fund Preferred Shares outstanding were to exceed the net
return on the Fund's portfolio, the Fund's leveraged
capital structure would result in a lower rate of return
to the Common Stock shareholders. See "Description of
Capital Stock--Preferred Stock."
RATING AGENCY
GUIDELINES AND
ASSET COVERAGE
REQUIREMENTS...... In connection with the anticipated issuance of Fund
Preferred Shares, the Fund's investments will be subject
to certain investment guidelines and certain minimum asset
and dividend coverage and liquidity requirements
established by the rating agencies rating the Fund
Preferred Shares. Provided that the Fund complies with
these guidelines, it is expected that the Fund Preferred
Shares will be rated "Aaa" and "AAA", as applicable, by at
least two rating agencies. In addition, in order to pay
dividends on the Common Stock, the Fund will be required
by the 1940 Act, to meet minimum asset coverage
requirements. See "Investment Objective and
Policies--Rating Agency Guidelines and Asset Coverage
Requirements."
DIVIDENDS AND
DISTRIBUTIONS..... Prior to the issuance of Fund Preferred Shares, the Fund
expects to distribute through the year, primarily in the
form of regular monthly dividends, substantially all (on
an annual basis) of its net investment income (that is,
income other than net realized long-term and short-term
capital gains) and its net realized short-term capital
gains, if any. Dividends to Common Stock shareholders are
expected to be declared approximately 45 days, and paid
approximately 60 to 90 days, after the completion of the
offering of shares of Common Stock. If the Fund Preferred
Shares are issued,
8
the Internal Revenue Service requires the Fund to allocate
particular types of income received by it for any taxable
year between shares of Common Stock and the Fund Preferred
Shares outstanding in proportion to the total amount of
distributions paid to each such class of shares for such
taxable year. Realized long term capital gains, if any,
are expected to be distributed annually. Investors should
note that the Fund is not expected to generate significant
income that qualifies for the intercorporate dividends
received deduction or that would be able to be excluded
from an individual's taxable income under certain tax
proposals currently under preliminary discussion by
federal governmental officials. See "Taxation."
DIVIDEND
REINVESTMENT AND
CASH PURCHASE
PLAN.............. Under the Fund's Dividend Reinvestment and Cash Purchase
Plan, a Common Stock shareholder whose shares are
registered in his or her own name will have all dividends
or distributions with respect to his or her shares of
Common Stock reinvested automatically in additional shares
of the Fund's Common Stock, unless the shareholder elects
to receive distributions in cash.
In addition, a Common Stock shareholder whose shares are
held in the name of a broker/dealer or nominee will have
all distributions reinvested automatically by the
broker/dealer or nominee in additional shares of Common
Stock under the plan unless the shareholder elects to
receive distributions in cash. A Common Stock shareholder
whose shares are held in the name of a broker/ dealer or
nominee should contact his or her respective broker/
dealer or nominee for details. See "Description of Capital
Stock--Dividend Reinvestment and Cash Purchase Plan" and
"Taxation."
RISK FACTORS AND
SPECIAL
CONSIDERATIONS.... Risk is inherent in all investing. Investing in any
investment company security involves risk, including the
risk that you may receive little or no return on your
investment or even that you may lose part or all of your
investment. Therefore, before investing you should
consider carefully the following risks that you assume
when you invest in shares of the Fund's Common Stock:
INTEREST RATE RISK. Changes in the level of interest rates
are expected to affect the value of the Fund's portfolio
holdings of fixed rate securities and, under certain
circumstances, its holdings of adjustable rate securities.
Subject to certain limitations described herein, the Fund
currently anticipates hedging, from time to time, some or
all of its holdings of fixed rate and adjustable rate
securities, for the purposes of (1) protecting against
declines in value attributable to significant increases in
interest rates in general and (2) providing increased
income in the event of significant increases in interest
rates while maintaining the Fund's relative resistance to
a reduction in income in the event of significant declines
in interest rates. There can be no guarantee that such
hedging strategies will be successful. Significant changes
in the interest rate environment, as well as other
factors, may
9
cause the Fund's holdings of preferred and debt securities
to be redeemed by the issuers, thereby reducing the Fund's
holdings of higher income-paying securities at a time when
the Fund may be unable to acquire other securities paying
comparable income rates with the redemption proceeds. In
addition to fluctuations due to changes in interest rates,
the value of the Fund's holdings of preferred and debt
securities, and as a result the Fund's net asset value,
may also be affected by other market and credit factors,
as well as by actual or anticipated changes in tax laws.
See "Investment Objective and Policies--Risk Factors and
Special Considerations."
HEDGING STRATEGY RISK. Certain of the investment
techniques that the Fund may employ for hedging or, under
certain circumstances, to increase income will expose the
Fund to risks. In addition to the hedging techniques
described elsewhere, i.e., positions in Treasury Bond or
Treasury Note futures contracts, use of options on these
positions, positions in interest rate swaps, and options
thereon ("swaptions"), these investment techniques may
include entering into interest rate and stock index
futures contracts and options on interest rate and stock
index futures contracts, purchasing and selling put and
call options on securities and stock indices, purchasing
and selling securities on a when-issued or delayed
delivery basis, entering into repurchase agreements, lend-
ing portfolio securities and making short sales of
securities "against the box." The Fund intends to comply
with regulations of the Securities and Exchange Commission
involving "covering" or segregating assets in connection
with the Fund's use of options and futures contracts. See
"Investment Objective and Policies--Investment
Techniques."
CREDIT RISK. Credit risk is the risk that an issuer of a
preferred or debt security will become unable to meet its
obligation to make dividend, interest and principal
payments. In general, lower rated preferred or debt
securities carry a greater degree of credit risk. If
rating agencies lower their ratings of preferred or debt
securities in the Fund's portfolio, the value of those
obligations could decline, which could jeopardize the
rating agencies' ratings of Fund Preferred Shares. In
addition, the underlying revenue source for a preferred or
debt security may be insufficient to pay principal or
interest in a timely manner. Because the primary source of
income for the Fund is the dividend, interest and
principal payments on the preferred or debt securities in
which it invests, any default by an issuer of a preferred
or debt security could have a negative impact on the
Fund's ability to pay dividends on Common Stock. Even if
the issuer does not actually default, adverse changes in
the issuer's financial condition may negatively affect its
credit rating or presumed creditworthiness. These
developments would adversely affect the market value of
the issuer's obligations.
LEVERAGE RISK. The Fund's use of leverage through the
issuance of Preferred Shares creates an opportunity for
increased Common Stock net income, but also creates
special risks for Common
10
Stockholders. There is no assurance that the Fund's
leveraging strategy will be successful. Risks affecting
the Fund's net asset value will be magnified if and when
the Fund issues Fund Preferred Shares. If the Fund's
current net investment income and capital gains are not
sufficient to meet dividend requirements on outstanding
Fund Preferred Shares, the Fund may need to liquidate
certain of its investments, thereby possibly reducing the
net asset value attributable to the Common Stock. In
addition, failure to meet required asset coverage
requirements for Fund Preferred Shares to satisfy certain
guidelines established by the rating agencies may result
in mandatory partial or full redemptions of Fund Preferred
Shares, which would reduce or eliminate the Fund's lev-
erage and could also adversely affect distributions to
holders of the Common Stock. Such redemptions may also
cause the Fund to incur additional transaction costs,
including costs associated with the sale of portfolio
securities. Leverage creates two major types of risks for
Common Stockholders:
- The likelihood of greater volatility of net asset value
and market price of Common Stock because changes in the
value of the Fund's portfolio are borne entirely by the
Common Stockholders; and
- The possibility either that Common Stock income will
fall if the dividend rate on the Fund Preferred Shares
or the interest rate on any borrowings rises, or that
Common Stock income will fluctuate because the dividend
rate on the Fund Preferred Shares or the interest rate
on any borrowings varies.
When the Fund is utilizing leverage, the fees paid to the
Adviser and its affiliates for investment advisory
services will be higher than if the Fund did not utilize
leverage because the fees paid will be calculated based on
the Fund's managed assets (which include the liquidation
preference on any Fund Preferred Shares and the principal
amount of any borrowings used for leverage). As a result,
the Adviser has a financial incentive for the Fund to
issue Fund Preferred Shares or to otherwise incur
leverage, which may create a conflict of interest. See
"Special Leverage Considerations" and "Description of
Capital Stock."
INDUSTRY CONCENTRATION RISK. The Fund concentrates its
investments in the utilities and banking industries. As a
result, the Fund's investments may be subject to greater
risk and market fluctuation than a fund that had
securities representing a broader range of investment
alternatives. See "Investment Objective and Policies--
Concentration."
PREFERRED SECURITIES RISK. Investment in preferred
securities carries certain risks including;
- Deferral Risk--Typically preferred securities contain
provisions that allow an issuer, at its discretion, to
defer distributions for up to 20 consecutive quarters.
If the Fund owns a preferred security that is deferring
its distributions, the Fund
11
may be required to report income for tax purposes while
it is not receiving any income.
- Redemption Risk--Preferred securities typically contain
provisions that allow for redemption in the event of
tax or security law changes in addition to call
features at the option of the issuer. In the event of a
redemption, the Fund may not be able to reinvest the
proceeds at comparable rates of return.
- Limited Voting Rights--Preferred securities typically
do not provide any voting rights.
- Subordination--Preferred securities are subordinated to
bonds and other debt instruments in a company's capital
structure in terms of priority to corporate income and
liquidation payments, and therefore will be subject to
greater credit risk than those debt instruments.
- Liquidity--Preferred securities may be substantially
less liquid than many other securities, such as common
stocks or U.S. government securities.
NO OPERATING HISTORY. The Fund is a newly organized,
closed-end investment company with no previous operating
history.
MARKET DISCOUNT RISK. As with any stock, the price of the
Fund's shares will fluctuate with market conditions and
other factors. Shares of closed-end investment companies
frequently trade at discounts from net asset value,
especially shortly after the completion of the initial
public offering. This characteristic of shares of a
closed-end fund is a risk separate and distinct from the
risk that the fund's net asset value may decrease. The
Fund cannot predict whether the Common Stock will trade
at, above or below net asset value. The risk of purchasing
shares of closed-end funds that may trade at a discount is
more pronounced for investors who wish to sell their
shares in a relatively short period of time after the
initial public offering. The Common Stock is designed for
long-term investors and should not be treated as a trading
vehicle. For those investors, realization of gain or loss
on their investment is likely to be more dependent upon
the existence of a premium or discount than upon portfolio
performance. Net asset value will be reduced immediately
following the initial offering by a sales load and
organizational and selling expenses paid by the Fund and
immediately following any offering of Fund Preferred
Shares by the costs of that offering paid by the Fund. See
"Investment Objective and Policies--Risk Factors and
Special Considerations."
MANAGEMENT RISK. The Fund is subject to management risk
because it is an actively managed portfolio. The adviser
will apply investment techniques and risk analyses in
making investment decisions for the Fund, but there can be
no guarantee that these will produce the desired results.
LOWER-RATED SECURITIES RISK. The Fund may invest up to 20%
of its total assets in its holdings of securities rated
below investment grade at the time of purchase or judged
to be comparable in
12
quality at the time of purchase. Lower rated preferred
stock or debt securities, or equivalent unrated
securities, which are commonly known as "junk bonds,"
generally involve greater volatility or price and risk of
loss of income and principal, and may be more susceptible
to real or perceived adverse economic and competitive
industry conditions than higher grade securities. It is
reasonable to expect that any adverse economic conditions
could disrupt the market for lower-rated securities, have
an adverse impact on the value of those securities, and
adversely affect the ability of the issuers of those
securities to repay principal, dividends and interest on
those securities.
CONVERSION RISK. Under the Fund's Bylaws, if at any time
after the third year following the offering made hereby,
shares of the Common Stock publicly trade for a
substantial period of time at a significant discount from
the Fund's then current net asset value per share, the
Board of Directors of the Fund is obligated to consider
taking various actions designed to reduce or eliminate the
discount, including recommending to shareholders amend-
ments to the Fund's Articles of Incorporation (together
with any amendments or supplements thereto, including any
articles supplementary, the "Articles" or "Articles of
Incorporation") to convert the Fund to an open-end
investment company, which would result in the redemption
of Fund Preferred Shares then outstanding and the
potential subsequent sale of Fund assets during
unfavorable market conditions. In addition, the Board may
consider taking actions designed to eliminate the discount
whenever it deems it to be appropriate. See "Repurchase of
Common Stock and Tender Offers; Conversion to Open-End
Fund."
ANTI-TAKEOVER PROVISIONS. The Fund's Articles of
Incorporation and Bylaws include provisions that could
have the effect of inhibiting the Fund's possible
conversion to open-end status and limiting the ability of
other entities or persons to acquire control of the Fund's
Board of Directors. In certain circumstances, these
provisions might also inhibit the ability of shareholders
to sell their shares at a premium over prevailing market
prices. See "Certain Provisions of the Articles of
Incorporation."
MARKET DISRUPTION. As a result of the terrorist attacks on
the World Trade Center and the Pentagon on September 11,
2001, some of the U.S. securities markets were closed for
a four-day period. These terrorist attacks and related
events have led to increased short-term market volatility
and may have long-term effects on U.S. and world economies
and markets. A similar disruption of the financial markets
could impact interest rates, auctions, secondary trading,
ratings, credit risk, inflation and other factors relating
to the Common Stock.
INFLATION RISK. Inflation risk is the risk that the value
of assets or income from the Fund's investments will be
worth less in the future as inflation decreases the value
of payments at future dates.
13
STOCK PURCHASES AND
TENDERS........... The Fund's Board of Directors currently contemplates that
the Fund, at least once each year, may consider
repurchasing shares of Common Stock in the open market or
in private transactions, or tendering for shares, in an
attempt to reduce or eliminate a market value discount
from net asset value, if one should occur. Upon the
issuance of Fund Preferred Shares, the Fund's ability to
repurchase shares of, or tender for, its Common Stock may
be limited by the asset coverage requirements of the 1940
Act and by asset coverage and other requirements imposed
by Moody's as a condition to rating the Fund Preferred
Shares. No assurance can be given that the Board of
Directors will decide to undertake share repurchases or
tenders or, if undertaken, that repurchases and/or tender
offers will result in the Fund's Common Stock trading at a
price that is close to, equal to or above net asset value.
The Fund may borrow to finance repurchases and/or tender
offers. See "Repurchase of Common Stock and Tenders
Offers; Conversion to Open-End Fund."
CUSTODIAN, TRANSFER
AGENT AND
DIVIDEND-PAYING
AGENT AND
REGISTRAR......... PFPC Trust Company serves as the Fund's custodian.
PFPC, Inc. serves as the Fund's transfer agent,
dividend-paying agent and registrar for the Common Stock.
See "Custodian, Transfer Agent and Dividend-Paying Agent
and Registrar."
14
SUMMARY OF FUND EXPENSES
The following table assumes the issuance of Fund Preferred Shares in an
amount equal to 36% of the Fund's capital (after issuance), assumes that the
Fund issues approximately 16,000,000 shares of Common Stock and shows Fund
expenses as a percentage of net assets attributable to shares of Common Stock.
Footnote 3 to the table also shows Fund expenses as a percentage of net assets
attributable to shares of Common Stock, but assumes that no Fund Preferred
Shares are issued or outstanding (such as will be the case prior to the Fund's
expected issuance of Fund Preferred Shares).
SHAREHOLDER TRANSACTION EXPENSES
Sales Load (as a percentage of offering
price)........................................ 4.50%
Offering Expenses Borne by the Fund (as a
percentage of offering price)(1).............. 0.20%
Dividend Reinvestment Plan Fees................. None(2)
PERCENTAGE OF NET
ASSETS ATTRIBUTABLE
TO COMMON STOCK
(ASSUMING THE
ISSUANCE OF FUND
PREFERRED SHARES)(3)
----------------------------
ANNUAL EXPENSES
Investment Advisory Fees........................ 0.73%(4)
Other Expenses.................................. 0.60%(5)
Total Annual Fund Operating Expenses............ 1.33%(1)
---------------------------
(1) The Adviser has agreed to pay all the Fund's organizational expenses. The
Adviser has also agreed to pay those offering costs of the Fund (other than
the sales load) that exceed $0.05 per share of Common Stock (0.20% of the
offering price). The offering costs to be paid by the Fund are not included
in the expenses shown in the table. Offering costs borne by Common
Stockholders will result in a reduction of capital of the Fund attributa-
ble to the Common Stock.
(2) You will pay brokerage charges if you direct the plan agent to sell your
Common Shares held in a dividend reinvestment account.
(3) The table presented below in this footnote estimates what the Fund's annual
expenses would be stated as percentages of the Fund's net assets
attributable to Common Stock but, unlike the table above, assumes that no
Fund Preferred Shares are issued or outstanding. This will be the case, for
instance, prior to the Fund's expected issuance of Fund Preferred Shares.
In accordance with these assumptions, the Fund's expenses would be
estimated to be as follows:
PERCENTAGE OF NET ASSETS
ATTRIBUTABLE TO COMMON
STOCK (ASSUMING NO FUND
PREFERRED SHARES ARE ISSUED
OR OUTSTANDING)
---------------------------
ANNUAL EXPENSES
Investment Advisory Fees........................ 0.49%(4)
Other Expenses.................................. 0.32%
Total Annual Fund Operating Expenses............ 0.81%(1)
---------------------
(4) Does not include the amounts paid to the Servicing Agent for its
shareholder servicing activities, which are included in "Other Expenses."
(5) If the Fund offers Fund Preferred Shares, costs of that offering, estimated
to be approximately 1.22% of the total dollar amount of the Fund Preferred
Shares offering (including the sales load paid to the underwriters for the
Fund Preferred Shares offering), will be borne immediately by Common
Stockholders and result in a reduction of the net asset value of the Common
Stock. Assuming the issuance of Fund Preferred Shares in an amount equal to
36% of the Fund's capital (after their issuance) these offering costs are
estimated to be approximately $2,604,583 or $0.16 per share of Common Stock
(0.65% of the offering price). These offering costs are not included among
the expenses shown in this table.
15
EXAMPLE
The purpose of the following table is to help a holder of Common Stock
understand the fees and expenses that such holder would bear directly or
indirectly. The expenses shown in the table are based on estimated amounts for
the Fund's first year of operations, unless otherwise indicated, and assume that
the Fund issues approximately 16,000,000 shares of Common Stock. If the Fund
issues fewer shares of Common Stock, all other things being equal, these
expenses would increase. See "Management of the Fund."
As required by relevant Securities and Exchange Commission regulations, the
following example illustrates the expenses (including the sales load of $45,
estimated offering expenses of this offering of $2.00 and the estimated offering
costs of issuing Fund Preferred Shares, assuming the Fund issues Fund Preferred
Shares representing 36% of the Fund's capital (after their issuance), of $6.51)
that you would pay on a $1,000 investment in shares of Common Stock, assuming
(1) total annual expenses of 1.33% of net assets attributable to shares of
Common Stock and (2) a 5% annual return(1):
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
Total Expenses Incurred....... $66 $91 $116 $179
-------------------
(1) THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF FUTURE EXPENSES.
ACTUAL EXPENSES MAY BE HIGHER OR LOWER. The example assumes that the
estimated "Other Expenses" set forth in the Annual Expenses table are
accurate and that all dividends and distributions are reinvested at net
asset value. Actual expenses may be greater or less than those assumed.
Moreover, the Fund's actual rate of return may be greater or less than the
hypothetical 5% return shown in the example.
THE FUND
The Fund is a newly organized, closed-end, diversified management investment
company registered under the Investment Company Act of 1940, as amended, and the
rules and regulations thereunder (the "1940 Act"). The Fund, which was
incorporated under the laws of the State of Maryland on May 23, 2002, is
registered under the 1940 Act and has its principal office at 301 E. Colorado
Boulevard, Suite 720, Pasadena, California 91101. The Fund's telephone number is
(626) 795-7300.
USE OF PROCEEDS
The net proceeds of the offering of shares of Common Stock will be
approximately $ ($ if the underwriters exercise the over-allotment
option in full) after payment of the sales load and organizational and offering
costs (other than the sales load) that do not exceed $0.05 per share of Common
Stock. The net proceeds of the offering will be invested in accordance with the
Fund's investment objective and policies (as stated below) as soon as
practicable after completion of the offering. The Fund currently anticipates
being able to do so within three months after the completion of the offering.
Pending investment of the net proceeds in accordance with the Fund's investment
objectives and policies, the Fund will invest in money market securities or
money market mutual funds. Investors should expect, therefore, that before the
Fund has fully invested the proceeds of the offering in accordance with its
investment objective and policies, the Fund's yield would be somewhat lower, but
that its net asset value would be subject to less fluctuation, than would be the
case at such time as the Fund is fully invested.
INVESTMENT OBJECTIVE AND POLICIES
GENERAL
The Fund's investment objective is high current income for holders of its
Common Stock consistent with preservation of capital. The Fund's investment
objective may not be changed without the
16
approval of the holders of at least 80% of the Fund's outstanding voting
securities (as defined below under "Investment Restrictions"), voting as a
single class, and at least 80% of the Fund's outstanding Fund Preferred Shares
(as defined below under "Investment Restrictions"), voting as a separate class.
See "Description of Capital Stock--Preferred Stock--Voting Rights" for
additional information with respect to the voting rights of holders of Fund
Preferred Shares. No assurance can be given that the Fund's investment objective
will be achieved.
The Fund pursues its investment objective by investing in a diversified
portfolio primarily consisting of preferred securities. In seeking its
objective, the Fund will normally invest at least 80% of its total assets in a
diversified portfolio of preferred securities. Under current market conditions,
the Fund expects that its portfolio of preferred securities will consist
principally of "hybrid" or taxable preferreds.
In selecting individual securities for investment, the Adviser considers,
among other things, current yield, price variability and the underlying
fundamental characteristics of the issuer, with particular emphasis on debt and
dividend coverage and the potential for the timely payment of dividends and
interest. It is expected that the Fund's assets will be invested primarily in
fixed rate and adjustable rate preferred securities. The Fund has no current
intention of investing in inverse floating rate securities. The Fund may invest
in other types of preferred securities--such as auction rate preferred stocks
and convertible preferred stocks--as well as debt and common equity securities
in appropriate circumstances. The Adviser currently anticipates using various
protective hedging techniques, including (1) entering into futures contracts and
options on futures contracts and (2) entering into interest rate swap positions
and options thereon ("swaptions"), from time to time for the purpose of hedging
some or all of its preferred securities and debt holdings. There is no limit on
the portion of the Fund's assets that can be hedged, subject to compliance with
applicable laws and regulations, as well as restrictions imposed in connection
with the rating of the Fund Preferred Shares. The Fund may invest up to 5% of
its total assets in each of options on securities and options on stock indices,
up to 10% of its total assets in each of initial margin deposits on futures
contracts and premiums paid for options thereon, and up to 5% of its total
assets for time premiums paid for swaptions. However, under current market
conditions, it is expected that up to an aggregate of 15% of the Fund's total
assets could be invested in options on securities and stock indices, initial
margin deposits and option premiums paid in connection with futures
transactions, and initial margin deposits and options premiums paid in
connection with interest rate swaps and swaptions. (See "Investment
Techniques--Futures Contracts and Options on Futures Contracts" for a discussion
of the limitations and risks associated with investments in futures contracts
and options on futures contracts. See also "Investment Techniques--Interest Rate
Swaps and Options Thereon ("Swaptions")" for a discussion of the limitations and
risks associated with positions in interest rate swaps and options thereon.) The
portion of the Fund's assets not invested in preferred securities and hedging
instruments may be invested in, among other securities, money market
instruments, money market mutual funds, corporate debt securities, asset-backed
securities, and securities issued or guaranteed by the U.S. Government, its
agencies or instrumentalities ("Government Securities"), which, depending on
market conditions, may at times have a higher or lower yield than preferred
securities in which the Fund invests. Under normal conditions, the Fund's
investments in such debt securities is limited to 20% of its total assets. Under
normal conditions, the Fund may also invest up to 15% of its total assets in
common stocks or convertible securities which trade in close relationship to
their underlying associated common stocks.
PORTFOLIO STRATEGIES
The Adviser believes that the pursuit of the strategies described below will
result in a high level of current income to the Fund's Common Stock consistent
with preservation of capital. Furthermore, that income is expected by the
Adviser to increase in response to significant increases in interest rates while
being relatively resistant to the impact of significant declines in interest
rates due to (1) the composition of fixed rate and adjustable rate securities
owned, (2) the maintenance of certain hedging positions
17
against some or all of the Fund's holdings of preferred and debt securities,
from time to time, and (3) the intended leveraging of the Fund through the
issuance of Fund Preferred Shares.
Coupon rates on fixed rate preferred and debt securities held by the Fund,
as their name implies, would be fixed regardless of the direction of interest
rates. In addition, the market prices of such securities would tend to
(1) decline as interest rates rose and (2) rise as interest rates fell.
Adjustable rate securities pay income that generally rises as interest rates
rise and falls as interest rates decline, often subject to minimum income floors
and maximum income ceilings (often called "collars"). All other things being
equal, adjustable rate preferreds will tend to have somewhat less price
variability than would fixed rate securities of comparable maturity.
Nevertheless, changing interest rate conditions may still affect adjustable rate
preferred stocks' principal value, which may expose the Fund to risk of loss.
See "Investment Objective and Policies--Risk Factors and Special
Considerations--Fluctuation in Share Price."
The Fund normally anticipates hedging some or all of the interest rate
exposure inherent in its holdings of these different types of preferred and debt
securities. Under current market conditions, this hedging would be accomplished
principally by one or more of the following strategies: (1) purchasing put
options (called a "long position in a put option") on Treasury Bond and/or
Treasury Note futures contracts, (2) entering into futures contracts to sell
Treasury Bonds and/or Treasury Notes (called a "short position in a futures
contract"), (3) entering into interest rate swap agreements as a "fixed rate
payer", and/or (4) purchasing options to enter into interest rate swap
agreements as a "fixed rate payer" (called a "pay fixed swaption").
The hedging positions that the Fund currently expects to hold normally
appreciate in value when interest rates rise significantly, reflecting either
the expected rise in yields of Treasury securities or interest rate swap yields,
as applicable, and the associated decline in the prices of underlying Treasury
securities or decreased net market value of an obligation to pay a fixed income
stream in a higher interest rate environment.
Conversely, such hedging positions would normally depreciate in value when
interest rates fall significantly. A short position in a Treasury Bond or
Treasury Note futures contract should reflect directly changes in the price of
that futures contract, i.e., benefiting from price declines and being adversely
affected by price increases. Further, the value of a long position in a put
option on a Treasury Bond or Treasury Note futures contract should rise and fall
in inverse relationship to the market price of that futures contract, but the
magnitude of the change in value would to a large extent depend upon whether and
the extent to which the exercise price of the put option was below
("out-of-the-money") or above ("in-the-money") the price of the futures
contract.
Similarly, a "pay-fixed" position in an interest rate swap should directly
reflect changes in the level of interest rate swap yields. Also, the value of an
option to pay fixed rate in an interest rate swap, i.e., a pay-fixed swaption,
will rise or fall in direct relationship to a pay-fixed interest rate swap's
value, but the magnitude of the value change would, to a large extent, depend on
whether and the extent to which the exercise yield of the pay-fixed swaption was
above ("out-of the-money") or below ("in-the-money") the existing level of
interest rate swap yields. A more specific explanation of options and swaptions
follows.
Should the Fund purchase an out-of-the-money put option on a Treasury Bond
or Treasury Note futures contract as part of its hedging strategies, that put
option would be expected to have value at its expiration date only if the price
of the underlying futures contract declined below the exercise price of the put
option. Accordingly, interest rates could generally increase moderately, and a
decline in value of the Fund's preferred and debt holdings could result without
the Fund receiving any offsetting benefit from its holdings of such put options.
The Fund would achieve a gain on a long position in an out-of-
18
the-money put option on a Treasury Bond or Treasury Note futures contract at the
time of its expiration only if interest rates were to increase significantly so
as to result in a decline in the price of the underlying futures contract
sufficient to cause the value of such put option at expiration to exceed the
premiums paid by the Fund to acquire it (plus transaction costs).
Should the Fund acquire an in-the-money put option on a Treasury Bond or
Treasury Note futures contract as part of its hedging strategies and should
interest rates generally increase subsequently, the value of that put option at
the time of its expiration would normally reflect favorably any decline in the
market price of the underlying futures contract. However, the premium paid to
acquire such in-the-money put option would have reflected the exercise value
already present in the option at the time of purchase, and therefore, the
premium would normally be higher than that paid for an out-of-the-money put
option. Furthermore, the value of an in-the-money put option would be adversely
impacted directly by an increase in the price of the underlying Treasury Bond or
Treasury Note futures contract which could result from a decline in interest
rates. The Fund currently intends to hedge using put options on Treasury Bonds
or Treasury Note futures contracts that are, at the time of purchase,
out-of-the-money.
An interest rate swap is an agreement between two parties where one party
agrees to pay a contractually stated fixed income stream, usually denoted as a
fixed percentage of an underlying "notional" amount, in exchange for receiving a
variable income stream, usually based on LIBOR, and denoted as a percentage of
the underlying notional amount. From the perspective of a fixed rate PAYER, if
interest rates rise, the payer will expect a rising level of income since the
payer is a receiver of floating rate income. This would cause the value of the
swap contract to rise in value, from the payer's perspective, because the
discounted present value of its obligatory payment stream is diminished at
higher interest rates, all at the same time it is receiving higher income.
Alternatively, if interest rates fall, the reverse occurs and the payer
simultaneously faces the prospects of both a diminished floating rate income
stream and a higher discounted present value of his fixed rate payment
obligation. For purposes of completing the analysis, these value changes all
work in reverse from the perspective of a fixed rate RECEIVER.
The use of pay fixed swaptions is, in many key respects, analogous to the
treatment of put options on futures contracts of Treasury securities. If the
Fund should buy an option to pay fixed in an interest rate swap at an exercise
yield above current market levels, such pay fixed swaption is deemed out-of-
the-money. Conversely, if the Fund should buy a pay fixed swaption with an
exercise yield below the current market level of interest rate swap yields, such
pay fixed swaption is considered in-the-money.
Should the Fund purchase an out-of-the-money pay fixed swaption as part of
its hedging strategies, that pay fixed swaption would be expected to have value
at its expiration date only if the then prevailing level of interest rate swap
yields was in excess of the exercise yield specified in the pay fixed swaption.
Accordingly, interest rates could generally increase moderately, and a decline
in value of the Fund's preferred and debt holdings could result without the Fund
receiving any offsetting benefit from its holdings of such pay fixed swaptions.
The Fund would achieve a gain on its holding of an out-of-the-money pay fixed
swaption at the time of its expiration only if interest rates were to increase
significantly so as to result in a rise in value from the perspective of a fixed
rate payer sufficient to exceed the premiums paid by the Fund to acquire the pay
fixed swaption (plus transaction costs).
Should the Fund acquire an in-the-money pay fixed swaption as part of its
hedging strategies and should interest rates generally increase subsequently,
the value of that pay fixed swaption at the time of its expiration would
normally reflect favorably any rise in value of the underlying interest rate
swap from the perspective of a fixed rate payer. However, the premium paid to
acquire such in-the-money pay fixed swaption would have reflected the exercise
value already present in the option at the time of purchase, and therefore, the
premium would normally be higher than that paid for an at-the-money or
out-of-the-money pay fixed swaption. Furthermore, the value of an in-the-money
pay fixed swaption
19
would be adversely impacted directly by a decrease in the yield of the
underlying interest rate swap contract, which could result from a general
decline in the level of interest rates.
In any event, the maximum loss that might be incurred on a long position in
either a put option on a Treasury futures contract or a pay-fixed swaption would
be limited to the premium paid for the purchase of such option or swaption (plus
transaction costs).
The response of the Fund's income to changes in interest rates will be
impacted by the effectiveness of its hedging strategies. In order for the Fund's
income from its holdings of fixed rate securities to increase as interest rates
rise, the Fund must achieve gains on its hedging positions. These gains can be
used to acquire additional shares of preferred or debt securities, which in turn
would generate additional dividend or interest income. In the case of generally
rising interest rates, the gains potentially achievable by the Fund from hedge
instruments will be reduced by the premiums paid for the purchase of options and
swaptions and to the extent that such options and swaptions held are out-of-
the-money when purchased. In order for the Fund's income to be relatively
resistant to significant declines in interest rates, the Fund must have limited
exposure to the magnitude of losses on hedge instruments which would occasion
the sale of some of its holdings of securities in order to cover such hedging
losses and related costs. The Fund's exposure to losses on hedge instruments in
the event of generally declining interest rates will be greater to the degree it
holds (a) short positions in futures contracts, pay fixed interest rate swaps,
and long positions in-the-money put options or swaptions rather than
(b) out-of-the-money put options or swaptions.
There are economic costs of hedging reflected in the pricing of futures,
swaps, options, and swaption contracts which can be significant, particularly
when long-term interest rates are substantially above short-term interest rates,
as is the case at present. The desirability of moderating these hedging costs
will be a factor in the Adviser's choice of hedging strategies, although costs
will not be the exclusive consideration in selecting hedge instruments. Although
appreciation is not a focus of the Fund, the Fund may select individual
investments based upon their potential for appreciation without regard to the
effect on current income, in an attempt to mitigate the impact on the Fund's
assets of the expected normal cost of hedging.
The Fund's use of hedging instruments and the availability of gains for
investment in additional shares of preferred and debt securities may be limited
by the restrictions and distribution requirements imposed on the Fund under
certain regulations of the Commodity Futures Trading Commission ("CFTC") and in
connection with its qualification as a regulated investment company under the
Internal Revenue Code of 1986, as amended (the "Code"). See "Investment
Techniques" below and "Taxation." The Adviser does not believe that these
restrictions and requirements will materially adversely affect the management of
the Fund or the ability of the Fund to achieve its investment objective.
There may be an imperfect correlation between changes in the value of the
Fund's portfolio holdings and hedging positions entered into by the Fund, which
may prevent the Fund from achieving the intended hedge or expose the Fund to
risk of loss. In addition, the Fund's success in using hedge instruments is
subject to the Adviser's ability to predict correctly changes in the
relationships of such hedge instruments to the Fund's portfolio holdings, and
there can be no assurance that the Adviser's judgment in this respect will be
accurate. Consequently, the use of hedging transactions might result in a poorer
overall performance for the Fund, whether or not adjusted for risk, than if the
Fund had not hedged its portfolio holdings.
The Fund Preferred Shares which the Fund expects to issue will have dividend
rates established by auctions which will typically be held at regular seven day
or other short intervals. This auction process is designed to result in a high
degree of principal stability for holders of the Fund Preferred Shares. The
dividend rates set pursuant to such auction process are expected to be
influenced by short-term
20
interest rates generally, so that the dividend rate on the Fund Preferred Shares
outstanding is expected to increase as short-term interest rates rise and to
decline as short-term interest rates fall.
In the event of an equal rise in long-term and short-term interest rates
from current levels, the additional income anticipated to be received from the
investment of gains on appreciated hedging positions (assuming a significant
rise in interest rates) when coupled with the net impact of increasing income
from adjustable rate securities would tend to more than offset the expected
increased dividend rate payable on the Fund Preferred Shares outstanding. Thus,
net income to the Common Stock is expected to rise in response to significant
increases in interest rates as described herein.
In the event of equal declines in long-term and short-term interest rates
from current levels, losses on hedge positions would be expected to result,
possibly requiring the sale of some of the Fund's securities holdings and
decreasing the Fund's investment income, although such hedging losses would be
limited to the amount of the premiums paid (plus transaction costs) to the
extent that the Fund hedged with long positions in put options or swaptions as
described above. Furthermore, the existence of income floors on adjustable rate
securities would mitigate the downward pressure on Fund income, to the degree
the Fund has holdings of such securities. In addition, lower interest rates
would be expected to result in a lower dividend rate on the Fund Preferred
Shares outstanding, which would increase net investment income available to
Common Stock.
However, in declining interest rate environments, issuers may call for
redemption those preferred and debt securities which have coupon rates above
prevailing rates. This would reduce the Fund's income since preferred and debt
securities paying comparable yields would not be available to be purchased with
the redemption proceeds. The combined impact of the limitation of hedge losses
through the use of options hedges, lower collars on adjustable rate securities
and the decline in the cost of the Fund Preferred Shares outstanding, in the
opinion of the Adviser, should contribute to the net income to the Fund's Common
Stock being relatively resistant to equal declines in long-term and short-term
interest rates, subject to the adverse impact of redemptions of the Fund's
higher yielding preferred and debt securities in the event of substantial
declines in interest rates.
If short-term interest rates were to rise while long-term rates remained
unchanged, the cost of the Fund's outstanding Fund Preferred Shares would be
expected to rise while coupon rates on the Fund's holdings of fixed rate and
adjustable rate securities would remain unchanged (with certain exceptions in
the case of adjustable rate securities whose income would rise if short term
rates were to exceed long term rates by a sufficiently wide margin). See
"Investment Objective and Policies--Portfolio Investments--Adjustable Rate
Preferred Stock."
However, such a hypothesized change in the relationship between short-term
and long-term rates also would be expected to reduce the cost of hedging
preferred and debt securities, regardless of whether such hedges were in futures
contracts, interest rate swaps, long positions in put options, or holdings of
pay fixed swaptions. The combined impact of the foregoing factors on the Fund's
net income would depend in large measure on the relative size of the Fund's
holdings of hedged preferred and debt securities and the hedging instruments
utilized.
In the opposite case, namely, a decline in short-term rates with long-term
rates remaining unchanged, the income from fixed rate and, for the most part,
adjustable rate securities would be unaffected. Under certain circumstances, the
income from adjustable rate securities may be adversely affected. The cost of
the Fund's outstanding Fund Preferred Shares would be expected to fall. On
balance, these various movements would contribute to a higher net return to the
Fund. However, in this interest rate environment, there would be an expected
increase in the cost of hedging preferred and debt securities. The combined
impact of the foregoing factors on the Fund, as under the scenario
21
described in the preceding paragraph, would depend in large measure on the
relative size of the Fund's holdings of different types of securities and the
hedge instruments utilized.
The portions of the Fund's assets invested in various types of preferred and
debt securities may vary from time to time. The portion of the Fund's securities
that will be hedged and the types of hedge positions held may also vary
significantly from time to time. There can be no assurance that the Fund will
seek to hedge its entire portfolio of preferred and debt securities or that, if
such hedging strategies were undertaken, they would be successful (1) in
protecting against declines in value attributable to rising interest rates in
general, and/or (2) in providing increased income in the event of significant
increases in interest rates while maintaining the Fund's relative resistance to
declines in income in the event of significant declines in interest rates.
PORTFOLIO INVESTMENTS
Under normal market conditions, the Fund will invest at least 80% of its
total assets in preferred securities. Preferred securities include "hybrid" or
taxable preferred securities and traditional preferred/ preference stock whose
dividends qualify for the inter-corporate dividends received deduction ("DRD")
that meet certain criteria (as described below). Under current market
conditions, the Fund expects that its portfolio of preferred securities will
consist principally of "hybrid" or taxable preferreds. For this reason, the
Fund's distributions will generally not qualify for the DRD. The Fund will
invest in hybrid, or fully taxable, preferred securities that meet the following
criteria: (1) the issuer has the ability to defer payments for a minimum period
of 18 months without triggering an event of default and (2) the security is a
junior and fully subordinated liability of an issuer or the beneficiary of a
guarantee that represents a junior and fully subordinated liability of the
guarantor. Hybrid securities that do not meet these criteria will be considered
debt securities.
"Hybrid" or taxable preferred securities are not eligible for the DRD and
are not legally considered equity of an issuer. They are typically junior and
fully subordinated liabilities of an issuer or the beneficiary of a guarantee
that is junior and fully subordinated to the other liabilities of the guarantor.
In addition, hybrids typically permit an issuer to defer the payment of income
for 18 months or more without triggering an event of default. Generally, the
deferral period is five years. Because of their subordinated position in the
capital structure of an issuer, the ability to defer payments for extended
periods of time without adverse consequence to the issuer, and certain other
features (such as restrictions on common dividend payments by the issuer or
ultimate guarantor when cumulative payments on the hybrids have not been made),
these issues are often treated as close substitutes to traditional preferred
securities, both by issuers and investors. Hybrid securities are also treated in
a similar fashion to traditional preferred/preference stocks by several
regulatory agencies, including the Federal Reserve Bank, and by credit rating
agencies, for various purposes, such as the assignment of minimum capital
ratios, over-collateralization rates and diversification limits. As is also true
of preferred/preference stock, hybrids have many of the key characteristics of
equity due to their subordinated position in an issuer's capital structure and
because their quality and value are heavily dependent on the profitability of
the issuer rather than on any legal claims to specific assets or cash flows.
Hybrid securities have been marketed under a variety of names, including, but
not limited to MIPS, QUIPS, TOPrS, TrUPS, QUIBS, QUIDS, CorTS, PINES, Trust
Preferred Securities and capital securities. As with traditional
preferred/preference stocks, hybrid or taxable preferreds may be convertible
into underlying common stock of the issuer or associated grantor.
Perpetual preferred/preference stocks are issued with no mandatory
retirement provisions, but typically are callable after a period of time at the
option of the issuer. No redemption can occur if full cumulative dividends have
not been paid, although issuers may be able to engage in open-market repurchases
without regard to any cumulative dividends payable. Sinking fund
preferred/preference stocks provide for the redemption of a portion of the issue
on a regularly scheduled basis with, in most cases, the entire issue being
retired at a future date.
22
Hybrid preferreds are typically issued with a final maturity date, although,
in certain instances the date may be extended and/or the final payment of
principal may be deferred at the issuer's option for a specified time without
any adverse consequences to the issuer. No redemption can typically take place
unless all cumulative payment obligations have been met, although issuers may be
able to engage in open-market repurchases without regard to any cumulative
dividends payable.
Preferred/preference stock is, with common stock, one of the two major types
of equity securities. Generally, preferred/preference stock receives dividends
prior to distributions on common stock and usually has a priority of claim over
common stockholders if the issuer of the stock is liquidated. The income paid by
an issuer to holders of its preferred/preference and common stocks is typically
eligible for the DRD. Unlike common stock, preferred stock does not usually have
voting rights; preferred/ preference stock, in some instances, is convertible
into common stock.
Preferred/preference securities have certain characteristics of both debt
and common equity securities. They are debt-like to the extent that their
promised income is contractually fixed. They are common equity-like since they
do not have rights to precipitate bankruptcy filings or collection activities in
the event of missed payments. Furthermore, they have many of the key
characteristics of equity due to their subordinated position in an issuer's
capital structure and because their quality and value are heavily dependent on
the profitability of the issuer rather than on any legal claims to specific
assets or cash flows.
In order to be payable, dividends on preferred/preference stock must be
declared by the issuer's board of directors. In addition, distributions on
hybrid securities are also subject to deferral and are thus not automatically
payable. Income payments on the typical preferred securities currently
outstanding are cumulative, causing dividends and distributions to accrue even
if not declared by the board of directors or otherwise made payable. There is,
of course, no assurance that dividends or distributions on the preferred
securities in which the Fund invests will be declared or otherwise made payable.
The Fund may acquire non-cumulative preferred securities subject to the
restrictions on quality adopted by the Fund, although the Adviser would
consider, among other things, their non-cumulative nature in making any decision
to purchase or sell such securities.
Shares of preferred securities have a liquidation value that generally
equals the original purchase price at the date of issuance. The market values of
preferred securities may be affected by favorable and unfavorable changes
impacting companies in the utilities and banking industries, which are prominent
issuers of preferred securities (See "Investment Objective and
Policies--Concentration" below), and by actual and anticipated changes in tax
laws, such as changes in corporate income tax rates and in the DRD.
Because the claim on an issuer's earnings represented by
preferred/preference stocks and hybrid securities may become onerous when
interest rates fall below the rate payable on the stock or for other reasons,
the issuer may redeem the securities. Thus, in declining interest rate
environments in particular, the Fund's holdings of higher coupon-paying
preferred/preference and hybrid securities may be reduced and the Fund would be
unable to acquire securities paying comparable coupons with the redemption
proceeds.
From time to time, preferred securities issues have been, and may in the
future be, offered having features other than those described below that are
typical for fixed rate, adjustable rate or auction rate preferred securities.
The Fund reserves the right to invest in these securities if the Adviser
believes that doing so would be consistent with the Fund's investment objective
and policies. Since the market for these instruments would be new, the Fund may
have difficulty disposing of them at a suitable price and time. In addition to
limited liquidity, these instruments may present other risks, such as high price
23
volatility. The Adviser believes that the unavailability of such innovative
securities would not adversely affect the Fund's ability to achieve its
investment objective.
CREDIT QUALITY. At least 80% of the Preferred securities that the Fund will
acquire will be rated investment grade (at least "Baa3" by Moody's or "BBB-" by
S&P) at the time of investment or will be securities of issuers whose senior
debt is rated investment grade by Moody's or S&P at the time of investment. In
addition, the Fund may acquire unrated issues that the Adviser deems to be
comparable in quality to rated issues in which the Fund is authorized to invest.
The Fund will limit to 20% of its total assets the portion of its portfolio
invested in preferred and debt securities rated below investment grade (which
securities must be rated at least "Ba3" by Moody's or "BB-" by S&P at the time
of purchase) or judged to be comparable in quality at the time of purchase;
however, any such securities must be issued by an issuer having a class of
senior debt rated investment grade outstanding. Securities rated "Baa" by
Moody's or "BBB" by S&P, although investment grade, are considered to have
speculative characteristics, and securities rated "Ba" or "BB" are believed to
have speculative elements and a greater vulnerability to default than
higher-rated securities. Moody's and S&P may modify certain letter ratings of
securities with the addition of a plus or a minus sign or other modifier in
order to show relative standing within the rating category.
References to a particular letter rating in this prospectus may or may not
be to the rating with or without regard to any specific modifiers as the context
requires.
The ratings of Moody's and S&P represent their opinions as to the quality of
the securities that they undertake to rate; the ratings are relative and
subjective and are not absolute standards of quality. The Adviser's judgment as
to credit quality of a security, thus, may differ from that suggested by the
ratings published by a rating service. A description of ratings by Moody's and
S&P relevant to the Fund's investments is included in Appendix A to this
prospectus. The policies of the Fund described above as to ratings of portfolio
investments apply only at the time of the purchase of a security, and the Fund
is not required to dispose of a security in the event Moody's or S&P downgrades
its assessment of the credit characteristics of the security's issuer, although
standards for rating the Fund Preferred Shares imposed by Moody's may result in
the Fund's disposing of securities that are downgraded.
TRADITIONAL FIXED RATE PREFERRED STOCK. Traditional fixed rate preferred
stocks have fixed dividend rates for the life of the issue and typically pay
dividends that qualify for the DRD. They can be perpetual with no maturity date
or subject to mandatory redemptions such as through a sinking fund. The category
of fixed rate preferred stocks also includes a variety of innovative securities
as well as certain convertible preferred securities. Certain fixed rate
preferred stocks have features intended to provide some degree of price
stability. These features may include an auction mechanism at some specified
future date. The auction feature is normally intended to enhance the probability
that a preferred stock shareholder will be able to dispose of his holdings close
to a pre-specified price, typically equal to par or stated value. Other price
stability mechanisms include convertibility into an amount of common equity of
the same issuer at some specified future date, typically in amounts not greater
than par value of the underlying preferred stocks. Another common form of fixed
rate preferred stock is the traditional convertible preferred stock, which
permits the holder to convert into a specified number of shares at the holder's
option at any time prior to some specified date. Innovative preferred stock and
traditional convertible preferred stock are often less liquid than the
conventional fixed rate preferred stock. The Fund's ability to achieve its
investment objective is not dependent on the availability of such innovative or
convertible preferred stocks.
ADJUSTABLE RATE PREFERRED STOCK. Unlike traditional fixed rate preferred
stocks, adjustable rate preferred stocks are preferred stocks that have a
dividend rate that adjusts periodically to reflect changes in the general level
of interest rates. (Like traditional fixed rate preferred stocks, these issues
typically
24
pay dividends that qualify for the DRD.) The adjustable dividend rate feature is
intended to make the market value of these securities less sensitive to changes
in interest rates than similar securities with fixed dividend rates.
Nonetheless, adjustable rate preferred stocks have fluctuated in market value
and are expected to do so in the future.
The dividend rate on an adjustable rate preferred stock is determined
typically each quarter by applying an adjustment formula established at the time
of issuance of the stock. Although adjustment formulas vary among issues, they
typically involve a fixed relationship either to (1) rates on specific classes
of debt securities issued by the U.S. Treasury or (2) LIBOR, with limits (known
as "collars") on the minimum and maximum dividend rates that may be paid. As the
maximum dividend rate is approached, any further increase in interest rates may
adversely affect the market value of the stock. Conversely, as the minimum
dividend rate is approached, any further decrease in interest rates may
positively affect the market value of the stock. The adjustment formula is fixed
at the time of issuance of the adjustable rate preferred stock and cannot be
changed without the approval of the holders thereof.
The market values of outstanding issues of adjustable rate preferred stock
may fluctuate in response to changing market conditions. In the event that
market participants in a particular issue demand a different dividend yield than
the adjustment formula produces, the market price will change to produce the
desired yield. The dividend yield demanded by market participants may vary with
changing perceptions of credit quality and the relative levels of short-term and
long-term interest rates, as well as other factors.
Most of the issues of adjustable rate preferred stocks currently outstanding
are perpetual.
HYBRID PREFERRED SECURITIES. Hybrid, or taxable preferreds, are a
comparatively new asset class, having first been introduced late in 1993. Income
paid on these securities is not eligible for the DRD, but does constitute
deductible interest expense for issuers thereof. The universe of hybrid issuers
consists overwhelmingly of fixed coupon rate issues with final stated maturity
dates. However, certain issues have adjustable coupon rates, which reset
quarterly in a manner similar to adjustable rate preferred stocks described
above. The hybrid preferred securities universe is divided into the "$25 par"
and the "institutional" segments. The $25 par segment is typified by securities
that are listed on the New York Stock Exchange, which trade and are quoted
"flat", i.e., without accrued dividend income, and which are typically callable
at par value five years after their original issuance date. The institutional
segment is typified by $1,000 par value securities that are not exchange-listed,
which trade and are quoted on an "accrued income" basis, and which typically
have a minimum of ten years of call protection (at premium prices) from the date
of their original issuance.
COMMON STOCK. The Fund may invest up to 15% of its total assets in common
stock. Common stock is defined as shares of a corporation that entitle the
holder to a pro rata share of the profits of the corporation, if any, without
preference over any other shareholder or class of shareholders, including
holders of the corporation's preferred stock and other senior equity. Common
stock usually carries with it the right to vote and frequently an exclusive
right to do so. Holders of common stock also have the right to participate in
the assets of the corporation after all other claims are paid. In selecting
common stocks for investment, the Fund expects generally to focus more on the
security's dividend-paying capacity than on its potential for appreciation.
Certain traditional and hybrid preferred securities are convertible into the
common stock of the associated issuer. To the extent that such preferred
securities, because of their terms and market conditions, trade in close
relationship to the underlying common stock of the issuer, they will be subject
to the limit of 15% of total assets, under normal market conditions, that
applies to common stocks.
25
AUCTION RATE PREFERRED STOCK. Auction rate preferred stocks pay dividends
that adjust based on periodic auctions. Auction rate preferred stocks are
similar to short-term corporate money market instruments in that an auction rate
preferred stockholder has the opportunity to sell the preferred stock at par in
an auction, normally conducted at 49-day or other short intervals, through which
buyers set the dividend rate in a bidding process for the next period. The
dividend rate set in the auction depends upon market conditions and the credit
quality of the particular issuer. The typical auction rate preferred stock's
dividend is limited to a specified maximum percentage of the Federal Reserve's
Commercial Paper Index as of the auction date. Further, the terms of auction
rate preferred stocks generally provide that the shares are redeemable by the
issuer at certain times.
The failures of several auctions since late 1990 have significantly
decreased the financial market's perception that the auction process can be
depended upon to guarantee that the price of such preferred stocks will
approximate par or stated value, particularly among lower rated issues.
MONEY MARKET INSTRUMENTS. Under normal conditions, the Fund may hold up to
15% of its total assets in cash or money market instruments or, subject to the
limitation on investments in investment companies, in money market mutual funds
holding such types of investments. The Fund intends to invest in money market
instruments or money market funds to meet its general working capital needs
including, but not limited to, the need for collateral in connection with
certain investment techniques (see "Investment Objective and
Policies--Investment Techniques" below), to hold as a reserve pending the
payment of dividends to investors and to meet the liquidity requirements of
rating agencies that rate the Fund Preferred Shares, and to facilitate the
payment of expenses and settlement of trades. As noted above, pending investment
of the net proceeds of this offering in accordance with the Fund's investment
objective and policies, the Fund may invest without limitation in money market
instruments. In addition, when the Adviser believes that economic circumstances
warrant a temporary defensive posture, the Fund may invest in short-term money
market instruments without regard to the normal 15% limitation. To the extent
the Fund invests in short-term money market instruments, it may not be pursuing
its investment objective of high current income.
Money market instruments that the Fund may acquire will be securities rated
in the highest short-term rating category by Moody's or S&P or the equivalent
from another major rating service, securities of issuers that have received such
ratings with respect to other short-term debt or comparable unrated securities.
Money market instruments in which the Fund typically expects to invest include:
Government Securities; bank obligations (including certificates of deposit, time
deposits and bankers' acceptances of U.S. or foreign banks); commercial paper
rated P-1 by Moody's or A-1 by S&P; and repurchase agreements. Money market
funds in which the Fund may invest, are expected to be rated "Aaa" by one or
more rating agencies.
As indicated above, the Fund may invest normally up to 15% of its total
assets in money market instruments but, under certain circumstances, may invest
without limit in money market instruments. Subject to these limits, the Fund may
invest up to 25% of its total assets in U.S. dollar-denominated money market
obligations of foreign banks or foreign branches of U.S. banks but will do so
only if the Adviser determines that the obligation presents minimal credit
risks. These obligations entail risks that are different from those of
investments in obligations of U.S. banks. These risks include foreign economic
and political developments, foreign governmental restrictions that may adversely
affect payment of principal and interest on the obligations, foreign exchange
controls and foreign withholding or other taxes on income. Foreign branches of
U.S. banks are not necessarily subject to the same or similar regulatory
requirements that apply to the domestic operations of U.S. banks, such as
mandatory reserve requirements, loan limitations and accounting, auditing and
financial record-keeping requirements. In addition, less information may be
publicly available about a foreign branch of a U.S. bank than about a U.S. bank.
26
The Fund may enter into repurchase agreement transactions with certain
member banks of the Federal Reserve System or with certain dealers listed on the
Federal Reserve Bank of New York's list of reporting dealers. A repurchase
agreement is a contract under which the buyer of a security simultaneously
commits to resell the security to the seller at an agreed-upon price on an
agreed-upon date. Under the terms of a typical repurchase agreement, the Fund
would acquire an underlying obligation for a relatively short period (usually
not more than seven days) subject to an obligation of the seller to repurchase,
and the Fund to resell, the obligation at an agreed-upon price and time, thereby
determining the yield during the Fund's holding period. This arrangement results
in a fixed rate of return that is not subject to market fluctuations during the
Fund's holding period. Under each repurchase agreement, the selling institution
will be required to maintain the value of the securities subject to the
repurchase agreement at not less than their repurchase price. Repurchase
agreements could involve certain risks in the event of default or insolvency of
the seller, including possible delays or restrictions on the Fund's ability to
dispose of the underlying securities. In evaluating these potential risks, the
Adviser, on an ongoing basis, monitors (1) with the assistance of the
Administrator, the value of the collateral underlying each repurchase agreement
of the Fund to ensure that the value is at least equal to the total amount of
the repurchase obligation, including interest, and (2) the creditworthiness of
the banks and dealers with which the Fund enters into repurchase agreements.
GOVERNMENT SECURITIES. Government Securities in which the Fund may invest
include direct obligations of the United States and obligations issued by U.S.
Government agencies and instrumentalities. Included among direct obligations of
the United States are Treasury Bills, Treasury Notes and Treasury Bonds, which
differ principally in terms of their maturities. Included among the securities
issued by U.S. Government agencies and instrumentalities are: securities that
are supported by the full faith and credit of the United States (such as
Government National Mortgage Association certificates), securities that are
supported by the right of the issuer to borrow from the U.S. Treasury (such as
securities of Federal Home Loan Banks), and securities that are supported by the
credit of the instrumentality (such as Federal National Mortgage Association and
Federal Home Loan Mortgage Corporation bonds).
ZERO COUPON SECURITIES. The Fund may invest up to 10% of its total assets in
zero coupon securities issued by the U.S. Government, its agencies or
instrumentalities as well as custodial receipts or certificates underwritten by
securities dealers or banks that evidence ownership of future interest payments,
principal payments or both on certain Government Securities. Zero coupon
securities pay no cash income to their holders until they mature and are issued
at substantial discounts from their value at maturity. When held to maturity,
their entire return comes from the difference between their purchase price and
their maturity value. Because interest on zero coupon securities is not paid on
a current basis, the values of securities of this type are subject to greater
fluctuations than are the values of securities that distribute income regularly
and may be more speculative than such securities. Accordingly, the values of
these securities may be highly volatile as interest rates rise or fall. In
addition, the Fund's investments in zero coupon securities will result in
special tax consequences. Although zero coupon securities do not make interest
payments, for tax purposes a portion of the difference between a zero coupon
security's maturity value and its purchase price is taxable income of the Fund
each year.
Custodial receipts evidencing specific coupon or principal payments have the
same general attributes as zero coupon Government Securities but are not
considered to be Government Securities. Although typically under the terms of a
custodial receipt the Fund is authorized to assert its rights directly against
the issuer of the underlying obligation, the Fund may be required to assert
through the custodian bank such rights as may exist against the underlying
issuer. Thus, in the event the underlying issuer fails to pay principal and/or
interest when due, the Fund may be subject to delays, expenses and risks that
are greater than those that would have been involved if the Fund had purchased a
direct obligation of the issuer. In addition, in the event that the trust or
custodial account in which the underlying security has been deposited is
determined to be an association taxable as a corporation,
27
instead of a non-taxable entity, the yield on the underlying security would be
reduced in respect of any taxes paid.
RESTRICTED SECURITIES (DIRECT PLACEMENTS). The Fund may invest up to 20% of
its total assets in securities purchased in direct placements. Securities
obtained by means of direct placement typically are less liquid than securities
traded on the open market because of statutory or contractual restrictions on
resale and thus are often referred to as restricted securities. Such securities
are therefore unlike securities traded in the open market, which can be sold
immediately if the market is adequate. This lack of liquidity creates special
risks for the Fund. However, the Fund could sell such securities if a
substantial market of qualified institutional buyers develops pursuant to
Rule 144A under the Securities Act of 1933, as amended, in privately negotiated
transactions with a limited number of purchasers or in public offerings
registered under such Act.
Direct placements of securities have frequently resulted in higher yields to
purchasers and more restrictive covenants to issuers, which may provide greater
protection for the purchaser than comparable registered securities. As it has
avoided the expense and delay involved in a public offering of its securities,
an issuer is often willing to offer the purchaser more attractive features in
its securities issued in direct placements. Also, adverse conditions in the
public securities markets may at certain times preclude a public offering of an
issuer's securities.
Because it is not possible to predict with assurance how the market for
restricted securities pursuant to Rule 144A will develop, the Fund will
carefully monitor the Fund's investments in such securities with particular
regard to valuation, liquidity and availability of information.
INVESTMENT COMPANY SECURITIES. The Fund may invest up to 10% of its total
assets in securities of registered investment companies. The Fund will not
acquire securities of any one investment company if, immediately thereafter, the
Fund would own in the aggregate (1) more than 3% of such issuer's total
outstanding voting securities or (2) securities issued by such issuer having an
aggregate value in excess of 5% of the Fund's total assets. To the extent that
investment advisory and brokerage expenses of an investment company are
reflected in the price of its shares held in the Fund's portfolio, there will be
a duplication of such expenses.
CONCENTRATION
The Fund intends to concentrate its investments in utility companies and
companies in the banking industry so that, under normal market conditions, at
least 25% of the Fund's total assets will be invested in securities issued by
utilities and an additional 25% or more of its total assets will be invested in
securities issued by companies in the banking industry. If adverse economic
conditions prevail in either or both of these industries at some future date,
the Fund, for defensive purposes, temporarily may invest less than 25% of its
total assets in the affected industry or industries. This concentration policy
is a fundamental policy of the Fund and cannot be changed without approval by
the vote of a majority of the Fund's outstanding voting securities, voting as a
single class, and a majority of the Fund's outstanding Fund Preferred Shares,
voting as a separate class, as described under "Investment Restrictions" below.
Consistent with the limitations set forth in the preceding paragraph, the
portion of the Fund's assets invested in each of the utilities, banking and
other industries will vary from time to time. The concentration of the Fund's
assets in the utilities and banking industries is a source of potential risk,
although the Fund intends to diversify its investments broadly among issuers in
order to reduce risk and will be subject to diversification requirements and
other investment limitations imposed by rating agencies in connection with the
rating of the Fund Preferred Shares intended to be issued by the Fund.
28
See "Investment Objective and Policies--Rating Agency Guidelines and Asset
Coverage Requirements."
UTILITY SECURITIES. The utilities industry generally includes companies
engaged in the generation, transmission or distribution of electric energy, gas,
or water, or, in certain instances, the providing of telephone and
telecommunications services. Certain segments of the industry and individual
companies within such segments may not perform as well as the industry as a
whole. Many utility companies historically have been subject to risks of
increases in fuel and other operating costs, high interest costs on borrowings
needed for capital improvement programs and costs associated with compliance
with and changes in environmental and other governmental regulations. In
particular, regulatory changes with respect to nuclear and conventionally fueled
power generating and transmission facilities could increase costs or impair the
ability of the utility companies to operate and utilize such facilities, thus
reducing the utility companies' earnings or resulting in losses. Rates of return
on investment of certain utility companies are subject to review by government
regulators. There can be no assurance that changes in regulatory policies or
accounting standards will not negatively affect utility companies' earnings or
dividends. Costs incurred by utilities, such as fuel and purchased power costs,
often are subject to immediate market action resulting from such things as
political or military forces operating in geographic regions where oil
production is concentrated or global or regional weather conditions, such as
droughts, while the rates of return of utility companies generally are subject
to review and limitation by state public utility commissions, which results
ordinarily in a lag or an absence of correlation between costs and return. It is
also possible that costs may not be offset by return. Utilities have, in recent
years, been affected by increased competition, which could adversely affect the
profitability or viability of such utilities. Electric utilities may also be
subject to increasing economic pressures due to deregulation of generation,
transmission and other aspects of their business.
BANK HOLDING COMPANY AND BANK STOCKS. Investment in the Fund involves
consideration of various regulatory and economic factors affecting bank holding
companies and their subsidiary banks.
For many years federal and state banking laws and regulations have limited
the ability of bank holding companies and banks to compete geographically and
have restricted sharply the activities in which they may engage. From time to
time, changes in law and regulation have been proposed to permit greater
diversification of the financial products of bank holding companies and banks,
but often such legislation has bogged down or, if it has been enacted, often it
has been limited in the scope of change it has facilitated. In 1994 the Congress
enacted legislation that enhanced the ability of bank holding companies and
banks to expand by acquisition or branching across state lines. Their ability to
engage in nonbanking activities, however, remained very limited.
In late 1999 the Congress enacted the Gramm-Leach-Bliley Act, a piece of
financial regulation reform legislation that altered the landscape of bank
holding company and bank regulation. The Act repealed provisions of the
Glass-Steagall Act that since 1933 had severely limited the underwriting of
securities by affiliates of banks and it repealed provisions of the Bank Holding
Company Act that had severely limited the insurance activities of bank holding
companies. The Gramm-Leach-Bliley Act created a new scheme or regulation for
FINANCIAL HOLDING COMPANIES--these are bank holding companies with high capital
levels, good compliance and management records and good records under the
Community Reinvestment Act that have elected to become financial holding
companies. Such companies enjoy several prerogatives versus bank holding
companies that have not made this election. First, they are allowed to engage in
a broad range of financial activities, including securities and insurance
activities, not merely activities that are closely related to banking. Second,
they are not subject to any Glass-Steagall-based limitations on their securities
underwriting and dealing activities. Third, they are permitted to invest in
nonfinancial companies and to control investment funds that invest in such
companies. Fourth, they do not require prior Federal Reserve approval to engage
in new activities or to acquire
29
non-banking companies. A large number of local and regional bank holding
companies have elected to become financial holding companies.
Federal law and regulations require commercial banks and bank holding
companies to maintain minimum levels of capital and liquidity and to establish
loan loss reserves. A bank's failure to maintain specified capital ratios may
trigger dividend restrictions, suspensions on payments on subordinated debt, and
limitations on growth. Bank regulators have broad authority in these instances
and can ultimately impose sanctions, including conservatorship or receivership,
on such non-complying banks even when these banks continue to be solvent,
thereby possibly resulting in the elimination of stockholders' equity. Unless a
bank holding company has subsidiaries other than banks that generate substantial
revenues, the holding company's cash flow and ability to declare dividends may
be impaired severely by restrictions on the ability of its bank subsidiaries to
declare dividends.
Fiscal and monetary policies of the government and general economic and
political conditions can affect the availability and cost of funds to banks,
loan demand and asset quality and thereby impact the earnings and financial
condition of banking institutions. Downturns in a regional or local economy or
in the general business cycle or depressed conditions in an industry, for
example, may adversely affect the quality or volume of a bank's loan portfolio,
particularly if the portfolio is concentrated in the affected region or
industry. From time to time, general economic conditions have adversely affected
financial institutions' energy, agricultural, commercial real estate,
less-developed country, venture capital, technology, telecommunications, and
highly-leveraged loan portfolios. The impact of a deteriorating economy or
industry upon institutions depends, in part, on the size of the institutions,
the extent to which they are involved in the type of lending or market affected,
the duration of the softening in the affected area and the managerial and
capital resources of the institutions. In addition, changes in accounting
rules applicable to loans and investment securities also may adversely impact
the financial condition of banking institutions.
INVESTMENT TECHNIQUES
For hedging purposes or, under certain circumstances, to increase its
income, the Fund may employ, among others, the investment techniques described
below, although its ability to engage in any of these strategies may be limited
by restrictions imposed on the Fund's operations in connection with obtaining
and maintaining (i) a rating for the Fund Preferred Shares outstanding and
(ii) its qualification as a regulated investment company under the Code.
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS. The Fund may enter into
interest rate and stock index futures contracts and may purchase and sell put
and call options on such futures contracts. The Fund will enter into such
transactions for hedging and other appropriate risk-management purposes or to
increase return, in accordance with the rules and regulations of the CFTC and
the Commission.
An interest rate futures contract is a standardized contract for the future
delivery of a specified security (such as a U.S. Treasury Bond or U.S. Treasury
Note) or its equivalent at a future date at a price set at the time of the
contract. A stock index futures contract is an agreement to take or make
delivery of an amount of cash equal to the difference between the value of the
index at the beginning and at the end of the contract period. The Fund may only
enter into futures contracts traded on regulated commodity exchanges.
Parties to a futures contract must make "initial margin" deposits to secure
performance of the contract. There are also requirements to make "variation
margin" deposits from time to time as the value of the futures contract
fluctuates. The Fund is not a commodity pool and, in compliance with CFTC
regulations currently in effect, may enter into any futures contracts and
related options for
30
"bona fide hedging" purposes and, in addition, for other purposes, provided that
aggregate initial margin and premiums required to establish positions other than
those considered by the CFTC to be "bona fide hedging" will not exceed 5% of the
Fund's net asset value, after taking into account unrealized profits and
unrealized losses on any such contracts. The Fund reserves the right to engage
in transactions involving futures and options thereon to the extent allowed by
CFTC regulations in effect from time to time and in accordance with the Fund's
policies. In addition, certain provisions of the Code may limit the extent to
which the Fund may enter into futures contracts or engage in options
transactions. See "Taxation."
Under regulations of the CFTC currently in effect, which may change from
time to time, with respect to futures contracts to purchase securities or stock
indices, call options on futures contracts purchased by the Fund and put options
on futures contracts written by the Fund, the Fund will set aside in a
segregated account liquid securities with a value at least equal to the value of
instruments underlying such futures contracts less the amount of initial margin
on deposit for such contracts. The current view of the staff of the Commission
is that the Fund's long and short positions in futures contracts as well as put
and call options on futures written by it must be collateralized with cash or
certain liquid assets held in a segregated account or "covered" in a manner
similar to that described below for covered options on securities (see
"Investment Objective and Policies--Investment Techniques--Options on
Securities" below) in order to counter the impact of any potential leveraging.
The Fund may either accept or make delivery of cash or the underlying
instrument specified at the expiration of an interest rate futures contract or
cash at the expiration of a stock index futures contract or, prior to
expiration, enter into a closing transaction involving the purchase or sale of
an offsetting contract. Closing transactions with respect to futures contracts
are effected on the exchange on which the contract was entered into (or a linked
exchange).
The Fund may purchase and write put and call options on interest rate
futures contracts and stock index futures contracts in order to hedge all or a
portion of its investments and may enter into closing purchase transactions with
respect to options written by the Fund in order to terminate existing positions.
There is no guarantee that such closing transactions can be effected at any
particular time or at all. In addition, daily limits on price fluctuations on
exchanges on which the Fund conducts its futures and options transactions may
prevent the prompt liquidation of positions at the optimal time, thus subjecting
the Fund to the potential of greater losses.
An option on an interest rate futures contract or stock index futures
contract, as contrasted with the direct investment in such a contract, gives the
purchaser of the option the right, in return for the premium paid, to assume a
position in a stock index futures contract or interest rate futures contract at
a specified exercise price at any time on or before the expiration date of the
option. Upon exercise of an option, the delivery of the futures position by the
writer of the option to the holder of the option will be accompanied by delivery
of the accumulated balance in the writer's futures margin account, which
represents the amount by which the market price of the futures contract exceeds,
in the case of a call, or is less than, in the case of a put, the exercise price
of the option on the futures contract. The potential loss related to the
purchase of an option on a futures contract is limited to the premium paid for
the option (plus transaction costs).
With respect to options purchased by the Fund, there are no daily cash
payments made by the Fund to reflect changes in the value of the underlying
contract; however, the value of the option does change daily and that change
would be reflected in the net asset value of the Fund.
While the Fund may enter into futures contracts and options on futures
contracts for hedging purposes, the use of futures contracts and options on
futures contracts might result in a poorer overall performance for the Fund than
if it had not engaged in any such transactions. If, for example, the Fund had
insufficient cash, it might have to sell a portion of its underlying portfolio
of securities in order to
31
meet daily variation margin requirements on its futures contracts or options on
futures contracts at a time when it might be disadvantageous to do so. There may
be an imperfect correlation between the Fund's portfolio holdings and futures
contracts or options on futures contracts entered into by the Fund, which may
prevent the Fund from achieving the intended hedge or expose the Fund to risk of
loss. Further, the Fund's use of futures contracts and options on futures
contracts to reduce risk involves costs and will be subject to the Adviser's
ability to predict correctly changes in interest rate relationships or other
factors. No assurance can be given that the Adviser's judgment in this respect
will be correct.
INTEREST RATE SWAPS AND OPTIONS THEREON ("SWAPTIONS"). The Fund may enter
into interest rate swap agreements and may purchase and sell put and call
options on such swap agreements, commonly referred to as swaptions. The Fund
will enter into such transactions for hedging some or all of its interest rate
exposure in its holdings of preferred securities. Interest rate swap agreements
and swaptions are highly specialized investments and are not traded on or
regulated by any securities exchange or regulated by the CFTC or the Commission.
An interest rate swap is an agreement between two parties where one party
agrees to pay a contractually stated fixed income stream, usually denoted as a
fixed percentage of an underlying "notional" amount, in exchange for receiving a
variable income stream, usually based on LIBOR, and denoted as a percentage of
the underlying notional amount. From the perspective of a fixed rate PAYER, if
interest rates rise, the payer will expect a rising level of income since the
payer is a receiver of floating rate income. This would cause the value of the
swap contract to rise in value, from the payer's perspective, because the
discounted present value of its obligatory payment stream is diminished at
higher interest rates, all at the same time it is receiving higher income.
Alternatively, if interest rates fall, the reverse occurs and it simultaneously
faces the prospects of both a diminished floating rate income stream and a
higher discounted present value of his fixed rate payment obligation. For
purposes of completing the analysis, these value changes all work in reverse
from the perspective of a fixed rate receiver.
A swaption is an agreement between two parties where one party purchases the
right from the other party to enter into an interest rate swap at a specified
date and for a specified "fixed rate" yield (or "exercise" yield). In a
pay-fixed swaption, the holder of the swaption has the right to enter into an
interest rate swap as a payer of fixed rate and receiver of variable rate, while
the writer of the swaption has the obligation to enter into the other side of
the interest rate swap. In a received-fixed swaption, the holder of the swaption
has the right to enter into an interest rate swap as a receiver of fixed rate
and a payer of variable rate, while the writer of the swaption has the
obligation to enter into the opposite side of the interest rate swap.
A pay fixed swaption is analogous to a put option on Treasury securities in
that it rises in value as interest rate swap yields rise. A receive fixed
swaption is analogous to a call option on Treasury securities in that it rises
in value as interest rate swap yields decline. As with other options on
securities, indices, or futures contracts, the price of any swaption will
reflect both an intrinsic value component, which may be zero, and a time premium
component. The intrinsic value component represents what the value of the
swaption would be if it were immediately exercisable into the underlying
interest rate swap. The intrinsic value component measures the degree to which
an option is in-the-money, if at all. The time premium represents the difference
between the actual price of the swaption and the intrinsic value.
It is customary market practice for swaptions to be "cash settled" rather
than an actual position in an interest rate swap being established at the time
of swaption expiration. For reasons set forth more fully below, the Fund's
Adviser expects to enter strictly into cash settled swaptions, i.e., where the
exercise value of the swaption is determined by reference to the market for
interest rate swaps then prevailing.
32
The pricing and valuation terms of interest rate swap agreements and
swaptions are not standardized and there is no clearinghouse whereby a party to
the agreement can enter into an offsetting position to close out a contract.
Interest rate swaps and swaptions must thus be regarded as inherently illiquid.
Interest rate swap agreements are usually (1) between an institutional investor
and a broker/ dealer firm or bank or (2) between institutional investors. In
addition, substantially all swaps are entered into subject to the standards set
forth by the International Swaps & Derivatives Association ("ISDA"). ISDA
represents participants in the privately negotiated derivatives industry. It
helps formulate the investment industry's position on regulatory and legislative
issues, develops international contractual standards, and offers arbitration on
disputes concerning market practice.
Under the rating agency guidelines imposed in connection with the intended
issuance of Fund Preferred Shares, it is expected that the Fund will be
authorized to enter into swaptions but not authorized to enter into interest
rate swap agreements. Certain rating agency guidelines may be changed from time
to time and it is expected that those relating to interest rate swaps would be
able to be revised by the Fund's Board, without shareholder vote of the Common
Stock or the Fund Preferred Shares, so long as the relevant rating agency(ies)
has given written notice that such revisions would not adversely affect the
rating of the Fund Preferred Shares then in effect.
The Board of Directors has currently limited the Fund's use of interest rate
swaps and swaptions as follows: (1) swaps and swaptions must be U.S. dollar
denominated and used for hedging purposes only; (2) no more than 5% of the
Fund's total assets, at the time of purchase, may be invested in time premiums
paid for swaptions; (3) swaps and swaptions must conform to the standards of the
ISDA Master Agreement; and (4) the counterparty must be a bank or broker/dealer
firm regulated under the laws of the United States of America that is (a) on a
list approved by the Fund's Board, (b) with capital of at least $100 million,
and (c) which is rated investment grade by both Moody's and S&P. These criteria
can be modified by the Board at any time in its discretion.
The Fund's Adviser expects that the Fund will be subject to the initial and
subsequent mark-to-market collateral requirements that are standard among ISDA
participants. These requirements help insure that the party who is a net obligor
at current market value has pledged for safekeeping, to the counterparty,
sufficient collateral to cover any losses should the obligor become incapable,
for whatever reason, of fulfilling its commitments under the swap or swaption
agreements. This is analogous, in many respects, to the collateral requirements
in place on regular futures and options exchanges. As long as the Fund is a
purchaser of swaptions, which is expected to be the only possibility under
rating agency guidelines applicable to the Fund Preferred Shares the Fund
intends to issue, the Fund would not have to pledge collateral. However, it
would have to monitor the market value of the swaptions held and insure that
they are properly collateralized.
The Fund has instituted procedures for valuing any swaps or swaptions
positions to which it is party. Swaps or swaptions will be valued by the
counterparty to the swap or swaption in question. Such valuation will then be
compared with the valuation provided by a broker/dealer or bank that is not a
party to the swap or swaption. In the event of material discrepancies, the Fund
has procedures in place for valuing the swap or swaption, subject to the
direction of the Fund's Board, which include reference to (1) third-party
information services, such as Bloomberg, and (2) comparison with the Adviser's
valuation models.
The use of interest rate swaps and swaptions, as the foregoing discussion
suggests, are subject to risks and complexities beyond what might be encountered
in standardized, exchange traded options and futures contracts. Such risks
include operational risks, valuation risks, credit risks, and/or counterparty
risk (i.e., the risk that the counterparty cannot or will not perform its
obligations under the agreement). In addition, at the time the interest rate
swap or swaption reaches its scheduled termination date, there is a risk that
the Fund will not be able to obtain a replacement transaction or that the terms
of the
33
replacement will not be as favorable as on the expiring transaction. If this
occurs, it could have a negative impact on the performance of the Fund.
While the Fund may utilize interest rate swaps and swaptions for hedging
purposes, their use might result in poorer overall performance for the Fund than
if it had not engaged in any such transactions. If, for example, the Fund had
insufficient cash, it might have to sell or pledge a portion of its underlying
portfolio of securities in order to meet daily mark-to-market collateralization
requirements at a time when it might be disadvantageous to do so. There may be
an imperfect correlation between the Fund's portfolio holdings and swaps or
swaptions entered into by the Fund, which may prevent the Fund from achieving
the intended hedge or expose the Fund to risk of loss. Further, the Fund's use
of swaps and swaptions to reduce risk involves costs and will be subject to the
Adviser's ability to predict correctly changes in interest rate relationships or
other factors. No assurance can be given that the Adviser's judgment in this
respect will be correct.
OPTIONS ON SECURITIES. In order to hedge against adverse market shifts, the
Fund may utilize up to 5% of its total assets to purchase put and call options
on securities. In addition, the Fund may seek to increase its income or may
hedge a portion of its portfolio investments through writing (i.e., selling)
covered put and call options. A put option embodies the right of its purchaser
to compel the writer of the option to purchase from the option holder an
underlying security or its equivalent at a specified price at any time during
the option period. In contrast, a call option gives the purchaser the right to
buy the underlying security or its equivalent covered by the option or its
equivalent from the writer of the option at the stated exercise price. Under
interpretations of the Commission currently in effect, which may change from
time to time, a "covered" call option means that so long as the Fund is
obligated as the writer of the option, it will own (1) the underlying
instruments subject to the option, (2) instruments convertible or exchangeable
into the instruments subject to the option or (3) a call option on the relevant
instruments with an exercise price no higher than the exercise price on the call
option written.
Similarly, the Commission currently requires that, to support its obligation
to purchase the underlying instruments if a put option written by the Fund is
exercised, the Fund either (a) deposit with its custodian in a segregated
account liquid securities having a value at least equal to the exercise price of
the underlying securities, (b) continue to own an equivalent number of puts of
the same "series" (that is, puts on the same underlying security having the same
exercise prices and expiration dates as those written by the Fund), or an
equivalent number of puts of the same "class" (that is, puts on the same
underlying security) with exercise prices greater than those it has written (or,
if the exercise prices of the puts it holds are less than the exercise prices of
those it has written, it will deposit the difference with its custodian in a
segregated account) or (c) sell short the securities underlying the put option
at the same or a higher price than the exercise price on the put option written.
The Fund will receive a premium when it writes put and call options, which
increases the Fund's return on the underlying security in the event the option
expires unexercised or is closed out at a profit. By writing a call, the Fund
will limit its opportunity to profit from an increase in the market value of the
underlying security above the exercise price of the option for as long as the
Fund's obligation as the writer of the option continues. Upon the exercise of a
put option written by the Fund, the Fund may suffer an economic loss equal to
the difference between the price at which the Fund is required to purchase the
underlying security and its market value at the time of the option exercise,
less the premium received for writing the option. Upon the exercise of a call
option written by the Fund, the Fund may suffer an economic loss equal to an
amount not less than the excess of the security's market value at the time of
the option exercise over the Fund's acquisition cost of the security, less the
sum of the premium received for writing the option and the difference, if any,
between the call price paid to the Fund and the Fund's acquisition cost of the
security. Thus, in some
34
periods the Fund might receive less total return and in other periods greater
total return from its hedged positions than it would have received from its
underlying securities unhedged.
The Fund may purchase and write options on securities that are listed on
national securities exchanges or are traded over the counter, although it
expects, under normal circumstances, to effect such transactions on national
securities exchanges.
As a holder of a put option, the Fund will have the right to sell the
securities underlying the option and as the holder of a call option, the Fund
will have the right to purchase the securities underlying the option, in each
case at their exercise price at any time prior to the option's expiration date.
The Fund may choose to exercise the options it holds, permit them to expire or
terminate them prior to their expiration by entering into closing sale
transactions. In entering into a closing sale transaction, the Fund would sell
an option of the same series as the one it has purchased. The ability of the
Fund to enter into a closing sale transaction with respect to options purchased
and to enter into a closing purchase transaction with respect to options sold
depends on the existence of a liquid secondary market. There can be no assurance
that a closing purchase or sale transaction can be effected when the Fund so
desires. The Fund's ability to terminate option positions established in the
over-the-counter market may be more limited than in the case of exchange-traded
options and may also involve the risk that securities dealers participating in
such transactions would fail to meet their obligations to the Fund.
In purchasing a put option, the Fund will seek to benefit from a decline in
the market price of the underlying security, while in purchasing a call option,
the Fund will seek to benefit from an increase in the market price of the
underlying security. If an option purchased is not sold or exercised when it has
remaining value, or if the market price of the underlying security remains equal
to or greater than the exercise price, in the case of a put, or remains equal to
or below the exercise price, in the case of a call, during the life of the
option, the option will expire worthless. For the purchase of an option to be
profitable, the market price of the underlying security must decline
sufficiently below the exercise price, in the case of a put, and must increase
sufficiently above the exercise price, in the case of a call, to cover the
premium and transaction costs. Because option premiums paid by the Fund are
small in relation to the market value of the instruments underlying the options,
buying options can result in large amounts of leverage. The leverage offered by
trading in options could cause the Fund's net asset value to be subject to more
frequent and wider fluctuation than would be the case if the Fund did not invest
in options.
OPTIONS ON STOCK INDICES. The Fund may utilize up to 5% of its total assets
to purchase put and call options on domestic stock indices to hedge against
risks of market-wide price movements affecting its assets. In addition, the Fund
may write covered put and call options on stock indices. A stock index measures
the movement of a certain group of stocks by assigning relative values to the
common stocks included in the index. Options on stock indices are similar to
options on securities. Because no underlying security can be delivered, however,
the option represents the holder's right to obtain from the writer, in cash, a
fixed multiple of the amount by which the exercise price exceeds (in the case of
a put) or is less than (in the case of a call) the closing value of the
underlying index on the exercise date. The advisability of using stock index
options to hedge against the risk of market-wide movements will depend on the
extent of diversification of the Fund's investments and the sensitivity of its
investments to factors influencing the underlying index. The effectiveness of
purchasing or writing stock index options as a hedging technique will depend
upon the extent to which price movements in the Fund's securities, investments
correlate with price movements in the stock index selected. In addition,
successful use by the Fund of options on stock indices will be subject to the
ability of the Adviser to predict correctly changes in the relationship of the
underlying index to the Fund's portfolio holdings. No assurance can be given
that the Adviser's judgment in this respect will be correct.
35
When the Fund writes an option on a stock index, it will establish a
segregated account with its custodian in which the Fund will deposit liquid
securities in an amount equal to the market value of the option, and will
maintain the account while the option is open.
WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS. New issues of preferred and
debt securities may be offered on a when-issued or delayed delivery basis, which
means that delivery and payment for the security normally take place within 45
days after the date of the commitment to purchase. The payment obligation and
the dividends that will be received on the security are fixed at the time the
buyer enters into the commitment. The Fund will make commitments to purchase
securities on a when-issued or delayed delivery basis only with the intention of
acquiring the securities, but may sell these securities before the settlement
date if the Adviser deems it advisable. No additional when-issued or delayed
delivery commitments will be made if more than 20% of the Fund's total assets
would be so committed. Securities purchased on a when-issued or delayed delivery
basis may be subject to changes in value based upon the public's perception of
the creditworthiness of the issuer and changes, real or anticipated, in the
level of interest rates. Securities purchased or sold on a when-issued or
delayed delivery basis may expose the Fund to risk because they may experience
these fluctuations prior to their actual delivery. The Fund will not accrue
income with respect to a debt security it has purchased on a when-issued or
delayed delivery basis prior to its stated delivery date but will accrue income
on a delayed delivery security it has sold. Purchasing or selling securities on
a when-issued or delayed delivery basis can involve the additional risk that the
yield available in the market when the delivery takes place actually may be
higher than that obtained in the transaction itself. A segregated account of the
Fund consisting of liquid securities equal at all times to the amount of the
Fund's when-issued and delayed delivery purchase commitments will be established
and maintained with the Fund's custodian. Placing securities rather than cash in
the segregated account may have a leveraging effect on the Fund's net asset
value per share; that is, to the extent that the Fund remains substantially
fully invested in securities at the same time that it has committed to purchase
securities on a when-issued or delayed delivery basis, greater fluctuations in
its net asset value per share may occur than if it has set aside cash to satisfy
its purchase commitments.
LENDING PORTFOLIO SECURITIES. The Fund is authorized to lend securities it
holds to brokers, dealers and other financial organizations, although it has no
current intention of doing so. Loans of the Fund's securities, if and when made,
may not exceed 33-1/3% of the Fund's assets taken at value. The Fund's loans of
securities will be collateralized by cash, letters of credit or Government
Securities that will be maintained at all times in a segregated account with the
Fund's custodian in an amount at least equal to the current market value of the
loaned securities. From time to time, the Fund may pay a part of the interest
earned from the investment of collateral received for securities loaned to the
borrower and/ or a third party that is unaffiliated with the Fund and that is
acting as a "finder."
By lending its portfolio securities, the Fund can increase its income by
continuing to receive interest on the loaned securities, by investing the cash
collateral in short-term instruments or by obtaining yield in the form of
interest paid by the borrower when Government Securities are used as collateral.
The risk in lending portfolio securities, as with other extensions of credit,
consists of the possible delay in recovery of the securities or the possible
loss of rights in the collateral should the borrower fail financially. The Fund
will adhere to the following conditions whenever it lends its securities:
(1) the Fund must receive at least 100% cash collateral or equivalent securities
from the borrower, which will be maintained by daily marking-to-market; (2) the
borrower must increase the collateral whenever the market value of the
securities loaned rises above the level of the collateral; (3) the Fund must be
able to terminate the loan at any time; (4) the Fund must receive reasonable
interest on the loan, as well as any dividends, interest or other distributions
on the loaned securities, and any increase in market value; (5) the Fund may pay
only reasonable custodian fees in connection with the loan; and (6) voting
rights on the loaned securities may pass to the borrower, except that, if a
material, event
36
adversely affecting the investment in the loaned securities occurs, the Fund's
Board of Directors must terminate the loan and regain the Fund's right to vote
the securities.
SHORT SALES AGAINST THE BOX. The Fund may make short sales of securities in
order to reduce market exposure and/or to increase its income if, at all times
when a short position is open, the Fund owns an equal or greater amount of such
securities or owns preferred securities, debt or warrants convertible or
exchangeable into an equal or greater number of the shares of common stock sold
short. Short sales of this kind are referred to as short sales of securities
"against the box." The broker-dealer that executes a short sale generally
invests the cash proceeds of the sale until they are paid to the Fund.
Arrangements may be made with the broker-dealer to obtain a portion of the
interest earned by the broker on the investment of short sale proceeds. The Fund
will segregate the securities against which short sales against the box have
been made in a special account with its custodian. Not more than 10% of the
Fund's total assets (taken at current value) may be held as collateral for such
sales at any one time.
RATING AGENCY GUIDELINES AND ASSET COVERAGE REQUIREMENTS
In connection with the anticipated issuance of Fund Preferred Shares, the
Fund's investments will be subject to certain investment guidelines (the "Rating
Agency Guidelines") established by the rating agencies rating the Fund Preferred
Shares at all times when the Fund Preferred Shares are outstanding. Provided
that the Fund complies with the Rating Agency Guidelines, it is expected that
the Fund Preferred Shares will be rated "Aaa" and "AAA" by the rating agencies,
but no assurance can be given that such a rating can be obtained. Moody's and
S&P each receives fees in connection with issuances of ratings.
It is anticipated that the Rating Agency Guidelines will require the Fund to
meet, as of certain specified dates, an "Eligible Asset Coverage Amount"
requirement. To meet the Eligible Asset Coverage Amount requirement, the Fund
must maintain a certain percentage of its assets in specific types of
investments ("Eligible Assets") with an aggregate value (determined using
procedures specified by the rating agencies) sufficient to cover the aggregate
liquidation preference of the outstanding Fund Preferred Shares plus accumulated
dividends to the redemption date or the liquidation date and certain projected
dividends. In addition, in order to pay dividends on the Common Stock, the 1940
Act requires the Fund to meet minimum asset coverage requirements (the "1940 Act
Asset Coverage Requirement"). The 1940 Act Asset Coverage Requirement will be
met if the value of the Fund's total assets, less all liabilities and
indebtedness of the Fund, is equal to at least 200% of the aggregate liquidation
preference of the outstanding Fund Preferred Shares. Compliance with the Rating
Agency Guidelines would impose restrictions on the securities in which the Fund
would invest and, in certain circumstances, meeting the Eligible Asset Coverage
Amount requirement and 1940 Act Asset Coverage Requirement would require the
Fund to redeem or purchase shares of its Fund Preferred Shares outstanding.
RISK FACTORS AND SPECIAL CONSIDERATIONS
Risk is inherent in all investing. Investing in any investment company
security involves risk, including the risk that you may receive little or no
return on your investment or even that you may lose part or all of your
investment. Therefore, before investing you should consider carefully the
following risks that you assume when you invest in shares of the Fund's Common
Stock.
INTEREST RATE RISK. Changes in the level of interest rates are expected to
affect the value of the Fund's portfolio holdings of fixed rate securities and,
under certain circumstances, its holdings of adjustable rate securities and
positions in hedging instruments, and the market price of the Common Stock.
Subject to certain limitations described herein, the Fund currently anticipates
hedging, from time
37
to time, some or all of its holdings of fixed rate and adjustable rate
securities, for the purposes of (1) protecting against declines in value
attributable to significant increases in interest rates in general and
(2) providing increased income in the event of significant increases in interest
rates while maintaining the Fund's relative resistance to a reduction in income
in the event of significant declines in interest rates. There can be no
guarantee that such hedging strategies will be successful. In addition to
fluctuations due to changes in interest rates, the value of the Fund's holdings
of preferred and debt securities and common stocks, and as a result, the Fund's
net asset value, may also be affected by other market and credit factors, as
well as by actual or anticipated changes in tax laws, such as corporate income
tax rates and the DRD. Further, the exercise of call provisions on preferred or
debt securities by their issuers due to generally falling interest rates or
otherwise, could result in the Fund not realizing the benefits of (i) price
appreciation in the securities above the call prices and/or (ii) stable income
in the event of declining yields for preferred and debt securities. In addition,
there can be no assurance that there will be sufficient liquidity of preferred
securities to enable the Fund to buy or sell preferred securities at prices that
the Adviser believes to be suitable.
HEDGING STRATEGY RISK. Certain of the investment techniques that the Fund
may employ for hedging or, under certain circumstances, to increase income will
expose the Fund to risks. In addition to the hedging techniques described
elsewhere, i.e., positions in Treasury Bond or Treasury Note futures contracts,
use of options on these positions, positions in interest rate swaps, and options
thereon ("swaptions"), these investment techniques may include entering into
interest rate and stock index futures contracts and options on interest rate and
stock index futures contracts, purchasing and selling put and call options on
securities and stock indices, purchasing and selling securities on a when-issued
or delayed delivery basis, entering into repurchase agreements, lending
portfolio securities and making short sales of securities "against the box." The
Fund intends to company with regulations of the Commission involving "covering"
or segregating assets in connection with the Fund's use of options and futures
contracts.
ILLIQUIDITY. Preferred securities, which will constitute the principal
portion of the Fund's assets, may be substantially less liquid than many other
securities such as common stocks or Government Securities. At any particular
time, a preferred security may not be actively traded in the secondary market,
even though it may be listed on the New York Stock Exchange or other securities
exchange. Many preferred securities currently outstanding are listed on the New
York Stock Exchange, although secondary market transactions in preferred
securities are frequently effected in the over-the-counter market, even in those
preferred securities that are listed. The prices of illiquid securities may be
more volatile than more actively traded securities and the absence of a liquid
secondary market may adversely affect the ability of the Fund to buy or sell its
preferred securities holdings at the times and prices desired and the ability of
the Fund to determine its net asset value.
LEVERAGE RISK. The Fund's use of leverage through the issuance of Preferred
Shares creates an opportunity for increased Common Stock net income, but also
creates special risks for Common Stockholders. There is no assurance that the
Fund's leveraging strategy will be successful. Risks affecting the Fund's net
asset value will be magnified if and when the Fund issues Fund Preferred Shares.
If the Fund's current net investment income and capital gains are not sufficient
to meet dividend requirements on outstanding Fund Preferred Shares, the Fund may
need to liquidate certain of its investments, thereby possibly reducing the net
asset value attributable to the Common Stock. In addition, failure to meet
required asset coverage requirements for Fund Preferred Shares or to satisfy
certain guidelines established by the rating agencies may result in mandatory
partial or full redemption of Fund Preferred Shares, which would reduce or
eliminate the Fund's leverage and could also adversely affect distributions to
holders of Common Stock. Such redemptions may also cause the Fund to incur
additional
38
transaction costs, including costs associated with the sale of portfolio
securities. Leverage creates two major types of risks for Common Stockholders:
- The likelihood of greater volatility of net asset value and market price
of Common Stock because changes in the value of the Fund's portfolio are
borne entirely by the Common Stockholders; and
- The possibility either that Common Stock income will fall if the dividend
rate on the Fund Preferred Shares or the interest rate on any borrowings
rises, or that Common Stock income will fluctuate because the dividend
rate on the Fund Preferred Shares or the interest rate on any borrowings
varies.
When the Fund is utilizing leverage, the fees paid to the Adviser and its
affiliates for investment advisory services will be higher than if the Fund did
not utilize leverage because the fees paid will be calculated based on the
Fund's managed assets (which include the liquidation preference on any Fund
Preferred Shares and the principal amount of any borrowings used for leverage).
As a result, the Adviser has a financial incentive for the Fund to issue Fund
Preferred Shares or to otherwise incur leverage, which may create a conflict of
interest. See "Special Leverage Considerations" and "Description of Capital
Stock."
INDUSTRY CONCENTRATION RISK. The Fund concentrates its investments in the
utilities and banking industries. As a result, the Fund's investments may be
subject to greater risk and market fluctuation than a fund that had securities
representing a broader range of investment alternatives. See "Investment
Objective and Policies--Concentration."
INCOME INELIGIBLE FOR DRD. Investors should note that the Fund is not
expected to generate significant income that qualifies for the DRD. In addition,
most distributions from the Fund are not expected to be able to be excluded from
an individual's taxable income under certain tax proposals currently under
preliminary discussion by federal governmental officials. These discussions are
preliminary, so their impact on the Fund and its shareholders cannot be
predicted. See "Taxation."
PREFERRED SECURITIES RISK. Investment in preferred securities carries
certain risks including:
- Deferral Risk--Typically preferred securities contain provisions that
allow an issuer, at its discretion, to defer distributions for up to 20
consecutive quarters. If the Fund owns a preferred security that is
deferring its distributions, the Fund may be required to report income
for tax purposes while it is not receiving any income.
- Redemption Risk--Preferred securities typically contain provisions that
allow for redemption in the event of tax or security law changes in
addition to call features at the option of the issuer. In the event of a
redemption, the Fund may not be able to reinvest the proceeds at
comparable rates of return.
- Limited Voting Rights--Preferred securities typically do not provide any
voting rights.
- Subordination--Preferred securities are subordinated to bonds and other
debt instruments in a company's capital structure in terms of priority to
corporate income and liquidation payments, and therefore will be subject
to greater credit risk than those debt instruments.
- Liquidity--Preferred securities may be substantially less liquid than
many other securities, such as common stocks or U.S. government
securities.
UNRATED SECURITIES. The Fund may invest in unrated securities that the
Adviser determines to be of comparable quality to the rated securities in which
the Fund may invest. Dealers may not maintain daily markets in unrated
securities and retail secondary markets for many of them may not exist. As a
39
result, the Fund's ability to sell these securities when the Adviser deems it to
be appropriate may be diminished.
LOWER-QUALITY PREFERRED AND DEBT SECURITIES. The Fund is permitted to invest
up to 20% of its total assets in preferred and debt securities rated at the time
of purchase below either "Baa3" by Moody's or "BBB-" by S&P or deemed to be of
comparable quality at the time of purchase, but at least equal to either "Ba3"
or "BB-" by such rating agencies, respectively. Preferred and debt securities
rated "Ba" by Moody's are judged to have speculative elements; their future
cannot be considered as well assured and earnings and asset protection may be
very moderate. Preferred and debt securities rated "BB" by S&P are regarded as
having predominantly speculative characteristics and, while such obligations
have less near-term vulnerability to default than other speculative issues, they
face major ongoing uncertainties or exposure to adverse business, financial or
economic conditions, which could lead to inadequate capacity to meet timely
payments. See Appendix A to this prospectus for a general description of Moody's
and S&P's ratings of preferred and debt securities.
The Fund may have difficulty disposing of certain preferred and debt
securities because the trading market for such lower-quality securities may be
thinner than the market for preferred and debt securities generally. To the
extent a secondary trading market for lower-quality preferred and debt
securities does exist, it generally is not as liquid as the secondary market for
higher-rated securities. The lack of a liquid secondary market, as well as
adverse publicity and investor perception with respect to these securities, may
have an adverse impact on market price and the Fund's ability to dispose of
particular issues in response to a specific economic event such as a
deterioration in the creditworthiness of the issuer. The lack of a liquid
secondary market for certain securities also may make it more difficult for the
Fund to obtain accurate market quotations for purposes of valuing the Fund's
portfolio and calculating its net asset value. The market behavior of preferred
and debt securities in lower rating categories is often more volatile than that
of higher quality securities.
LOWER-RATED SECURITIES RISK. The Fund may invest up to 20% of its total
assets in its holdings of securities rated below investment grade at the time of
purchase or judged to be comparable in quality at the time of purchase.
Lower-rated preferred stock or debt securities, or equivalent unrated
securities, which are commonly known as "junk bonds," generally involve greater
volatility of price and risk of loss of income and principal, and may be more
susceptible to real or perceived adverse economic and competitive industry
conditions than higher grade securities. It is reasonable to expect that any
adverse economic conditions could disrupt the market for lower-rated securities,
have an adverse impact on the value of those securities, and adversely affect
the ability of the issuers of those securities to repay principal, dividends and
interest on those securities.
ANTI-TAKEOVER PROVISIONS. The Fund's Articles of Incorporation and Bylaws
include provisions that could have the effect of inhibiting the Fund's possible
conversion to open-end status and limiting the ability of other entities or
persons to acquire control of the Fund's Board of Directors. In certain
circumstances, these provisions might also inhibit the ability of shareholders
to sell their shares at a premium over prevailing market prices. See "Certain
Provisions of the Articles of Incorporation."
MARKET DISRUPTION. As a result of the terrorist attacks on the World Trade
Center and the Pentagon on September 11, 2001, some of the U.S. securities
markets were closed for a four-day period. These terrorist attacks and related
events have led to increased short-term market volatility and may have long-term
effects on U.S. and world economies and markets. A similar disruption of the
financial markets could impact interest rates, auctions, secondary trading,
ratings, credit risk, inflation and other factors relating to the Common Stock.
CONVERSION RISK. Under the Fund's Bylaws, if at any time after the third
year following the offering made hereby, shares of the Common Stock publicly
trade for a substantial period of time at a
40
significant discount from the Fund's then current net asset value per share, the
Board of Directors of the Fund is obligated to consider taking various actions
designed to reduce or eliminate the discount, including recommending to
shareholders amendments to the Fund's Articles of Incorporation to convert the
Fund to an open-end investment company, which would result in the redemption of
Fund Preferred Shares then outstanding and the potential subsequent sale of Fund
assets during unfavorable market conditions. In addition, the Board may consider
taking actions designed to eliminate the discount whenever it deems it to be
appropriate.
NO PRIOR HISTORY. The Fund is a newly organized, closed-end investment
company with no previous operating history.
MARKET DISCOUNT RISK. As with any stock, the price of the Fund's shares will
fluctuate with market conditions and other factors. Shares of closed-end
investment companies frequently trade at a discount from net asset value,
especially shortly after the completion of the initial public offering. The
Common Stock is designed for long-term investors and should not be treated as a
trading vehicle. This characteristic of shares of a closed-end fund is a risk
separate and distinct from the risk that the fund's net asset value will
decrease. The Fund cannot predict whether the Common Stock will trade at, above
or below net asset value. The risk of purchasing shares of a closed-end fund
that might trade at a discount is more pronounced for investors who wish to sell
their shares in a relatively short period of time after the initial public
offering. For those investors, realization of gain or loss on their investment
is likely to be more dependent upon the existence of a premium or discount than
upon portfolio performance and the possible advantages associated with the
leveraging of the Common Stock. Net asset value will be reduced immediately
following the initial offering by a sales load and organizational and selling
expenses paid by the Fund and immediately following any offering of Fund
Preferred Shares by the costs of that offering paid by the Fund. The Common
Stock is not redeemable.
SPECIAL LEVERAGE CONSIDERATIONS
EFFECTS OF LEVERAGE
Subject to market conditions and the Fund's receipt of an "Aaa" and "AAA"
credit ratings by rating agencies on the Fund Preferred Shares, within three
months after the completion of the offering of the Common Stock the Fund intends
to offer Fund Preferred Shares representing up to approximately 36% of the
Fund's capital immediately after their issuance. The issuance of Fund Preferred
Shares is intended to occur as soon as practicable after the proceeds of this
offering are invested. No assurance can be given that Fund Preferred Shares
representing that percentage of the Fund's capital will in fact be issued and,
if issued, will remain outstanding for any specific period of time. The issuance
of Fund Preferred Shares would result in the financial leveraging of the Common
Stock.
Although the terms of the Fund Preferred Shares and the timing and other
terms of its offering will be determined by the Fund's Board of Directors, the
Fund anticipates that, while the Fund will pay dividends on the Fund Preferred
Shares outstanding that typically reflect shorter-term rates (which would
generally be redetermined at relatively short intervals), the net return on the
Fund's portfolio, including proceeds of the Fund Preferred Shares offering, will
for the applicable comparison period exceed the dividends paid on the Fund
Preferred Shares. So long as the Fund, during the applicable comparison period,
is able to invest the proceeds of the Fund Preferred Shares offering in
securities that provide, on average, a higher net return than the rate of return
based on the then current dividends paid on the Fund Preferred Shares
outstanding after taking into account the expenses of the Fund Preferred Shares
offering and the Fund's operating expenses, the effect of leverage will be to
cause Common Stock shareholders to realize a higher current rate of return than
if the Fund were not leveraged. The leverage would also have the effect of
increasing the net asset value of the Common Stock to a greater extent than if
the Fund were not leveraged in the event the net asset value per share of the
Fund's investment portfolio increased.
41
Based on current and historical relationships between short-term,
intermediate-term and long-term yields, during the relatively short period after
the Fund Preferred Shares have been issued but before the proceeds of that
offering have been fully invested in accordance with the Fund's investment
objective and policies, the Fund will probably not be able to earn a
sufficiently high return on its investments to permit leverage to be of benefit
to Common Stock shareholders. However, before authorizing the issuance of the
Fund Preferred Shares, the Board of Directors of the Fund will consider the
length of time expected to be necessary to invest the proceeds of the Fund
Preferred Shares offering in an effort to maximize the benefits of leverage to
Common Stockholders.
Utilization of leverage is a speculative investment technique and involves
certain risks to the holders of Common Stock. These include the possibility of
higher volatility of the net asset value of the Common Stock and potentially
more volatility in the market value of the Common Stock. So long as the Fund is
able to realize a higher net return on its investment portfolio than the then
current cost of any leverage together with other related expenses, the effect of
the leverage will be to cause holders of Common Stock to realize a higher
current net investment income than if the Fund were not so leveraged. On the
other hand, to the extent that the then current cost of any leverage, together
with other related expenses, approaches the net return on the Fund's investment
portfolio, the benefit of leverage to holders of Common Stock will be reduced,
and if the then current cost of any leverage were to exceed the net return on
the Fund's portfolio, the Fund's leveraged capital structure would result in a
lower rate of return to holders of Common Stock than if the Fund were not so
leveraged.
Any increases in the Fund's assets, whether attributable to net capital
appreciation, the reinvestment of dividends or the issuance of additional shares
pursuant to the Fund's Dividend Reinvestment and Cash Purchase Plan, will result
in a decrease in the percentage of the Fund's capitalization represented by Fund
Preferred Shares outstanding, thereby reducing the effects of leverage. Since
any decline in the net asset value of the Fund's investments would be borne
entirely by holders of Common Stock, the effect of leverage in a declining
market would result in a greater decrease in net asset value to holders of
Common Stock than if the Fund were not leveraged, which would likely be
reflected in a greater decline in the market price for shares of Common Stock.
In an extreme case, if the Fund's current investment income were not sufficient
to meet dividend requirements on the Fund Preferred Shares outstanding, the Fund
may be required to liquidate certain of its investments and use the proceeds to
meet such requirements, thereby possibly reducing the net asset value
attributable to the Common Stock. For that reason, no assurance can be given
that the issuance of Fund Preferred Shares will result in a higher return to
Common Stock shareholders.
A flattening of the yield curve would reduce the current advantage of
longer-term interest rates over the short-term interest rates and could affect
the Fund adversely. In such a case, the cost to the Fund of the dividends paid
on the Fund Preferred Shares outstanding, which would generally reflect
shorter-term interest rates, could rise relative to the Fund's dividend income.
Under the typical adjustment formula, the dividend rates on adjustable rate
preferred stocks would reflect only the change in longer-term Treasury Bond
yields as the current yield curve flattened, which could impact negatively the
prices of such adjustable rate preferred stocks as well. Should the yield curve
become inverted, resulting in the discount yield on 3-month Treasury Bills
exceeding the yields on 10- and 20-year Treasury securities, the dividend rates
of adjustable rate preferred stocks would then generally be determined by the
yields on such shorter-term Treasury Bills for as long as this inverted yield
curve continued to exist. In the case of fixed rate preferred stocks, a
flattening or inversion of the yield curve would not affect the Fund's dividend
income but could negatively impact the value of such stocks.
Under the 1940 Act, the Fund is not permitted to issue preferred shares
unless immediately after the issuance the value of the Fund's total assets is at
least 200% of the liquidation value of the outstanding preferred shares (i.e.,
such liquidation value may not exceed 50% of the Fund's total assets
42
less liabilities other than borrowing). In addition, the Fund is not permitted
to declare any cash dividend or other distribution on its Common Stock unless,
at the time of such declaration, the value of the Fund's total assets less
liabilities other than borrowing is at least 200% of such liquidation value. If
Fund Preferred Shares are issued, the Fund intends, to the extent possible, to
purchase or redeem Fund Preferred Shares from time to time to the extent
necessary in order to maintain coverage of any Fund Preferred Shares of at least
200%. If the Fund has Fund Preferred Shares outstanding, two of the Fund's
Directors will be elected by the holders of Fund Preferred Shares, voting
separately as a class. The remaining Directors of the Fund will be elected by
holders of Common Stock and Fund Preferred Shares voting together as a single
class. In the event the Fund failed to pay dividends on Fund Preferred Shares
for two years, Fund Preferred Shareholders would be entitled to elect a majority
of the Directors of the Fund. The failure to pay dividends or make distributions
could result in the Fund ceasing to qualify as a regulated investment company
under the Code, which could have a material adverse effect on the value of the
Common Stock.
The Fund may be subject to certain restrictions imposed by guidelines of one
or more rating agencies which may issue ratings for Fund Preferred Shares. These
guidelines may impose asset coverage or portfolio composition requirements that
are more stringent than those imposed on the Fund by the 1940 Act. It is not
anticipated that these guidelines will impede the Adviser from managing the
Fund's portfolio in accordance with the Fund's investment objective and
policies. In addition to other considerations, to the extent that the Fund
believes that the covenants and guidelines required by a rating agency or
another rating agency would impede its ability to meet its investment objective,
or if the Fund is unable to obtain the ratings from rating agencies on the Fund
Preferred Shares (expected to be "Aaa" or "AAA"), the Fund will not issue the
Fund Preferred Shares.
Assuming that the Fund Preferred Shares will represent approximately 36% of
the Fund's capital and pay dividends at an annual average rate of 3%, the income
generated by the Fund's portfolio (net of estimated expenses) must exceed 1.18%
in order to cover such dividend payments and other expenses specifically related
to the Fund Preferred Shares. Of course, these numbers are merely estimates,
used for illustration. Actual Fund Preferred Share dividend rates may vary
frequently and may be significantly higher or lower than the rate estimated
above.
The following table is furnished in response to requirements of the
Commission. It is designed to illustrate the effect of leverage on Common Stock
total return, assuming investment portfolio total returns (comprised of income
and changes in the value of investments held in the Fund's portfolio) of -10%,
-5%, 0%, 5% and 10%. These assumed investment portfolio returns are hypothetical
figures and are not necessarily indicative of the investment portfolio returns
expected to be experienced by the Fund. The table further reflects the issuance
of Fund Preferred Shares representing approximately 36% of the Fund's total
capital and the Fund's currently projected annual Fund Preferred Share dividend
rate of 3%.
Assumed Portfolio Total
Return (Net of
Expenses).............. (10)% (5)% 0% 5% 10%
Common Stock Total
Return................. (17.31)% (9.50)% (1.69)% 6.13% 13.94%
Common Stock total return is composed of two elements--the Common Stock
dividends paid by the Fund (the amount of which is largely determined by the net
investment income of the Fund after paying dividends on Fund Preferred Shares)
and gains or losses on the value of the securities the Fund owns. As required by
Commission rules, the table assumes that the Fund is more likely to suffer
capital losses than to enjoy capital appreciation.
During the time in which the Fund is utilizing leverage, the fees paid to
the Adviser and the Servicing Agent for services will be higher than if the Fund
did not utilize leverage because the fees
43
paid will be calculated based on the Fund's managed assets. Only the Fund's
holders of Common Stock bear the cost of the Fund's fees and expenses.
The Fund may also borrow money as a temporary measure for extraordinary or
emergency purposes, including the payment of dividends and the settlement of
securities transactions which otherwise might require untimely dispositions of
Fund securities.
Until the Fund Preferred Shares are issued, the Common Stock will not be
leveraged, and the special leverage considerations described above will not
apply.
MANAGEMENT OF INVESTMENT PORTFOLIO AND CAPITAL STRUCTURE
In the event of an increase in short-term rates or other changed market
conditions to a point at which the Fund's leverage could adversely affect Common
Stock shareholders as noted above, or in anticipation of those changes, the Fund
may attempt to reduce the degree to which it is leveraged by partially or fully
redeeming or otherwise purchasing Fund Preferred Shares. If market conditions
subsequently warranted "releveraging" of the Fund's capital structure, the Fund
might sell previously unissued shares of preferred stock or shares of preferred
stock that the Fund previously issued but later repurchased.
Under the 1940 Act, the Fund is not permitted to issue shares of preferred
stock unless immediately after their issuance the net asset value of the Fund's
portfolio is at least 200% of the liquidation value of the outstanding preferred
stock (expected to equal the original purchase price per share plus any
accumulated and unpaid dividends). In addition, the Fund is not permitted to
declare any cash dividend or other distribution on the Common Stock unless, at
the time of the declaration, the net asset value of the Fund's portfolio
(determined after deducting the amount of the dividend or distribution) is at
least 200% of the liquidation value of the preferred stock outstanding. Under
the Fund's proposed capital structure, assuming the sale of Fund Preferred
Shares representing approximately 36% of the Fund's capital immediately
following the issuance of those shares of stock, the net asset value of the
Fund's portfolio is expected to be approximately 278% of the liquidation value
of the Fund Preferred Shares. If the Fund's assets declined to a point where the
Fund no longer met the 200% asset coverage test (which would represent a 28%
decline in the value of the Fund's assets from the initial asset coverage of
278%), the Fund would be restricted from making distributions to Common Stock
shareholders until the 200% asset coverage requirement was again met. To the
extent possible, the Fund intends to purchase or partially or fully redeem Fund
Preferred Shares from time to time to maintain coverage of Fund Preferred Shares
of at least 200%. As a result, holders of Fund Preferred Shares may be required
to liquidate their shares before they otherwise would have and at times that
they may deem to be disadvantageous.
INVESTMENT RESTRICTIONS
The Fund has adopted certain fundamental investment restrictions that may
not be changed without the prior approval of the holders of a majority of the
Fund's outstanding voting securities, voting as a single class, and approval of
the holders of a majority of the Fund's outstanding shares of preferred stock,
voting as a separate class. A "majority of the Fund's outstanding voting
securities" for this purpose means the lesser of (1) 67% or more of the shares
of Common Stock and shares of preferred stock present at a meeting of
shareholders, voting as a single class, if the holders of more than 50% of such
shares are present or represented by proxy at the meeting, or (2) more than 50%
of the outstanding shares of Common Stock and outstanding shares of preferred
stock voting as a single class. A majority of the Fund's outstanding shares of
preferred stock for this purpose is determined in a similar manner, by applying
the percentages in the previous sentence to outstanding shares of preferred
stock.
44
For purposes of the restrictions listed below, all percentage limitations apply
immediately after a purchase or initial investment, and any subsequent change in
any applicable percentage resulting from market fluctuations does not require
elimination of any security from the Fund's portfolio. Under its fundamental
restrictions, the Fund may not:
(1) Purchase securities (other than Government Securities) of any issuer if
as a result of the purchase more than 5% of the value of the Fund's total assets
would be invested in the securities of that issuer, except that up to 25% of the
value of the Fund's total assets may be invested without regard to this 5%
limitation.
(2) Purchase more than 10% of the voting securities of any one issuer,
except that (i) this limitation is not applicable to the Fund's investments in
Government Securities and (ii) up to 25% of the value of the Fund's total assets
may be invested without regard to this 10% limitation.
(3) Issue senior securities (including borrowing money for other than
temporary or emergency purposes) except in conformity with the limits set forth
in the 1940 Act.
(4) Sell securities short or purchase securities on margin, except for such
short-term credits as are necessary for the clearance of transactions, but the
Fund may make margin deposits in connection with transactions in options on
securities, futures and options on futures, and may make short sales of
securities "against the box."
(5) Underwrite any issue of securities, except to the extent that the sale
of portfolio securities may be deemed to be an underwriting.
(6) Purchase, hold or deal in real estate or oil and gas interests, except
that the Fund may invest in securities of companies that deal in real estate or
are engaged in the real estate business, including real estate investment
trusts, and securities secured by real estate or interests in real estate and
the Fund may hold and sell real estate or mortgages on real estate acquired
through default, liquidation, or other distributions of an interest in real
estate as a result of the Fund's ownership of such securities.
(7) Invest in commodities, except that the Fund may enter into futures
contracts, including interest rate and stock index futures, and may purchase
options and write covered options on futures contracts and securities, as
described in this prospectus.
(8) Lend any funds or other assets, except through purchasing debt
securities, lending portfolio securities and entering into repurchase agreements
consistent with the Fund's investment objective.
(9) Invest more than 25% of its total assets in the securities of issuers in
any single industry other than each of the utilities and banking industries,
except that this limitation will not be applicable to the purchase of Government
Securities.
(10) Make any investments for the purpose of exercising control or
management of any company.
Except for the investment restrictions set forth above, the Fund's
investment objective and the Fund's policy of concentrating in the utilities and
banking industries, the other policies and percentage limitations referred to in
this prospectus are not fundamental policies of the Fund and, unless provided to
the contrary in the Fund's Articles of Incorporation (together with any
amendments or supplements thereto, including any articles supplementary, the
"Articles" or "Articles of Incorporation"), may be changed by the Fund's Board
of Directors without shareholder approval. In addition, (1) the Fund's
investment objective, (2) the Fund's status as a diversified investment company
(the requirements for which are embodied in investment restrictions nos. 1 and 2
above) and (3) the Fund's policy of not
45
making any investments for the purpose of exercising control or management of
any company (see investment restriction no. 10 above) may not be changed except
through an amendment to the Fund's charter. Any such amendment would require the
vote of 80% of the votes of the Fund's Common Stock and Preferred Stock entitled
to be cast by stockholders, voting as a single class, and of at least 80% of the
votes of the Fund's Preferred Stock entitled to be cast by stockholders, voting
as a separate class. The Fund's policy of investing at least 80% of its total
assets in preferred securities is non-fundamental and may be changed by the
Board of Directors without shareholder approval, to become effective on at least
60 days' written notice to shareholders prior to any such change.
The Fund intends to apply for ratings for the Fund Preferred Shares the Fund
intends to issue. In order to obtain and maintain these ratings the Fund will be
required to comply with investment quality, diversification and other guidelines
established by the rating agencies that will be more restrictive in many
respects than the restrictions set forth above. See "Investment Objective and
Policies--Rating Agency Guidelines and Asset Coverage Requirements." The Fund
does not anticipate that such guidelines would have a material adverse effect on
the Common Stock shareholders or the Fund's ability to achieve its investment
objective.
MANAGEMENT OF THE FUND
DIRECTORS AND OFFICERS
The business and affairs of the Fund are managed under the direction of the
Fund's Board of Directors. Information pertaining to the Directors and officers
of the Fund is set forth below.
TERM OF OFFICE PRINCIPAL
POSITIONS(S) AND LENGTH OF OCCUPATION(S)
NAME, ADDRESS, AND AGE HELD WITH FUND TIME SERVED DURING PAST FIVE YEARS
---------------------- ------------------------- ------------------------- -------------------------
NON-INTERESTED
DIRECTORS:
MARTIN BRODY Director Since inception Retired.
c/o HMK Associates
30 Columbia Turnpike
Floral Park, NJ 07932
Age: 81
DAVID GALE Director Since inception President and CEO of
Delta Dividend Delta Dividend
Group, Inc. Group, Inc.
301 Pine Street (investments).
San Francisco, CA 94104
Age: 52
MORGAN GUST Director Since inception Since January 1, 1999,
Giant Industries, Inc. Executive Vice President,
23733 N. Scottsdale Road Giant Industries, Inc.;
Scottsdale, AZ 85255 and, for more than five
Age: 55 years prior thereto, Vice
President, General
Counsel and Vice
President--
Administration, Giant
Industries, Inc.
ROBERT F. WULF Director Since inception Since March 1984,
3560 Deerfield Drive Financial Consultant;
South Trustee, University of
Salem, OR 97302 Oregon Foundation;
Age: 65 Trustee, San Francisco
Theological Seminary.
NUMBER OF
FUNDS
IN FUND
COMPLEX
OVERSEEN BY OTHER DIRECTORSHIPS HELD
NAME, ADDRESS, AND AGE DIRECTOR BY DIRECTOR
---------------------- ------------------------- -------------------------
NON-INTERESTED
DIRECTORS:
MARTIN BRODY 3 Director, Jacklyn Inc.
c/o HMK Associates (luggage and
30 Columbia Turnpike accessories); Emeritus
Floral Park, NJ 07932 Director, Smith Barney
Age: 81 Mutual Funds (18 funds)
DAVID GALE 3 --
Delta Dividend
Group, Inc.
301 Pine Street
San Francisco, CA 94104
Age: 52
MORGAN GUST 3 --
Giant Industries, Inc.
23733 N. Scottsdale Road
Scottsdale, AZ 85255
Age: 55
ROBERT F. WULF 3 --
3560 Deerfield Drive
South
Salem, OR 97302
Age: 65
46
TERM OF OFFICE PRINCIPAL
POSITIONS(S) AND LENGTH OF OCCUPATION(S)
NAME, ADDRESS, AND AGE HELD WITH FUND TIME SERVED DURING PAST FIVE YEARS
---------------------- ------------------------- ------------------------- -------------------------
INTERESTED
DIRECTORS:
DONALD F. CRUMRINE+ Director and Chairman of Since inception Chairman of the Board,
301 E. Colorado Boulevard the Board since December 1996, and
Suite 720 previously held other
Pasadena, CA 91101 officerships of
Age: 55 Flaherty & Crumrine;
Director of Flaherty &
Crumrine.
NICHOLAS DALMASO+ Director, Vice President Since inception Chief Operations Officer
210 N. Hale Street and Assistant Secretary and General Counsel of
Wheaton, IL 60187 Claymore Securities, Inc.
Age: 37 since November, 2001.
Associate General Counsel
of Nuveen Investments
from July 1999 to
November, 2001. Prior to
that, Associate General
Counsel of Van Kampen
Investments.
OFFICERS
ROBERT M. ETTINGER President Since inception Since December 1996,
301 E. Colorado Boulevard President of Flaherty &
Suite 720 Crumrine.
Pasadena, CA 91101
Age: 44
PETER C. STIMES Vice President, Chief Since inception Since December 1996, Vice
301 E. Colorado Boulevard Financial Officer, Chief President of Flaherty &
Suite 720 Accounting Officer, Crumrine.
Pasadena, CA 91101 Treasurer and Assistant
Age: 47 Secretary
R. ERIC CHADWICK Vice President, Secretary Since Inception Since January 1999,
301 E. Colorado Boulevard and Assistant Treasurer portfolio manager of
Suite 720 Flaherty & Crumrine and
Pasadena, CA 91101 since 2001, Vice
Age: 27 President of Flaherty &
Crumrine; from January
1997 through November
1998, portfolio manager
of Koch Industries, Inc.
NUMBER OF
FUNDS
IN FUND
COMPLEX
OVERSEEN BY OTHER DIRECTORSHIPS HELD
NAME, ADDRESS, AND AGE DIRECTOR BY DIRECTOR
---------------------- ------------------------- -------------------------
INTERESTED
DIRECTORS:
DONALD F. CRUMRINE+ 3 --
301 E. Colorado Boulevard
Suite 720
Pasadena, CA 91101
Age: 55
NICHOLAS DALMASO+
210 N. Hale Street
Wheaton, IL 60187
Age: 37
OFFICERS
ROBERT M. ETTINGER -- --
301 E. Colorado Boulevard
Suite 720
Pasadena, CA 91101
Age: 44
PETER C. STIMES -- --
301 E. Colorado Boulevard
Suite 720
Pasadena, CA 91101
Age: 47
R. ERIC CHADWICK -- --
301 E. Colorado Boulevard
Suite 720
Pasadena, CA 91101
Age: 27
---------------------------
+ "Interested person" of the Fund as defined in the 1940 Act.
Messrs. Crumrine and Dalmaso are each considered an "interested person"
because of their affiliation with the Adviser and Servicing Agent,
respectively.
Each Director who is not a director, officer or employee of the Adviser or the
Servicing Agent or any of their affiliates receives a fee of $9,000 per annum
plus $500 for each in-person meeting of the Board of Directors or any committee
and $100 for each such meeting conducted by telephone conference call. In
addition, all Directors are reimbursed for travel and out-of-pocket expenses
associated with attending Board of Directors or committee meetings.
Commencing with the first annual meeting of shareholders, the Board of
Directors will be divided into three classes having terms of one, two and three
years, respectively. At the annual meeting of shareholders in each year
thereafter, the term of one class will expire and Directors will be elected to
47
serve in that class for terms of three years. It is anticipated that, under the
Fund's Articles of Incorporation and the 1940 Act, holders of Fund Preferred
Shares (when issued), voting as a single class, will elect two Directors and
holders of the Common Stock and the Fund Preferred Shares (when issued), voting
as a single class, will elect the remaining Directors, subject to the provisions
of the 1940 Act and the Fund's Articles, which will permit the holders of Fund
Preferred Shares to elect the minimum number of additional Directors that when
combined with the two Directors elected by the holders of Fund Preferred Shares
would give the holders of Fund Preferred Shares a majority of the Directors when
dividends are in arrears for two full years. Messrs. Gust and Dalmaso are
expected to represent the holders of Fund Preferred Shares, and the remaining
Directors are subject to election by holders of the Common Stock and the Fund
Preferred Shares (when issued), voting as a single class. Directors elected by
holders of Common Stock and Fund Preferred Shares will be apportioned among the
classes of Directors. The Fund's Articles of Incorporation limit the liability
of Directors and officers of the Fund to the Fund or its shareholders for
damages, and require that the Fund indemnify its Directors and officers against
liabilities and expenses incurred by reason of their services to the Fund, to
the fullest extent permitted by Maryland law. These provisions do not apply to
liabilities or expenses incurred as a result of any Director's or officer's
willful misfeasance, bad faith, gross negligence or reckless disregard of his
duties. The Fund, at its expense, provides liability insurance for the benefit
of its Directors and officers.
Overall responsibility for management and supervision of the Fund rests with
the Fund's Board of Directors. The Directors approve all significant agreements
between the Fund and the persons or companies that furnish services to the Fund,
including agreements with its investment adviser, servicing agent,
administrator, custodian and transfer agent. The day-to-day operations of the
Fund are delegated to the Adviser.
The Audit Committee is comprised of all of the independent directors of the
Fund (Messrs. Brody, Gale, Gust and Wulf). The role of the Fund's Audit
Committee is to assist the Board of Directors in its oversight of the Fund's
financial reporting process. The Audit Committee operates pursuant to a Charter
that was approved by the Board of Directors of the Fund on December 16, 2002. As
set forth in the Charter, management is responsible for the preparation,
presentation and integrity of the Fund's financial statements, and for the
procedures designed to ensure compliance with accounting standards and
applicable laws and regulations. The independent accountants are responsible for
planning and carrying out proper audits and reviews of the Fund's financial
statements and expressing an opinion as to their conformity with accounting
principles generally accepted in the United States of America.
The Fund's Nominating Committee is comprised of all of the independent
directors of the Fund. The Nominating Committee is responsible for considering
candidates for election to the Board of Directors in the event a position is
vacated or created. The Nominating Committee will consider recommendations by
shareholders if a vacancy were to exist. Any such recommendations should be
forwarded to the Secretary of the Fund.
48
OWNERSHIP OF SECURITIES
Set forth in the table below is the dollar range of equity securities owned
by the Directors as of the date of this prospectus in the Fund and the aggregate
dollar range of equity securities in the three registered investment companies
in the Preferred Funds family.
AGGREGATE DOLLAR RANGE OF
EQUITY SECURITIES IN ALL
REGISTERED INVESTMENT
COMPANIES OVERSEEN BY
DOLLAR RANGE OF EQUITY DIRECTOR IN FAMILY OF
NAME OF DIRECTOR SECURITIES IN THE FUND*(1) INVESTMENT COMPANIES*(1)(2)
---------------- -------------------------- ---------------------------
INTERESTED DIRECTORS
Donald F. Crumrine E(3) E
Nicholas Dalmaso A A
INDEPENDENT DIRECTORS
Martin Brody A B
David Gale A C
Morgan Gust A C
Robert F. Wulf A C
-------------------
* Key to Dollar Ranges:
A. None
B. $1--$10,000
C. $10,000--$50,000
D. $50,000--$100,000
E. Over $100,000
(1) This information for the other two Preferred Funds has been furnished by
each Director as of December 31, 2001. "Beneficial ownership" is determined
in accordance with Rule 16a-1(a)(2) of the Securities Exchange Act of 1934.
(2) Less than 1%.
(3) Mr. Crumrine may be deemed to beneficially own Fund shares held by the
Adviser as a result of his ownership of shares of the Adviser.
49
COMPENSATION
The following table sets forth certain information regarding the estimated
compensation of the Fund's Directors for the fiscal year ended November 30,
2002. Directors and executive officers of the Fund do not receive pension or
retirement benefits from the Fund.
COMPENSATION TABLE
TOTAL COMPENSATION
FROM FUND AND FUND
AGGREGATE COMPENSATION FROM COMPLEX PAID TO FUND
NAME OF PERSON AND POSITION THE FUND DIRECTORS*
--------------------------- --------------------------- --------------------
Donald F. Crumrine
Director and Chairman of the Board $0 $0
Nicholas Dalmaso
Director, Vice President and Assistant
Secretary $0 $0
Martin Brody
Director $0 $26,500
David Gale
Director $0 $27,100
Morgan Gust
Director $0 $27,300
Robert F. Wulf
Director $0 $27,400
-------------------
* Represents the total estimated compensation to be paid to such persons for
the fiscal year ended November 30, 2002 by those funds which are considered
part of the same "fund complex" because they have a common investment
adviser.
INVESTMENT ADVISER
Flaherty & Crumrine Incorporated serves as the Fund's investment adviser
pursuant to an advisory agreement between the Fund and the Adviser (the
"Advisory Agreement"). The Adviser, which was organized in 1983 and has offices
at 301 E. Colorado Boulevard, Pasadena, California 91101, specializes in the
management of portfolios of preferred securities, including related hedging
activities, for institutional investors and had aggregate assets under
management, as of November 30, 2002 (which do not include the net assets of the
Fund) of approximately $890 million. The Adviser is registered as an investment
adviser under the Investment Advisers Act of 1940, as amended, and also serves
as an investment adviser to Preferred Income Fund Incorporated and Preferred
Income Opportunity Fund Incorporated, closed-end investment companies investing
primarily in preferred securities, which as of November 30, 2002 had
approximately $409 million in aggregate total assets. In managing the day-to-
day operations of the Fund, the Adviser relies on the expertise of its team of
money management professionals, consisting of Messrs. Crumrine, Ettinger, Stimes
and Chadwick, whose backgrounds are described above. Mr. Robert T. Flaherty, a
founder of the Adviser, along with Messrs. Crumrine and Ettinger may each be
deemed to control the Adviser by virtue of their ownership of the Adviser.
Subject to the supervision and direction of the Fund's Board of Directors,
the Adviser manages the Fund's portfolio in accordance with the Fund's
investment objective and policies, places orders to purchase and sell securities
and employs professional portfolio managers and securities analysts who provide
research services to the Fund. For its services, the Adviser is paid a fee
computed and paid monthly equal to an annual rate of 0.525% on the first $200
million of the Fund's average weekly total managed assets, which is reduced to
0.45% on the next $300 million of the Fund's average weekly total managed assets
and 0.40% on the Fund's average weekly total managed assets above $500 million.
(FOR PURPOSES OF CALCULATING SUCH FEE, THE FUND'S TOTAL MANAGED ASSETS MEANS THE
TOTAL ASSETS OF THE FUND (INCLUDING ANY ASSETS ATTRIBUTABLE TO ANY FUND
PREFERRED SHARES THAT MAY BE OUTSTANDING OR OTHERWISE
50
ATTRIBUTABLE TO THE USE OF LEVERAGE) MINUS THE SUM OF ACCRUED LIABILITIES (OTHER
THAN DEBT, IF ANY, REPRESENTING FINANCIAL LEVERAGE). FOR PURPOSES OF DETERMINING
TOTAL MANAGED ASSETS, THE LIQUIDATION PREFERENCE OF THE FUND PREFERRED SHARES IS
NOT TREATED AS A LIABILITY.)
The Advisory Agreement provides that the Adviser shall not be liable for any
error of judgment or mistake of law or for any loss suffered by the Fund in
connection with the matters to which the Advisory Agreement relates, except
liability resulting from willful misfeasance, bad faith or gross negligence on
the Adviser's part in the performance of its duties or from reckless disregard
of its obligations and duties under the Advisory Agreement ("disabling
conduct"). The Advisory Agreement also provides that the Fund will indemnify the
Adviser for any loss, claim, damage, liability or expense not resulting from
disabling conduct on the part of the Adviser.
CODE OF ETHICS
The Fund and the Adviser have each adopted a written Code of Ethics (the
"Code of Ethics"), which permits personnel covered by the Code of Ethics
("Covered Persons") to invest in securities, including securities that may be
purchased or held by the Fund. The Code of Ethics also contains provisions
designed to address the conflicts of interest that could arise from personal
trading by advisory personnel, including: (1) all Covered Persons must report
their personal securities transactions at the end of each quarter; (2) with
certain limited exceptions, all Covered Persons must obtain preclearance before
executing any personal securities transactions; (3) Covered Persons may not
execute personal trades in a security if there are any pending orders in that
security by the Fund; and (4) certain Covered Persons may not invest in initial
public offerings without prior approval.
The Board reviews the administration of the Code of Ethics at least annually
and may impose sanctions for violations of the Code of Ethics.
SERVICING AGENT
Claymore Securities, Inc. (the "Servicing Agent") serves as the Fund's
Servicing Agent. In this capacity, it acts as shareholder servicing agent to the
Fund and provides oversight of the Administrator. Pursuant to a shareholder
servicing agreement (the "Servicing Agreement"), the Servicing Agent's duties
include developing and maintaining a website for the Fund; reviewing materials
made available to shareholders to assure compliance with applicable laws,
rules and regulations; disseminating the Fund's net asset value, market price
and discount; maintaining ongoing contact with brokers whose clients hold or may
have an interest in acquiring Fund shares; replying to information requests from
shareholders or prospective investors; and aiding in secondary market support
for the Fund through regular written and oral communications with the Fund's New
York Stock Exchange specialist and the investment community. As compensation for
its services, the Fund pays the Servicing Agent a fee computed and paid monthly
at the annual rate of 0.025% on the first $200 million of the Fund's average
weekly total managed assets, 0.10% on the next $300 million of the Fund's
average weekly total managed assets and 0.15% on the Fund's average weekly total
managed assets above $500 million. Total managed assets are computed in the same
manner as described above for the Adviser's fee. Claymore Securities, Inc.
specializes in the creation, development and distribution of investment
solutions for advisors and their valued clients. The Servicing Agent is
registered with the SEC as a broker-dealer.
ADMINISTRATOR AND TRANSFER AGENT
PFPC, Inc. (the "Administrator") serves as the Fund's administrator. In its
capacity as such, the Administrator calculates the net asset value of the Common
Stock and generally assists in all aspects of the administration and operation
of the Fund. Pursuant to an administration agreement between the
51
Fund and the Administrator (the "Administration Agreement"), as compensation for
the Administrator's services the Fund pays the Administrator a monthly fee at an
annual rate of 0.10% on the first $200 million of the Fund's average weekly
total managed assets, 0.04% on the next $300 million of the Fund's average
weekly total managed assets and 0.03% on the Fund's average weekly total managed
assets above $500 million. (For purposes of calculating such fee, the Fund's
total managed assets means the total assets of the Fund (including any assets
attributable to any Fund Preferred Shares that may be outstanding or otherwise
attributable to the use of leverage) minus the sum of accrued liabilities (other
than debt representing financial leverage). For purposes of determining total
managed assets, the liquidation preference of the Fund Preferred Shares is not
treated as a liability.) The Administrator also serves as the Fund's Common
Stock servicing agent (transfer agent), dividend-paying agent and registrar. As
compensation for the Administrator's services as such, the Fund pays the
Administrator a fee computed and paid monthly at an annual rate of 0.02% on the
first $150 million of the Fund's average weekly net assets attributable to the
Common Stock, 0.01% on the next $350 million of the Fund's average weekly net
assets attributable to the Common Stock and 0.005% on the Fund's average weekly
net assets attributable to the Common Stock above $500 million (which for
purposes of calculating such fee, will be deemed to be the average weekly value
of the Fund's total assets minus the sum of the Fund's liabilities (which
liabilities include the aggregate liquidation preference of the Fund's
outstanding Fund Preferred Shares) and accumulated dividends, if any, on the
Fund Preferred Shares), plus certain out-of-pocket expenses.
DURATION AND TERMINATION; NON-EXCLUSIVE SERVICES
The Advisory Agreement is effective on the date the Fund's registration
statement is declared effective by the SEC and will, unless earlier terminated
as described below, remain in effect for two years and from year to year
thereafter if approved annually (1) by the Board of Directors of the Fund or by
the holders of a majority of the Fund's outstanding voting securities and
(2) by a majority of the Directors who are not parties to the Advisory Agreement
or "interested persons" (as defined in the 1940 Act) of any such party. The
Advisory Agreement terminates on its assignment by any party and may be
terminated without penalty on 60 days' written notice at the option of any party
or by vote of the shareholders of the Fund. Each of the Administration Agreement
and the Servicing Agreement is effective on the date the Fund's registration
statement is declared effective and will terminate unless approved annually by
the Board of Directors of the Fund. Each of the Administration Agreement and the
Servicing Agreement is terminable upon 30 days' notice by the Fund and 60 day's
notice by the other party to the agreement.
The services of the Adviser, the Administrator and the Servicing Agent are
not deemed to be exclusive, and nothing in the relevant service agreements
prevents either of them or their affiliates from providing similar services to
other investment companies and other clients (whether or not their investment
objectives and policies are similar to those of the Fund) or from engaging in
other activities.
ESTIMATED EXPENSES
The Adviser, the Administrator and the Servicing Agent are each obligated to
pay expenses associated with providing the services contemplated by the
agreements to which they are parties, including compensation of and office space
for their respective officers and employees connected with investment and
economic research, trading and investment management and administration of the
Fund. The Adviser and the Servicing Agent are each obligated to pay the fees of
any Director of the Fund who is affiliated with it, except that the Fund will
bear travel expenses or an appropriate portion thereof of directors, officers or
employees of the Adviser and the Servicing Agent to the extent such expenses
relate to attendance at meetings of the Fund's Board of Directors or any
committee thereof. The Fund pays all other expenses incurred in the operation of
the Fund including, among other things, advisory, servicing and administration
fees, expenses for legal and independent accountants' services, costs of
52
printing proxies, stock certificates and shareholder reports, charges of the
custodian and transfer and dividend-paying agent and registrar, expenses in
connection with the Dividend Reinvestment and Cash Purchase Plan, Commission
fees, fees and expenses of unaffiliated Directors, membership fees in trade
associations, fidelity bond coverage for the Fund's officers and employees,
Directors' and officers' errors and omissions and liability insurance coverage,
interest, brokerage costs and stock exchange fees, taxes, stock exchange listing
fees and expenses, expenses of qualifying the Fund's shares for sale in various
states, expenses in connection with auctions of Fund Preferred Shares
outstanding, litigation and other extraordinary or non-recurring expenses, and
other expenses properly payable by the Fund. The fees and expenses incident to
the offering and issuance of Common Stock and the Fund Preferred Shares issued
by the Fund (which include certain marketing expenses of the underwriters, the
Servicing Agent and the Adviser) will be recorded as a reduction of capital of
the Fund attributable to the Common Stock.
On the basis of the anticipated size of the Fund immediately following the
offering, assuming no exercise of the over-allotment option, the Adviser
estimates that the Fund's annual operating expenses will be approximately
$3,097,850 without taking expenses incident to the initial offering of the Fund
Preferred Shares into account. No assurance can be given, in light of the Fund's
investment objective and policies, however, that actual annual operating
expenses will not be substantially more or less than this estimate and, in fact,
the Fund's annual expenses in the year in which the Fund offers its Fund
Preferred Shares can be expected to be substantially higher than the estimate.
Costs incurred in connection with the organization of the Fund, estimated at
$24,113, will be borne by the Adviser. Offering expenses relating to the Fund's
Common Stock (other than the sales load), estimated at $775,887, that do not
exceed $0.05 per share of Common Stock will be payable upon completion of the
Common Stock offering and will be charged to capital upon the commencement of
investment operations of the Fund. Offering expenses with regard to the Fund
Preferred Shares will be payable upon the completion of the offering of the Fund
Preferred Shares and will be charged to capital attributable to Common Stock at
such time.
PORTFOLIO TRANSACTIONS
GENERAL
The Fund's portfolio securities ordinarily are purchased from and sold to
parties acting as either principal or agent. In general, preferred stocks are
traded on a net basis with dealers acting as principal for their own account.
While there is no stated commission on such transactions, the price usually
includes compensation for the risk and costs incurred by the dealer. When a
party acts as agent, a stated commission cost will be incurred. The Adviser will
consider the commission cost in determining the effective price of the security.
Orders are placed directly with a principal market maker unless a better price
can be obtained by using a broker. Newly issued securities are purchased
directly from the issuer or the underwriter. The prices paid to underwriters of
newly issued securities usually include a concession paid by the issuer to the
underwriter.
Transactions on behalf of the Fund are allocated by the Adviser in its best
judgment to various dealers, which may include Merrill Lynch and other members
of the syndicate that participate in the underwriting of the Common Stock. The
primary consideration is prompt and effective execution of orders at the most
favorable price. Subject to that primary consideration, dealers may be selected
for research, statistical or other services to enable the Adviser to supplement
its own research and analysis with the views and information of other securities
firms. Research and investment services are those which brokerage houses
customarily provide to institutional investors and include research reports on
particular issues and industries.
53
Brokerage and research services furnished by brokers and dealers through
which the Fund effects securities transactions may be used by the Adviser in
advising other accounts and, conversely, brokerage and research services
furnished to the Adviser by brokers and dealers in connection with other
accounts advised by the Adviser may be used by the Adviser in advising the Fund.
Although it is not possible to place a dollar value on these services, it is the
Adviser's view that the receipt and study of such services should not reduce the
overall costs of its research services.
Investment decisions for the Fund are made independently from those of other
accounts advised by the Adviser. If such other accounts are prepared to invest
in, or desire to dispose of, securities at the same time as the Fund, however,
available investments or opportunities for sales will be allocated equitably to
each entity. In some cases, this procedure may adversely affect the size of the
position obtained for or disposed of by the Fund or the price paid or received
by the Fund.
The Fund's Board of Directors periodically reviews the commissions paid by
the Fund to determine if the commissions paid over representative periods of
time were reasonable in relation to the benefits inuring to the Fund.
PORTFOLIO TURNOVER
The Fund may engage in portfolio trading when considered appropriate, but
short-term trading will not be used as the primary means of achieving the Fund's
investment objective. The Fund cannot accurately predict its securities
portfolio turnover rate, but anticipates that its annual turnover rate will not
exceed 50% under normal market conditions. Portfolio turnover rate is calculated
by dividing the lesser of the Fund's annual sales or purchases of portfolio
securities by the monthly average value of securities in the portfolio during
the year, excluding any portfolio security (including hedging instruments), the
maturity of which at the time of acquisition is one year or less. Higher
portfolio turnover rates could result in corresponding increases in brokerage
commissions. The Fund will not consider turnover rate a limiting factor in
making investment decisions consistent with its investment objective and
policies.
DIVIDENDS AND DISTRIBUTIONS
The Fund's policy, which may be changed by the Fund's Board of Directors,
will be to distribute throughout the year, primarily in the form of regular
monthly dividends, substantially all (on an annual basis) of its net investment
income (that is, income other than net realized long-term and short-term capital
gains) and its net realized short-term capital gains, if any, to the holders of
the Common Stock. Dividends to Common Stock shareholders are expected to be
declared approximately 45 days, and paid approximately 60-90 days, after the
completion of the offering of shares of Common Stock. Expenses of the Fund are
accrued each day. The Fund will determine whether to distribute annually its net
realized long-term capital gains, if any, to Common Stock shareholders and
holders of Fund Preferred Shares outstanding. For a discussion of the
consequences of this determination to shareholders, see "Taxation--Taxation of
the Fund and its Investments."
After the issuance of Fund Preferred Shares, the dividends and capital gain
distributions to Common Stock shareholders will consist of the Fund's net
investment income and net realized short-term capital gains, if any, and, to the
extent distributed by the Fund, net realized long-term capital gains, remaining
after the payment of accumulated dividends on the Fund Preferred Shares
outstanding. While any Fund Preferred Shares are outstanding, the Fund may not
declare or pay any cash dividend or other distribution on the Common Stock
unless at the time of the declaration (1) all accumulated dividends on the Fund
Preferred Shares outstanding have been paid and (2) the Fund's net asset value
(determined after deducting the amount of that dividend or other distribution on
the Common Stock) is at least 200% of the liquidation value of the outstanding
Fund Preferred Shares (expected to equal
54
the original purchase price per share plus any accumulated and unpaid dividends
thereon). This limitation on the Fund's ability to make distributions on the
Common Stock could, under certain circumstances, impair the Fund's ability to
maintain its qualification for Federal income tax purposes as a regulated
investment company or to avoid the imposition of a 4% excise tax on certain
undistributed income. See "Taxation."
If for any full taxable year, the Fund's total payments to its shareholders
attributable to the taxable year exceed net investment income and net realized
capital gains due to its intent to make regular monthly dividend payments, the
excess payments generally will be treated as a tax-free return of capital (up to
the amount of the shareholder's tax basis in his or her shares). The amount
treated as a tax-free return of capital will reduce a shareholder's adjusted
basis in his or her shares. Pursuant to the requirements of the 1940 Act and
other applicable laws, a notice will accompany any distribution paid from
sources other than net investment income. In the event that the Fund pays to its
shareholders amounts in excess of its net investment income and net realized
capital gains, such payments may have the effect of decreasing the Fund's total
assets, which may increase the Fund's expense ratio. The Fund's Board of
Directors intends to monitor the amount of dividends paid in order to seek to
avoid such excess payments.
NET ASSET VALUE
The net asset value of the Fund's Common Stock is determined as of the close
of trading on the New York Stock Exchange, currently 4:00 p.m., New York time,
on the last day on which the New York Stock Exchange is open for trading of each
week and month and at such other times as the Board shall determine. It is
determined by dividing the value of the Fund's net assets attributable to common
shares by the number of shares of Common Stock outstanding. The value of the
Fund's net assets attributable to common shares is deemed to equal the value of
the Fund's total assets less (i) the Fund's liabilities, (ii) the aggregate
liquidation value of the outstanding Fund Preferred Shares and
(iii) accumulated and unpaid dividends on the outstanding Fund Preferred Shares.
Securities listed on a national securities exchange are valued on the basis
of the last sale on such exchange on the day of valuation, except as described
hereafter. In the absence of sales of listed securities and with respect to
(a) securities for which the most recent sale prices are not deemed to represent
fair market value and (b) unlisted securities (other than money market
instruments), securities are valued at the mean between the closing bid and
asked prices when quoted prices for investments are readily available.
Investments in over-the-counter derivative instruments, such as interest rate
swaps and options thereon ("swaptions") are valued at the prices obtained from
the broker/dealer or bank that is the counterparty to such instrument, subject
to comparison of such valuation with a valuation obtained from a broker/dealer
or bank that is not a counterparty to the particular derivative instrument.
Investments for which market quotations are not readily available or for which
management determines that the prices are not reflective of current market
conditions are valued at fair value as determined in good faith by or under the
direction of the Board of Directors, including reference to valuations of other
securities which are comparable in quality, maturity and type. Investments in
money market instruments, which mature in 60 days or less, are valued at
amortized cost. Investments in money market funds are valued at their net asset
value.
DESCRIPTION OF CAPITAL STOCK
COMMON STOCK
The Fund is authorized to issue up to 250,000,000 shares of capital stock,
of which 240,000,000 are classified as Common Stock, par value $.01 per share.
The Board of Directors is authorized to amend the Articles to increase or
decrease the aggregate number of shares of stock of the Fund or the
55
number of shares of stock of any class or series that the Fund has authority to
issue. All shares of Common Stock have equal non-cumulative voting rights and
equal rights with respect to dividends and distribution of assets upon
liquidation. Shares of Common Stock are fully paid and non-assessable when
issued and have no preemptive, conversion or exchange rights. So long as any
Fund Preferred Shares are outstanding, the Fund is not permitted to declare
dividends or make any distributions with respect to or purchase its Common Stock
unless, at the time of such declaration, distribution or purchase, as applicable
(and after giving effect thereto), all accumulated dividends on Fund Preferred
Shares outstanding have been paid, and unless asset coverage (as defined in the
1940 Act) with respect to the Fund Preferred Shares would be at least 200% after
giving effect to the dividend, distribution or purchase. See "Description of
Capital Stock--Preferred Stock" below.
PREFERRED STOCK
The Fund's Articles of Incorporation authorize the issuance of up to
10,000,000 shares of preferred stock having a par value of $.01 per share in one
or more series, with rights as determined by the Board of Directors, without the
approval of the Common Stock shareholders. Common Stock shareholders have no
preemptive right to purchase any shares of preferred stock that might be issued
by the Fund.
LIMITED ISSUANCE OF FUND PREFERRED SHARES. Under the 1940 Act, the Fund
could issue Fund Preferred Shares with an aggregate liquidation value of up to
one-half of the value of the Fund's total assets less liabilities other than
borrowings, measured immediately after issuance of the Fund Preferred Shares.
"Liquidation value" means the original purchase price of the shares being
liquidated plus any accrued and unpaid dividends. In addition, the Fund is not
permitted to declare any cash dividend or other distribution on its Common Stock
unless the liquidation value of the Fund Preferred Shares is less than one-half
of the value of the Fund's total assets less liabilities other than borrowings
(determined after deducting the amount of such dividend or distribution)
immediately after the distribution. If the Fund sells all the Common Stock and
Fund Preferred Shares discussed in this prospectus, the liquidation value of the
Fund Preferred Shares is expected to be approximately 36% of the value of the
Fund's total assets less liabilities other than borrowings. The Fund intends to
purchase or redeem Fund Preferred Shares, if necessary, to keep that fraction
below one-half.
DISTRIBUTION PREFERENCE. The Fund Preferred Shares will have complete
priority over the Common Stock.
LIQUIDATION PREFERENCE. In the event of any voluntary or involuntary
liquidation, dissolution or winding up of the affairs of the Fund, holders of
Fund Preferred Shares will be entitled to receive a preferential liquidating
distribution (expected to equal the original purchase price per share plus
accumulated and unpaid dividends thereon, whether or not earned or declared)
before any distribution of assets is made to holders of Common Stock. After
payment of the full amount of the liquidating distribution to which they are
entitled, the holders of Fund Preferred Shares outstanding will not be entitled
to any further participation in any distribution of assets by the Fund. A
consolidation, merger or statutory share exchange of the Fund with or into any
other corporation or corporations or a sale of all or substantially all of the
assets of the Fund will not be deemed to be a liquidation, dissolution or
winding up of the Fund for the purposes of determining liquidation rights.
VOTING RIGHTS. Fund Preferred Shares are required to be voting shares and to
have equal voting rights with Common Stock. Except as otherwise indicated in
this prospectus and except as otherwise required by applicable law, holders of
Fund Preferred shares will vote together with holders of Common Stock as a
single class.
56
Holders of Fund Preferred Shares, voting as a separate class, will be
entitled to elect two of the Fund's Directors. The remaining Directors will be
elected by holders of Common Stock and holders of Fund Preferred Shares, voting
together as a single class. In the unlikely event that two full years of accrued
dividends are unpaid on the Fund Preferred Shares, the holders of all
outstanding Fund Preferred Shares, voting as a separate class, will be entitled
to elect a majority of the Fund's Directors until all dividends in arrears have
been paid or declared and set apart for payment.
A majority of the votes entitled to be cast by the holders of Fund Preferred
Shares outstanding, voting as a separate class, will be required to amend the
Fund's Articles of Incorporation so as to affect adversely any contract right of
the Fund Preferred Shares set forth in the Fund's Articles of Incorporation in
any material respect or issue any shares of preferred stock ranking prior to or
on a parity with the Fund Preferred Shares as to dividends or upon liquidation
(other than previously authorized shares, including shares purchased or redeemed
by the Fund). Unless a higher percentage is provided for under "Certain
Provisions of the Articles of Incorporation," the affirmative vote of a majority
of the votes entitled to be cast by holders of Fund Preferred Shares
outstanding, voting as a separate class, will be required to approve any plan of
reorganization adversely affecting the shares or any action requiring a vote of
security holders under Section 13 (a) of the 1940 Act including, among other
things, changes in the Fund's investment objective or changes in certain
restrictions described above under "Investment Objective and Policies" and
"Investment Restrictions." The class vote of holders of Fund Preferred Shares
outstanding described above will in each case be in addition to a separate vote
of the requisite percentage of the votes entitled to be cast by holders of
shares of Common Stock and outstanding Fund Preferred Shares, voting as a single
class, necessary to authorize the action in question. The voting provisions with
respect to Fund Preferred Shares described in this prospectus will not apply if
at, or prior to, the time at which the act with respect to which the vote would
otherwise be required is effected, all outstanding Fund Preferred Shares have
been redeemed or called for redemption and sufficient funds shall have been
deposited in trust to effect such redemptions.
REDEMPTION, PURCHASE AND SALE OF FUND PREFERRED SHARES. The terms of the
Fund Preferred Shares may provide than they are redeemable at certain times, in
whole or in part, at the original purchase price per share plus accumulated
dividends. The terms may also state that the Fund may tender for or purchase
Fund Preferred Shares and resell any shares so tendered. Any redemption of
purchase of Fund Preferred Shares by the Fund will reduce the leverage
applicable to Common Stock, while any resale of shares by the Fund will increase
such leverage. See "Use of Leverage."
The discussion above describes the Board of Directors' present intention
with respect to a possible offering of Fund Preferred Shares. If the Board of
Directors determines to authorize such an offering, the terms of the Fund
Preferred Shares may be the same as, or different from, the terms described
above, subject to applicable law and the Fund's Articles of Incorporation. The
Board of Directors, without the approval of the Common Stock shareholders, may
authorize an offering of preferred stock or may determine not to authorize such
an offering.
PRINCIPAL SHAREHOLDER
As of the date of this prospectus, the Adviser was the record and beneficial
owner of all of the outstanding shares of Common Stock and thus was deemed in
"control" of the Fund as "control" is defined in the 1940 Act. These shares were
issued in respect of the Adviser's contribution of the Fund's initial capital.
The Adviser has undertaken that these shares were purchased for investment
purposes only and that they will be sold only pursuant to a registration
statement under the Securities Act of 1933, as amended (the "Securities Act"),
or an applicable exemption from the registration requirements of the Securities
Act.
57
DIVIDEND REINVESTMENT AND CASH PURCHASE PLAN
Under the Fund's Dividend Reinvestment and Cash Purchase Plan (the "Plan"),
a shareholder whose shares of Common Stock are registered in his or her own name
will have all distributions reinvested automatically by the Administrator as
agent under the Plan in additional shares of Common Stock, unless the
shareholder elects to receive distributions in cash.
Distributions with respect to shares registered in the name of a
broker-dealer or other nominee (that is, in "street name") will also be
reinvested automatically by the broker or nominee in additional shares under the
Plan, unless the shareholder elects to receive distributions in cash (but only
in the latter case if the service is provided by the broker or nominee). A
shareholder who holds shares of Common Stock registered in the name of a broker
or other nominee may not be able to transfer the shares to another broker or
nominee and continue to participate in the Plan. Investors who own shares of
Common Stock registered in street name should consult their broker or nominee
for details regarding reinvestment.
The number of shares of Common Stock distributed to participants in the Plan
in lieu of a cash dividend is determined in the following manner. Whenever the
market price per share of the Fund's Common Stock is equal to or exceeds the net
asset value per share on the valuation date, participants in the Plan will be
issued new shares valued at the higher of net asset value or 95% of the
then-current market value. Otherwise, the Administrator will buy shares of the
Common Stock in the open market, on the New York Stock Exchange or elsewhere, on
or shortly after the payment date of the dividend or distribution and continuing
until the ex-dividend date of the Fund's next distribution to holders of the
Common Stock or until it has expended for such purchases all of the cash that
would otherwise be payable to the participants. The number of purchased shares
of Common Stock that will then be credited to the participants' accounts will be
based on the average per share purchase price of the shares so purchased,
including brokerage commissions. If the Administrator commences purchases in the
open market and the then-current market price of the shares (plus any estimated
brokerage commissions) subsequently exceeds their net asset value most recently
determined before the completion of the purchases, the Administrator will
attempt to terminate purchases in the open market and cause the Fund to issue
the remaining dividend or distribution in shares. In this case, the number of
shares received by the participant will be based on the weighted average of
prices paid for shares purchased in the open market and the price at which the
Fund issues the remaining shares. These remaining shares will be issued by the
Fund at the higher of net asset value or 95% of the then-current market value.
Plan participants are not subject to any charge for reinvesting dividends or
capital gains distributions. Each Plan participant will, however, bear a
proportionate share of brokerage commissions incurred with respect to the
Administrator's open market purchases in connection with the reinvestment of
dividends or capital gains distributions.
The automatic reinvestment of dividends and capital gains distributions will
not relieve Plan participants of any income tax that may be payable on the
dividends or capital gains distributions. A participant in the Plan will be
treated for Federal income tax purposes as having received, on the dividend
payment date, a dividend or distribution in an amount equal to the cash that the
participant could have received instead of shares.
In addition to acquiring shares of Common Stock through the reinvestment of
cash dividends and distributions, a shareholder may invest any further amounts
from $100 to $3,000 semi-annually at the then-current market price in shares
purchased through the Plan. Such semi-annual investments are subject to any
brokerage commission charges incurred.
58
A shareholder whose Common Stock is registered in his or her own name and
who participates in the Plan may terminate participation in the Plan at any time
by notifying the Administrator in writing, by completing the form on the back of
the Plan account statement and forwarding it to the Administrator or by calling
the Administrator directly. A termination will be effective immediately if
notice is received by the Administrator not less than 10 days before any
dividend or distribution record date. Otherwise, the termination will be
effective, and only with respect to any subsequent dividends or distributions,
on the first day after the dividend or distribution has been credited to the
participant's account in additional shares of the Fund. Upon termination and
according to a participant's instructions, the Administrator will either
(a) issue certificates for the whole shares credited to shareholder's Plan
account and a check representing any fractional shares or (b) sell the shares in
the market. Shareholders who hold common stock registered in the name of a
broker or other nominee should consult their broker or nominee to terminate
participation.
The Plan is described in more detail in the Fund's Plan brochure.
Information concerning the Plan may be obtained from the Administrator at
1-800-331-1710.
TAXATION
The following general discussion summarizes certain U.S. Federal income tax
considerations affecting the Fund and its shareholders. This discussion does not
address state, local, or non-U.S. taxes. It is intended to be only a summary and
is not intended as a substitute for careful tax planning by prospective
shareholders. Prospective shareholders should therefore consult their own tax
advisors prior to purchasing shares of Common Stock.
This discussion only deals with persons who will hold Common Stock as a
capital asset within the meaning of Section 1221 of the Code. It does not
address the U.S. Federal income tax consequences that may be relevant to a
particular holder subject to special treatment under certain U.S. Federal income
tax laws (for example, nonresident aliens, foreign corporations and persons
subject to the alternative minimum tax provisions of the Code). Also, this
discussion is not intended to be applicable to all categories of investors, some
of which, such as dealers in securities of foreign currency, banks, trusts,
insurance companies, tax-exempt organizations (employment, charitable or other),
pension plans, persons that have a functional currency other than the U.S.
dollar and investors in pass-through entities, may be subject to special rules.
This discussion is based on the Code, the final, temporary and proposed
Treasury regulations promulgated thereunder, administrative pronouncements and
judicial decisions, all as in effect on the date hereof and all of which are
subject to change, possibly with retroactive effect. We have not requested, and
will not request, a ruling from the U.S. Internal Revenue Service, or the "IRS,"
with respect to any of the U.S. Federal income tax consequences described below.
There can be no assurance that the IRS will not disagree with or challenge any
of the conclusions set fort herein.
TAXATION OF THE FUND AND ITS INVESTMENTS
The Fund intends to qualify each year as a "regulated investment company"
under Subchapter M of the Code. To so qualify, the Fund must, among other
things: (1) derive at least 90% of its gross income in each taxable year from
dividends, interest, payments with respect to securities loans, gains from the
sale or other disposition of stock, securities or foreign currencies, or certain
other income (including, but not limited to, gains from options, futures and
forward contracts) derived with respect to the Fund's business of investing in
such stock, securities or foreign currencies and (2) diversify its holdings so
that, at the end of each quarter of the Fund's taxable year (a) at least 50% of
the market value of the Fund's total assets is represented by cash and cash
items, Government Securities, securities of other regulated investment companies
and other securities, with such other securities limited, with
59
respect to any one issuer, to an amount no greater than 5% of the value of the
Fund's total assets and not greater than 10% of the outstanding voting
securities of such issuer and (b) not more than 25% of the market value of the
Fund's total assets is invested in the securities (other than Government
Securities or securities of other regulated investment companies) of any one
issuer or of any two or more issuers that the Fund controls and which are
determined to be in the same or similar trades or businesses or related trades
or businesses. In order to meet these requirements, the Fund may be restricted
in the utilization of certain of the investment techniques described under
"Investment Objective and Policies--Investment Techniques."
As a regulated investment company, the Fund will not be subject to Federal
income tax on its net investment income (I.E., income other than its net
realized long-term and short-term capital gains) and its net realized long-term
and short-term capital gains, if any, that it distributes to its shareholders,
provided that an amount equal to at least 90% of its investment company taxable
income (I.E., at least 90% of its taxable income minus the excess, if any, of
its net realized long-term capital gains over its net realized short-term
capital losses (including any capital loss carryovers) plus or minus certain
other adjustments as specified in Section 852 of the Code but without regard to
the dividends paid deduction specified therein) for the taxable year is so
distributed, but will be subject to tax at regular corporate rates on any income
or gains that it does not distribute. Further, the Fund will be subject to a
Federal corporate income tax with respect to such distributed amounts in any
year that it fails to qualify as a regulated investment company or fails to meet
this distribution requirement. Any dividend declared by the Fund in October,
November or December of any calendar year and payable to shareholders of record
on a specified date in such a month shall be deemed to have been received by
each such shareholder on December 31 of such calendar year and to have been paid
by the Fund not later than such December 31, provided that such dividend is
actually paid by the Fund to such shareholders during January of the following
calendar year.
The Fund intends to distribute annually to its shareholders substantially
all of its investment company taxable income. The Fund also currently intends to
distribute any of its net realized long-term capital gains in excess of net
realized short-term capital losses (including any capital loss carryovers).
However, the Board of Directors of the Fund may in the future determine to
instead retain any such excess for investment. If the Fund retains for
investment an amount in excess of its net long-term capital gains less its net
short-term capital losses and capital loss carryovers, it will be subject to a
Federal corporate income tax (currently at a rate of 35%) on the amount
retained. In that event, the Fund expects to designate such retained amounts as
undistributed capital gains in a written notice to its shareholders each of whom
(a) will be required to include in income for Federal income tax purposes, as
long-term capital gains, its proportionate share of the undistributed amount,
(b) will be entitled to credit its proportionate share of the 35% tax paid by
the Fund on the undistributed amount against its own Federal income tax
liabilities, if any, and to claim refunds to the extent its credits exceed its
liabilities, and (c) will be entitled to increase its tax basis, for Federal
income tax purposes, in its shares by an amount equal to 65% of the amount of
undistributed capital gains included in its income.
The Code imposes a 4% nondeductible excise tax on the Fund to the extent the
Fund does not distribute by the end of any calendar year at least 98% of the sum
of its net investment income for that year, the net amount of its capital gains
(both long-term and short-term) for the one-year period ending, as a general
rule, on October 31 of that year and certain undistributed amounts from previous
years. For this purpose, however, any income or gain retained by the Fund that
is subject to corporate income tax will be considered to have been distributed
by year-end.
If, at any time when Fund Preferred Shares are outstanding, the Fund does
not meet the 1940 Act Asset Coverage Requirement or the Eligible Asset Coverage
Amount Requirement, the Fund will be required to suspend dividends and
distributions to holders of Common Stock until such coverage is restored. See
"Description of Capital Stock." A suspension of dividends and distributions
might prevent
60
the Fund from (1) satisfying the 90% distribution requirement described above,
thereby causing the Fund to fail to qualify to be taxed as a regulated
investment company or (2) making sufficient distributions to avoid the 4% excise
tax described above. Upon any failure to meet the Eligible Asset Coverage Amount
Requirement or the 1940 Act Asset Coverage Requirement, the Fund will be
required to redeem Fund Preferred Shares in order to maintain or restore the
requisite asset coverage and avoid the adverse consequences to the Fund and its
shareholders of failing to qualify to be taxed as a regulated investment
company. There can be no assurance, however, that any such redemption would
achieve such objectives.
If, in any taxable year, the Fund fails to qualify as a regulated investment
company under the Code, it would be taxed in the same manner as an ordinary
corporation and distributions to its shareholders would not be deductible by the
Fund in computing its taxable income. In addition, in the event of a failure to
qualify, the Fund's distributions, to the extent derived from the Fund's current
or accumulated earnings and profits, would constitute dividends (eligible for
the DRD), even though those distributions might otherwise (at least in part)
have been treated in the shareholders' hands as long-term capital gains. If the
Fund fails to qualify as a regulated investment company in any year, it must pay
out its earnings and profits accumulated in that year in order to qualify again
as a regulated investment company. In addition, if the Fund failed to qualify as
a regulated investment company for a period greater than two taxable years, the
Fund may be required to recognize any net built-in gains with respect to certain
of its assets (the excess of the aggregate gains, including items of income,
over aggregate losses that would have been realized if it had been liquidated)
in order to qualify as a regulated investment company in a subsequent year.
If the Fund is the holder of record of any stock on the record date for any
dividends payable with respect to such stock, such dividends are included in the
Fund's gross income not as of the date received but as of the later of (a) the
date such stock became ex-dividend with respect to such dividends (I.E., the
date on which a buyer of stock would not be entitled to receive the declared,
but unpaid, dividends) or (b) the date the Fund acquired such stock.
Accordingly, in order to satisfy its income distribution requirements, the Fund
may be required to pay dividends based on anticipated earnings, and shareholders
may receive dividends in an earlier year than would otherwise be the case.
The Fund's transactions will be subject to special provisions of the Code
that, among other things, may affect the character of gains and losses realized
by the Fund (I.E., may affect whether gains or losses are ordinary or capital),
may accelerate recognition of income to the Fund and may defer Fund losses.
These rules could, therefore, affect the character, amount and timing of
distributions to shareholders. These provisions also (a) will 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), and (b) may cause the Fund to recognize income
without receiving cash with which to make distributions in amounts necessary to
satisfy the 90% distribution requirement for qualifying to be taxed as a
regulated investment company and the 98% distribution requirement for avoiding
excise taxes. The Fund intends to monitor its transactions, make the appropriate
tax elections and make the appropriate entries in its books and records when it
acquires any futures contract, option or hedged investment in order to mitigate
the effect of these rules and prevent disqualification of the Fund to be taxed
as a regulated investment company.
TAXATION OF THE FUND'S SHAREHOLDERS
GENERAL. The Fund currently intends to distribute substantially all of its
net investment income and substantially all of its net realized long-term and
short-term capital gains for each of its taxable years. Generally, dividends
paid by the Fund derived from its net investment income (other than income
designated as qualifying for the DRD) are taxable to shareholders as ordinary
income. In addition, any distributions designated as being made from the Fund's
net realized long-term capital
61
gains are taxable to shareholders as long-term capital gains, regardless of the
holding period of such shareholders of the Fund's shares.
Distributions will be treated in the manner described above regardless of
whether such distributions are paid in cash or in additional shares of the Fund.
A shareholder whose distributions are reinvested in shares will be treated as
having received a dividend equal to the fair market value of the new shares
issued to the shareholder or the amount of cash allocated to the shareholder for
the purchase of shares on its behalf.
A holder of shares of Common Stock that (1) is taxed as a corporation for
Federal income tax purposes, (2) meets the applicable holding period and taxable
income requirements of Section 246 of the Code, (3) is not subject to the
"debt-financed portfolio stock" rules of Section 246A of the Code with respect
to such holder's investment in shares of Common Stock, and (4) otherwise is
entitled to the DRD under Section 243 of the Code, will be entitled to claim a
deduction in an amount equal to 70% of the dividends received on shares of
Common Stock which are designated by the Fund as qualifying for the DRD. The
Fund expects its portfolio to consist primarily of "hybrid" or taxable
preferreds. For this reason, most of the Fund's distributions will generally not
qualify for the DRD.
DISTRIBUTIONS IN EXCESS OF EARNINGS AND PROFITS. If, for any taxable year of
the Fund, the amount of distributions paid for such year exceeds its net
investment income and net realized long-term and short-term gains for such year,
the amount of such excess distribution will be treated as ordinary income up to
the amount of the Fund's current and accumulated earnings and profits as
calculated for Federal income tax purposes and any remaining excess distribution
thereafter will, as a general rule, first be treated as a non-taxable return of
capital to the extent of (and in reduction of) the shareholder's tax basis in
its shares and, after such basis has been reduced to zero, will constitute a
capital gain to the shareholder (assuming that the shares of Common Stock are
held as a capital asset). This reduction of basis would operate to increase the
shareholder's capital gain (or decrease its capital loss) upon a sale, exchange
or other disposition of its shares. Under current Federal income tax principles,
current earnings and profits are allocated first to shares of preferred stock
and any remaining current earnings and profits (after all distributions are
taken into account on the preferred stock) are allocated to common stock. Thus,
the Fund anticipates that it will allocate its current earnings and profits to
distributions on the Fund Preferred Shares prior to an allocation of such
earnings and profits to the Common Stock unless required to do otherwise by
applicable law. Since the Fund anticipates that it will distribute substantially
all of its net investment income and net realized long-term and short-term
capital gains in each of its taxable years, the Fund does not expect to have
significant amounts of accumulated earnings and profits.
If the Fund does not have any accumulated earnings and profits and makes, by
the end of its taxable year, an amount of Common Stock distributions on the
Common Stock which exceeds the amount of its current earnings and profits, then
each Common Stock dividend paid for that taxable year would be treated, in the
same proportion, in part as a dividend of taxable income and in part as a
non-taxable return of capital.
Dividends and distribution on the Fund's shares are generally subject to
federal income tax as described herein, even though such dividends and
distributions may economically represent a return of a particular shareholder's
investment. Such distributions are likely to occur in respect of shares
purchased at a time when the Fund's net asset value reflects gains that are
either unrealized or realized but not distributed. Such realized gains may be
required to be distributed even when the Fund's net asset value also reflects
unrealized losses. Distributions are taxable to a shareholder even if they are
paid from income or gains earned by the Fund prior to the shareholder's
investment (and thus included in the price paid by the shareholders).
62
The IRS currently requires that a regulated investment company that has two
or more classes of stock allocate to each such class proportionate amounts of
each type of its income (such as ordinary income and capital gains) based upon
the percentage of total dividends paid out of earnings or profits to each class
for the tax year. Accordingly, the Fund intends each year to allocate capital
gain dividends between its Common Shares and Fund Preferred Shares in proportion
to the total dividends paid out of earnings or profits to each class with
respect to such tax year. Dividends qualifying and not qualifying for the
dividends received deduction will similarly be allocated between and among these
classes.
TENDER OFFERS TO PURCHASE SHARES. Under current law, a holder of Common
Stock which tenders, in response to a tender offer by the Fund, all shares of
the Fund owned by such holder (as well as any shares considered owned by such
shareholder under attribution rules contained in the Code) will realize a
taxable gain or loss depending upon the amount realized and such shareholder's
basis in its shares. Such gain or loss will be treated as capital gain or loss
if the shares are held as capital assets in the shareholder's hands and will be
long-term or short-term depending upon the shareholder's holding period for the
shares. If a holder of Common Stock shares tenders, in response to a tender
offer by the Fund, less than all shares owned by and attributed to such holder
(or if the Fund purchases only some of the shares tendered by such holder), the
proceeds received may be treated as a taxable dividend, return of capital or
capital gain depending on the Fund's earnings and profits and the shareholder's
basis in the tendered shares.
SALE OR EXCHANGE OF SHARES. Upon the sale or exchange of shares of the Fund
which a shareholder holds as a capital asset, such shareholder may realize a
capital gain or loss which will be long-term or short-term, depending upon the
shareholder's holding period for shares. Generally, a shareholder's gain or loss
will be a long-term gain or loss if the shares have been held for more than one
year.
However, all or a portion of any loss realized upon a taxable disposition of
Fund shares will be disallowed to the extent the shares disposed of are replace
(including through reinvestment of dividends) within a period of 60 days
beginning 30 days before and ending 30 days after the disposition. In such a
case, the basis of the newly purchased shares acquired will be adjusted to
reflect the disallowed loss. Any loss realized by a shareholder on a taxable
disposition of Fund shares held by the shareholder for six months or less will
be treated as a long-term capital loss to the extent of any distributions of net
capital gain received by the shareholder (or amounts treated as undistributed
capital gains) with respect to such shares.
BACKUP WITHHOLDING. If a shareholder fails to furnish a correct taxpayer
identification number, fails to report fully dividend or interest income, or
fails to certify that it has provided a correct taxpayer identification number
and that it is not subject to backup withholding, then the shareholder may be
subject to a "backup withholding" tax at a 30% rate (for 2002 and 2003) with
respect to (1) taxable dividends and capital gain distributions and (2) the
proceeds of any sales or repurchases of Fund shares. An individual's taxpayer
identification number is his social security number. The backup withholding tax
is not an additional tax and may be credited against a taxpayer's Federal income
tax liability. Corporate shareholders and certain other shareholders are or may
be exempt from backup withholding.
STATEMENTS AND NOTICES. Each shareholder will receive an annual statement as
to the Federal income tax status of its dividends and distributions from the
Fund for the prior calendar year. Furthermore, shareholders may also receive, if
appropriate, various written notices after the close of the Fund's taxable year
regarding the Federal income tax status of certain dividends and distributions
that were paid (or that are treated as having been paid) by the Fund to its
shareholders during the preceding year.
63
OTHER TAXES. Dividends and distributions also may be subject to additional
state and local taxes depending on each shareholder's particular situation.
THE FOREGOING IS ONLY A SUMMARY OF CERTAIN TAX CONSEQUENCES AFFECTING THE
FUND AND ITS SHAREHOLDERS. SHAREHOLDERS ARE ADVISED TO CONSULT THEIR OWN TAX
ADVISORS WITH RESPECT TO THE PARTICULAR TAX CONSEQUENCES TO THEM OF AN
INVESTMENT IN THE FUND.
REPURCHASE OF COMMON STOCK AND TENDER OFFERS;
CONVERSION TO OPEN-END FUND
The Fund is a closed-end investment company and as such its shareholders do
not have the right to cause the Fund to redeem their shares. Instead, the Fund's
shares of Common Stock will trade in the open market at a price that is a
function of several factors, including dividend levels (which are in turn
affected by expenses), net asset value, call protection, dividend stability,
portfolio credit quality, relative demand for and supply of such shares in the
market, general market and economic conditions and other factors. Shares of
closed-end investment companies frequently trade at a discount from net asset
value, or in some cases trade at a premium. Some closed-end companies have taken
certain actions, including the repurchase of common stock in the market at
market prices and the making of one or more tender offers for common stock at
prices close to net asset value, in an effort to reduce or mitigate any such
discount. Others have converted to an open-end investment company, the shares of
which are redeemable at net asset value.
If at any time after the third year following the offering made hereby,
shares of the Common Stock publicly trade for a substantial period of time at a
significant discount from the Fund's then current net asset value per share, the
Board of Directors will consider, at its next regularly scheduled meeting and
regularly thereafter (not less frequently than annually) as long as such
discount persists, taking various actions designed to reduce or eliminate the
discount, including recommending to shareholders amendments of the Fund's
Articles of Incorporation to convert the Fund to an open-end investment company.
The Board may not choose to adopt any actions with respect to the Fund's
discount. Accordingly, the Fund cannot assure you that the Board will decide to
take any particular action, or, if taken, that share repurchases or tender
offers will cause the Fund's shares to trade at a price equal to their net asset
value.
As noted above, so long as any Fund Preferred Shares are outstanding, the
Fund may not purchase, redeem or otherwise acquire any shares of its Common
Stock unless (1) all accumulated dividends on Fund Preferred Shares have been
declared and paid and (2) at the time of the purchase, redemption or
acquisition, the net asset value of the Fund's portfolio (determined after
deducting the acquisition price of the Common Stock) is at least 200% of the
liquidation value of the then-outstanding Fund Preferred Shares (expected to
equal the original purchase price per share plus any accumulated and unpaid
dividends thereon).
If the Fund converted to an open-end company, it would be required to redeem
all Fund Preferred Shares then outstanding (requiring that it liquidate a
portion of its investment portfolio), and the Fund's Common Stock would no
longer be listed on the New York Stock Exchange. In contrast to a closed-end
investment company, shareholders of an open-end investment company may require
the company to redeem their shares at any time (except in certain circumstances
as authorized by or under the 1940 Act) at their net asset value, less any
redemption charge that is in effect at the time of redemption.
64
Before deciding whether to take any action if the shares of Common Stock
trade below net asset value, the Board would consider all relevant factors,
including the extent and duration of the discount, the liquidity of the Fund's
portfolio, the impact of any action that might be taken on the Fund or its
shareholders, market considerations and the effect of certain tax
considerations, including maintenance of the Fund's tax status as a regulated
investment company. Based on these considerations, even if the Fund's shares
should trade at a discount, the Board may determine that, in the interest of the
Fund and its shareholders, no action should be taken.
Conversion of the Fund to an open-end investment company would require an
amendment of the Articles. Under the Articles, such an amendment would require
the affirmative vote of at least 80% of the Board of Directors and at least 80%
of the votes entitled to be cast by holders of shares of Common Stock of the
Fund. In addition, as long as shares of Preferred Stock (including Fund
Preferred Shares) remain outstanding, the amendment would need to be approved by
the affirmative vote of at least 80% of the votes entitled to be cast by any
Preferred Stock (including Fund Preferred Shares) outstanding, voting as a
separate class. If an amendment providing for the conversion of the Fund to an
open-end investment company has been previously approved by a vote of 80% of the
Continuing Directors (as defined below), only a majority of the votes entitled
to be cast by holders of shares of Common Stock and Fund Preferred Shares
outstanding, voting together as a single class, would be required to approve the
conversion. "Continuing Director" means any member of the Board of Directors of
the Fund who (a) is not an Interested Party or an affiliate or associate of an
Interested Party and has been a member of the Board of Directors for a period of
at least 12 months (or since the Fund's commencement of operations, if that is
less than 12 months); or (b) is a successor of a Continuing Director who is not
an Interested Party or an affiliate or an associate of an Interested Party and
is recommended to succeed a Continuing Director by a majority of the Continuing
Directors then on the Board of Directors; or (c) is elected to the Board of
Directors to be a Continuing Director by a majority of the Continuing Directors
then on the Board of Directors and who is not an Interested Party or an
affiliate or associate of an Interested Party. "Interested Party" means any
person, other than the Fund's investment adviser or any of its affiliates, which
enters into, or proposes to enter into, a business combination with the Fund or
which individually or together with any other persons beneficially owns or is
deemed to own, directly or indirectly, more than 5% of any class of the Fund's
securities.
CERTAIN PROVISIONS OF THE ARTICLES OF INCORPORATION
ANTI-TAKEOVER PROVISIONS
The Fund's Articles of Incorporation include provisions that could have the
effect of limiting the ability of other entities or persons to acquire control
of the Fund or to change the composition of its Board of Directors and could
have the effect of depriving shareholders of an opportunity to sell their shares
at a premium over prevailing market prices by discouraging a third party from
seeking to obtain control of the Fund. Commencing with the first annual meeting
of shareholders, the Board of Directors will be divided into three classes. At
the annual meeting of shareholders in each year thereafter, the term of one
class expires and each Director elected to the class will hold office for a term
of three years. This provision could delay for up to two years the replacement
of a majority of the Board of Directors. The Articles provide that the maximum
number of Directors that may constitute the Fund's entire Board is 12. A
Director may be removed from office only with cause, and then only by vote of at
least 80% of the votes entitled to be cast by holders of Common Stock with
respect to Directors elected by them and at least 80% of the votes entitled to
be cast by holders of outstanding Preferred Stock with respect to the Directors
elected by them. The maximum number of Directors may be increased only by an
amendment to the Articles approved by 80% of the votes entitled to be cast by
holders of Common Stock and any outstanding Preferred Stock, each voting as a
separate class, unless approved by 80% of the Continuing Directors, in which
case the approval of a majority of the votes entitled to be cast by holders of
Common Stock and any outstanding Preferred Stock, each voting as a
65
separate class, will be required unless otherwise required by the Articles or
unless otherwise required by law.
The Articles require the favorable vote of at least 80% of the entire Board
of Directors and of at least 80% of the votes entitled to be cast by holders of
Common Stock and, as long as shares of Preferred Stock remain outstanding,
Preferred Stock, each voting as a separate class, to authorize the conversion of
the Fund from a closed-end to an open-end investment company as defined in the
1940 Act (except under certain circumstances described above in "Repurchase of
Common Stock and Tender Offers; Conversion to Open-End Fund"). The Articles of
Incorporation also require the favorable vote of at least 80% of the Directors
and at least 80% of the votes entitled to be cast by holders of Common Stock and
any outstanding Preferred Stock, each voting as a separate class, to approve,
adopt or authorize the following:
(i) merger, consolidation or share exchange of the Fund with or
into any other person;
(ii) issuance or transfer by the Fund (in one or a series of
transactions in any 12 month period) of any securities of the Fund to
any other person or entity for cash, securities or other property (or
combination thereof) having an aggregate fair market value of
$1,000,000 or more excluding sales of securities of the Fund in
connection with a public offering or private placement, issuances of
securities of the Fund pursuant to a dividend reinvestment and cash
purchase plan adopted by the Fund and issuances of securities of the
Fund upon the exercise of any stock subscription rights distributed
by the Fund;
(iii) sale, lease, exchange, mortgage, pledge, transfer or other
disposition by the Fund (in one or a series of transactions in any 12
month period) to or with any person of any assets of the Fund having
an aggregate fair market value of $1,000,000 or more except for
portfolio transactions effected by the Fund in the ordinary course of
its business (transactions within clauses (i) and (ii) and this
clause (iii) each being known individually as a "Business
Combination");
(iv) any proposal as to the voluntary liquidation or dissolution
of the Fund or any amendment to the Fund's Articles of Incorporation
to terminate its existence; and
(v) any shareholder proposal as to specific investment decisions
made or to be made with respect to the Fund's assets.
However, separate 80% votes of the holders of shares of Common Stock and any
outstanding Preferred Stock will not be required with respect to the
transactions described in (i) through (iv) above (A) if they are approved by a
vote of at least 80% of the Continuing Directors, in which case (x) the
affirmative vote of a majority of the votes entitled to be cast by all
stockholders (including by holders of Common Stock and Preferred Stock), voting
together as a single class, shall be required to approve such action if it is an
action under (i) or (iv) above or an action under (iii) with respect to a matter
as to which a stockholder vote is required under Maryland law, and (y) no
shareholder vote is required to approve an action under (ii) above or any other
under (iii) above as to which a stockholder vote is not required under Maryland
law. In addition, separate 80% votes of the holders of shares of Common Stock
and any outstanding Preferred Stock will not be required in the case of a
Business Combination, if certain conditions regarding the consideration paid by
the person entering into, or proposing to enter into, a Business Combination
with the Fund and various other requirements are satisfied, in which case the
affirmative vote of a majority of the votes entitled to be cast by all
shareholders shall be required to approve such action if any shareholders'
approval is required by law. The Fund's Bylaws contain
66
provisions the effect of which is to prevent matters, including nominations of
Directors, from being considered at shareholders' meetings where the Fund has
not received sufficient prior notice of the matters.
The Board of Directors has determined that the voting requirements described
above, which are greater than the minimum requirements under Maryland law or the
1940 Act, are in the best interests of shareholders generally. Reference should
be made to the Articles and Bylaws of the Fund on file with the Commission for
the full text of these provisions.
CUSTODIAN, TRANSFER AGENT, DIVIDEND-PAYING AGENT AND REGISTRAR
PFPC Trust Company, an indirect wholly owned subsidiary of PNC Financial
Services Group, located at 8800 Tinicum Boulevard, Suite 200, 3rd Floor,
Philadelphia, PA 19153, acts as custodian of the Fund's investments. The
Administrator located at 4400 Computer Drive, Westborough, MA 01581, serves as
the transfer agent, dividend-paying agent and registrar for the Fund's Common
Stock. The Administrator also serves as agent in connection with the Dividend
Reinvestment and Cash Purchase Plan for the Common Stock.
67
UNDERWRITING
Subject to the terms and conditions of a purchase agreement dated
, 2003, each underwriter named below has severally agreed to purchase,
and the Fund has agreed to sell to such underwriter, the respective number of
shares of Common Stock set forth opposite the name of such underwriter.
NUMBER OF SHARES
UNDERWRITER OF COMMON STOCK
----------- ----------------
Merrill Lynch, Pierce, Fenner & Smith
Incorporated............................
Raymond James & Associates, Inc...................
A.G. Edwards & Sons, Inc..........................
Legg Mason Wood Walker, Incorporated..............
RBC Dain Rauscher Inc.............................
Wachovia Securities, Inc..........................
Wells Fargo Securities, LLC.......................
Advest, Inc.......................................
BB&T Capital Markets, a division of Scott &
Stringfellow, Inc...............................
Robert W. Baird & Co. Incorporated................
Claymore Securities, Inc..........................
Fahnestock & Co. Inc..............................
Ferris, Baker Watts, Incorporated.................
J.J.B. Hilliard, W.L. Lyons, Inc..................
Huntleigh Securities Corporation..................
Janney Montgomery Scott LLC.......................
McDonald Investments Inc., a KeyCorp Company......
Morgan Keegan & Company, Inc......................
Ryan Beck & Co....................................
Wedbush Morgan Securities Inc.....................
-------
Total..................................
The purchase agreement provides that the obligations of the underwriters to
purchase the shares of Common Stock included in this offering are subject to the
approval of certain legal matters by counsel and to certain other conditions.
The underwriters are obligated to purchase all the shares of Common Stock sold
under the purchase agreement if any of the shares of Common Stock are purchased.
In the purchase agreement, the Fund and the Adviser have agreed to indemnify the
underwriters against certain liabilities, including certain liabilities arising
under the Securities Act of 1933, or to contribute to payments the underwriters
may be required to make for any of those liabilities.
The underwriters propose to initially offer some of the shares of Common
Stock directly to the public at the public offering price set forth on the cover
page of this prospectus and some of the shares of Common Stock to certain
dealers at the public offering price less a concession not in excess of $ per
share. The sales load the Fund will pay of $1.125 per share is equal to 4.5% of
the initial offering price. The underwriters may allow, and the dealers may
reallow, a discount not in excess of $ per share to other dealers. After the
initial public offering, the public offering price, concession and discount may
be changed.
68
The following table shows the public offering price, sales load, estimated
offering expenses and proceeds to the Fund. The information assumes either no
exercise or full exercise by the underwriters of their over-allotment option.
PER SHARE WITHOUT OPTION WITH OPTION
--------- -------------- -----------
Public offering price.............. $25.00 $ $
Sales load......................... $1.125 $ $
Estimated offering expenses........ $0.05 $ $
Proceeds to the Fund............... $23.825 $ $
The expenses of the offering are estimated at $775,887 and are payable by
the Fund. The Fund has agreed to pay the underwriters $0.0083 per share of
Common Stock as a partial reimbursement of expenses incurred in connection with
the offering. The Adviser has agreed to pay all organizational expenses of the
Fund. The Adviser has also agreed to pay those offering costs of the Fund (other
than the sales load, but including the partial reimbursement of expenses
described in the second preceding sentence) that exceed $0.05 per share of
Common Stock.
The Fund has granted the underwriters an option to purchase up to
additional shares of Common Stock at the public offering price, less the
sales load, within 45 days from the date of this prospectus solely to cover any
over-allotments. If the underwriters exercise this option, each will be
obligated, subject to conditions contained in the purchase agreement, to
purchase a number of additional shares proportionate to that underwriter's
initial amount reflected in the above table.
Until the distribution of the shares of Common Stock is complete, Securities
and Exchange Commission rules may limit underwriters and selling group members
from bidding for and purchasing shares of Common Stock. However, the
representatives may engage in transactions that stabilize the price of shares of
Common Stock, such as bids or purchases to peg, fix or maintain that price.
If the underwriters create a short position in shares of Common Stock in
connection with the offering, i.e., if they sell more shares of Common Stock
than are listed on the cover of this prospectus, the representatives may reduce
that short position by purchasing shares of Common Stock in the open market. The
representatives may also elect to reduce any short position by exercising all or
part of the over-allotment option described above. The underwriters may also
impose a penalty bid, whereby selling concessions allowed to syndicate members
or other broker-dealers in respect of shares of Common Stock are repurchased by
the syndicate in stabilizing or covering transactions. Purchases of shares of
Common Stock to stabilize the price or to reduce a short position may cause the
price of the Common Stock to be higher than it might be in the absence of such
purchases.
Neither the Fund nor any of the underwriters makes any representation or
prediction as to the direction or magnitude of any effect that the transactions
described above may have on the price of the shares of Common Stock. In
addition, neither the Fund nor any of the underwriters makes any representation
that the representatives will engage in these transactions or that these
transactions, once commenced, will not be discontinued without notice.
The Fund has agreed not to offer or sell any additional shares of Common
Stock for a period of 180 days after the date of the purchase agreement without
the prior written consent of the underwriters, except for the sale of the Common
Stock to the underwriters pursuant to the purchase agreement and certain
transactions relating to the Fund's Dividend Reinvestment Plan.
The Fund anticipates that the underwriters may from time to time act as
brokers or dealers in executing the Fund's portfolio transactions after they
have ceased to be underwriters. The underwriters
69
are active underwriters of, and dealers in, securities, and therefore can be
expected to engage in portfolio transactions with the Fund.
One or more of the underwriters of shares of Common Stock may also act as an
underwriter of the Fund Preferred Shares.
The Adviser (and not the Fund) has also agreed to pay a fee to Merrill Lynch
quarterly at the annual rate of 0.10% of the Fund's average daily managed assets
(including assets attributable to any Fund Preferred Shares that may be
outstanding) during the continuance of the Investment Advisory Agreement. The
maximum amount of this fee will not exceed 4.5% of the aggregate initial
offering price of the Common Stock offered hereby; provided, that in determining
when the maximum amount has been paid the value of each of the quarterly
payments shall be discounted at the annual rate of 10% to the closing date of
this offering. Merrill Lynch has agreed to provide certain after-market services
to the Adviser designed to maintain the visibility of the Fund on an ongoing
basis and to provide relevant information, studies or reports regarding the Fund
and the closed-end investment company industry.
The address of Merrill Lynch, Pierce, Fenner & Smith Incorporated is 4 World
Financial Center, New York, New York 10080.
PERFORMANCE RELATED AND COMPARATIVE INFORMATION
From time to time in its advertising and sales literature, the Fund may
include historical correlations of the market in preferred stocks, as measured
by the Merrill Lynch Preferred Stock Hybrid Securities Index, with the
investment-grade bond market, as measured by the Lehman Brothers Aggregate Bond
Index, the non-investment grade bond market, as measured by the Lehman Brothers
High Yield Index, and the equity market, as measured by the S&P 500 Index, with
such correlations calculated by the Adviser. The Merrill Lynch Preferred Stock
Hybrid Securities Index is an unmanaged index consisting of investment-grade
exchange-traded preferred stocks with outstanding market values of at least $50
million and with maturities of at least one year that are covered by Merrill
Lynch Fixed Income Research. The Lehman Brothers Aggregate Bond Index is an
unmanaged index consisting of all investment-grade, publicly-issued, fixed-rate,
dollar-denominated, nonconvertible debt issues and commercial mortgage-backed
securities with maturities of at least one year and outstanding par values of at
least $150 million. The Lehman Brothers High Yield Index is an unmanaged index
covering the universe of fixed-rate non-investment-grade debt with maturities of
at least one year and outstanding par values of at least $150 million and
includes the debt of both U.S. and non-U.S. corporations. The S&P 500 is a
capitalization-weighted index of 500 widely-held stocks designed to measure the
performance of the broad domestic economy. Such correlations will be included to
demonstrate the movement of the preferred stock market in relation to the equity
and debt markets. There have been numerous instances in the past when, for brief
intervals of time, the various sectors of the preferred security asset class
have moved independently of one another, eventually moving back together. The
Adviser believes it is well positioned to possibly take advantage of short-term
inefficiencies in the preferred securities market in an attempt to enhance
investment performance.
The Fund's advertising and sales literature may also include a discussion of
the anticipated ratings breakdown of the various components of the Fund's
portfolio under various market conditions.
ABOUT FLAHERTY & CRUMRINE INCORPORATED
The Adviser was formed in 1983 with the express intention of managing
portfolios of preferred securities for institutional investors and has over 12
years of experience in managing leveraged and
70
hedged preferred securities funds. The Adviser serves as an investment adviser
to two existing registered investment companies investing in preferred
securities that each have at least ten years of performance. Through its
experience in the preferred securities markets, the Adviser has developed and
over time utilized a methodology designed to implement the portfolio and
interest rate management strategies necessary in seeking to obtain high
sustainable income, although there can be no guarantee that such strategies will
be successful under any particular market conditions. The Fund's focus on
research goes beyond reliance on rating agencies as each member of the Adviser's
management team holds the Chartered Financial Analyst-Registered Trademark-
designation, and the firm devotes substantial resources to evaluating the
creditworthiness of each portfolio investment.
LEGAL MATTERS
The validity of the shares of Common Stock offered hereby will be passed on
for the Fund by Willkie Farr & Gallagher, New York, New York. Certain legal
matters will be passed on for the Underwriters by Clifford Chance US LLP, New
York, New York. Counsel for the Fund and the Underwriters may rely, as to
certain matters of Maryland law, on Venable, Baetjer and Howard, LLP, Baltimore,
Maryland.
REPORTS TO SHAREHOLDERS
The Fund sends unaudited semiannual and audited annual reports to the
holders of its securities, including a list of investments held.
EXPERTS
The financial statement of the Fund included in this prospectus has been so
included in reliance upon the report of KPMG LLP, independent auditors, as
experts in auditing and accounting. The address of KPMG LLP is 99 High Street,
Boston, MA 02110-2371.
71
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholder of
F&C/CLAYMORE PREFERRED SECURITIES INCOME FUND INCORPORATED:
We have audited the accompanying statement of assets and liabilities of
F&C/Claymore Preferred Securities Income Fund Incorporated as of January ,
2003. This financial statement is the responsibility of the Fund's management.
Our responsibility is to express an opinion on this financial statement based on
our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statement is free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statement. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit of this financial
statement provides a reasonable basis for our opinion.
In our opinion, the financial statement referred to above presents fairly,
in all material respects, the financial position of F&C/Claymore Preferred
Securities Income Fund Incorporated as of January , 2003, in conformity with
accounting principles generally accepted in the United States of America.
KPMG LLP
January , 2003
72
F&C/CLAYMORE PREFERRED SECURITIES INCOME FUND INCORPORATED
STATEMENT OF ASSETS AND LIABILITIES
JANUARY , 2003
ASSETS
ASSETS:
Cash............................................ $ --
Deferred offering expenses (Note 2).............
------------
Total Assets.................................... $
------------
LIABILITIES
LIABILITIES:
Accrued offering expenses (Note 2).............. $
------------
Net Assets...................................... $
============
NET ASSETS CONSIST OF:
Preferred stock, $.01 par value; 10,000,000 shares
authorized, no shares outstanding............... $ 0
Common Stock, $.01 par value per share;
240,000,000 shares authorized, ___shares issued
and outstanding
Additional paid-in capital........................
------------
Total Net Assets.................................. $ 100,000
============
Net Asset Value per common share ($100,000 divided
by ___ shares of common stock outstanding)...... $
------------
-------------------
NOTES
TO
FINANCIAL
STATEMENTS
(1) The Fund was incorporated as a Maryland corporation on May 23, 2002, and
has had no operations to date other than matters relating to its
organization and registration as a diversified, closed- end management
investment company under the Investment Company Act of 1940, as amended,
and the sale and issuance of ___shares of its Common Stock to Flaherty &
Crumrine Incorporated.
(2) Costs incurred in connection with the organization of the Fund, estimated
at $ , will be borne by the Fund's investment adviser. Costs relating
to the public offering of the Fund's shares, estimated to be approximately
$ , will be charged to paid-in capital.
73
APPENDIX A
A description of Moody's and S&P's ratings follows below:
MOODY'S
PREFERRED STOCK RATINGS
"Aaa"--Preferred stocks which are rated "Aaa" are judged to be of best
quality. This rating indicates good asset protection and the least risk of
dividend impairment within the universe of preferred stocks.
"Aa"--preferred stocks which are rated "Aa" are judged to be of high quality
by all standards. This rating indicates that there is reasonable assurance that
earnings and asset protection will remain relatively well maintained in the
foreseeable future.
"A"--Preferred stocks which are rated "A" possess many favorable investment
attributes and are to be considered as upper-medium grade. While risks are
judged to be somewhat greater than in the "Aaa" and "Aa" classifications,
earnings and asset protection are, nevertheless, expected to be maintained at
adequate levels.
"Baa"--Preferred stocks which are rated "Baa" are considered as medium-grade
obligations (they are neither highly protected nor poorly secured). Earnings and
asset protection appear adequate at present but may be questionable over any
great length of time.
"Ba"--Preferred stocks which are rated "Ba" are judged to have speculative
elements; their future cannot be considered as well assured. Often the
protection of interest and principal payments may be very moderate, and thereby
not well safeguarded during both good and bad times over the future. Uncertainty
of position characterizes securities in this class.
Moody's applies numerical modifiers 1, 2 and 3 in each generic rating
classification above in its preferred stock rating system. The modifier 1
indicates that the security ranks in the higher end of its generic rating
category; the modifier 2 indicates a mid-range ranking; and the modifier 3
indicates a ranking in the lower end of that generic rating category.
COMMERCIAL PAPER RATINGS
The rating Prime-1 (P-l) is the highest commercial paper rating assigned by
Moody's. Issuers (or related supporting institutions) rated P-1 have a superior
ability for repayment of senior short-term debt obligations, and will normally
be evidenced by leading market positions in well-established industries, high
rates of return on funds employed, conservative capitalization structure with
moderate reliance on debt and ample asset protection, broad margins in earnings
coverage of fixed financial charges and high internal cash generation, and
well-established access to a range of financial markets and assured sources of
alternate liquidity.
S & P
PREFERRED STOCK RATINGS
AAA--This is the highest rating that may be assigned to a preferred stock
issue and indicates an extremely strong capacity to pay the preferred stock
obligations.
A-1
AA--A preferred stock issue rated AA also qualifies as a high-quality fixed
income security. The capacity to pay preferred stock obligations is very strong,
although not as overwhelming as for issues rated AAA.
A--An issue rated A is backed by a sound capacity to pay the preferred stock
obligations, although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions.
BBB--An issue rated BBB is regarded as backed by an adequate capacity to pay
the preferred stock obligations. Although it normally exhibits adequate
protection parameters, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity to make payments for preferred stock
in this category than for issues in the A category.
BB--An issue rated BB is regarded, on balance, as predominantly speculative
with respect to the issuer's capacity to repay preferred stock obligations, but
has less near-term vulnerability to default than other speculative issues. While
such issues will likely have some quality and protective characteristics, these
are outweighed by major ongoing uncertainties or risk exposure to adverse
business, financial or economic conditions, which could lead to inadequate
capacity to meet timely payments.
To provide more detailed indications of preferred stock quality, the ratings
of AA, A, BBB and BB may be modified by the addition of a plus (+) or a minus
(-) sign to show the relative standing within the major rating categories.
COMMERCIAL PAPER RATINGS
An S&P commercial paper rating is a current assessment of the likelihood of
timely payment of debt having an original maturity of no more than 365 days.
A--Issues assigned this highest rating are regarded as having the greatest
capacity for timely payment. Issues in this category are delineated with the
numbers 1, 2 and 3 to indicate the relative degree of safety.
This designation indicates that the degree of safety regarding timely
payment is either overwhelming or very strong. Those issues determined to
possess overwhelming safety characteristics are denoted with a plus sign (+)
designation.
A-2
SHARES
F&C/CLAYMORE PREFERRED SECURITIES INCOME FUND INCORPORATED
COMMON STOCK
----------------
PROSPECTUS
-------------------
MERRILL LYNCH & CO.
RAYMOND JAMES
A.G. EDWARDS & SONS, INC.
LEGG MASON WOOD WALKER
INCORPORATED
RBC CAPITAL MARKETS
WACHOVIA SECURITIES
WELLS FARGO SECURITIES, LLC
ADVEST, INC.
BB&T CAPITAL MARKETS
ROBERT W. BAIRD & CO.
CLAYMORE SECURITIES, INC.
FAHNESTOCK & CO. INC.
FERRIS, BAKER WATTS
INCORPORATED
J.J.B. HILLIARD, W.L. LYONS, INC.
HUNTLEIGH SECURITIES CORPORATION
JANNEY MONTGOMERY SCOTT LLC
MCDONALD INVESTMENTS INC.
MORGAN KEEGAN & COMPANY, INC.
RYAN BECK & CO.
WEDBUSH MORGAN SECURITIES
, 2003
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
PART C - OTHER INFORMATION
ITEM 24. FINANCIAL STATEMENTS AND EXHIBITS
1. Financial Statements
Financial Statements included in Part A of this Registration Statement:
None.
Financial Statements included in Part B of this Registration Statement:
None.
2. Exhibits
(a) (1) Articles of Incorporation. (**)
(2) Amended and Restated Articles of Incorporation. (*)
(b) By-Laws. (*)
(c) Not applicable.
(d) Specimen certificate for Common Stock, par value $.01 per share.
(*)
(e) Not applicable.
(f) Not applicable.
(g) Investment Advisory Agreement between the Fund and Flaherty &
Crumrine Incorporated ("F&C"). (*)
(h) Form of Underwriting Agreement with Merrill Lynch & Co. (*)
(i) Not applicable.
(j) (1) Custodian Agreement between the Fund and PFPC Trust
Company. (*)
(2) Transfer Agency Agreement between the Fund and PFPC, Inc.
(*)
(3) Administration Agreement between the Fund and PFPC, Inc.
(*)
(4) Services Agreement between the Fund and Claymore
Securities, Inc. ("Claymore"). (*)
(k) Additional Compensation Agreement between F&C and Merrill
Lynch.(*)
(l) (1) Opinion and consent of Willkie Farr & Gallagher. (*)
(2) Opinion and consent of Venable, Baetjer and Howard,
LLP. (*)
1048174.4
(m) Not applicable.
(n) (1) Consent of KPMG, LLP. (*)
(2) Power of Attorney (***)
(o) Not applicable.
(p) Not applicable.
(q) (1) Code of Ethics of the Fund. (*)
(2) Code of Ethics of F&C. (*)
(3) Code of Ethics of Claymore. (*)
-------------------
(*) To be filed by subsequent amendment.
(**) Previously filed as an exhibit to the Fund's Registration Statement on
Form N-2 under the Securities Act of 1933, as amended (1933 Act File
No. 333-91282) and the Investment Company Act of 1940, as amended
(1940 Act File No. 811-21129) filed with the Securities and Exchange
Commission on June 26, 2002.
(***) Filed herewith on the signature page to this Registration Statement.
ITEM 25. MARKETING ARRANGEMENTS
Reference is made to the Form of Underwriting Agreement to be filed as
Exhibit (h) hereto.
ITEM 26. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
Securities and Exchange Commission Fees $
Printing and Engraving Expenses
Legal Fees
Accounting Expenses
Rating Agency Fees
Miscellaneous Expenses
Total $
ITEM 27. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL
None.
ITEM 28. NUMBER OF HOLDERS OF SECURITIES
The Fund has not yet commenced operations.
ITEM 29. INDEMNIFICATION
2
1048174.4
Section 2-418 of the General Corporation Law of the State of Maryland
and Article VIII of the Registrant's Articles of Incorporation provide for
indemnification.
Insofar as indemnification for liabilities arising under the Securities
Act of 1933, as amended, may be permitted to directors, officers and controlling
persons of the Registrant, pursuant to the foregoing provisions or otherwise,
the Registrant has been advised that in the opinion of the Securities and
Exchange Commission such indemnification is against public policy as expressed
in the Securities Act of 1933 and is, therefore, unenforceable. In the event
that a claim for indemnification against such liabilities (other than the
payment by the Registrant of expenses incurred or paid by a director, officer or
controlling person of the Registrant in the successful defense of any action,
suit or proceeding) is asserted by such director, officer or controlling person
in connection with the securities being registered, the Registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it as against public policy as expressed in the Act and
will be governed by the final adjudication of such issue.
ITEM 30. BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER
Registrant is fulfilling the requirement of this Item 30 to provide a
list of the officers and directors of its investment advisers, together with
information as to any other business, profession, vocation or employment of a
substantial nature engaged in by that entity or those of its officers and
directors during the past two years, by incorporating by reference the
information contained in the Form ADV filed with the SEC pursuant to the
Investment Advisers Act of 1940 by F&C (SEC File No. 801-19384) and Claymore
(SEC File No. 801-54810).
ITEM 31. LOCATION OF ACCOUNTS AND RECORDS
F&C/Claymore Preferred Securities Income Fund Incorporated
c/o Flaherty & Crumrine Incorporated
301 E. Colorado Blvd. - Suite 720
Pasadena, CA 91101
(Registrant's Articles of Incorporation and By Laws)
Flaherty & Crumrine Incorporated
301 E. Colorado Blvd. - Suite 720
Pasadena, CA 91101
(with respect to its services as Adviser)
Claymore Securities, Inc.
210 N. Hale Street
Wheaton, IL 60187
(with respect to its services as Servicing Agent)
ITEM 32. MANAGEMENT SERVICES
Not applicable.
ITEM 33. UNDERTAKINGS
3
1048174.4
1. Registrant undertakes to suspend offering its shares until it amends
its prospectus if (1) subsequent to the effective date of its registration
statement, the net asset value per share declines more than 10 percent from its
net asset value per share as of the effective date of this registration
statement, or (2) the net asset value per share increases to an amount greater
than its net proceeds as stated in the prospectus.
2. Not applicable.
3. Not applicable.
4. Not applicable.
5. Registrant hereby undertakes that:
(a) For purposes of determining any liability under the Securities Act
of 1933, the information omitted from the form of prospectus filed as part of
this registration statement in reliance upon Rule 430A and contained in a form
of prospectus filed by Registrant pursuant to 497(h) under the Act shall be
deemed to be part of the registration statement as of the time it was declared
effective.
(b) For the purpose of determining any liability under the Securities
Act of 1933, each post-effective amendment that contains a form of prospectus
shall be deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.
6. The Registrant undertakes to send by first class mail or other means
designed to ensure equally prompt delivery, within two business days or receipt
of a written request or oral request, any Statement of Additional Information.
4
1048174.4
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant has duly caused this registration
statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Pasadena, State of California, on the 20th day of
December, 2002.
F&C/CLAYMORE PREFERRED SECURITIES INCOME
FUND INCORPORATED
By: /s/ Robert M. Ettinger
----------------------
Robert M. Ettinger
President
POWER OF ATTORNEY
Each person whose signature appears below, hereby makes, constitutes and
appoints each of Robert M. Ettinger and Donald F. Crumrine, with full power to
act without the other, as his agent and attorney-in-fact for the purpose of
executing in his name, in his capacity as a Director of the F&C/Claymore
Preferred Securities Income Fund Incorporated, all amendments to the
registration statement on Form N-2 to be filed with the United States Securities
and Exchange Commission pursuant to the Securities Act of 1933, as amended, and
the Investment Company Act of 1940, as amended, and the rules and regulations
promulgated thereunder.
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed below by the following persons in the
capacities and on the date indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Robert M. Ettinger President (Chief Executive Officer) December 20, 2002
----------------------
Robert M. Ettinger
/s/ Peter C. Stimes Chief Financial Officer December 20, 2002
----------------------
Peter C. Stimes
/s/ Donald F. Crumrine Director and Chairman of the Board December 20, 2002
----------------------
Donald F. Crumrine
/s/ Martin Brody Director December 20, 2002
----------------
Martin Brody
/s/ Nicholas Dalmaso Director December 20, 2002
--------------------
Nicholas Dalmaso
/s/ David Gale Director December 20, 2002
--------------
David Gale
/s/ Morgan Gust Director December 20, 2002
---------------
Morgan Gust
/s/ Robert F. Wulf Director December 20, 2002
------------------
Robert F. Wulf
5
1048174.4
EXHIBIT INDEX
6