As filed with the Securities and Exchange Commission on April 15, 2003
Securities Act File No. 333-103841
Investment Company Act File No. 811-21129
U.S. Securities And Exchange Commission
Washington, D.C. 20549
-------------------
FORM N-2
(CHECK APPROPRIATE BOX OR BOXES)
[x] REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
[x] Pre-Effective Amendment No. 1
[ ] Post-Effective Amendment No.
and/or
[x] REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
[x] Amendment No. 4
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F&C/Claymore Preferred Securities Income Fund Incorporated
(Exact Name of Registrant as Specified In Charter)
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301 E. Colorado Boulevard
Pasadena, California 91101
(Address of Principal Executive Offices)
Registrant's Telephone Number, including Area Code: 626-795-7300
Robert M. Ettinger
301 E. Colorado Boulevard
Suite 720
Pasadena, CA 91101
(Name and Address of Agent For Service)
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WITH COPIES TO:
Rose F. DiMartino, Esq.
Willkie Farr & Gallagher
787 Seventh Avenue
New York, New York 10019
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Approximate Date of Proposed Public Offering: As soon as practicable
after the effective date of this Registration Statement.
If any 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. [ ]
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CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933
PROPOSED MAXIMUM PROPOSED MAXIMUM
TITLE OF SECURITIES BEING AMOUNT BEING OFFERING PRICE PER AGGREGATE OFFERING AMOUNT OF
REGISTERED REGISTERED(1) UNIT PRICE REGISTRATION FEE(1)(2)
-------------------------------------------------------------------------------------------------------------------------
Auction Market Preferred Stock, 21,680 shares $25,000 $542,000,000 $43,847.80
$0.01 par value
(1) As calculated pursuant to Rule 457(c) under the Securities Act of 1933, as
amended.
(2) Of this amount, $80.90 was transmitted prior to the initial filing of the
Registration Statement and the remainder was transmitted prior to this
filing.
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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 THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATES AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING
PURSUANT TO SAID SECTION 8(a), MAY DETERMINE.
2
SUBJECT TO COMPLETION
PRELIMINARY PROSPECTUS DATED APRIL 15, 2003
THE INFORMATION IN THIS PROSPECTUS IN 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.
PROSPECTUS
$542,000,000
[F&C LOGO] [CLAYMORE LOGO]
F&C/CLAYMORE PREFERRED SECURITIES
INCOME FUND INCORPORATED
AUCTION MARKET PREFERRED SHARES ("AMPS")
3,200 SHARES, SERIES M7
3,200 SHARES, SERIES T7
3,200 SHARES, SERIES W7
3,200 SHARES, SERIES TH7
3,200 SHARES, SERIES F7
2,840 SHARES, SERIES T28
2,840 SHARES, SERIES W28
LIQUIDATION PREFERENCE $25,000 PER SHARE
-------------
F&C/Claymore Preferred Securities Income Fund Incorporated (the "Fund") is a
recently organized, diversified, closed-end 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 (which securities must be
rated at least either 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.
THE OFFERING. The Fund is offering 21,680 Auction Market Preferred Shares
("AMPS") in seven separate series: 3,200 Shares Series M7, 3,200 Shares
Series T7, 3,200 Shares Series W7, 3,200 Shares Series Th7, 3,200 Shares
Series F7, 2,840 Shares Series T28 and 2,840 Shares Series W28. The AMPS will
not be listed on any exchange. Generally, investors may only buy and sell the
AMPS through an order placed at an auction with or through a broker-dealer that
has entered into an agreement with the auction agent or in a secondary market
that certain broker-dealers may maintain. These broker-dealers are not required
to maintain a market in the AMPS, and a secondary market, if one develops, may
not provide investors with liquidity.
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.
INVESTING IN THE AMPS INVOLVES RISKS THAT ARE DESCRIBED IN "RISKS OF THE
FUND" BEGINNING ON PAGE 42 OF THIS PROSPECTUS. CERTAIN OF THESE RISKS ARE
SUMMARIZED IN "PROSPECTUS SUMMARY--RISKS OF THE FUND" BEGINNING ON PAGE 9 OF THE
PROSPECTUS. THE MINIMUM PURCHASE AMOUNT OF THE AMPS IS $25,000.
----------------
PER SHARE TOTAL
--------- -----
Public offering price............................ $25,000 $542,000,000
Sales load....................................... $250 $5,420,000
Proceeds, before expenses, to the Fund(1)........ $24,750 $536,580,000
(1) Not including offering expenses payable by the Fund estimated to be
$475,000
The public offering price per share will be increased by the amount of
dividends, if any, that have accumulated from the date the AMPS are first
issued.
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 underwriters are offering the AMPS subject to various conditions. The
AMPS will be ready for delivery in book-entry form only through the facilities
of The Depository Trust Company on or about April , 2003.
--------------------
MERRILL LYNCH & CO. A.G. EDWARDS & SONS, INC.
-------------
The date of this prospectus is , 2003.
This prospectus sets forth concisely information about the Fund you should
know before investing. You should read the prospectus before deciding whether to
invest and retain it for future reference. A Statement of Additional
Information, dated April , 2003 (the "SAI"), containing additional information
about the Fund, has been filed with the Securities and Exchange Commission (the
"SEC") and is incorporated by reference in its entirety into this prospectus.
You can review the table of contents of the SAI on page 74 of this prospectus.
You may request a free copy of the SAI by calling (800) 345-7999 or by writing
to the Fund. You may also obtain the SAI and other information regarding the
Fund on the SEC's web site (http://www.sec.gov).
Investors in the AMPS will be entitled to receive cash dividends at an
annual rate that may vary for the successive dividend periods for the AMPS. The
dividend rate for the initial dividend period for each Series will be as
follows: Series M7 -- %, Series T7 -- %, Series W7 -- %,
Series Th7 -- %, Series F7 -- %, Series T28 -- % and Series W28 --
%. The initial dividend period for the AMPS is from the date of issuance
through the following applicable dates: Series M7 -- , 2003;
Series T7 -- , 2003; Series W7 -- , 2003; Series Th7 -- ,
2003; Series F7 -- , 2003; Series T28 -- , 2003; and
Series W28 -- , 2003. For subsequent dividend periods, the AMPS will pay
dividends based on a rate generally set at auctions held every seven days for
Series M7, T7, W7, Th7 and F7 and every 28 days for Series T28 and W28. After
the initial rate period described in this prospectus, investors may generally
only buy or sell AMPS through an order placed at an auction with or through a
broker-dealer in accordance with the procedures specified in this prospectus.
The dividend rate that results from an auction will not be greater than the
applicable maximum rate for any rate period. See "Description of AMPS--Dividends
and Rate Periods--Calculation of Dividend Payment." Prospective purchasers
should carefully review the auction procedures described in this prospectus, and
should note:
- a buy order (called a "bid") or sell order is a commitment to buy or sell
AMPS based on the results of an auction;
- purchases and sales will be settled on the next business day after the
auction; and
- ownership of the AMPS will be maintained in book-entry form by or through
The Depository Trust Company (or any successor securities depository).
The AMPS, which have no history of public trading, are not listed on an
exchange. Broker-dealers may maintain a secondary trading market in the AMPS
outside of the auctions; however, they have no obligation to do so, and there
can be no assurance that a secondary market for the AMPS will develop or, if it
does develop, that it will provide holders with a liquid trading market (i.e.,
trading will depend on the presence of willing buyers and sellers, and the
trading price will be subject to variables to be determined at the time of the
trade by such broker-dealers). A general increase in the level of interest rates
may have an adverse effect on the secondary market price of the AMPS, and an
investor that sells AMPS between auctions may receive a price per share of less
than $25,000.
The AMPS will be senior to the Fund's outstanding shares of common stock,
par value $0.01 per share ("Common Shares"), which are traded on the New York
Stock Exchange under the symbol "FFC." The AMPS have a liquidation preference of
$25,000 per share, plus any accumulated, unpaid dividends. The AMPS also have
priority over the Common Shares as to distribution of assets. See "Description
of AMPS." The Fund may redeem AMPS as described under "Description of
AMPS-Redemption." It is a condition of closing this offering that the AMPS be
offered with a rating of "Aaa" from Moody's Investors Service, Inc. ("Moody's")
and of "AAA" from Fitch Ratings ("Fitch").
The AMPS do not represent a deposit or obligation of, and are not guaranteed
or endorsed by, any bank or other insured depositary institution, and are 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
Financial Highlights (Unaudited).................. 19
The Fund.......................................... 20
Use of Proceeds................................... 20
Capitalization.................................... 21
Portfolio Composition............................. 21
Investment Objective and Policies................. 21
Risks of the Fund................................. 42
Management of the Fund............................ 48
Description of AMPS............................... 51
The Auction....................................... 60
Net Asset Value................................... 64
Description of Capital Structure.................. 64
Repurchase of Common Stock and Tender Offers;
Conversion to Open-End Fund..................... 66
Tax Matters....................................... 68
Certain Provisions of the Articles of
Incorporation................................... 70
Underwriting...................................... 72
Custodian, Transfer Agent and Auction Agent....... 73
Legal Matters..................................... 73
Available Information............................. 73
Table of Contents of the Statement of Additional
Information..................................... 74
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 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.
3
PROSPECTUS SUMMARY
THIS IS ONLY A SUMMARY. THIS SUMMARY MAY NOT CONTAIN ALL OF THE INFORMATION
THAT YOU SHOULD CONSIDER BEFORE INVESTING IN THE AMPS. YOU SHOULD REVIEW THE
MORE DETAILED INFORMATION CONTAINED IN THIS PROSPECTUS AND IN THE SAI,
ESPECIALLY THE INFORMATION SET FORTH UNDER THE HEADING "RISKS OF THE FUND."
THE FUND............ F&C/Claymore Preferred Securities Income Fund Incorporated
(the "Fund") is a recently organized, diversified,
closed-end management investment company. The Fund
commenced operations on January 31, 2003 in connection
with an initial public offering of 36,500,000 Common
Shares. As of March 31, 2003, the Fund had 40,854,198
Common Shares outstanding and assets of approximately
$977,787,265. The Fund's Common Shares are traded on the
New York Stock Exchange under the symbol "FFC." The Fund's
principal office is located at 301 E. Colorado Boulevard,
Pasadena, California 91101, and its telephone number is
(626) 795-7300. See "The Fund."
THE OFFERING........ The Fund is offering 21,680 AMPS, $0.01 par value, at a
purchase price of $25,000 per share plus dividends, if
any, that have accumulated from the date the Fund first
issues the AMPS. Seven separate series are being offered:
3,200 Shares Series M7, 3,200 Shares Series T7,
3,200 Shares Series W7, 3,200 Shares Series Th7,
3,200 Shares Series F7, 2,840 Shares Series T28 and
2,840 Shares Series W28. The AMPS are being offered by a
group of underwriters (the "Underwriters") led by Merrill
Lynch, Pierce, Fenner & Smith Incorporated ("Merrill
Lynch").
The AMPS entitle their holders to receive cash dividends
at an annual rate that may vary for the successive
dividend periods for the AMPS. In general, except as
described under "Description of AMPS--Dividends and Rate
Periods," the dividend period for the Series M7, T7, W7,
Th7 and F7 AMPS will be seven days and the dividend period
for the Series T28 and W28 AMPS will be 28 days. The
auction agent will determine the dividend rate for a
particular rate period by an auction conducted on the
business day immediately prior to the start of that rate
period. See "The Auction."
The AMPS are not listed on an exchange. Instead, investors
will generally buy or sell AMPS in an auction by
submitting orders to broker-dealers that have entered into
an agreement with the auction agent.
Generally, investors in AMPS will not receive certificates
representing ownership of their shares. The securities
depository (The Depository Trust Company or any successor)
or its nominee for the account of the investor's
broker-dealer will maintain record ownership of AMPS in
book-entry form. An investor's broker-dealer, in turn,
will maintain records of that investor's beneficial
ownership of AMPS.
ADVISER AND Flaherty & Crumrine Incorporated (the "Adviser"), a
SERVICING AGENT... registered investment adviser, acts as the Fund's
investment adviser. The
4
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 March 31, 2003 (excluding the net
assets of the Fund), equal to approximately $938 million.
Claymore Securities, Inc. (the "Servicing Agent"), a
registered broker-dealer, acts as shareholder servicing
agent to the Fund. Claymore specializes in the creation,
development and distribution of investment solutions for
advisors and their valued clients.
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 Common Shares and generally
assists in all aspects of the Fund's administration and
operation. The Administrator also serves as the Fund's
Common Shares servicing agent (transfer agent),
dividend-paying agent and registrar.
FEES AND EXPENSES... 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 include the liquidation preference of the
AMPS and the principal amount of any borrowings used for
leverage), 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 (which include the liquidation preference on the
AMPS and the principal amount of any borrowings used for
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 AMPS is not treated as a liability. See
"Management of the Fund--Adviser."
The Fund pays the Administrator a monthly fee computed on
the basis of the average weekly total managed assets of
the Fund at an annual rate equal to 0.10% of the first
$200 million in assets, 0.04% on the next $300 million in
assets, 0.03% on the next $500 million in assets and 0.02%
on assets in excess of $1 billion. For acting as Common
Shares transfer agent, dividend-paying agent and
registrar, the Fund pays the Administrator a monthly fee
computed on the basis of the average weekly net assets
attributable to the Common Shares at an annual rate equal
to 0.02% of the first $150 million in assets, 0.01% on the
next $350 million in assets, 0.005% on the next
$500 million in assets
5
and 0.0025% on assets in excess of $1 billion. See
"Management of the Fund--Administrative Services."
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 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 holding
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
6
"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 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. Preferred securities
include securities that are commonly known as MIPs, QUIPS,
TOPrS, TrUPS, QUIDS, CorTS, 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.
7
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.
FOREIGN SECURITIES. The Fund will invest primarily in the
securities of U.S. issuers. However, the Fund may invest
up to 10% of total assets in the securities other than
money market securities of companies organized outside the
United States. All foreign securities held by the Fund
will be denominated in U.S. dollars.
See "Investment Objective and Policies."
LEVERAGE............ The Fund expects to utilize financial leverage on an
ongoing basis for investment purposes. The Fund
anticipates that, immediately after the completion of the
offering of AMPS, the AMPS (together with any other
outstanding forms of leverage) will represent
approximately 36% of the Fund's total managed assets. This
amount may vary, but the Fund will not incur leverage
(including AMPS and other forms of leverage) in an amount
exceeding 50% of its total managed assets. "Total managed
assets" means the net asset value of the Common Shares
plus the liquidation preference of any preferred shares
(including the AMPS) and the principal amount of any
borrowings used for leverage. Although the Fund may in the
future offer other preferred shares, the Fund does not
currently intend to offer preferred shares other than the
AMPS offered in this prospectus.
As an alternative to AMPS (during periods in which no AMPS
are outstanding), the Fund may incur leverage through the
issuance of commercial paper or notes or other borrowings.
Any AMPS or borrowings will have seniority over the Common
Shares.
The Fund generally will not utilize leverage if it
anticipates that it would result in a lower return to
holders of the Fund's Common Shares ("Common
Shareholders") over time than if leverage were not used.
Use of financial leverage creates an opportunity for
increased income for Common Shareholders, but, at the same
time, creates the possibility for greater loss (including
the likelihood of greater volatility of dividends on the
Common Shares and of the net asset value and market price
of the Common Shares), and there can be no assurance that
the Fund's use of leverage will be successful. Because the
fees received by the Adviser are based on the total
managed assets of the Fund (including assets represented
by the AMPS and other leverage), the Adviser has a finan-
cial incentive for the Fund to issue the AMPS and incur
other leverage. See "Risks of the Fund--General Risks of
Investing in the Fund--Leverage Risk."
8
RISKS OF THE FUND... Risk is inherent in all investing. Therefore, before
investing in the AMPS and the Fund, you should consider
the risks carefully. The following paragraphs summarize
certain important risks to which the Fund and the AMPS are
subject. For a more detailed discussion of these risks,
see "Risks of the Fund."
RISKS OF INVESTING IN THE AMPS
The primary risks of investing in the AMPS include:
DIVIDEND PAYMENT RISK. The Fund will not be permitted to
declare dividends or other distributions with respect to
the AMPS unless the Fund meets certain asset coverage
requirements.
In certain circumstances, the Fund may not earn sufficient
income from its investments to pay dividends on the AMPS.
REDEEMABILITY. Unlike shares of an open-end mutual fund,
including a money market mutual fund, the AMPS may not be
redeemed at the option of the holder.
INTEREST RATE RISK. The AMPS pay dividends based on
shorter-term interest rates. The Fund purchases equity
securities that pay dividends that are based on the
performance of the issuers and debt securities that pay
interest based on longer-term yields. These dividends and
interest payments are typically, although not always,
higher than shorter-term interest rates. Dividends, as
well as longer-term and shorter-term interest rates,
fluctuate. If shorter-term interest rates rise, dividend
rates on AMPS may rise so that the amount of dividends
paid to holders of AMPS exceeds the income from the
portfolio securities. Because income from the Fund's
entire investment portfolio (not just the portion of the
portfolio purchased with the proceeds of the AMPS
offering) is available to pay dividends on AMPS, however,
dividend rates on AMPS would need to exceed the net rate
of return on the Fund's portfolio by a significant margin
before the Fund's ability to pay dividends on AMPS would
be jeopardized. If long-term interest rates rise, this
could negatively impact the value of the Fund's investment
portfolio and thus reduce the amount of assets serving as
asset coverage for the AMPS.
AUCTION RISK. You may not be able to sell your AMPS at an
auction if the auction fails, i.e., if there are more AMPS
offered for sale than there are buyers for those shares.
Also, if you place a bid order (an order to retain AMPS)
at an auction only at a specified rate, and that rate
exceeds the rate set at the auction, your order will be
deemed an irrevocable offer to sell your AMPS, and you
will not retain your AMPS. Additionally, if you buy AMPS
or elect to retain AMPS without specifying a rate below
which you would not wish to buy or continue to hold those
shares, and the auction sets a below-market rate, you may
receive a lower rate of return on your AMPS than the
market rate for similar investments. The dividend period
for the AMPS may be changed by the Fund, subject to
certain conditions and with notice to the holders of the
AMPS, which could also affect the liquidity
9
of your investment. See "Description of AMPS" and "The
Auction."
SECONDARY MARKET RISK. If you try to sell your AMPS
between auctions, you may not be able to sell any or all
of your shares, or you may not be able to sell them for
$25,000 per share or $25,000 per share plus accumulated
dividends. Changes in interest rates could affect the
price you would receive if you sold your AMPS in the
secondary market, particularly if the Fund has designated
a special rate period (a dividend period of more than
seven days for Series M7, T7, W7, Th7 and F7 and of more
than 28 days for Series T28 and W28). Broker-dealers that
maintain a secondary trading market (if any) for the AMPS
are not required to maintain this market, and the Fund is
not required to redeem shares if either an auction or an
attempted secondary market sale fails because of a lack of
buyers. The AMPS are not registered on a stock exchange or
The Nasdaq Stock Market, Inc. ("NASDAQ"). If you sell your
AMPS between auctions, you may receive less than the price
you paid for them, especially when market interest rates
have risen since the last auction or during a special rate
period.
RATINGS AND ASSET COVERAGE RISK. While it is a condition
to the closing of the offering that Moody's assigns a
rating of "Aaa" and Fitch assigns a rating of "AAA" to the
AMPS, these ratings do not eliminate or necessarily
mitigate the risks of investing in AMPS. In addition,
Moody's, Fitch or another rating agency rating the AMPS
could downgrade the AMPS, which may make your shares less
liquid at an auction or in the secondary market. If a
rating agency downgrades the AMPS, the Fund may (but is
not required to) alter its portfolio in an effort to
improve the rating, although there is no assurance that it
will be able to do so to the extent necessary to restore
the prior rating. See "Risks of the Fund--Portfolio
Turnover." Such a downgrade could affect the liquidity of
the AMPS. In addition, the Fund may be forced to redeem
your AMPS to meet regulatory or rating agency require-
ments. The Fund may also voluntarily redeem AMPS under
certain circumstances. See "Description of
AMPS--Redemption." The asset coverage requirements imposed
by a rating agency may limit the Fund's ability to invest
in certain securities or utilize certain investment
techniques that the Adviser might otherwise consider
desirable. See "Description of AMPS--Rating Agency
Guidelines and Asset Coverage" for a description of the
rating agency guidelines with which the Fund must
currently comply.
RESTRICTIONS ON DIVIDENDS AND OTHER DISTRIBUTIONS.
Restrictions imposed on the declaration and payment of
dividends or other distributions to the holders of the
Fund's Common Shares and AMPS, both by the 1940 Act and by
requirements imposed by rating agencies, might impair the
Fund's ability to maintain its qualification as a
regulated investment company for federal income tax
purposes. While the Fund intends to redeem AMPS to enable
the Fund to distribute its income as required to maintain
10
its qualification as a regulated investment company under
the Code, there can be no assurance that such redemptions
can be effected in time to meet the requirements of the
Code. See "Tax Matters."
PORTFOLIO INVESTMENTS RISK. In certain circumstances, the
Fund may not earn sufficient income from its investments
to pay dividends on AMPS. In addition, the value of the
Fund's investment portfolio may decline, reducing the
asset coverage for the AMPS. If an issuer whose securities
the Fund purchases experiences financial difficulties,
defaults, or is otherwise affected by adverse market
factors, there may be a negative impact on the income
and/or asset value of the Fund's investment portfolio,
which would reduce asset coverage for the AMPS and make it
more difficult for the Fund to pay dividends on the AMPS.
GENERAL RISKS OF INVESTING IN THE FUND
In addition to the risks described above, certain general
risks relating to an investment in the Fund may under
certain circumstances reduce the Fund's ability to pay
dividends and meet its asset coverage requirements on the
AMPS. These risks include:
LIMITED OPERATING HISTORY. The Fund is a recently
organized, diversified, closed-end management investment
company that has been operational for less than three
months.
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,
which would reduce the asset coverage on the AMPS. 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 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. The Fund's use of
leverage through the issuance of the AMPS may tend to
magnify interest rate risk. See "Investment Objective and
Policies--Risks of the Fund."
11
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
position, 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 AMPS. Rating downgrades will
affect the value of the Fund's portfolio holdings, whether
they were higher or lower rated prior to the downgrade. 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 Shares and the
AMPS. 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.
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 "hybrid" or taxable preferred
securities contain provisions that allow an issuer, at
its discretion, to
12
defer distributions for up to 20 consecutive quarters
and traditional preferred securities may defer
distributions indefinitely. If the Fund owns a
preferred security that is deferring its dis-
tributions, 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.
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 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 com-
petitive 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 Common Shares offering,
Common Shares 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 amendments to the
Fund's Articles of Incorporation (together with any amend-
ments or supplements thereto, including any articles
supplementary, the "Articles" or "Articles of
Incorporation") to convert the
13
Fund to an open-end investment company, which would result
in the redemption of any AMPS then outstanding and the
potential subsequent sale of Fund assets during
unfavorable market conditions. In addition, the Board of
Directors may consider taking actions designed to
eliminate the discount whenever it deems it to be
appropriate, which could result in a reduction in the
asset coverage for AMPS. The Board is not required to
adopt any actions with respect to the Fund's discount and
may, in fact, choose not to do so. See "Repurchase of
Common Stock and Tender Offers; Conversion to Open-End
Fund."
TWO POTENTIAL PARTICIPANTS IN THE COMMON SHARES OFFERING
SENT UNAUTHORIZED E-MAILS TO CERTAIN OF THEIR CLIENTS AND
POTENTIAL INVESTORS. Two employees of Bear Stearns & Co.
Inc. ("Bear Stearns") distributed unauthorized e-mails to
over 500 potential investors. In addition, one employee of
Deutsche Bank Securities Inc. ("Deutsche Bank")
distributed unauthorized e-mails to 10 potential
investors. Neither the Fund, the Adviser nor any member of
the underwriting syndicate group nor any of their
officers, directors or employees authorized, encouraged or
were involved in any way in the preparation or
distribution of those e-mails and each specifically
disclaimed any responsibility for the distribution of
those e-mails. The distribution of the e-mails to
investors may have constituted an offer by each of Bear
Stearns and Deutsche Bank, respectively, that did not meet
the requirements of the Securities Act of 1933. If the
unauthorized e-mails did constitute a violation of the
Securities Act of 1933, those recipients, if any, of the
e-mails that purchased Common Shares might sue the Fund
for damages, the amount of which cannot be determined.
Once Bear Stearns and Deutsche Bank, respectively, became
aware of the mistaken distribution, each contacted its
respective addressees and notified them that the e-mail
they received and the information in the e-mail should be
disregarded and that only the preliminary prospectus and
the investor guide authorized by the Fund could be relied
upon in considering an investment in the Fund. Neither
Bear Stearns nor Deutsche Bank was an underwriter of
Common Shares nor a dealer authorized by the underwriters
to sell Common Shares nor did either offer or sell any
shares in the Common Shares offering.
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. See "Certain Provisions of the
Articles of Incorporation."
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.
14
TAX RISK. Future changes in tax law or regulation could
adversely affect the Fund and its portfolio holdings
including their valuation, which could negatively impact
the Fund's shareholders and distributions they receive
from the Fund. Tax changes can be given retroactive
effect.
FOREIGN SECURITY RISK. The prices of foreign securities
may be affected by factors not present with U.S.
securities, including currency exchange rates, political
and economic conditions, less stringent regulation and
higher volatility. As a result, many foreign securities
may be less liquid and more volatile than U.S. securities.
PORTFOLIO TURNOVER. The Fund may engage in frequent and
active portfolio trading when considered appropriate, but
it will not use short-term trading as the primary means of
achieving its investment objective. There are no limits on
the rate of portfolio turnover. A higher turnover rate may
result in correspondingly greater transactional expenses,
which are borne by the Fund. High portfolio turnover may
also result in the realization of net short-term capital
gains by the Fund that, when distributed to shareholders,
will reduce the asset coverage on the AMPS.
RECENT DEVELOPMENTS. 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. In addition, certain
auction agents for auction rate preferred shares similar
to the AMPS were unable to run auctions during that
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
adversely impact the Fund in general and the AMPS in
particular by, for example, affecting interest rates,
auctions and auction participants, such as the auction
agents and broker-dealers, secondary trading, ratings,
credit risk, inflation and other factors relating to
securities and other financial instruments.
TRADING MARKET...... The AMPS will not be listed on a stock exchange. Instead,
you may buy or sell AMPS at a periodic auction by
submitting orders to a broker-dealer that has entered into
a separate agreement with the Fund's auction agent (a
"Broker-Dealer") or to a broker-dealer that has entered
into an agreement with a Broker-Dealer. In addition to the
auctions, Broker-Dealers and other broker-dealers may (but
are not required to) maintain a separate secondary trading
market in AMPS, but may discontinue this activity at any
time. You may transfer AMPS outside of auctions only to or
through a Broker-Dealer, a broker-dealer that has entered
into a separate agreement with a Broker-Dealer, or other
persons as the Fund permits. There can be no assurance
that a secondary trading market for the AMPS will develop
or, if it does develop, that it will provide holders of
AMPS with liquidity of investment. See "The Auction."
15
RATINGS............. The Fund will issue the AMPS only if the AMPS have
received a credit quality rating of "Aaa" from Moody's and
of "AAA" from Fitch. These ratings are an assessment of
the capacity and the willingness of an issuer to pay
preferred stock obligations, and are not a recommendation
to purchase, hold or sell those shares inasmuch as the
rating does not comment as to the market price or
suitability for a particular investor. Ratings issued by a
nationally recognized statistical rating agency such as
Moody's or Fitch do not eliminate or mitigate the risks of
investing in the AMPS. These ratings may be changed,
suspended or withdrawn in the rating agencies' discretion.
See "Risks of the Fund."
DIVIDENDS AND RATE The table below shows the dividend rate, the dividend
PERIODS........... payment date and the number of days for the initial rate
period of each Series of the AMPS. For subsequent dividend
periods, the AMPS will normally pay dividends based on a
rate set at auctions held every seven days for Series M7,
T7, W7, Th7 and F7 and every 28 days for Series T28 and
W28. In most instances, dividends are payable on the first
business day following the end of the rate period. The
rate set at auction will not exceed the applicable max-
imum rate. See "Description of AMPS--Dividends and Rate
Periods."
Dividends on the AMPS will be cumulative from the date the
shares are first issued and will be paid out of legally
available funds.
DIVIDEND
PAYMENT SUBSEQUENT NUMBER
INITIAL DATE FOR DIVIDEND OF DAYS
DIVIDEND INITIAL RATE PAYMENT IN INITIAL
SERIES RATE PERIOD DAY RATE PERIOD
------ -------- -------------------------------- --------------- -----------
M7 % , 2003 Every Tuesday
T7 % , 2003 Every Wednesday
W7 % , 2003 Every Thursday
Th7 % , 2003 Every Friday
F7 % , 2003 Every Monday
T28 % , 2003 Every 28 days
W28 % , 2003 Every 28 days
Notwithstanding the schedule above, the Fund may,
subject to certain conditions, designate special
rate periods of more than seven days for the
Series M7, T7, W7, Th7 and F7 AMPS and more than
28 days for the Series T28 and W28 AMPS. The Fund
may not designate a special rate period unless
sufficient clearing bids were made in the most
recent auction. In addition, full cumulative
dividends and any amounts due with respect to
mandatory redemptions or optional redemptions must
be paid in full or deposited with the auction
agent. The Fund also must have received
confirmation from Moody's and Fitch or any
substitute rating agency that the proposed special
rate period will not adversely affect such
agency's then-current rating on the AMPS and the
lead Broker-Dealer designated by the Fund,
initially
16
Merrill Lynch, must not have objected to the
declaration of a special rate period. The dividend
payment date for a special rate period will be set
out in the notice designating the special rate
period. See "Description of AMPS--Dividends and
Rate Periods."
LIQUIDATION PREFERENCE............................ If the Fund is liquidated, the Fund must pay to
holders of AMPS $25,000 per share, plus
accumulated but unpaid dividends, if any, whether
or not earned or declared. See "Description of
AMPS--Liquidation."
ASSET MAINTENANCE................................. Under the Fund's Articles Supplementary (the
"Articles Supplementary"), which establish and fix
the rights and preferences of the AMPS, the Fund
must maintain:
- asset coverage on the AMPS as required by the
rating agencies rating the AMPS, and
- asset coverage of at least 200% with respect to
senior securities that are stock, including the
AMPS, as discussed in "Description of
AMPS--Rating Agency Guidelines and Asset
Coverage."
In the event that the Fund does not maintain (or
cure a failure to maintain) these coverage tests,
some or all of the AMPS will be subject to
mandatory redemption. Please see the
Articles Supplementary, which is attached as
Appendix B to the SAI. See "Description of
AMPS--Redemption."
Based on the composition of the Fund's portfolio
as of March 31, 2003, the Fund estimates that the
asset coverage of the AMPS, as measured pursuant
to the 1940 Act and the rules and regulations
thereunder, would be approximately 279% if the
Fund were to issue all of the AMPS offered in this
prospectus, representing approximately 36% of the
Fund's total managed assets after their issuance.
This asset coverage will change from time to time.
REDEMPTION........................................ The Fund will be required to redeem AMPS if it
fails to meet the asset coverage tests required by
the 1940 Act or the rating agencies rating the
AMPS and fails to correct such a failure in a
timely manner. The Fund may voluntarily redeem
AMPS, in whole or in part, under certain
circumstances. See "Description of
AMPS--Redemption." Although the AMPS are subject
to redemption under certain circumstances, unlike
the shares of an open-end investment company, the
AMPS may not be redeemed at a shareholder's
option.
VOTING RIGHTS..................................... The 1940 Act requires that the holders of AMPS and
any other outstanding preferred shares of the
Fund, voting together as a single class separate
from the Common Shareholders, have the right to
elect at least two Directors of the Fund at all
times and to elect a majority of the Directors if
two years' dividends on the AMPS or any other
preferred shares are unpaid until all unpaid
17
dividends on the AMPS and any other preferred
shares are paid or otherwise provided for by the
Fund. The holders of AMPS and any other
outstanding preferred shares will vote as a
separate class on certain other matters as
required under the Articles of Incorporation, the
Articles Supplementary or the 1940 Act. See
"Description of AMPS--Voting Rights." Each Common
Share, each share of AMPS, and each share of any
other series of preferred shares of the Fund is
entitled to one vote per share.
FEDERAL INCOME TAXATION........................... The distributions with respect to the AMPS (other
than certain distributions in redemption of AMPS)
will constitute dividends to the extent of the
Fund's current or accumulated earnings and
profits, as calculated for federal income tax
purposes. Such dividends generally will be taxable
as ordinary income to holders. Distributions of
net capital gains (i.e., the excess of net
long-term capital gains over net short-term
capital losses) that are designated by the Fund as
capital gain dividends will be treated as
long-term capital gains in the hands of holders
receiving such distributions. The Internal Revenue
Service (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 distributed
to each class for the tax year. Accordingly, the
Fund intends each year to allocate capital gain
dividends between and among its Common Shares and
AMPS. Ordinary income dividends and dividends
qualifying for the dividends received deduction
will similarly be allocated between classes. See
"Tax Matters."
CUSTODIAN AND AUCTION AGENT....................... PFPC Trust Company serves as the Fund's custodian.
Wilmington Trust Company will act as auction
agent, transfer agent, dividend paying agent and
redemption agent for the AMPS.
18
FINANCIAL HIGHLIGHTS (UNAUDITED)
The information contained in the table below under the headings "Per Share
Operating Performance" and "Ratios/Supplemental Data" shows the unaudited
operating performance of the Fund from the commencement of the Fund's operations
on January 31, 2003 through March 31, 2003. Because the Fund is recently
organized and commenced operations on January 31, 2003, the table covers
approximately eight weeks of operations, during which a substantial portion of
the Fund's portfolio was held in temporary investments pending investment in
securities that meet the Fund's investment objective and policies. Accordingly,
the information presented may not provide a meaningful picture of the Fund's
operating performance.
FOR THE PERIOD FROM
JANUARY 31, 2003*
THROUGH
MARCH 31, 2003
(UNAUDITED)
-------------------
PER SHARE OPERATING PERFORMANCE:
Net Asset Value, Beginning of Period (Common
Shares)(1).................................... $ 23.82
Less Offering Costs Charged to Additional Paid
in Capital(2)................................. --
--------
23.82
--------
INVESTMENT OPERATIONS:
Net Investment Income(3)........................ 0.13
Net Realized and Unrealized Loss on
Investments................................... (0.02)
--------
Total from Investment Operations................ 0.11
--------
Net Asset Value, End of Period (Common
Shares)....................................... $ 23.93
========
Market Value, End of Period (Common Shares)..... $ 24.96
Total Investment Return on Market Value
(%)(4)........................................ (0.16)
Total Investment Return on Net Asset Value
(%)(4)........................................ 0.46
RATIOS/SUPPLEMENTAL DATA:
Ratio of Expenses to Average Net Assets
Applicable to Common Shares (%)............... 0.75(5)
Ratio of Net Investment Income to Average Net
Assets (%).................................... 3.45(5)
Portfolio Turnover Rate (%)..................... 13(6)
Net Assets Applicable to Common Shares, End of
Period (000).................................. $977,787
-------------------
* Commencement of operations.
(1) Net asset value at beginning of period reflects the deduction of the sales
load of $1.125 per share and offering costs of $0.05 per share paid by the
shareholder from the $25.00 offering price.
(2) The costs of the AMPS offering, estimated to be $5,895,000 (including the
sales load paid to the Underwriters for the AMPS offering), will be borne
immediately by holders of Common Shares and result in a reduction in the
net asset value of the Common Shares.
(3) Computed using average Common Shares outstanding.
(4) Total return on net asset value is calculated assuming a purchase at the
offering price of $25.00, less the sales load of $1.125 and offering costs
of $0.05, and the ending net asset value per share.
Total return on market value is calculated assuming a purchase at the
offering price of $25.00 on the inception date of trading (January 29,
2003) and the sale at the current market price on the last day of the
period.
Total return on net asset value and total return on market value are not
computed on an annualized basis.
(5) Annualized.
(6) Not annualized.
19
THE FUND
The Fund is a recently organized, diversified, closed-end management
investment company. The Fund was incorporated under the laws of the State of
Maryland on May 23, 2002 and is registered as an investment company under the
1940 Act. As a recently-organized entity, the Fund has a limited operating
history. The Fund's principal office is located at 301 E. Colorado Boulevard,
Suite 720, Pasadena California 91101, and its telephone number is (626)
795-7300.
The Fund commenced operations on January 31, 2003 in connection with an
initial public offering of 36,500,000 of its Common Shares. The proceeds of such
offering were approximately $869,612,500 after the payment of organizational and
offering expenses. In connection with the initial public offering of the Fund's
Common Shares, the underwriters for the Common Shares were granted an option to
purchase up to an additional 5,475,000 Common Shares to cover over-allotments.
On February 18, 2003 and March 19, 2003, respectively, such underwriters
purchased, at a price of $23.875 per Common Share, an additional 2,500,000 and
1,850,000 Common Shares of the Fund pursuant to the over-allotment option. The
Fund's Common Shares are traded on the New York Stock Exchange under the symbol
"FFC."
USE OF PROCEEDS
The net proceeds of the offering of AMPS will be approximately $536,105,000,
after payment of the estimated offering costs and the sales load. The Fund will
invest the net proceeds of the offering in accordance with the Fund's investment
objective and policies as stated below. It is presently anticipated that the
Fund will be able to invest substantially all of the net proceeds in accordance
with its investment objective and policies within three months of the completion
of this offering. Pending such use, it is anticipated that the proceeds will be
invested in money market securities or money market mutual funds.
20
CAPITALIZATION
The following table sets forth the unaudited capitalization of the Fund as
of March 31, 2003, and as adjusted to give effect to the issuance of the AMPS
offered hereby (including estimated offering expenses and sales load of
$5,895,000).
ACTUAL AS ADJUSTED
------ -----------
AMPS, $0.01 par value (no shares
issued; 21,680 shares issued, as
adjusted, at $25,000 per share
liquidation preference)......... $ 0 $ 542,000,000
Common Shares, $0.01 par value,
240,000,000 shares authorized,
40,854,198 shares issued and
outstanding..................... $973,351,267 $ 967,456,267
Undistributed net investment
income.......................... $ 5,243,711 $ 5,243,711
Accumulated net realized gain
(loss) on investment
transactions.................... $ (1,883,500) $ (1,883,500)
Net unrealized
appreciation/(depreciation) on
investments..................... $ 1,075,787 $ 1,075,787
Net assets attributable to Common
Shares.......................... $977,787,265 $ 971,892,265
Net assets attributable to Common
Shares plus liquidation value of
AMPS............................ $977,787,265 $1,513,892,265
PORTFOLIO COMPOSITION
As of April 11, 2003, 61.4% of the market value of the Fund's portfolio was
invested in preferred securities, 2.8% in money market securities, 4.5% in
convertible fixed income and common equity securities and 34.4% in long-term
debt securities. This information reflects the composition of the Fund's assets
at March 31, 2003, and is not necessarily representative of the Fund's portfolio
as of the date hereof or at any time in the future.
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 approval of the holders of at least 80%
of the Fund's outstanding voting securities, voting as a single class, and at
least 80% of the Fund's outstanding preferred shares (including the AMPS),
voting as a separate class. See "Description of AMPS--Voting Rights" for
additional information with respect to the voting rights of holders of AMPS. 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. The Fund's policy of investing at
least 80% of its total assets in preferred securities is not a fundamental
policy of the Fund and can 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.
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.
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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 AMPS. 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.
The Fund currently intends to invest primarily in the securities of U.S.
issuers. However, the Fund may invest up to 10% of its total assets in the
securities other than money market securities of companies organized outside the
United States. The Fund will only invest in foreign securities that are U.S.
dollar-denominated.
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 Shares 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 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 AMPS.
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 "Risks of the Fund."
22
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-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
23
could result from a decline in interest rates. The Fund generally 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 ratepayer, 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 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
24
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
Code. See "Investment Techniques" below and "Tax Matters." 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 AMPS will have dividend rates established by auctions which will
typically be held at regular seven day, 28-day or other short intervals. This
auction process is designed to result in a high degree of principal stability
for holders of the AMPS. The dividend rates set pursuant to such auction process
are expected to be influenced by short-term interest rates generally, so that
the dividend rate on outstanding AMPS 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 outstanding AMPS. Thus, net income to the
Common Shares 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
25
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 outstanding AMPS, which
would increase net investment income available to Common Shares.
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 outstanding AMPS, in the opinion of the Adviser,
should contribute to the net income to the Fund's Common Shares 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 AMPS 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 AMPS 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 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.
26
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. Certain tax
proposals currently under preliminary discussion by federal government officials
would generally eliminate the taxation of dividends paid by corporations out of
previously taxed corporate income. However, it is uncertain if and in what form
this proposal will ultimately be adopted. As proposed, it would be possible for
the Fund to distribute tax-free to shareholders certain dividends paid on
certain stocks in its portfolio. Under current market conditions and current tax
law, the Fund intends to invest principally in "hybrid" or taxable preferred
securities, the payments on which do not appear to be excludable from taxable
income under the current proposals. If tax law changes in a way that affords tax
benefits to traditional preferred securities, the Fund would take those tax
benefits into account when determining whether to invest in different types of
preferred securities. As a result, the Fund might hold a smaller portion of its
assets in hybrid preferreds and a larger portion in traditional preferreds than
currently contemplated.
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, QUIDS, CorTS, 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.
27
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
28
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 the SAI. 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 AMPS imposed by Moody's or Fitch 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 pay dividends that qualify for the DRD.) The adjustable dividend rate
feature is intended to make the
29
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, at times 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.
30
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 AMPS, 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.
31
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 obliga-tions 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,
32
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 sufficiently liquid. 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, administrative 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 preferred shares
(including the AMPS), voting as a separate class, as described under
"Description of AMPS--Voting Rights" 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 AMPS. See "Description of AMPS--Rating Agency Guidelines and Asset
Coverage."
33
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 non-banking companies. A large number of local
and regional bank holding companies have elected to become financial holding
companies.
34
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 outstanding AMPS 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 "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
35
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 "Tax Matters."
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 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
36
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.
37
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 con-tractual standards, and offers arbitration on
disputes concerning market practice.
Under the rating agency guidelines imposed in connection with the issuance
of AMPS, the Fund is 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 related to interest
rate swaps would be able to be revised by the Fund's Board, without shareholder
vote of the Common Shares or the AMPS, so long as the relevant rating
agency(ies) has given written notice that such revisions would not adversely
affect the rating of the AMPS 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, 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 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.
38
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 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.
39
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.
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.
40
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 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
41
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.
FUNDAMENTAL INVESTMENT POLICIES
The Fund has adopted certain fundamental investment policies designed to
limit investment risk and maintain portfolio diversification. These fundamental
investment policies may not be changed without the 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 (including the AMPS), voting as a separate class. A "majority of
the outstanding voting securities" for these purposes means (i) 67% or more of
the Common Shares and shares of preferred stock present at a meeting, voting as
a single class, if the holders of more than 50% of such shares outstanding are
present or represented by proxy, or (ii) more than 50% of the Common Shares and
shares of preferred stock outstanding, voting as a single class, whichever of
(i) or (ii) is less. 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.
The Fund may become subject to guidelines which are more limiting than the
investment restrictions set forth above or in the SAI in order to obtain and
maintain ratings from Moody's and Fitch on the AMPS. It is not currently
anticipated that these guidelines will materially impede the Adviser from
managing the Fund's portfolio in accordance with the Fund's investment objective
and policies. See "Description of AMPS--Rating Agency Guidelines and Asset
Coverage." See "Fundamental Investment Restrictions" in the SAI for a complete
list of the fundamental investment policies of the Fund and "Description of
AMPS--Voting Rights" for additional information with respect to the voting
rights of holders of AMPS.
RATING AGENCY REQUIREMENTS
In connection with their rating the AMPS, Moody's and Fitch will impose
asset coverage tests and other restrictions that may limit the Fund's ability to
engage in certain of the transactions described above. See "Description of
AMPS--Rating Agency Guidelines and Asset Coverage."
RISKS OF THE FUND
Investing in the Fund involves risk, including the risk that you may receive
little or no return on your investment or 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 AMPS.
The Fund is a recently organized, diversified, closed-end management
investment company designed primarily as a long-term investment and not as a
trading vehicle. The Fund is not intended to be a complete investment program
and, due to the uncertainty inherent in all investments, there can be no
assurance that the Fund will achieve its investment objective.
RISKS OF INVESTING IN THE AMPS
DIVIDEND PAYMENT RISK. The Fund will not be permitted to declare dividends
or other distributions with respect to the AMPS unless the Fund meets certain
asset coverage requirements.
42
In certain circumstances, the Fund may not earn sufficient income from its
investments to pay dividends on the AMPS.
REDEEMABILITY. Unlike shares of a open-end mutual fund, including a money
market mutual fund, the AMPS may not be redeemed at the option of the holder.
INTEREST RATE RISK. The AMPS pay dividends based on shorter-term interest
rates. The Fund purchases equity securities that pay dividends that are based on
the performance of the issuers and debt securities that pay interest based on
longer-term yields. These dividends and interest payments are typically,
although not always, higher than shorter-term interest rates. Dividends, as well
as longer-term and shorter-term interest rates, fluctuate. If shorter-term
interest rates rise, dividend rates on AMPS may rise so that the amount of
dividends paid to holders of AMPS exceeds the income from the Fund's portfolio
securities. Because income from the Fund's entire investment portfolio (not just
the portion of the portfolio purchased with the proceeds of the AMPS offering)
is available to pay dividends on AMPS, however, dividend rates on AMPS would
need to exceed the net rate of return on the Fund's portfolio by a significant
margin before the Fund's ability to pay dividends on AMPS would be jeopardized.
If long-term interest rates rise, this could negatively impact the value of the
Fund's investment portfolio and thus reduce the amount of assets serving as
asset coverage for AMPS.
AUCTION RISK. You may not be able to sell your AMPS at an auction if the
auction fails, i.e., if there are more AMPS offered for sale than there are
buyers for those shares. Also, if you place a bid order (an order to retain
AMPS) at an auction only at a specified rate, and that rate exceeds the rate set
at the auction, your order will be deemed an irrevocable offer to sell your
AMPS, and you will not retain your AMPS. Additionally, if you buy AMPS or elect
to retain AMPS without specifying a rate below which you would not wish to buy
or continue to hold those shares, and the auction sets a below-market rate, you
may receive a lower rate of return on your AMPS than the market rate for similar
investments. The dividend period for the AMPS may be changed by the Fund,
subject to certain conditions and with notice to the holders of the AMPS, which
could also affect the liquidity of your investment. See "Description of AMPS"
and "The Auction."
SECONDARY MARKET RISK. If you try to sell your AMPS between auctions, you
may not be able to sell any or all of your shares, or you may not be able to
sell them for $25,000 per share or $25,000 per share plus accumulated dividends.
Changes in interest rates could affect the price you would receive if you sold
your AMPS in the secondary market, particularly if the Fund has designated a
special rate period (a dividend period of more than seven days in the case of
Series M7, T7, W7, Th7 or F7, or 28 days in the case of Series T28 or W28).
Broker-dealers that maintain a secondary trading market (if any) for the AMPS
are not required to maintain this market, and the Fund is not required to redeem
shares if either an auction or an attempted secondary market sale fails because
of a lack of buyers. The AMPS are not listed on a stock exchange or NASDAQ. If
you sell your AMPS between auctions, you may receive less than the price you
paid for them, especially when market interest rates have risen since the last
auction or during a special rate period.
RATINGS AND ASSET COVERAGE RISK. While it is a condition to the closing of
the offering that Moody's assigns a rating of "Aaa" and Fitch assigns a rating
of "AAA" to the AMPS, these ratings do not eliminate or necessarily mitigate the
risks of investing in AMPS. In addition, Moody's, Fitch or another rating agency
rating the AMPS could downgrade the AMPS, which may make your shares less liquid
at an auction or in the secondary market. If a rating agency downgrades the
AMPS, the Fund may (but is not required to) alter its portfolio in an effort to
improve the rating, although there is no assurance that it will be able to do so
to the extent necessary to restore the prior rating. See "Portfolio Turnover."
In addition, the Fund may be forced to redeem your AMPS to meet regulatory or
rating agency requirements. The Fund may also voluntarily redeem AMPS under
certain circumstances. See "Description of AMPS--Redemption." The asset coverage
requirements imposed by a rating agency
43
may limit the Fund's ability to invest in certain securities or utilize certain
investment techniques that the Adviser might otherwise consider desirable. See
"Description of AMPS--Rating Agency Guidelines and Asset Coverage" for a
description of the rating agency guidelines with which the Fund must currently
comply.
RESTRICTIONS ON DIVIDENDS AND OTHER DISTRIBUTIONS. Restrictions imposed on
the declaration and payment of dividends or other distributions to the holders
of the Fund's Common Shares and AMPS, both by the 1940 Act and by requirements
imposed by rating agencies, might impair the Fund's ability to maintain its
qualification as a regulated investment company for federal income tax purposes.
While the Fund intends to redeem AMPS to enable the Fund to distribute its
income as required to maintain its qualification as a regulated investment
company under the Code, there can be no assurance that such redemptions can be
effected in time to meet the requirements of the Code. See "Tax Matters."
PORTFOLIO INVESTMENTS RISK. In certain circumstances, the Fund may not earn
sufficient income from its investments to pay dividends on AMPS. In addition,
the value of the Fund's investment portfolio may decline, reducing the asset
coverage for the AMPS. If an issuer whose securities the Fund purchases
experiences financial difficulties, defaults, or is otherwise affected by
adverse market factors, there may be a negative impact on the income and/or
asset value of the Fund's investment portfolio, which will reduce asset coverage
for the AMPS and make it more difficult for the Fund to pay dividends on the
AMPS.
GENERAL RISKS OF INVESTING IN THE FUND
LIMITED OPERATING HISTORY. The Fund is a recently organized, diversified,
closed-end management investment company that has been operational for less than
three months.
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 Shares and
the asset coverage of the AMPS. 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. 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
44
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 AMPS
creates an opportunity for increased Common Shares net income, but also creates
special risks for Common Shareholders. There is no assurance that the Fund's
leveraging strategy will be successful. Risks affecting the Fund's net asset
value will be magnified by the issuance of AMPS. If the Fund's current net
investment income and capital gains are not sufficient to meet dividend
requirements on outstanding AMPS, the Fund may need to liquidate certain of its
investments, thereby possibly reducing the net asset value attributable to the
Common Shares. In addition, failure to meet required asset coverage requirements
for AMPS or to satisfy certain guidelines established by the rating agencies may
result in mandatory partial or full redemption of AMPS, which would reduce or
eliminate the Fund's leverage and could also adversely affect distributions to
holders of Common Shares. Such redemptions may also cause the Fund to incur
additional transaction costs, including costs associated with the sale of
portfolio securities.
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 total managed assets (which include the liquidation preference on AMPS
and the principal amount of any borrowings used for leverage). As a result, the
Adviser has a financial incentive for the Fund to issue AMPS or to otherwise
incur leverage, which may create a conflict of interest.
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. Certain tax
proposals currently under preliminary discussion by federal government officials
would eliminate the taxation of dividends paid by corporations out of previously
taxed corporate income. However, it is uncertain if, and in what form, this
proposal will ultimately be adopted. As proposed, it would be possible for the
Fund to distribute tax-free to shareholders certain dividends paid on certain
stocks in its portfolio. Under current market conditions and current tax law,
the Fund intends to invest principally in "hybrid" or taxable preferred
securities, the payments on which do not appear to be excludable from taxable
income under the current proposals. If tax law changes in a way that affords tax
benefits to traditional preferred securities, the Fund would take those tax
benefits into account when determining whether to invest in different types of
preferred
45
securities. As a result, the Fund might hold a smaller portion of its assets in
hybrid preferreds and a larger portion in traditional preferreds than currently
contemplated. See "Tax Matters."
PREFERRED SECURITIES RISK. Investment in preferred securities carries
certain risks including:
- Deferral Risk--Typically "hybrid" or taxable preferred securities contain
provisions that allow an issuer, at its discretion, to defer
distributions for up to 20 consecutive quarters and traditional preferred
securities may defer distributions indefinitely. 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
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 the SAI 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 calcu-lating its net asset value. The market behavior of preferred
and debt securities in lower rating catego-ries is often more volatile than that
of higher quality securities.
46
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.
TWO POTENTIAL PARTICIPANTS IN THE COMMON SHARES OFFERING SENT UNAUTHORIZED
E-MAILS TO CERTAIN OF THEIR CLIENTS AND POTENTIAL INVESTORS. Two employees of
Bear Stearns & Co. Inc. ("Bear Stearns") distributed unauthorized e-mails to
over 500 potential investors. In addition, one employee of Deutsche Bank
Securities Inc. ("Deutsche Bank") distributed unauthorized e-mails to 10
potential investors. Neither the Fund, the Adviser nor any member of the
underwriting syndicate group nor any of their officers, directors or employees
authorized, encouraged or were involved in any way in the preparation or
distribution of those e-mails and each specifically disclaimed any
responsibility for the distribution of those e-mails. The distribution of the
e-mails to investors may have constituted an offer by each of Bear Stearns and
Deutsche Bank, respectively, that did not meet the requirements of the
Securities Act of 1933. If the unauthorized e-mails did constitute a violation
of the Securities Act of 1933, those recipients, if any, of the e-mails that
purchased Common Shares might sue the Fund for damages, the amount of which
cannot be determined. Once Bear Stearns and Deutsche Bank, respectively, became
aware of the mistaken distribution, each contacted its respective addressees and
notified them that the e-mail they received and the information in the e-mail
should be disregarded and that only the preliminary prospectus and the investor
guide authorized by the Fund could be relied upon in considering an investment
in the Fund. Neither Bear Stearns nor Deutsche Bank was an underwriter of Common
Shares nor a dealer authorized by the underwriters to sell Common Shares nor did
either offer or sell any shares in the Common Shares offering.
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. See "Certain
Provisions of the Articles of Incorporation."
CONVERSION RISK. Under the Fund's Bylaws, if at any time after the third
year following the Common Shares offering, the Common Shares 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 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 AMPS 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, which could result in a
reduction in the asset coverage for AMPS. The Board is not required to adopt any
actions with respect to the Fund's discount and may, in fact, choose not to do
so.
TAX RISK. Future changes in tax law or regulation could adversely affect the
Fund and its portfolio holdings, including their valuation, which could
negatively impact the Fund's shareholders and distributions they receive from
the Fund. Tax changes can be given retroactive effect.
FOREIGN SECURITY RISK. The prices of foreign securities may be affected by
factors not present in U.S. markets. The value of the Fund's foreign investments
may be adversely affected by political and
47
social instability in their home countries and by changes in economic or
taxation policies in those countries. Foreign securities are also subject to the
risks of nationalization, expropriation or confiscatory taxation, currency
blockage, and adverse political changes or diplomatic developments.
Foreign companies generally are subject to less stringent regulations,
including financial and accounting controls, than are U.S. companies. As a
result, there generally is less publicly available information about foreign
companies than about U.S. companies. Many foreign securities may be less liquid
and more volatile than U.S. securities.
PORTFOLIO TURNOVER. The Fund may engage in frequent and active portfolio
trading when the Adviser considers it to be appropriate, but the Fund will not
use short-term trading as the primary means of achieving its investment
objective. Although the Fund cannot accurately predict its annual portfolio
turnover rate, it is not expected to exceed 100% under normal circumstances.
However, there are no limits on the rate of portfolio turnover, and investments
may be sold without regard to the length of time held when, in the opinion of
the Adviser, investment considerations warrant such action. A higher turnover
rate may result in correspondingly greater transactional expenses that are borne
by the Fund. High portfolio turnover may also result in the realization of net
short-term capital gains by the Fund that, when distributed to shareholders,
will reduce the asset coverage on the AMPS. See "Tax Matters."
RECENT DEVELOPMENTS. 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. In addition, certain auction agents
for auction rate preferred shares similar to the AMPS were unable to run
auctions during that 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 adversely impact the Fund in general and the AMPS in particular by, for
example, affecting interest rates, auctions and auction participants, such as
the auction agents and broker-dealers, secondary trading, ratings, credit risk,
inflation and other factors relating to securities and other investments.
MANAGEMENT OF THE FUND
The business and affairs of the Fund are managed under the direction of the
Board of Directors. Subject always to the investment objective and policies of
the Fund and to the general supervision of the Directors, the Adviser is
responsible for management of the Fund's investment portfolio. The names and
business addresses of the Directors and officers of the Fund and their principal
occupations and other affiliations during the past five years are set forth
under "Management of the Fund" in the SAI.
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 March 31, 2003 (which do not include the net assets of the
Fund) of approximately $938 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 March 31, 2003 had approximately
$424 million in aggregate total assets. In managing the day-to-day
48
operations of the Fund, the Adviser relies on the expertise of its team of money
management professionals, consisting of Messrs. Donald F. Crumrine, Robert M.
Ettinger, Peter C. Stimes and R. Eric Chadwick, whose backgrounds are described
in the SAI.
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 ASSETS ATTRIBUTABLE TO ANY PREFERRED SHARES
(INCLUDING THE AMPS) THAT MAY BE OUTSTANDING OR OTHERWISE 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 AMPS 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.
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. Pursuant to a shareholder servicing agree-ment (the "Servicing
Agreement"), the Servicing Agent's duties include developing and maintaining a
website for the Fund; assisting in the review of materials made available to
shareholders to assure compliance with applicable laws, rules and regulations;
assisting in the dissemination of 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 closed-end fund analyst 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 COMMON SHARES 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
Shares and generally assists in all aspects of the administration and operation
of the Fund. Pursuant to an administration agreement between the 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
49
Fund's average weekly total managed assets, 0.03% on the next $500 million of
the Fund's average weekly total managed assets and 0.02% on the Fund's average
weekly total managed assets above $1 billion. (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 preferred shares (which include the
liquidation preference on the AMPS and the principal amount of any borrowings
used for 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 AMPS is not treated as a liability.)
The Administrator also serves as the Fund's Common Shares 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 Shares, 0.01% on the
next $350 million of the Fund's average weekly net assets attributable to the
Common Shares, 0.005% on the next $500 million of the Fund's average weekly net
assets attributable to the Common Shares and 0.0025% on the Fund's average
weekly net assets attributable to the Common Shares above $1 billion (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 AMPS) and accumulated dividends, if any, on the AMPS), plus certain
out-of-pocket expenses.
DURATION AND TERMINATION; NON-EXCLUSIVE SERVICES
The Advisory Agreement became effective on January 28, 2003 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 became effective on January 28, 2003 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 any of them or their affiliates from providing similar services to
other investment companies and other clients (whether or not their invest-ment
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
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
50
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 outstanding AMPS, 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 Shares and the AMPS (which
include certain marketing expenses of the underwriters, the Servicing Agent and
the Adviser) are recorded as a reduction of capital of the Fund attributable to
the Common Shares.
On the basis of the anticipated size of the Fund immediately following the
offering, the Adviser estimates that the Fund's annual operating expenses will
be approximately $11,811,693. 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.
Offering expenses with regard to the AMPS will be payable upon the
completion of the offering of the AMPS and will be charged to capital
attributable to Common Shares.
ADDITIONAL COMPENSATION AGREEMENT
In connection with the offering of the Fund's Common Shares, the Adviser
agreed to pay from its own assets additional compensation to Merrill Lynch. This
additional compensation will be payable quarterly at the annual rate of 0.10% of
the Fund's average daily total managed assets (including assets attributable to
any AMPS that may be outstanding) during the continuance of the Advisory
Agreement or other advisory agreement between the Adviser and the Fund. The
total amount of these additional payments will not exceed 4.5% of the total
price to the public of the Common Shares sold in the offering of the Fund's
Common Shares; provided, that in determining when the maximum additional
compensation amount has been paid, the value of each of the quarterly payments
shall be discounted at the annual rate of 10% to January 31, 2003, the closing
date of such offering. Merrill Lynch has agreed to provide certain after-market
support 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.
DESCRIPTION OF AMPS
THE FOLLOWING IS A BRIEF DESCRIPTION OF THE TERMS OF THE AMPS. FOR A MORE
COMPLETE DESCRIPTION OF THE AMPS, PLEASE REFER TO THE DETAILED DESCRIPTION OF
THE AMPS IN THE ARTICLES SUPPLEMENTARY, WHICH IS ATTACHED AS APPENDIX B TO THE
SAI. CERTAIN OF THE CAPITALIZED TERMS USED HEREIN ARE DEFINED IN THE
ARTICLES SUPPLEMENTARY. THIS DESCRIPTION DOES NOT PURPORT TO BE COMPLETE AND IS
SUBJECT TO AND QUALIFIED IN ITS ENTIRETY BY REFERENCE TO THE FUND'S ARTICLES OF
INCORPORATION AND ARTICLES SUPPLEMENTARY. THE ARTICLES OF INCORPORATION AND
ARTICLES SUPPLEMENTARY HAVE BEEN FILED AS EXHIBITS TO THE REGISTRATION STATEMENT
OF WHICH THIS PROSPECTUS IS PART.
GENERAL
Under the Articles of Incorporation, the Fund is authorized to issue up to
10,000,000 shares of preferred stock (which are generally referred to in this
prospectus as "preferred shares") having a par value of $0.01 per share in one
or more series, with such preferences, voting powers, terms of redemption, if
any, and special or relative rights or privileges (including conversion rights,
if any) determined by the Board of Directors, without the approval of Common
Shareholders. The AMPS are preferred shares with $0.01 par value per share. The
AMPS will have a liquidation preference of $25,000 per share, plus an amount
equal to accumulated but unpaid dividends (whether or not earned or declared).
51
The AMPS will rank on a parity with shares of any other series of preferred
shares of the Fund as to the payment of dividends and the distribution of assets
upon liquidation. The AMPS carry one vote per share on all matters on which such
shares are entitled to vote. The AMPS, when issued by the Fund and paid for
pursuant to the terms of this prospectus, will be fully paid and non-assessable
and will have no preemptive, exchange or conversion rights. Any AMPS repurchased
or redeemed by the Fund will be classified as authorized and unissued preferred
shares without designation as to series. The AMPS will not be subject to any
sinking fund, but will be subject to mandatory redemption and optional
redemption under certain circumstances described below.
DIVIDENDS AND RATE PERIODS
GENERAL. The following is a general description of dividends and rate
periods for the AMPS. The initial rate periods for the AMPS will be , ,
, , , and days, respectively, for the Series M7, T7, W7, Th7, F7,
T28 and W28 shares, and the dividend rates for this period will be %, %,
%, %, %, % and %, respectively. Subsequent rate periods generally
will be seven days for Series M7, T7, W7, Th7 and F7 shares and 28 days for
Series T28 and W28 shares, and the dividend rates for those periods will
generally be determined by auction. Further description of the auction
procedures can be found below under "The Auction" and in the
Articles Supplementary, which is attached as Appendix B to the SAI. The Fund,
subject to certain conditions, may change the length of subsequent rate periods
by designating them as special rate periods. See "--Designation of Special Rate
Periods" below.
DIVIDEND PAYMENT DATES. Dividends on AMPS will be payable when, as and if
declared by the Board of Directors, out of legally available funds in accordance
with the Articles of Incorporation, the Articles Supplementary and applicable
law. Dividend periods generally will begin on the first business day after an
auction. If dividends are payable on a day that is not a business day, then
dividends will generally be payable on the next business day, or as otherwise
specified in the Articles Supplementary. The Fund, at its discretion, may
establish dividend payment dates in respect of any special rate period of AMPS
consisting of less than 30 days, provided that such dates shall be set forth in
the notice of special rate period relating to such special rate period and
certain other requirements are met. Dividends on any special rate period
consisting of more than 30 days will generally be payable on the first business
day of each calendar month within such special rate period.
Dividends will be paid through The Depository Trust Company ("DTC") on each
dividend payment date. The dividend payment date will normally be the first
business day after the dividend period ends. DTC, in accordance with its current
procedures, is expected to distribute dividends received from the auction agent
in same-day funds on each dividend payment date to members of DTC that will act
on behalf of existing or potential holders of AMPS ("Agent Members"). These
Agent Members are in turn expected to distribute such dividends to the persons
for whom they are acting as agents. Each of the current Broker-Dealers has
currently indicated to the Fund that dividend payments will be available in
same-day funds on each dividend payment date to customers that use a
Broker-Dealer or a Broker-Dealer's designee as Agent Member.
CALCULATION OF DIVIDEND PAYMENT. The Fund computes the dividend per share of
AMPS by multiplying the applicable rate then in effect for the AMPS by a
fraction. The numerator of this fraction will normally be seven for Series M7,
T7, W7, Th7 and F7 and 28 days for Series T28 and W28 (i.e., the number of days
in the rate period), and the denominator will normally be 360. If the Fund has
designated a special rate period, then the numerator will be the number of days
in the special rate period, and the denominator will normally be 360. In either
case, this rate is then multiplied by $25,000 to arrive at the dividend per
share.
52
Dividends on the AMPS will accumulate from the date of their original issue,
which is April , 2003. For each dividend payment period after the relevant
initial rate period, the dividend rate will be the dividend rate determined at
auction, except as otherwise provided in the Articles Supplementary. The
dividend rate that results from an auction will not be greater than the
applicable maximum rate described below.
The applicable maximum rate for any rate period will be the applicable
percentage (set forth in the table below) of the applicable reference rate on
such date generally determined based on the lower of the credit rating or
ratings assigned to the AMPS by Moody's or Fitch on the auction date for such
period. If Moody's or Fitch or both shall not make such ratings available, the
rate shall be determined by reference to equivalent ratings issued by a
substitute rating agency. The reference rate will be the applicable "AA"
Financial Composite Commercial Paper Rate (for a rate period of fewer than 184
days) or the Treasury Index Rate (as defined below) (for a rate period of 184
days or more).
APPLICABLE PERCENTAGE PAYMENT TABLE
CREDIT RATINGS
------------------------------------------------------
MOODY'S FITCH APPLICABLE PERCENTAGE
-------------------------------- -------------------- ---------------------
"Aa3" or higher AA- or higher 150%
"A3" to "A1" A- to A+ 200%
"Baa3" to "Baa1" BBB- to BBB+ 225%
Below "Baa3" Below BBB- 275%
The " 'AA' Financial Composite Commercial Paper Rate" is the rate on
commercial paper issued by corporations whose bonds are rated AA by S&P as made
available by the Federal Reserve Bank of New York or, if such rate is not made
available by the Federal Reserve Bank of New York, the arithmetical average of
such rates as quoted to the auction agent by certain commercial paper dealers
designated by the Fund.
The "Treasury Index Rate" is the average yield to maturity for certain U.S.
Treasury securities having substantially the same length to maturity as the
applicable dividend period for the AMPS. For a more detailed description, please
see the Articles Supplementary.
Prior to 12:00 noon, New York City time, on each dividend payment date, the
Fund is required to deposit with the auction agent sufficient funds for the
payment of declared dividends. As specified in the Articles Supplementary,
auctions will generally not be held if the Fund fails to make such deposit. In
such a situation, dividends for the next dividend period would normally be paid
at a higher default rate, as provided in the Articles Supplementary. The Fund
does not intend to establish any reserves for the payment of dividends.
The Board of Directors may amend the applicable maximum rate to increase the
percentage amount by which the reference rate described above is multiplied to
determine the applicable maximum rate shown without the vote or consent of the
holders of AMPS or any other shareholder of the Fund, but only with confirmation
from each rating agency then rating the AMPS that such action will not impair
such agency's then-current rating of the AMPS, and after consultation with the
Broker-Dealers, provided that immediately following any such increase the Fund
could meet the Preferred Shares Basic Maintenance Amount test discussed below
under "--Rating Agency Guidelines and Asset Coverage."
RESTRICTIONS ON DIVIDENDS AND OTHER DISTRIBUTIONS. Except as provided below,
while the AMPS are outstanding, the Fund generally may not declare, pay or set
apart for payment, any dividend or other distribution in respect of its Common
Shares (other than in additional Common Shares or rights to
53
purchase Common Shares or other shares ranking junior to the AMPS as to the
payment of dividends and the distribution of assets upon liquidation). In
addition, the Fund generally may not call for redemption, redeem or purchase any
of its Common Shares (except by conversion into or exchange for shares of the
Fund ranking junior to the AMPS as to the payment of dividends and the
distribution of assets on liquidation). However, the Fund is not confined by the
above restrictions if:
- immediately after such dividend declaration or payment transaction,
(i) the discounted value of the Fund's portfolio (i.e., the aggregate
value of the Fund's portfolio according to criteria set forth by each
rating agency then rating the AMPS) would be equal to or greater than the
Preferred Shares Basic Maintenance Amount (as defined below) and
(ii) the 1940 Act Preferred Shares Asset Coverage would be satisfied (see
"--Rating Agency Guidelines and Asset Coverage" below);
- full cumulative dividends on the AMPS due on or prior to the Fund's most
recently ended dividend period have been paid or have been declared and
sufficient funds for the payment thereof deposited with the auction
agent; and
- the Fund has redeemed the full number of AMPS required to be redeemed by
any provision for mandatory redemption.
The Fund generally will not declare, pay or set apart for payment any
dividend on any class or series of shares of the Fund ranking, as to the payment
of dividends, on a parity with the AMPS unless the Fund has declared and paid
the lesser of full cumulative dividends or the same proportionate share of
dividends on the AMPS through the most recent dividend payment date. When the
Fund has not paid dividends in full upon the AMPS through the most recent
dividend payment date or upon any class or series of shares of the Fund ranking,
as to the payment of dividends, on a parity with the AMPS through their most
recent respective dividend payment dates, the amount of dividends declared per
share on the AMPS and such other class or series of shares will in all cases
bear to each other the same ratio that accumulated dividends per share on the
AMPS and such other class or series of shares bear to each other.
DESIGNATION OF SPECIAL RATE PERIODS. The Fund may, in certain situations, in
consultation with the lead Broker-Dealer designated by the Fund (initially
Merrill Lynch), declare a special rate period on the AMPS. To declare a special
rate period, the Fund will give notice (a "notice of special rate period") to
the auction agent and to each Broker-Dealer. The notice of special rate period
will state the length of the special rate period, which may not be greater than
five years. The Fund may not designate a special rate period unless sufficient
clearing bids for the AMPS were made in the most recent auction. In addition,
full cumulative dividends and any amounts due with respect to mandatory
redemptions or optional redemptions must be paid in full or deposited with the
auction agent. The Fund also must have received confirmation from Moody's and
Fitch or any substitute rating agency that the proposed special rate period will
not impair such agency's then-current rating of the AMPS and the lead
Broker-Dealer designated by the Fund must not have objected to the declaration
of a special rate period. The Fund may provide that, in order to redeem AMPS at
the Fund's option during a special rate period, the Fund must pay to holders of
the AMPS a "redemption premium" in addition to the redemption price per share of
$25,000 plus an amount equal to the accumulated but unpaid dividends. A notice
of special rate period will specify whether the AMPS will be subject to optional
redemption during such special rate period and, if so, the redemption premium,
if any, required to be paid by the Fund in connection with such optional
redemption.
The Fund's declaration of a special rate period may affect the liquidity of
your investment. A special rate period would be longer than a regular rate
period, and you would be unable to sell AMPS in an auction for a corresponding
longer period of time. If you sell your AMPS between auctions, you may receive
less than the price you paid for them, especially when market interest rates
have risen. The risks described in this paragraph will become greater as the
length of the special rate period increases.
54
VOTING RIGHTS
Except as otherwise described in this prospectus and in the SAI or as
otherwise set forth in the Articles of Incorporation or the
Articles Supplementary or required by law, holders of AMPS will have equal
voting rights with Common Shareholders and holders of any other preferred shares
of the Fund (each class having one vote per share) and will vote together with
Common Shareholders and any other preferred shares as a single class.
Holders of outstanding preferred shares of the Fund, including AMPS, voting
as a separate class, are entitled to elect two of the Fund's Directors. The
remaining Directors are elected by Common Shareholders and holders of preferred
shares, including the AMPS, voting together as a single class. In addition, if
at any time dividends (whether or not earned or declared) on any outstanding
preferred shares of the Fund, including AMPS, are due and unpaid in an amount
equal to two full years of dividends, and sufficient cash or specified
securities have not been deposited with the auction agent for the payment of
such dividends, the sole remedy of holders of the outstanding preferred shares
of the Fund is that the number of Directors will be automatically increased by
the smallest number that, when added to the two Directors elected exclusively by
the holders of preferred shares as described above, would constitute a majority
of the Directors. The holders of preferred shares of the Fund will be entitled
to elect such Directors at a special meeting of holders of preferred shares held
as soon as practicable after the occurrence of such event and at all subsequent
meetings at which Directors are to be elected. The terms of office of the
persons who are Directors at the time of that election will continue unless the
election of additional Directors by the holders of preferred stock would cause
the number of Directors to exceed 12. In this case, the terms of office of a
number of Directors elected by holders of Common Shares and preferred stock,
voting as a single class, will terminate so that the number of remaining
Directors and the number of additional Directors does not exceed 12. If the Fund
thereafter pays in full (or otherwise provides for) all dividends payable on all
outstanding preferred shares of the Fund, the special voting rights stated above
will cease and the terms of office of the additional Directors elected by the
holders of the preferred shares will automatically terminate.
Unless a higher percentage is provided for under the Articles of
Incorporation or the Articles Supplementary or applicable law, the Fund will
not, without the affirmative vote or consent of the holders of at least a
majority (as defined in the 1940 Act) of the AMPS outstanding at the time
(voting together as a separate class), except as noted below:
(a) authorize, create or issue any class or series of shares ranking
prior to or on a parity with the AMPS with respect to payment of
dividends or the distribution of assets on liquidation, or authorize,
create or issue additional AMPS, unless, in each case, the Fund obtains
written confirmation from Moody's (if Moody's is then rating the AMPS)
and Fitch (if Fitch is then rating the AMPS), or any other rating agency
then rating the AMPS, that such authorization, creation or issuance
would not impair the rating then assigned by such rating agency to the
AMPS, in which case the vote or consent of the holders of the AMPS is
not required;
(b) amend, alter or repeal the provisions of the
Articles Supplementary if such amendment, alteration or repeal would
affect adversely the preferences, rights or powers expressly set forth
in the Articles of Incorporation or the Articles Supplementary of
holders of the AMPS, unless, in each case, the Fund obtains written
confirmation from Moody's (if Moody's is then rating the AMPS) and Fitch
(if Fitch is then rating the AMPS), or any other rating agency then
rating the AMPS, that such amendment, alteration or repeal would not
impair the rating then assigned by such rating agency to the AMPS, in
which case the vote or consent of the holders of the AMPS is not
required; or
(c) authorize the Fund's conversion from a closed-end to an open-end
investment company.
55
For purposes of the foregoing, no matter shall be deemed adversely to affect
any preference, right or power of a holder of AMPS unless such matter
(i) adversely alters or abolishes any preferential right of the AMPS;
(ii) creates, adversely alters or abolishes any right in respect of redemption
of such shares; or (iii) creates or adversely alters (other than to abolish) any
restriction on transfer applicable to such shares. The vote of holders of any
AMPS described in this paragraph will in each case be in addition to a separate
vote of the requisite percentage, if any, of Common Shares and/or preferred
shares necessary to authorize the action in question.
Unless a higher percentage is provided for under the Articles of
Incorporation or the Articles Supplementary or applicable law, the affirmative
vote of the holders of a majority (as defined in the 1940 Act) of the
outstanding shares of preferred stock of any series, including the AMPS, voting
separately from any other series, will be required with respect to any matter
that materially and adversely affects the rights, preferences or powers of that
series in a manner different from that of other series or classes of the Fund's
shares of capital stock. For purposes of the foregoing, no matter shall be
deemed to adversely affect any rights, preference or power unless such matter
(i) adversely alters or abolishes any preferential right of such series;
(ii) creates, adversely alters or abolishes any right in respect of redemption
of such series; or (iii) creates or adversely alters (other than to abolish) any
restriction on transfer applicable to such series. The vote of holders of any
series of preferred stock or AMPS described in this paragraph will in each case
be in addition to a separate vote of the requisite percentage, if any, of Common
Shares and/or preferred shares necessary to authorize the action in question.
Unless a higher percentage is provided for under the Articles of
Incorporation or the Articles Supplementary or applicable law, the affirmative
vote of the holders of a majority (as defined in the 1940 Act) of the
outstanding AMPS, voting together as a single class, will be required to approve
any plan of reorganization (including any plan of reorganization arising out of
bankruptcy proceedings) adversely affecting such 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 restrictions designated as
fundamental under "Fundamental Investment Restrictions" in the SAI and changes
in the Fund's subclassification as a closed-end investment company. In addition,
(1) the Fund's investment objective, (2) the Fund's status as a diversified
investment company and (3) the Fund's policy of not making any investments for
the purpose of exercising control or management of any company 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 entitled to be cast by the holders of
the Fund's Common Shares and preferred stock (including the AMPS), voting as a
single class, and of at least 80% of the votes of the preferred stock (including
the AMPS) entitled to be cast by stockholders, voting as a separate class. To
the extent permitted by applicable law, no vote of Common Shareholders, either
separately or together with holders of preferred shares as a single class, is
necessary to take the actions contemplated by (a) and (b) above.
The foregoing voting provisions will not apply with respect to AMPS if, at
or prior to the time when a vote is required, such shares have been
(i) redeemed or (ii) called for redemption and sufficient funds have been
deposited in trust to effect such redemption.
If a series of preferred shares other than the AMPS is issued in the future,
it is anticipated that such series would have voting rights comparable to those
described above.
RATING AGENCY GUIDELINES AND ASSET COVERAGE
In connection with the Fund's receipt of a rating of "Aaa" from Moody's and
a rating of "AAA" from Fitch with respect to the AMPS, the Fund is required to
maintain assets having in the aggregate a
56
discounted value at least equal to the AMPS Basic Maintenance Amount. The AMPS
Basic Maintenance Amount includes the sum of (a) the aggregate liquidation
preference of any preferred shares then outstanding (including the AMPS) and
(b) certain accrued and projected payment obligations of the Fund, including
without limitation certain accrued and projected dividends on any preferred
shares then outstanding (including the AMPS).
Moody's and Fitch have each established separate guidelines for calculating
discounted value. These guidelines specify discount factors that the Fund must
apply to various types of securities in its portfolio for purposes of
calculating whether the discounted value of the Fund's assets equals the AMPS
Basic Maintenance Amount (with the level of discount generally becoming greater
as the credit quality of a security becomes lower). In addition, under the
guidelines, certain types of securities (including securities in which the Fund
may otherwise invest) are not eligible for inclusion in the calculation of the
discounted value of the Fund's portfolio. Such ineligible securities include,
for example, certain lower-rated preferred and debt securities. The Fund may
invest in such securities to the extent appropriate guidelines are met. The
rating agency guidelines for calculating discounted value do not impose any
limitations on the percentage of the Fund's assets that may be invested in
ineligible assets, and the amount of ineligible assets included in the Fund's
portfolio at any time may vary depending upon the rating, diversification and
other characteristics of the eligible assets included in the portfolio.
In addition, the Fund is required by the 1940 Act, as well as by the rating
agency guidelines, to maintain asset coverage of at least 200% with respect to
senior securities that are equity securities, including the AMPS ("1940 Act
Preferred Shares Asset Coverage"). The Fund's 1940 Act Preferred Shares Asset
Coverage is tested as of the last business day of each month in which any senior
equity securities are outstanding. The minimum required 1940 Act Preferred
Shares Asset Coverage amount of 200% may be increased or decreased if the 1940
Act is amended. Based on the composition of the portfolio of the Fund and market
conditions as of March 31, 2003, the 1940 Act Preferred Shares Asset Coverage
with respect to all of the Fund's preferred shares, assuming the issuance on
that date of all AMPS offered hereby and giving effect to the deduction of the
related offering costs and sales load estimated at $5,895,000, would have been
computed as follows:
Value of Fund assets less liabilities
not constituting senior securities = $1,513,892,265 = 279%
---------------------------------------- ------------
Senior securities representing indebtedness $ 542,000,000
plus
liquidation value of the preferred shares
In the event the Fund does not timely cure a failure to maintain (a) a
discounted value of the eligible assets in its portfolio equal to the Preferred
Shares Basic Maintenance Amount or (b) the 1940 Act Preferred Shares Asset
Coverage, in each case in accordance with the requirements of the rating agency
or agencies then rating the AMPS, the Fund will be required to redeem AMPS as
described under "--Redemption--Mandatory Redemption" below.
In addition to the requirements described above, the rating agency
guidelines impose restrictions on the Fund's use of certain financial
instruments or investment techniques that the Fund might otherwise utilize. For
example, the guidelines limit the use of certain hedging transactions such as
futures contracts and options. The guidelines also limit the use of certain
other investment techniques, including borrowing of money, short sales, loans of
portfolio securities, and reverse repurchase agreements. For a complete
description of such restrictions, see the Articles Supplementary, which is
attached as Appendix B to the SAI.
57
The Fund may, but is not required to, adopt any modifications to the
guidelines that may be established by Moody's or Fitch. Failure to adopt any
such modifications, however, may result in a change in the ratings described
above or a withdrawal of ratings altogether. In addition, any rating agency
providing a rating for the AMPS may, at any time, change or withdraw any such
rating. The Directors may, without shareholder approval, amend, alter or repeal
any or all of the definitions and related provisions that have been adopted by
the Fund pursuant to the rating agency guidelines in the event the Fund receives
written confirmation from Moody's and/ or Fitch, as the case may be, that any
such amendment, alteration or repeal would not impair the rating then assigned
by such rating agency to the AMPS.
As recently described by Moody's and Fitch, a preferred stock rating is an
assessment of the capacity and willingness of an issuer to pay preferred stock
obligations. The rating on the AMPS is not a recommendation to purchase, hold or
sell those shares, inasmuch as the rating does not comment as to market price or
suitability for a particular investor. The rating agency guidelines described
above also do not address the likelihood that an owner of AMPS will be able to
sell such shares in an auction or otherwise. The ratings are based on current
information furnished to Moody's and Fitch by the Fund and the Adviser and
information obtained from other sources. The ratings may be changed, suspended
or withdrawn as a result of changes in, or the unavailability of, such
information. The Fund's Common Shares have not been rated by a nationally
recognized statistical rating organization.
A rating agency's guidelines will apply to the AMPS only so long as the
rating agency is rating the shares. The Fund will pay certain fees to Moody's
and Fitch for rating the AMPS. A more detailed description of how Moody's and
Fitch calculate discounted value and the other limitations imposed by the rating
agencies is contained in the Articles Supplementary, which is attached as
Appendix B to the SAI.
LIQUIDATION
Subject to the rights of holders of any series or class or classes of shares
ranking on a parity with AMPS with respect to the distribution of assets upon
liquidation of the Fund, upon a liquidation of the Fund (whether voluntary or
involuntary), the holders of AMPS then outstanding will be entitled to receive
and to be paid, out of the assets of the Fund available for distribution to its
shareholders, before any payment or distribution will be made on the Common
Shares or any other class of shares of the Fund ranking junior to the AMPS, an
amount equal to the liquidation preference with respect to such AMPS ($25,000
per share), plus an amount equal to all dividends thereon (whether or not earned
or declared by the Fund, but excluding any interest thereon) accumulated but
unpaid to (but not including) the date of final distribution in same-day funds
in connection with the liquidation of the Fund. If such assets of the Fund are
insufficient to make the full liquidation payment on the outstanding AMPS, no
distribution shall be made on any shares of any other class or series of
preferred shares ranking on a parity with the AMPS with respect to the
distribution of assets upon such liquidation unless proportionate distributive
amounts shall be paid on the AMPS, ratably, in proportion to the full
distributable amounts for which holders of all such parity shares are
respectively entitled upon such liquidation. After the payment to the holders of
AMPS of the full preferential amounts provided for as described herein, the
holders of AMPS as such will have no right or claim to any of the remaining
assets of the Fund.
For purposes of the foregoing paragraph, a liquidation of the Fund does not
include:
- the sale of all or any portion of the property or business of the Fund;
- the merger or consolidation of the Fund into or with any corporation,
business trust or other entity; or
- the merger or consolidation of any corporation, business trust or other
entity into or with the Fund.
58
REDEMPTION
MANDATORY REDEMPTION. The Fund is required to maintain (a) a discounted
value of eligible portfolio securities equal to the Preferred Shares Basic
Maintenance Amount and (b) the 1940 Act Preferred Shares Asset Coverage.
Eligible portfolio securities for the purposes of (a) above will be determined
from time to time by the rating agencies then rating the AMPS. If the Fund fails
to maintain such asset coverage amounts and does not timely cure such failure in
accordance with the requirements of the Articles Supplementary, the Fund must
redeem all or a portion of the AMPS. This mandatory redemption will take place
on a date that the Directors specify out of legally available funds in
accordance with the Articles of Incorporation, the Articles Supplementary and
applicable law, at the redemption price of $25,000 per share, plus accumulated
but unpaid dividends (whether or not earned or declared but excluding any
interest thereon) to (but not including) the date fixed for redemption. In
determining the number of AMPS required to be redeemed in accordance with the
foregoing, the Fund will allocate the number of shares required to be redeemed
to satisfy the Preferred Shares Basic Maintenance Amount or the 1940 Act
Preferred Shares Asset Coverage, as the case may be, pro rata among the AMPS and
any other preferred shares of the Fund subject to redemption or retirement. The
mandatory redemption will be limited to the number of AMPS and any other
preferred shares necessary to restore the required discounted value or the 1940
Act Preferred Shares Asset Coverage, as the case may be.
OPTIONAL REDEMPTION. The Fund, at its option, may redeem the AMPS, in whole
or in part, out of legally available funds. Any optional redemption will occur
on any dividend payment date at the optional redemption price per share of
$25,000, plus an amount equal to accumulated but unpaid dividends (whether or
not earned or declared but excluding any interest thereon) to (but not
including) the date fixed for redemption, plus the premium, if any, specified in
a special redemption provision. No AMPS may be redeemed if the redemption would
cause the Fund to violate the 1940 Act. The Fund has the authority to redeem the
AMPS for any reason and may redeem all or part of the outstanding AMPS if it
anticipates that the Fund's leveraged capital structure will result in a lower
rate of return to Common Shareholders for any significant period of time than
that obtainable if the Common Shares were unleveraged. The Fund may exercise
such redemption option as to some or all of the AMPS, subject to certain
limitations. The optional redemption of AMPS will, if less than all the AMPS are
redeemed, be made on a pro rata basis.
The Fund will not make any optional redemption unless (i) the Fund has
available certain deposit securities with maturities or tender dates not later
than the day preceding the applicable redemption date and having a value not
less than the amount (including any applicable premium) due to holders of the
AMPS by reason of the redemption of the AMPS on such date fixed for the
redemption and (ii) the Fund has eligible assets with an aggregate discounted
value at least equal to the Preferred Shares Basic Maintenance Amount (both
before and after giving effect to such redemption).
Notwithstanding the foregoing, if unpaid dividends exist with respect to the
AMPS (whether or not earned or declared), no AMPS shall be redeemed (by either
mandatory redemption or optional redemption) unless all outstanding AMPS are
simultaneously redeemed; provided, however, that this limitation will not apply
to an otherwise lawful purchase or exchange offer made on the same terms to the
holders of all outstanding AMPS.
Although the AMPS are subject to redemption under certain circumstances as
described above and under "--Mandatory Redemption," unlike the shares of an
open-end mutual fund, the AMPS may not be redeemed at a shareholder's option.
59
THE AUCTION
GENERAL
Under the Articles Supplementary, the applicable rate for the AMPS for each
rate period after the initial rate period will generally be the rate that
results from an auction conducted as set forth in the Articles Supplementary and
summarized below. In such an auction, persons determine to hold or offer to sell
AMPS regardless of the rate set by the auction or offer to purchase or sell AMPS
based on specific dividend rates bid by them. See the Articles Supplementary,
which is attached as Appendix B of the SAI, for a more complete description of
the auction process.
AUCTION AGENCY AGREEMENT. The Fund will enter into an auction agency
agreement with the auction agent (currently, Wilmington Trust Company) which
provides, among other things, that the auction agent will follow the auction
procedures set forth in the Articles Supplementary to determine the applicable
rate for the AMPS so long as the applicable rate for the AMPS is to be based on
the results of an auction.
The auction agent may terminate the auction agency agreement upon notice to
the Fund no earlier than 60 days after such notice. If the auction agent should
resign, the Fund will attempt to appoint another qualified institution to act as
auction agent. The Fund may remove the auction agent provided that prior to such
removal the Fund has entered into an agreement with a successor auction agent to
perform substantially similar services.
BROKER-DEALER AGREEMENTS. Each auction requires the participation of one or
more Broker-Dealers. The auction agent will enter into agreements with one or
more Broker-Dealers selected by the Fund that provide for the participation of
those Broker-Dealers in auctions for AMPS ("Broker-Dealer Agreements").
The auction agent will pay to each Broker-Dealer after each auction, from
funds provided by the Fund, a service charge that will generally be at the
annual rate of 1/4 of 1% of the stated value ($25,000 per share) of the AMPS
held by a Broker-Dealer's customers upon settlement in an auction.
The Fund may request the auction agent to terminate one or more
Broker-Dealer Agreements at any time upon five days' notice, provided that at
least one Broker-Dealer Agreement is in effect after such termination. A
Broker-Dealer or the auction agent may terminate a Broker-Dealer Agreement at
any time upon five days' written notice, subject to certain conditions. Each
Broker-Dealer Agreement shall automatically terminate upon the redemption of all
outstanding AMPS or upon termination of the auction agency agreement.
AUCTION PROCEDURES
Prior to the submission deadline on each auction date for the AMPS, each
customer of a Broker-Dealer who is listed on the records of that Broker-Dealer
(or, if applicable, the auction agent) as a beneficial owner of AMPS may submit
the following types of orders with respect to AMPS to that Broker-Dealer:
1. Hold Order--indicating its desire to hold AMPS without regard to the
applicable rate for the next rate period.
2. Bid--indicating its desire to purchase or hold the indicated number
of AMPS at $25,000 per share if the applicable rate for the next
rate period is not less than the rate specified in the bid. A bid
order by an existing holder will be deemed an irrevocable offer to
sell
60
AMPS at $25,000 per share if the applicable rate for the next rate
period is less than the rate specified in the bid.
3. Sell Order--indicating its desire to sell AMPS at $25,000 per share
without regard to the applicable rate for the next rate period.
A beneficial owner of AMPS may submit different types of orders to its
Broker-Dealer with respect to different AMPS then held by the beneficial owner.
A beneficial owner that submits a bid to its Broker-Dealer having a rate higher
than the applicable maximum rate on the auction date will be treated as having
submitted a sell order to its Broker-Dealer. A beneficial owner that fails to
submit an order to its Broker-Dealer will ordinarily be deemed to have submitted
a hold order to its Broker-Dealer. However, if a beneficial owner fails to
submit an order for some or all of its shares to its Broker-Dealer for an
auction relating to a rate period of more than 91 days, such beneficial owner
will be deemed to have submitted a sell order for such shares to its
Broker-Dealer. A sell order constitutes an irrevocable offer to sell the AMPS
subject to the sell order. A beneficial owner that offers to become the
beneficial owner of additional AMPS is, for the purposes of such offer, a
potential holder as discussed below.
A potential holder is either a customer of a Broker-Dealer that is not a
beneficial owner of AMPS but that wishes to purchase AMPS or a beneficial owner
that wishes to purchase additional AMPS. A potential holder may submit bids to
its Broker-Dealer in which it offers to purchase AMPS at $25,000 per share if
the applicable rate for the next rate period is not less than the rate specified
in such bid. A bid placed by a potential holder specifying a rate higher than
the applicable maximum rate on the auction date will not be accepted.
The Broker-Dealers in turn will submit the orders of their respective
customers who are beneficial owners and potential holders to the auction agent.
Unless otherwise permitted by the Fund, the Broker-Dealers will designate
themselves as existing holders of shares subject to orders submitted or deemed
submitted to them by beneficial owners. They will also designate themselves as
potential holders of shares subject to orders submitted to them by potential
holders. However, neither the Fund nor the auction agent will be responsible for
a Broker-Dealer's failure to comply with these procedures. Any order placed with
the auction agent by a Broker-Dealer as or on behalf of an existing holder or a
potential holder will be treated the same way as an order placed with a
Broker-Dealer by a beneficial owner or potential holder. Similarly, any failure
by a Broker-Dealer to submit to the auction agent an order for any AMPS held by
it or customers who are beneficial owners will be treated as a beneficial
owner's failure to submit to its Broker-Dealer an order in respect of AMPS held
by it. A Broker-Dealer may also submit orders to the auction agent for its own
account as an existing holder or potential holder, provided that it is not an
affiliate of the Fund.
There are sufficient clearing bids in an auction if the number of AMPS
subject to bids submitted or deemed submitted to the auction agent by
Broker-Dealers for potential holders with rates equal to or lower than the
applicable maximum rate is at least equal to the sum of the number of AMPS
subject to sell orders submitted or deemed submitted to the auction agent by
Broker-Dealers for existing holders and the number of AMPS subject to bids
specifying rates higher than the applicable maximum rate submitted or deemed
submitted to the auction agent by Broker-Dealers for existing holders. If there
are sufficient clearing bids, the applicable rate for the AMPS for the next
succeeding rate period thereof will be the lowest rate specified in the
submitted bids that, taking into account such rate and all lower rates bid by
Broker-Dealers as or on behalf of existing holders and potential holders, would
result in such existing holders and potential holders owning the AMPS available
for purchase in the auction.
61
If there are not sufficient clearing bids, the applicable rate for the next
rate period will be the applicable maximum rate on the auction date. If there
are not sufficient clearing bids, beneficial owners of AMPS that have submitted
or are deemed to have submitted sell orders may not be able to sell in the
auction all shares subject to such sell orders. If all of the outstanding AMPS
are the subject of submitted hold orders, then the rate period following the
auction will automatically be the same length as the preceding rate period and
the applicable rate for the next rate period will be 80% of the reference rate
(I.E., 80% of the applicable "AA" Financial Composite Commercial Paper Rate (for
a rate period of fewer than 184 days) or Treasury Index Rate (for a rate period
of 184 days or more)).
The auction procedures include a pro rata allocation of shares for purchase
and sale, which may result in an existing holder continuing to hold or selling,
or a potential holder purchasing, a number of AMPS that is different from the
number of shares specified in its order. To the extent the allocation procedures
have that result, Broker-Dealers that have designated themselves as existing
holders or potential holders in respect of customer orders will be required to
make appropriate pro rata allocations among their respective customers.
Settlement of purchases and sales will be made on the next business day
(which is also a dividend payment date) after the auction date through DTC.
Purchasers will make payment through their Agent Members in same-day funds to
DTC against delivery to their respective Agent Members. DTC will make payment to
the sellers' Agent Members in accordance with DTC's normal procedures, which
currently provide for payment against delivery by their Agent Members in
same-day funds.
The auctions for Series M7, T7, W7, Th7 and F7 AMPS will normally be held
every seven days (normally every Monday, Tuesday, Wednesday, Thursday and
Friday, respectively) and those for the Series T28 and W28 AMPS will normally be
held every 28 days (normally on Tuesday and Wednesday, respectively), and each
subsequent rate period will normally begin on the following business day
(normally the following Tuesday, Wednesday, Thursday, Friday and Monday in the
case of Series M7, T7, W7, Th7 and F7, respectively, and normally the following
Wednesday and Thursday in the case of Series T28 and W28, respectively).
The first auction for Series M7 will be held , 2003, for Series T7,
, 2003, for Series W7, , 2003, for Series Th7, , 2003, for
Series F7, , 2003, for Series T28, , 2003, and for Series W28,
, 2003, in each case the business day preceding the dividend payment date
for the initial dividend period. Thereafter, except during special rate periods,
auctions for the Series M7, T7, W7, Th7 and F7 AMPS normally will be held every
seven days thereafter and auctions for the Series T28 and W28 AMPS normally will
be held every 28 days thereafter, and each subsequent dividend period for a
Series of AMPS normally will begin on the business day following the relevant
auction date.
If an auction date is not a business day because the New York Stock Exchange
is closed for business due to an act of God, natural disaster, extreme weather,
act of war, civil or military disturbance, act of terrorism, sabotage, riots or
a loss or malfunction of utilities or communications services, or if the auction
agent is not able to conduct an auction in accordance with the auction
procedures for any such reason, then the dividend rate for the next dividend
period will be the dividend rate determined on the previous auction date.
If a dividend payment date is not a business day because the New York Stock
Exchange is closed for business due to an act of God, natural disaster, extreme
weather, act of war, civil or military
62
disturbance, act of terrorism, sabotage, riots or a loss or malfunction of
utilities or communications services, or if the dividend payable on such date
cannot be paid for any such reason then:
- the dividend payment date for the affected dividend period will be the
next business day on which the Fund and the auction agent can pay the
dividend using commercially reasonable best efforts;
- the affected dividend period will end on the day it otherwise would have
ended; and
- the next dividend period will begin and end on the dates on which it
otherwise would have begun and ended.
The following is a simplified example of how a typical auction works. Assume
that the Fund has 1,000 outstanding AMPS and three current holders. The three
current holders and three potential holders submit orders through broker-dealers
at the auction:
Current Holder A........................ Owns 500 shares, wants to sell all 500 Bid order of 2.1% rate for all 500
shares if auction rate is less than 2.1% shares
Current Holder B........................ Owns 300 shares, wants to hold Hold order--will take the auction rate
Current Holder C........................ Owns 200 shares, wants to sell all 200 Bid order of 1.9% rate for all 200
shares if auction rate is less than 1.9% shares
Potential Holder D...................... Wants to buy 300 shares if auction rate Places order to buy 300 shares at or
is 2.0% or greater above 2.0%
Potential Holder E...................... Wants to buy 500 shares if auction rate Places order to buy 500 shares at or
is 1.9% or greater above 1.9%
Potential Holder F...................... Wants to buy 400 shares if auction rate Places order to buy 400 shares at or
is 2.1% or greater above 2.1%
The lowest dividend rate that will result in all 1,000 AMPS continuing to be
held is 1.9%. Therefore, the dividend rate will be 1.9%. Current holders B and C
will continue to own their shares. Current holder A will sell its shares because
A's dividend rate bid was higher than the dividend rate. Potential holder E will
buy 500 shares because its bid rate was at or below the dividend rate. Potential
holders D and F will not buy any shares because their bid rates were above the
dividend rate.
The dividend rates used in the example above are hypothetical, and are not
necessarily indicative of the rates that may be payable on the AMPS at any time.
For further description of the auction procedures, please see the Articles
Supplementary, which is attached as Appendix B to the SAI.
SECONDARY MARKET TRADING AND TRANSFER OF AMPS
The underwriters are not required to make a market in the AMPS. The
Broker-Dealers (including the underwriters) may maintain a secondary trading
market for the AMPS outside of auctions, but they are not required to do so.
There can be no assurance that a secondary trading market for AMPS will develop
or, if it does develop, that it will provide holders of AMPS with liquidity of
investment. The AMPS will not be listed on any stock exchange or on the NASDAQ
market. Investors who purchase AMPS in an auction (particularly if the Fund has
declared a special rate period) should note that, because the dividend rate on
such shares will be fixed for the length of that dividend period, the value of
such shares may fluctuate in response to the changes in interest rates, and may
be more or less than
63
their original cost if sold on the open market in advance of the next auction
thereof, depending on market conditions.
You may sell, transfer, or otherwise dispose of AMPS only in whole shares
and only:
- pursuant to a bid or sell order placed with the auction agent in
accordance with the auction procedures;
- to a Broker-Dealer; or
- to such other persons as may be permitted by the Fund; provided, however,
that (x) if you hold your AMPS in the name of a Broker-Dealer, a sale or
transfer of your AMPS to that Broker-Dealer, or to another customer of
that Broker-Dealer, will not be considered a sale or transfer for
purposes of the foregoing limitation if that Broker-Dealer remains the
existing holder of the AMPS immediately after the transaction; and
(y) in the case of all transfers, other than through an auction, the
Broker-Dealer (or other person, if the Fund permits) receiving the
transfer will advise the auction agent of the transfer.
NET ASSET VALUE
The net asset value of the Fund's Common Shares is determined as of the
close of trading on the New York Stock Exchange, usually 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 Common Shares 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 AMPS and (iii) accumulated and unpaid
dividends on the outstanding AMPS.
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 STRUCTURE
The Fund is a corporation organized under the laws of the State of Maryland.
The Fund is authorized to issue up to 250,000,000 shares of capital stock,
of which 240,000,000 are classified as Common Shares, par value $0.01 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 number of
shares of stock of any class or series that the Fund has authority to issue. All
Common
64
Shares have equal non-cumulative voting rights and equal rights with respect to
dividends and distribution of assets upon liquidation. Common Shares are fully
paid and non-assessable when issued and have no preemptive, conversion or
exchange rights.
The Articles of Incorporation authorize the issuance of up to 10,000,000
shares of preferred stock having a par value of $0.01 per share in one or more
series, with rights as determined by the Board of Directors, without the
approval of the Common Shareholders. Common Shareholders have no preemptive
right to purchase any shares of preferred stock that might be issued by the
Fund. (The Directors have authorized 3,200 Series M7, 3,200 Series T7, 3,200
Series W7, 3,200 Series Th7, 3,200 Series F7, 2,840 Series T28 and 2,840
Series W28 shares.)
For a description of the AMPS, see "Description of AMPS."
The following table shows the number of (i) shares authorized and
(ii) shares outstanding for each class of authorized securities of the Fund as
of April 11, 2003.
NUMBER HELD BY
NUMBER OR FOR THE ACCOUNT NUMBER
TITLE OF CLASS AUTHORIZED OF THE FUND OUTSTANDING
-------------- ----------- ------------------ -------------------
Common Shares 240,000,000 0 40,854,198
Series M7 AMPS 3,200* 0 0
Series T7 AMPS 3,200* 0 0
Series W7 AMPS 3,200* 0 0
Series Th7 AMPS 3,200* 0 0
Series F7 AMPS 3,200* 0 0
Series T28 AMPS 2,840* 0 0
Series W28 AMPS 2,840* 0 0
-------------------
* Assumes authorization of 21,680 AMPS by the Board of Directors prior to the
issuance of the AMPS.
Common Shareholders are entitled to share equally in dividends declared by
the Board of Directors payable to Common Shareholders and in the net assets of
the Fund available for distribution to Common Shareholders after payment of the
preferential amounts payable to holders of any outstanding preferred shares,
including the AMPS. Neither Common Shareholders nor holders of AMPS have
conversion rights or the right to cause the Fund to redeem their shares. Upon
liquidation of the Fund, after paying or adequately providing for the payment of
all liabilities of the Fund and the liquidation preference with respect to any
outstanding preferred shares, and upon receipt of such releases, indemnities and
refunding agreements as they deem necessary for their protection, the Directors
may distribute the remaining assets of the Fund among the Common Shareholders.
Pursuant to the Fund's Dividend Reinvestment and Cash Purchase Plan, all
Common Shareholders whose shares are registered in their own names will have all
dividends, including any capital gain dividends, reinvested automatically in
additional Common Shares by the Administrator as agent for the Common
Shareholders, unless the Common Shareholder elects to receive cash. The Fund and
the Administrator reserve the right to amend or terminate the Dividend
Reinvestment and Cash Purchase Plan.
Common Shareholders will vote with the holders of the AMPS and any other
outstanding preferred shares on each matter submitted to a vote of Common
Shareholders, except as described under "Description of AMPS--Voting Rights" and
except as otherwise required by the Articles of Incorporation, the Articles
Supplementary or applicable law.
65
Shareholders of each class or series are entitled to one vote for each share
held. Except as provided under "Description of AMPS--Voting Rights" and except
as otherwise required by the Articles of Incorporation, the Articles
Supplementary or applicable law, holders of preferred shares, including the
AMPS, voting as a separate class, are entitled to elect two Directors, and the
remaining Directors will be elected by holders of Common Shares and preferred
shares (including the AMPS), voting as a single class.
Under the 1940 Act, so long as any AMPS or any other preferred shares are
outstanding, Common Shareholders will not be entitled to receive any dividends
or other distributions from the Fund, unless at the time of such declaration,
(1) all accrued dividends on the AMPS have been paid and (2) the value of the
Fund's total assets (determined after deducting the amount of such dividend or
other distribution), less all liabilities and indebtedness of the Fund not
represented by "senior securities" (as defined in the 1940 Act), is at least
300% of the aggregate amount of senior securities representing indebtedness (to
the extent any such senior securities are outstanding) and at least 200% of the
aggregate amount of any senior securities representing indebtedness plus the
aggregate liquidation value of the outstanding preferred shares. In addition to
the requirements of the 1940 Act, the Fund is required to comply with other
asset coverage requirements as a condition of the Fund obtaining a rating of the
AMPS from rating agencies. These requirements include an asset coverage test
more stringent than under the 1940 Act. See "Description of AMPS--Dividends and
Rate Periods--Restrictions on Dividends and Other Distributions."
The Fund will send unaudited reports at least semi-annually and audited
financial statements annually to all of its shareholders.
The Common Shares of the Fund commenced trading on the New York Stock
Exchange on January 29, 2003. On April 11, 2003, the net asset value per Common
Share was $23.77, and the closing price per Common Share on the New York Stock
Exchange was $25.00.
OTHER ISSUES RELATING TO THE AMPS
Under the 1940 Act, the Fund is permitted to have outstanding more than one
series of preferred shares as long as no single series has priority over another
series as to the distribution of assets of the Fund or the payment of dividends.
Neither Common Shareholders nor holders of AMPS have pre-emptive rights to
purchase any AMPS or any other preferred shares that the Fund may issue.
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
Common Shares 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 Common Shares offering,
Common Shares publicly trade for a substantial period of time at a significant
discount from the Fund's then current net asset
66
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 AMPS are outstanding, the Fund may not
purchase, redeem or otherwise acquire any of its Common Shares unless (1) all
accumulated dividends on AMPS 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
Shares) is at least 200% of the liquidation value of the then outstanding AMPS
(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 AMPS then outstanding (requiring that it liquidate a portion of its
investment portfolio), and the Fund's Common Shares 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.
Before deciding whether to take any action if the Common Shares 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 AMPS) 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
AMPS) 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 Common Shares and AMPS
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
67
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.
TAX MATTERS
The following federal income tax discussion is based on the advice of
Willkie Farr & Gallagher, counsel to the Fund, and reflects provisions of the
Code, existing Treasury Regulations, rulings published by the IRS, and other
applicable authority, as of the date of this prospectus. These authorities are
subject to change by legislative or administrative action, possibly with
retroactive effect. The following discussion is only a summary of some of the
important tax considerations generally applicable to investments in the Fund.
For more detailed information regarding tax considerations, see the SAI. There
may be other tax considerations applicable to particular investors. In addition,
income earned through an investment in the Fund may be subject to state and
local taxes. Prospective investors should consult their own tax advisors with
regard to the general tax consequences of the purchase, ownership, or
disposition of Fund shares, as well as the tax consequences arising under the
laws of any state, foreign country or other taxing jurisdiction.
The Bush Administration has announced a proposal to eliminate the federal
income tax on dividends of income previously taxed at the corporate level. In
addition, under the proposal, shareholders may be provided with basis
adjustments to reflect income taxed at the corporate level that is not
distributed. Basis adjustments may not be allocated to certain shares that are
preferred and limited as to dividends. Under the proposal, regulated investment
companies such as the Fund may be permitted to pass through to their
shareholders the excludable dividends and basis adjustments. Excludable
dividends may not be a tax preference for alternative minimum tax purposes. At
this time, however, it is uncertain if, and in what form, the proposal will
ultimately be adopted. Accordingly, it is not possible to evaluate how this
proposal might affect the discussion below.
The Fund intends to qualify each year for taxation as a regulated investment
company eligible for treatment under the provisions of Subchapter M of the Code.
If the Fund so qualifies and satisfies certain distribution requirements, the
Fund will not be subject to federal income tax on income distributed in a timely
manner to its shareholders in the form of dividends or capital gain
distributions.
In order for any portion of any distributions to holders of AMPS to be
eligible to be treated as capital gain dividends, the AMPS must be treated as
equity for federal income tax purposes. Based on advice from counsel, the Fund
believes that the AMPS will constitute equity for federal income tax purposes.
This belief relies in part on a published ruling of the IRS stating that certain
variable rate preferred stock similar in many material respects to the AMPS
represents equity. If the IRS were to assert successfully that variable rate
preferred stock such as the AMPS should be treated as debt for federal income
tax purposes, distributions on AMPS (including distributions designated by the
Fund as capital gain dividends) would be taxable as ordinary income (as opposed
to capital gains).
To satisfy the distribution requirement applicable to regulated investment
companies, amounts paid as dividends by the Fund to its shareholders, including
holders of its preferred shares, must qualify for the dividends-paid deduction.
If the Fund realizes a long-term capital gain, it will be required to allocate
such gain between and among the Common Shares and any preferred shares issued by
the Fund in proportion to the total dividends paid to each class during the year
in which the income is realized.
If at any time when preferred shares are outstanding the Fund does not meet
applicable asset coverage requirements, it will be required to suspend
distributions to Common Shareholders until the requisite asset coverage is
restored. Any such suspension may cause the Fund to pay a 4% federal excise tax
(imposed on regulated investment companies that fail to distribute for a given
calendar year,
68
generally, at least 98% of their net investment income and capital gain net
income) and income tax on undistributed income or gains, and may, in certain
circumstances, prevent the Fund from qualifying for treatment as a regulated
investment company. The Fund may redeem preferred shares in an effort to comply
with the distribution requirement applicable to regulated investment companies
and to avoid income and excise taxes. The Fund may have to dispose of portfolio
securities to generate cash for such redemption, which may result in transaction
expenses and gain at the Fund level and in further distributions.
The Fund's investments in certain debt obligations may cause the Fund to
recognize taxable income in excess of the cash generated by such obligations.
Thus, the Fund could be required at times to liquidate other investments,
including when it is not advantageous to do so, in order to satisfy its
distribution requirements.
The Fund may at times buy investments at a discount from the price at which
they were originally issued, especially during periods of rising interest rates.
For federal income tax purposes, some or all of this market discount will be
included in the Fund's ordinary income and will be taxable to shareholders as
such.
For federal income tax purposes, distributions of investment income are
taxable as ordinary income, assuming the Fund has sufficient current or
accumulated earnings and profits. Whether distributions of capital gains are
taxed as ordinary income or capital gains is determined by how long the Fund
owned the investments that generated such capital gains, rather than how long a
shareholder has owned his or her shares. Distributions of gains from the sale of
investments that the Fund owned for more than one year that are designated by
the Fund as capital gain dividends will be taxable as capital gains.
Distributions of gains from the sale of investments that the Fund owned for one
year or less will be taxable as ordinary income. Distributions are taxable to
shareholders even if they are paid from income or gains earned by the Fund
before a shareholder's investment (and thus were included in the price the
shareholder paid). Any gain resulting from the sale or exchange of Fund shares
will generally also be subject to tax.
The Fund's investments in non-U.S. securities may be subject to non-U.S.
taxes, including withholding taxes. In that case, the Fund's yield on those
securities would be decreased. Shareholders generally will not be entitled to
claim a credit or deduction with respect to foreign taxes. In addition, the
Fund's investments in non-U.S. securities or currencies other than the U.S.
dollar may increase or accelerate the Fund's recognition of ordinary income and
may affect the timing or amount of the Fund's distributions.
The Fund's transactions in options, futures contracts, hedging transactions,
forward contracts, swap agreements, straddles and foreign currencies will be
subject to special tax rules (including mark-to-market, constructive sale,
straddle, wash sale and short sale rules), the effect of which may be to
accelerate income to the Fund, defer losses to the Fund, cause adjustments in
the holding periods of the Fund's securities, convert long-term capital gains
into short-term capital gains and convert short-term capital losses into
long-term capital losses. These rules could therefore affect the amount, timing
and character of distributions to shareholders.
If, in connection with the designation of a special rate period, (i) the
Fund provides in a notice of special rate period that the Fund may redeem all or
a portion of the AMPS and that upon such redemption the holders of the AMPS may
receive a premium in addition to receipt of a redemption price per share equal
to the sum of $25,000 plus an amount equal to the accumulated but unpaid
dividends thereon during the whole or any part of the special rate period,
(ii) based on all the facts and circumstances at the time of the designation of
the special rate period the Fund is more likely than not to redeem such AMPS
during the special rate period, and (iii) the premium to be paid upon
69
redemption during such special rate period exceeds a specified DE MINIMIS
amount, it is possible that the holders of the AMPS will be required to accrue
the premium as a dividend (to the extent of the Fund's earnings and profits).
The Fund generally is required to withhold and remit to the U.S. Treasury a
percentage of the taxable dividends and other distributions paid to any
shareholder who fails to properly furnish the Fund with a correct taxpayer
identification number (TIN), who has under-reported dividend or interest income,
or who fails to certify to the Fund that he or she is not subject to such
withholding. The backup withholding tax rate will be (i) 30% for amounts paid
during 2003, (ii) 29% for amounts paid during 2004 and 2005, and (iii) 28% for
amounts paid during 2006 through 2010. The backup withholding rate will be 31%
for amounts paid after December 31, 2010, unless Congress enacts tax legislation
providing otherwise. The Bush Administration has announced a proposal to
accelerate reductions in tax rates which may change the backup withholding rate
as well. In order for a foreign investor to qualify for exemption from the
back-up withholding tax rates and for reduced withholding tax rates under income
tax treaties, the foreign investor must comply with special certification and
filing requirements. Foreign investors in the Fund should consult their tax
advisers in this regard.
It is not expected that investors will be subject to the alternative minimum
tax as a result of an investment in the Fund. This section relates only to
federal income tax consequences of investing in the Fund; the consequences under
other tax laws may differ. Shareholders should consult their tax advisers as to
the possible application of foreign, state and local income tax laws to Fund
dividends and capital distributions. Please see the SAI for additional
information regarding the tax aspects of investing in the Fund.
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 stock entitled to elect
the Director's successor. 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 Shares 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 Shares and any outstanding Preferred Stock, voting together as a single
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 Shares 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
70
of at least 80% of the Directors and at least 80% of the votes entitled to be
cast by holders of Common Shares 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 Common Shares 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 Shares 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 Shares
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 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.
71
UNDERWRITING
Subject to the terms and conditions of a purchase agreement dated April ,
2003, the underwriters named below have agreed to purchase, and the Fund has
agreed to sell to such underwriters, the number of AMPS set forth below.
NUMBER OF AMPS
--------------
UNDERWRITER SERIES M7 SERIES T7 SERIES W7 SERIES TH7 SERIES F7 SERIES T28 SERIES W28
----------- ------------ ------------ ------------ ------------- ------------ ------------- -------------
Merrill Lynch, Pierce,
Fenner & Smith
Incorporated...
A.G. Edwards & Sons,
Inc. ..................
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total..........
========== ========== ========== ========== ========== ========== ==========
The purchase agreement provides that the obligations of the underwriters to
purchase the AMPS included in this offering are subject to the approval of
certain legal matters by counsel and to other conditions, including, without
limitation, the receipt by the underwriters of customary closing certificates,
opinions and other documents and the receipt by the Fund of "Aaa" and "AAA"
ratings on the AMPS from Moody's and Fitch, respectively, as of the time of the
closing of the offering. The underwriters are obligated to purchase all the AMPS
sold under the purchase agreement if any of the AMPS are purchased. In the
purchase agreement, the Fund and the Adviser have agreed to indemnify the
underwriters against certain liabilities, including liabilities arising under
the Securities Act of 1933, or to contribute payments the underwriters may be
required to make for any of those liabilities.
The underwriters propose to initially offer some of the AMPS directly to the
public at the public offering price set forth on the cover page of this
prospectus and some of the AMPS 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 $250 per share is equal to 1% of the initial offering price of the AMPS.
After the initial public offering, the underwriters may change the public
offering price and the concession. Investors must pay for any AMPS purchased on
or before April , 2003.
The Fund anticipates that the underwriters may from time to time act as
brokers or dealers in executing the Fund's portfolio transactions, although the
underwriters will not act as principals in any transaction until after they have
ceased to be underwriters.
The Fund anticipates that the underwriters or their affiliates may, from
time to time, act in auctions as broker-dealers and receive fees as set forth
under "The Auction." The underwriters are active underwriters of, and dealers
in, securities and act as market makers in a number of such securities, and
therefore can be expected to engage in portfolio transactions with, and perform
services for, the Fund.
The settlement date for the purchase of the AMPS will be April , 2003, as
agreed upon by the underwriters, the Fund and the Adviser pursuant to
Rule 15c6-1 under the Securities Exchange Act of 1934.
The principal business addresses of the underwriters are: Merrill Lynch,
Pierce, Fenner & Smith Incorporated, 4 World Financial Center, New York, New
York 10080 and A.G. Edwards & Sons, Inc., One North Jefferson Avenue, St. Louis,
Missouri 63103.
For a description of the compensation paid to Merrill Lynch in connection
with the offering of the Fund's Common Stock, please see "Management of the
Fund--Additional Compensation Agreement."
72
CUSTODIAN, TRANSFER AGENT AND AUCTION AGENT
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 Shares.
Wilmington Trust Company, 1110 North Market Street, Wilmington, Delaware
19896, serves as the auction agent, transfer agent, registrar, dividend paying
agent and redemption agent for the AMPS.
LEGAL MATTERS
The validity of the shares offered hereby is being passed on for the Fund by
Willkie Farr & Gallagher, New York, New York, and certain other legal matters
will be passed on for the underwriters by Clifford Chance US LLP. Counsel for
the Fund and the Underwriters may rely, as to certain matters of Maryland law,
on Venable, Baetjer and Howard, LLP, Baltimore, Maryland.
AVAILABLE INFORMATION
The Fund is subject to certain informational requirements under the federal
securities laws and in accordance therewith is required to file reports, proxy
statements and other information with the SEC. Any such reports, proxy
statements and other information can be inspected and copied at the public
reference facilities of the SEC, Judiciary Plaza, 450 Fifth Street, N.W.,
Washington, D.C. 20549. Reports, proxy statements and other information
concerning the Fund can also be inspected at the offices of the New York Stock
Exchange, Exchange Place, New York, New York 10006.
Additional information regarding the Fund and the AMPS is contained in the
Registration Statement on Form N-2, including amendments, exhibits and schedules
thereto, relating to such shares filed by the Fund with the SEC. This prospectus
does not contain all of the information set forth in the Registration Statement,
including any amendments, exhibits and schedules thereto. For further
information with respect to the Fund and the shares offered hereby, reference is
made to the Registration Statement. Statements contained in this prospectus as
to the contents of any contract or other document referred to are not
necessarily complete and in each instance reference is made to the copy of such
contract or other document filed as an exhibit to the Registration Statement,
each such statement being qualified in all respects by such reference.
A copy of the Registration Statement may be inspected without charge at the
SEC's principal office in Washington, D.C., and copies of all or any part
thereof may be obtained from the SEC upon the payment of certain fees prescribed
by the SEC. The SEC maintains a Web site (http://www.sec.gov) that contains the
Registration Statement, other documents incorporated by reference, and other
information the Fund has filed electronically with the SEC, including proxy
statements and reports filed under the Securities Exchange Act of 1934.
73
TABLE OF CONTENTS OF THE STATEMENT OF ADDITIONAL INFORMATION
PAGE
----
Fundamental Investment Restrictions............... 3
Investment Objective and Policies................. 4
Management of the Fund............................ 9
Investment Advisory Services...................... 14
Portfolio Transactions and Brokerage.............. 16
Determination of Net Asset Value.................. 17
Distributions..................................... 17
Description of Shares............................. 19
Additional Information Concerning the Auctions for
AMPS............................................ 20
Taxation.......................................... 21
Performance-Related and Comparative and Other
Information..................................... 28
Counsel and Independent Accountants............... 29
Additional Information............................ 30
Financial Statements.............................. 31
Appendix A--Ratings of Investments................ A-1
Appendix B--Articles Supplementary................ B-1
74
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
$542,000,000
[F&C LOGO] [CLAYMORE LOGO]
F&C/CLAYMORE PREFERRED SECURITIES
INCOME FUND INCORPORATED
AUCTION MARKET PREFERRED SHARES ("AMPS")
3,200 SHARES, SERIES M7
3,200 SHARES, SERIES T7
3,200 SHARES, SERIES W7
3,200 SHARES, SERIES TH7
3,200 SHARES, SERIES F7
2,840 SHARES, SERIES T28
2,840 SHARES, SERIES W28
LIQUIDATION PREFERENCE $25,000 PER SHARE
----------
PROSPECTUS
----------
MERRILL LYNCH & CO.
A.G. EDWARDS & SONS, INC.
, 2003
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
The information in this Statement of Additional Information 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
Statement of Additional Information 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, DATED APRIL 15, 2003
F&C/CLAYMORE PREFERRED SECURITIES
INCOME FUND INCORPORATED
301 E. Colorado Boulevard
Suite 720
Pasadena, California 91101
(626) 795-7300
STATEMENT OF ADDITIONAL INFORMATION
APRIL , 2003
F&C/Claymore Preferred Securities Income Fund Incorporated (the "Fund")
is a recently organized, diversified, closed-end management investment company
incorporated under the laws of the State of Maryland on May 23, 2002.
This Statement of Additional Information relating to the Series M7,
T7, W7, Th7, F7, T28 and W28 Auction Market Preferred Stock ("AMPS") of the
Fund is not a prospectus, but should be read in conjunction with the
prospectus of the Fund, dated April , 2003 (the "Prospectus"). This
Statement of Additional Information does not include all information that a
prospective investor should consider before purchasing AMPS, and investors
should obtain and read the Prospectus prior to purchasing such shares. This
Statement of Additional Information is incorporated by reference in its
entirety into the Prospectus. Copies of the Statement of Additional
Information and Prospectus may be obtained free of charge by writing or
calling the address or phone number shown above. You may also obtain a copy
of the Prospectus on the web site (http://www.sec.gov) of the Securities and
Exchange Commission ("SEC"). Capitalized terms used but not defined herein
have the same meanings ascribed to them in the Prospectus.
TABLE OF CONTENTS
FUNDAMENTAL INVESTMENT RESTRICTIONS 3
INVESTMENT OBJECTIVE AND POLICIES 4
MANAGEMENT OF THE FUND 9
INVESTMENT ADVISORY SERVICES 14
PORTFOLIO TRANSACTIONS AND BROKERAGE 16
DETERMINATION OF NET ASSET VALUE 17
DISTRIBUTIONS 17
DESCRIPTION OF SHARES 19
ADDITIONAL INFORMATION CONCERNING THE AUCTIONS FOR AMPS 20
TAXATION 22
PERFORMANCE-RELATED AND COMPARATIVE AND OTHER INFORMATION 28
COUNSEL AND INDEPENDENT ACCOUNTANTS 30
ADDITIONAL INFORMATION 30
FINANCIAL STATEMENTS 31
APPENDIX A - RATINGS OF INVESTMENTS A-1
APPENDIX B - ARTICLES SUPPLEMENTARY B-1
This Statement of Additional Information is dated April , 2003.
2
FUNDAMENTAL 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 ("Common Shares") 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 Common Shares 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. 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.
3
(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 the 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 the Prospectus or this Statement of Additional Information 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 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 Shares and Preferred Stock (including the AMPS)
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.
It is a condition of closing this offering that the AMPS be offered
with a credit quality rating of "Aaa" from Moody's and "AAA" from Fitch. In
order to obtain and maintain these ratings the Fund will be required to
comply with investment quality, diversification and other guidelines
established by such rating agencies that will be more restrictive in many
respects than the restrictions set forth above. The Fund does not anticipate
that such guidelines would have a material adverse effect on the Fund's
ability to achieve its investment objective. Moody's and Fitch receive fees
in connection with their rating issuances.
INVESTMENT OBJECTIVE AND POLICIES
4
ADDITIONAL INFORMATION REGARDING FUND INVESTMENTS
The following descriptions supplement the descriptions of the
investment objective, strategies and risks set forth in the Prospectus. Except
as specifically provided herein or in the Prospectus, the Fund's investment
policies are not fundamental and may be changed by the Board of Directors of the
Fund without the approval of the shareholders.
LOWER-RATED SECURITIES
Under rating agency established criteria described in Appendix A,
medium- and lower-rated securities and comparable unrated securities will likely
have some quality and protective characteristics that are outweighed by large
uncertainties or major risk exposures to adverse conditions. Medium- and
lower-rated securities may have poor prospects of ever attaining any real
investment standing, may have a current identifiable vulnerability to default,
may be unlikely to have the capacity to pay interest and repay principal when
due in the event of adverse business, financial or economic conditions, and/or
may be likely to be in default or not current in the payment of interest or
principal. Such securities are considered speculative with respect to the
issuer's capacity to pay interest and repay principal in accordance with the
terms of the obligations. Accordingly, it is possible that these types of
factors could reduce the value of securities held by the Fund, with a
commensurate effect on the asset coverage on the AMPS.
Changes by recognized rating services in their ratings of any
fixed-income security and in the ability of an issuer to make payments of
interest and principal may also affect the value of these investments. A
description of the ratings of certain rating agencies is set forth in Appendix
A. The ratings generally represent the opinions of those organizations as to the
quality of the securities that they rate. Such ratings, however, are relative
and subjective, are not absolute standards of quality, are subject to change and
do not evaluate the market risk or liquidity of the securities. Ratings of a
non-U.S. debt instrument, to the extent that those ratings are undertaken, are
related to evaluations of the country in which the issuer of the instrument is
located. Ratings generally take into account the currency in which a non-U.S.
debt instrument is denominated.
The secondary markets for lower-rated securities are generally not as
liquid as the secondary markets for higher rated securities. The secondary
markets for lower-rated securities are concentrated in relatively few market
makers and participants in the market are generally institutional investors,
including insurance companies, banks, other financial institutions and mutual
funds. In addition, the trading volume for lower-rated securities is generally
lower than that for higher-rated securities and the secondary markets could
contract under adverse market or economic conditions independent of any specific
adverse changes in the condition of a particular issuer. These factors may have
an adverse effect on the ability of the Fund to dispose of particular portfolio
investments, may adversely affect the value of the Fund's investment portfolio
and may limit the ability of the Fund to obtain accurate market quotations for
purposes of valuing securities and calculating net asset value. If the Fund is
not able to obtain precise or accurate market quotations for a particular
security, it will become more difficult to value its portfolio securities, and a
greater degree of judgment may be necessary in making such valuations. Less
liquid secondary markets may also affect the ability of the Fund to sell
securities at their fair value. If the secondary markets for lower-rated
securities contract due to
5
adverse economic conditions or for other reasons, certain liquid securities in
the Fund's portfolio may become illiquid and the proportion of the Fund's assets
invested in illiquid securities may significantly increase.
Prices for lower-rated securities may be affected by legislative and
regulatory developments to a greater extent than higher-rated securities. These
laws could adversely affect the Fund's investment practices and the value of its
investment portfolio, the secondary market for lower-rated securities, the
financial condition of issuers of these securities and the value of outstanding
lower-rated securities. For example, federal legislation requiring the
divestiture by federally insured savings and loan associations of their
investments in lower-rated bonds and limiting the deductibility of interest by
certain corporate issuers of lower-rated bonds adversely affected the market in
the past.
While the market values of securities rated below investment grade and
comparable unrated securities tend to react less to fluctuations in interest
rate levels than do those of higher-rated securities, the values of certain of
these securities also tend to be more sensitive to individual corporate
developments and changes in economic conditions than higher rated securities. In
addition, such securities present a higher degree of credit risk. Issuers of
these securities are often highly leveraged and may not have more traditional
methods of financing available to them, so that their ability to service their
debt obligations during an economic downturn or during sustained periods of
rising interest rates may be impaired. The risk of loss due to default by such
issuers is significantly greater than with investment grade securities because
such securities generally are unsecured and subordinated to the prior payment of
senior indebtedness. The Fund also may incur additional expenses to the extent
that it is required to seek recovery upon a default in the payment of principal
or interest on its portfolio holdings.
The Fund may only invest in non-investment grade securities that are
rated at least either Ba3 or BB-, provided that the issuer has investment grade
senior debt outstanding.
FOREIGN SECURITIES
The Fund may invest up to 10% of its total assets in securities
other than money market securities of non-U.S. issuers. Investors should
recognize that investing in the securities of foreign issuers involves
special considerations which are not typically associated with investing in
the securities of U.S. issuers. Investments in securities of foreign issuers
may involve risks arising from differences between U.S. and foreign
securities markets, including less volume, much greater price volatility in
and illiquidity of certain foreign securities markets, different trading and
settlement practices and less (or different) governmental supervision and
regulation, from changes in currency exchange rates, from high and volatile
rates of inflation, from economic, social and political conditions and, as
with domestic multinational corporations, from fluctuating interest rates.
Other investment risks include the possible imposition of foreign
withholding taxes on certain amounts of the Fund's income, the possible seizure
or nationalization of foreign assets and the possible establishment of exchange
controls, expropriation, confiscatory taxation, other foreign governmental laws
or restrictions which might affect adversely payments due on securities held by
the Fund, the lack of extensive operating experience of eligible foreign
sub-
6
custodians and legal limitations on the ability of the Fund to recover assets
held in custody by a foreign sub-custodian or depository in the event of the
sub-custodian's or depository's bankruptcy or other event adversely affecting
such sub-custodian or depository.
In addition, there may be less publicly available information about a
foreign issuer than about a U.S. issuer, and foreign issuers may not be subject
to the same accounting, auditing and financial record-keeping standards and
requirements as U.S. issuers. In particular, the assets and profits appearing on
the financial statements of a foreign issuer may not reflect its financial
position or results of operations in the way they would be reflected had the
financial statements been prepared in accordance with U.S. generally accepted
accounting principles. In addition, for an issuer that keeps accounting records
in local currency, inflation accounting rules may require, for both tax and
accounting purposes, that certain assets and liabilities be restated on the
issuer's balance sheet in order to express items in terms of currency of
constant purchasing power. Inflation accounting may indirectly generate losses
or profits. Consequently, financial data may be materially affected by
restatements for inflation and may not accurately reflect the real condition of
those issuers and securities markets. Finally, in the event of a default in any
such foreign obligations, it may be more difficult for the Fund to obtain or
enforce a judgment against the issuers of such obligations.
RESTRICTED SECURITIES
The Fund may invest up to 20% of the total assets of the Fund (taken at
market value at the time of investment) in direct placements. The above
limitation applies only at the time a security is purchased, and the Fund is not
required to dispose of securities if, due to market movements, greater than 20%
of the Fund's total assets are invested in direct placements. Securities
obtained by means of direct placement typically are less liquid than securities
traded on the open market and in some cases can be considered "illiquid". The
term "illiquid securities" for these purposes means securities that cannot be
disposed of within seven days in the ordinary course of business at
approximately the amount at which the Fund has valued the securities.
The Board of Directors has delegated to Flaherty & Crumrine
Incorporated (the "Adviser") the day-to-day determination of the illiquidity
of any security held by the Fund, although it has retained oversight and
ultimate responsibility for such determinations. Certain illiquid securities
may require pricing at fair value as determined in good faith under the
supervision of the Board of Directors. See "Determination of Net Asset
Value." The Adviser may be subject to significant delays in disposing of
illiquid securities held by the Fund, and transactions in illiquid securities
may entail registration expenses and other transaction costs that are higher
than those for transactions in liquid securities. If adverse market
conditions were to develop during any such delay, the Fund might obtain a
less favorable price than that which prevailed when it decided to sell.
U.S. GOVERNMENT SECURITIES
U.S. Government securities are obligations of, or guaranteed by, the
U.S. Government, its agencies or instrumentalities. The U.S. Government does not
guarantee the net asset value of the Fund's shares. Some U.S. Government
securities, such as Treasury bills, notes and bonds, and securities guaranteed
by the Government National Mortgage Association, are supported by the
7
full faith and credit of the United States; others, such as those of the Federal
Home Loan Banks, are supported by the right of the issuer to borrow from the
U.S. Treasury; others, such as those of the Federal National Mortgage
Association, are supported by the discretionary authority of the U.S. Government
to purchase the agency's obligations; and still others, such as those of the
Student Loan Marketing Association, are supported only by the credit of the
instrumentality. No assurance can be given that the U.S. Government will provide
financial support to U.S. Government-sponsored instrumentalities if it is not
obligated to do so by law. U.S. Government securities include securities that
have no coupons, or have been stripped of their unmatured interest coupons,
individual interest coupons from such securities that trade separately and
evidences of receipt of such securities. Such securities may pay no cash income,
and are purchased at a deep discount from their value at maturity. Custodial
receipts issued in connection with so-called trademark zero-coupon securities,
such as CATs and TIGRs, are not issued by the U.S. Treasury, and are therefore
not U.S. Government securities, although the underlying bond represented by such
receipt is a debt obligation of the U.S. Treasury. Other zero-coupon Treasury
securities (E.G., STRIPs and CUBEs) are direct obligations of the U.S.
Government.
CONVERTIBLE SECURITIES
The Fund may invest in convertible preferred securities. Certain
classes of preferred stock are convertible, meaning the preferred stock is
convertible into shares of common stock of the issuer. A convertible security
generally entitles the holder to receive interest or dividends paid or accrued
until the convertible security matures or is redeemed, converted or exchanged.
By holding a convertible security, the Fund can receive a steady stream of
interest payments or dividends and still have the option to convert the security
to common stock.
As a fixed income security, a convertible preferred security tends to
increase in market value when interest rates decline and to decrease in value
when interest rates rise. While convertible securities generally offer lower
interest or dividend yields than non-convertible securities of similar quality,
their value tends to increase as the market value of the underlying stock
increases and to decrease when the value of the underlying stock decreases.
Convertible securities generally rank senior to common stock in a
corporation's capital structure and, therefore, generally entail less risk than
the corporation's common stock. A convertible security may be subject to
redemption at the option of the issuer at a predetermined price. If a
convertible security held by the Fund is called for redemption, the Fund would
be required to permit the issuer to redeem the security and convert it to
underlying common stock, or would sell the convertible security to a third
party.
PORTFOLIO TURNOVER
The Fund may engage in frequent and active portfolio trading when the
Adviser considers it to be appropriate, but the Fund will not use short-term
trading as the primary means of achieving its investment objective. Although
the Fund cannot accurately predict its annual portfolio turnover rate, it is
not expected to exceed 100% under normal circumstances. However, there are no
limits on the rate of portfolio turnover, and investments may be sold without
regard to the length of time held when, in the opinion of the Adviser,
8
investment considerations warrant such action. A higher turnover rate may result
in correspondingly greater transactional expenses that are borne by the Fund.
High portfolio turnover may also result in the increased realization of net
short-term capital gains by the Fund that, when distributed to shareholders,
will reduce the asset coverage on the AMPS. See "Taxation."
OTHER INVESTMENTS; NEW SECURITIES AND OTHER INVESTMENT TECHNIQUES.
New types of securities and other investment and hedging practices are
developed from time to time. The Adviser expects, consistent with the Fund's
investment objective and policies, to invest in such new types of securities
and to engage in such new types of investment practices if the Adviser
believes that these investments and investment techniques may assist the Fund
in achieving its investment objective. In addition, the Adviser may use
investment techniques and instruments that are not specifically described
herein.
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.
NUMBER OF
FUNDS
IN FUND
TERM OF OFFICE PRINCIPAL COMPLEX
POSITIONS(S) AND LENGTH OF OCCUPATION(S) OVERSEEN BY OTHER DIRECTORSHIPS
NAME, ADDRESS, AND AGE HELD WITH FUND TIME SERVED DURING PAST FIVE YEARS DIRECTOR HELD BY DIRECTOR
---------------------- -------------- -------------- ---------------------- ----------- ------------------
NON-INTERESTED
DIRECTORS:
MARTIN BRODY Director Since inception Retired. 3 Director, Jacklyn
c/o HMK Associates Inc. (luggage and
30 Columbia Turnpike accessories)
Floral Park, NJ 07932
Age: 81
DAVID GALE Director Since inception President and CEO of 3 --
Delta Dividend Delta Dividend Group,
Group, Inc. Inc. (investments).
301 Pine Street
San Francisco, CA 94104
Age: 53
MORGAN GUST Director Since inception From March 2002, 3 --
Giant Industries, Inc. President, Giant
23733 N. Scottsdale Road Industries, Inc.
Scottsdale, AZ 85255 (petroleum refining
Age: 55 and marketing); and,
for more than five
years prior thereto,
Executive Vice
President, and various
other Vice President
positions at Giant
Industries, Inc.
ROBERT F. WULF Director Since inception Since March 1984, 3 --
3560 Deerfield Drive Financial Consultant;
9
NUMBER OF
FUNDS
IN FUND
TERM OF OFFICE PRINCIPAL COMPLEX
POSITIONS(S) AND LENGTH OF OCCUPATION(S) OVERSEEN BY OTHER DIRECTORSHIPS
NAME, ADDRESS, AND AGE HELD WITH FUND TIME SERVED DURING PAST FIVE YEARS DIRECTOR HELD BY DIRECTOR
---------------------- -------------- -------------- ---------------------- ----------- ------------------
South Trustee, University of
Salem, OR 97302 Oregon Foundation;
Age: 65 Trustee, San Francisco
Theological Seminary.
INTERESTED
DIRECTORS:
DONALD F. CRUMRINE+ Director, Since inception Chairman of the Board, 3 --
301 E. Colorado Boulevard Chairman of since December 1996,
Suite 720 the Board and and previously held
Pasadena, CA 91101 Chief other officerships of
Age: 55 Executive Flaherty & Crumrine;
Officer Director of Flaherty &
Crumrine.
NICHOLAS DALMASO+ Director, Since inception Chief Operations
210 N. Hale Street Vice Officer and General
Wheaton, IL 60187 President and Counsel of Claymore
Age: 37 Assistant Securities, Inc. since
Secretary 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 President of Flaherty & -- --
301 E. Colorado Boulevard Crumrine since December
Suite 720 1996, and previously
Pasadena, CA 91101 held other officerships
Age: 44 of Flaherty & Crumrine;
Director of Flaherty &
Crumrine.
PETER C. STIMES Vice Since inception Vice President of -- --
301 E. Colorado Boulevard President, Flaherty & Crumrine.
Suite 720 Chief
Pasadena, CA 91101 Financial
Age: 47 Officer,
Chief
Accounting
Officer,
Treasurer and
Assistant
Secretary
R. ERIC CHADWICK Vice Since inception Vice President of -- --
301 E. Colorado Boulevard President, Flaherty & Crumrine
Suite 720 Secretary and since August 2001,
Pasadena, CA 91101 Assistant and previously (since
Age: 27 Treasurer January 1999) portfolio
manager of Flaherty &
Crumrine. Prior to
that, worked as
portfolio manager of
Koch Industries, Inc.
------------------------------------
+ "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 Claymore Securities, Inc., the
Fund's shareholder servicing agent (the "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
10
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 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 AMPS
(when issued), voting as a single class, will elect two Directors and holders
of the Common Shares and the AMPS (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 AMPS to elect the
minimum number of additional Directors that when combined with the two
Directors elected by the holders of AMPS would give the holders of AMPS 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 AMPS, and
the remaining Directors are subject to election by holders of the Common
Shares and the AMPS (when issued), voting as a single class. Directors
elected by holders of Common Shares and AMPS 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 initially approved by the Board of Directors of the Fund
on December 16, 2002 and amended on April 7, 2003. 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 audits 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
11
consider recommendations by shareholders if a vacancy were to exist. Any such
recommendations should be forwarded to the Secretary of the Fund.
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 Statement of Additional
Information 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 INVESTMENT
NAME OF DIRECTOR SECURITIES IN THE FUND *(1) 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, 2002. "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.
COMPENSATION
The following table sets forth certain information regarding the
estimated compensation of the Fund's Directors for the fiscal year ended
November 30, 2003. Directors and executive officers of the Fund do not receive
pension or retirement benefits from the Fund.
COMPENSATION TABLE
12
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 $39,750
David Gale
Director $0 $40,725
Morgan Gust
Director $0 $40,950
Robert F. Wulf
Director $0 $41,100
-----------------
* Represents the total estimated compensation to be paid to such persons for
the fiscal year ended November 30, 2003 by those funds which are considered
part of the same "fund complex" because they have a common investment
adviser.
SHAREHOLDERS
As of April 11, 2003, the following person owned of record the number
of Common Shares noted below, representing the indicated percentage of the
Fund's outstanding shares as of such date and, except as noted below, no other
person owned of record or, to the knowledge of the Fund, owned beneficially 5%
or more of any class of shares of the Fund.
SHAREHOLDER NUMBER OF COMMON PERCENTAGE OF THE FUND'S
SHARES OUTSTANDING SHARES AS OF
APRIL 11, 2003
------------------------------------------------------------------------------------------------------------------
Cede & Co. 40,786,334 99.83%
55 Water Street, 25th Floor
New York, New York 10041-0001
13
INVESTMENT ADVISORY SERVICES
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 hedged preferred
securities funds. The Adviser serves as an investment adviser to two other
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 Adviser's focus on research goes
beyond reliance on rating agencies and each member of the Adviser's
management team holds the Chartered Financial Analyst(R) designation, and the
firm devotes substantial resources to evaluating the creditworthiness of each
portfolio investment.
DIRECTOR APPROVAL OF THE INVESTMENT ADVISORY AGREEMENT
The Board of Directors approved an Investment Advisory Agreement
between the Adviser and the Fund (the "Advisory Agreement") at a meeting held
on January 16, 2003. As noted above, each Director other than Mr. Dalmaso
also serves as a director for the two other closed-end investment companies
advised by the Adviser, each of which principally invests in preferred
securities. As a result, the Directors, in their collective years of service
as directors of such funds, have gained significant knowledge regarding
matters such as the fees and expenses of investment companies with similar
objectives and policies and the operations and prior performance of the
Adviser.
In connection with their meeting, the Directors met with
representatives of the Adviser, including investment advisory personnel, and
reviewed materials specifically relating to the Advisory Agreement, including
materials prepared by Fund counsel and counsel to the Independent Directors.
In considering the Advisory Agreement, the Board of Directors, including the
Independent Directors, did not identify any single factor as determinative.
Matters considered by the Board of Directors, including the Independent
Directors, in connection with its approval of the Advisory Agreement included
the following:
- the economic outlook and the general investment outlook in the
markets in which the Fund proposes to invest, as well as the
investment performance of a peer group of funds (including other
funds advised by the Adviser) and the performance of an
appropriate index.
- the Adviser's investment philosophy and process, operational
stability and financial condition, as well as the size
and experience of the Adviser's investment staff.
14
- the expected quality of the Adviser's services with respect to
compliance with the Fund's investment policies and restrictions
and its policies on personal securities transactions.
- the nature, quality and extent of services to be performed by the
Adviser pursuant to the Advisory Agreement.
- the Fund's expected expense ratio and the expense ratios of a
peer group of funds. They also considered the amount and nature
of fees paid by shareholders, including the fact that the
Adviser agreed to pay organizational expenses and offering
costs of the Fund (other than the sales load) that exceed $0.05
per Common Share. In evaluating the Fund's investment advisory
fees, the Directors also took into account the demands,
complexity and expected quality of the investment advisory
services to the Fund. The Directors also noted the fact that,
because the advisory fees paid to the Adviser by the Fund are
based on the Fund's managed assets, which include the
liquidation preference on any AMPS and the principal amount of
any borrowings used for leverage, the Adviser has a financial
incentive for the Fund to issue AMPS and use other forms of
leverage, which may create a conflict of interest between the
Adviser and the Fund's shareholders.
- whether there is potential for realization of any economies of
scale with respect to the management of the Fund and whether the
Fund will appropriately benefit from such economies of scale.
Based on their evaluation of all factors that they deemed to be
material, including, but not limited to, those factors described above, and
assisted by the advice of independent counsel, the Directors, including the
Independent Directors, concluded that the proposed investment advisory fee
structure was fair and reasonable, and that approval of the Advisory Agreement
was in the best interest of the Fund and its shareholders.
CONTROLLING PERSONS
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.
CODE OF ETHICS
The Fund and the Adviser have each adopted a Code of Ethics pursuant
to Rule 17j-1 under the 1940 Act. The Codes of Ethics permit employees to
invest in securities for their own accounts, under certain circumstances,
including securities that may be purchased or held by the Fund. Text-only
versions of the codes of ethics may be viewed online or downloaded from the
EDGAR Database on the SEC's internet web site at www.sec.gov. You may also
review and copy those documents by visiting the SEC's Public Reference Room
in Washington, DC. Information on the operation of the Public Reference Room
may be obtained by calling the SEC at 202-942-8090. In addition, copies of
the Codes of Ethics may be obtained,
15
after mailing the appropriate duplicating fee, by writing to the SEC's Public
Reference Section, 450 5th Street, N.W., Washington, DC 20549-0102 or by e-mail
request at publicinfo@sec.gov.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Subject to policies established by the Board and the oversight of the
Adviser, the Adviser is primarily responsible for the Fund's portfolio
decisions and the placing of the Fund's portfolio transactions.
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 generally 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 participated in the underwriting of the
Common Shares and/or the AMPS. 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.
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.
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.
Investment decisions for the Fund are made independently from those of
other funds or accounts managed by the Adviser. Such other funds or accounts
may also invest in the same securities as the Fund. If those funds or
accounts are prepared to invest in, or desire to dispose of, the same
security at the same time as the Fund, however, transactions in such
securities will be made, insofar as feasible, for the respective funds and
accounts in a manner
16
deemed equitable to all. 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. In addition, because of different investment
objectives, a particular security may be purchased for one or more funds or
accounts when one or more funds or accounts are selling the same security.
DETERMINATION OF NET ASSET VALUE
The method for determining the net asset value per Common Share is
summarized in the Prospectus.
The total net asset value of the Common Shares (the excess of the
assets of the Fund over the Fund's liabilities) is determined at the close of
regular trading (usually 4:00 p.m. Eastern time) on the last day that the New
York Stock Exchange (the "Exchange") is open for trading of each week and month
and at such other times as the Board of Directors shall determine.
DISTRIBUTIONS
See "Description of AMPS - Dividends and Rate Periods" and
"Description of Capital Structure" in the Prospectus for information related
to distributions made to Fund shareholders.
For tax purposes, the Fund is currently required to allocate net
capital gain and other categories of income between the Common Shares and the
AMPS in proportion to total dividends paid to each class for the year in
which such capital gain or other category of income is realized.
While any AMPS are outstanding, the Fund may not declare any cash
dividend or other distribution on its Common Shares unless at the time of
such declaration (1) all accrued dividends on the AMPS have been paid, (2)
the net asset value of the Fund's portfolio (determined after deducting the
amount of such dividend or other distribution) is at least 200% of the
liquidation value of any outstanding AMPS, (3) the Fund has redeemed the full
number of AMPS and any other preferred shares outstanding required to be
redeemed by any provision in the Articles Supplementary requiring mandatory
redemption, and (4) other requirements imposed by any rating agencies rating
any AMPS issued by the Fund have been met.
These limitations on the Fund's ability to make distributions on its
Common Shares could cause the Fund to incur income and excise tax and, under
certain circumstances, impair the ability of the Fund to maintain its
qualification for taxation as a regulated investment company. See "Taxation."
DIVIDEND REINVESTMENT AND CASH PURCHASE PLAN
Under the Fund's Dividend Reinvestment and Cash Purchase Plan (the
"Plan"), a shareholder whose Common Shares are registered in his or her own name
will have all distributions reinvested automatically by the Administrator as
agent under the Plan in additional Common Shares, unless the shareholder elects
to receive distributions in cash.
17
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 Common Shares 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 Common Shares registered
in street name should consult their broker or nominee for details regarding
reinvestment.
The number of Common Shares distributed to participants in the Plan in
lieu of a cash dividend is determined in the following manner. Whenever the
market price per Common Share 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 Common Shares 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 Shares or until it has
expended for such purchases all of the cash that would otherwise be payable to
the participants. The number of purchased Common Shares 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 Common Shares 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.
A shareholder whose Common Shares are registered in his or her own name
and who participates the Plan may terminate participation in the Plan at any
time by notifying the
18
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.
DESCRIPTION OF SHARES
COMMON SHARES
The Fund's Articles of Incorporation authorize the issuance of
240,000,000 Common Shares, par value $0.01 per share. All Common Shares of the
Fund have equal rights as to the payment of dividends and the distribution of
assets upon liquidation of the Fund. The Common Shares currently outstanding
have been fully paid and are non-assessable, and have no pre-emptive or
conversion rights or rights to cumulative voting. At any time when the
AMPS are outstanding, Common Shareholders will not be entitled to receive any
distributions from the Fund unless all accrued dividends on AMPS have been
paid, asset coverage (as defined in the 1940 Act) with respect to AMPS and
certain forms of indebtedness would be at least 200% and 300%, respectively,
after giving effect to such distributions, and other requirements imposed by
any rating agencies rating the AMPS have been met. See " - AMPS" below. See
"Description of AMPS - Rating Agency Guidelines and Asset Coverage" and
"Description of Capital Structure" in the Prospectus.
The Common Shares are listed on the New York Stock Exchange under the
symbol "FFC." The Fund intends to hold annual meetings of shareholders, as
required under the rules of the New York Stock Exchange currently applicable to
listed companies.
Shares of closed-end investment companies may frequently trade at
prices lower than net asset value. Shares of closed-end investment companies
like the Fund that invest primarily in preferred securities have during some
periods traded at prices higher than net asset value and during other periods
traded at prices lower than net asset value. There can be no assurance that the
Common Shares or shares of other similar funds will trade at a price higher than
net asset value in the future. The net asset value of the Common Shares was
reduced immediately following the offering of the Common Shares after payment of
the sales load and organizational and offering expenses. Whether investors will
realize gains or losses upon the sale of Common Shares will depend entirely upon
whether the market price of the Common Shares at the time of sale is above or
below the original purchase price for the shares. Since the market price of the
19
Fund's Common Shares will be determined by factors beyond the control of the
Fund, the Fund cannot predict whether the Common Shares will trade at, below, or
above net asset value or at, below or above the initial public offering price.
Accordingly, the Common Shares are designed primarily for long-term investors,
and investors in the Common Shares should not view the Fund as a vehicle for
trading purposes.
AMPS
See "Description of AMPS" and "Description of Capital Structure" in
the Prospectus for information relating to the AMPS. The Articles
Supplementary, which establishes many of the terms of the AMPS, is set forth
in its entirety in Appendix B to this Statement of Additional Information.
ADDITIONAL INFORMATION CONCERNING
THE AUCTIONS FOR AMPS
GENERAL
AUCTION AGENCY AGREEMENT. The Fund will enter into an auction
agency agreement with the auction agent (currently, Wilmington Trust Company)
which provides, among other things, that the auction agent will follow the
auction procedures set forth in the Articles Supplementary for purposes of
determining the applicable rate for AMPS so long as the applicable rate for
such shares is to be based on the results of an auction.
BROKER-DEALER AGREEMENTS. Each auction requires the participation of
one or more broker-dealers that have entered into a separate agreement with the
auction agent (each, a "Broker-Dealer"). The auction agent will enter into
broker-dealer agreements with one or more Broker-Dealers selected by the Fund
that provide for the participation of those Broker-Dealers in auctions for
AMPS.
SECURITIES DEPOSITORY. The Depository Trust Company ("DTC") will
act as securities depository for the agent members (defined below) with
respect to the AMPS. One certificate for each series of the AMPS will be
registered in the name of Cede & Co., as nominee of DTC. Each such
certificate will bear a legend to the effect that such certificate is issued
subject to the provisions restricting transfers of AMPS contained in the
Articles Supplementary. Prior to the commencement of the right of preferred
shareholders to elect a majority of the Fund's Directors, as described under
"Description of AMPS - Voting Rights" in the Prospectus, Cede & Co. will be
the holder of record of all AMPS, and owners of the AMPS will not be entitled
to receive certificates representing their ownership interest in the AMPS.
DTC, a New York-chartered limited purpose trust company, performs
services for its participants, some of whom (and/or their representatives)
own DTC. DTC maintains lists of its participants and will maintain the
positions (ownership interests) held by each such participant (the "agent
member") in AMPS, whether for its own account or as a nominee for another
person.
20
AUCTION AGENT
The auction agent will act as agent for the Fund in connection with
auctions. In the absence of bad faith or negligence on its part, the auction
agent will not be liable for any action taken, suffered, or omitted or for any
error of judgment made by it in the performance of its duties under the auction
agency agreement.
The auction agent may rely upon, as evidence of the identities of
the existing holders of AMPS, the auction agent's registry of existing
holders, the results of auctions and notices from any Broker-Dealer (or other
person, if permitted by the Fund) with respect to transfers described under
"The Auction" in the Prospectus and notices from the Fund. The auction agent
is not required to accept any such notice for an auction unless it is
received by the auction agent by 3:00 p.m., New York City time, on the
business day preceding such auction.
The auction agent may terminate the auction agency agreement upon
notice to the Fund on a date no earlier than 60 days after such notice. If the
auction agent should resign, the Fund will attempt to appoint a successor
auction agent. The Fund may remove the auction agent provided that prior to such
removal the Fund shall have entered into an agreement with a successor auction
agent.
BROKER-DEALERS
After each auction for the AMPS, the auction agent will pay to each
Broker-Dealer, from funds provided by the Fund, a service charge that will
generally be at the annual rate of 1/4 of 1% of the stated value ($25,000) of
the AMPS held by such Broker-Dealer's customers upon settlement in such
auction.
The Broker-Dealer agreement provides that a Broker-Dealer (other
than an affiliate of the Fund) may submit orders in auctions for its own
account, unless the Fund notifies all Broker-Dealers that they may no longer
do so, in which case Broker-Dealers may continue to submit hold orders and
sell orders for their own accounts. Any Broker-Dealer that is an affiliate of
the Fund may submit orders in auctions, but only if such orders are not for
its own account. If a Broker-Dealer submits an order for its own account in
any auction, it might have an advantage over other bidders because it would
have knowledge of all orders submitted by it in that auction; such
Broker-Dealer, however, would not have knowledge of orders submitted by other
Broker-Dealers in that auction.
The Fund may request the auction agent to terminate one or more
Broker-Dealer agreements at any time upon five days' notice, provided that at
least one Broker-Dealer agreement is in effect after such termination. A
Broker-Dealer or the auction agent may terminate the Broker-Dealer agreement
at any time upon five days' written notice; provided, however, that if the
Broker-Dealer is Merrill Lynch, neither the Broker-Dealer nor the auction
agent may terminate the Broker-Dealer agreement without first obtaining the
prior written consent of the Fund to such termination, which consent shall
not be withheld unreasonably. Each Broker-Dealer agreement shall
automatically terminate upon the redemption of all outstanding AMPS or upon
termination of the auction agency agreement.
21
TAXATION
Set forth below is a discussion of certain U.S. federal income tax
issues concerning the Fund and the purchase, ownership and disposition of Fund
shares. This discussion does not purport to be complete or to deal with all
aspects of federal income taxation that may be relevant to shareholders in light
of their particular circumstances. This discussion is based upon present
provisions of the Internal Revenue Code of 1986, as amended (the "Code"), the
regulations promulgated thereunder, and judicial and administrative ruling
authorities, all of which are subject to change, which change may be
retroactive. Prospective investors should consult their own tax advisers with
regard to the federal tax consequences of the purchase, ownership, or
disposition of Fund shares, as well as the tax consequences arising under the
laws of any state, foreign country, or other taxing jurisdiction.
The Bush Administration has announced a proposal to eliminate the
federal income tax on dividends of income previously taxed at the corporate
level. In addition, under the proposal, shareholders may be provided with basis
adjustments to reflect income taxed at the corporate level that is not
distributed. Basis adjustments nay not be allocated to certain shares that are
preferred and limited as to dividends. Under the proposal, regulated investment
companies such as the Fund may be permitted to pass through to their
shareholders the excludable dividends and basis adjustments. Excludable
dividends may not be a tax preference for alternative minimum tax purposes. At
this time, however, it is uncertain if, and in what form, the proposal will
ultimately be adopted. Accordingly, it is not possible to evaluate how this
proposal might affect the discussion below.
TAXATION OF THE FUND
The Fund intends to elect to be treated as, and to qualify annually as,
a regulated investment company under Subchapter M of the Code.
To qualify for the favorable U.S. federal income tax treatment
generally accorded to regulated investment companies, the Fund must, among other
things, (a) derive in each taxable year at least 90% of its gross income from
dividends, interest, payments with respect to securities loans and gains from
the sale or other disposition of stock, securities or foreign currencies or
other income derived with respect to its business of investing in such stock,
securities or currencies; (b) diversify its holdings so that, at end of each
quarter of the taxable year, (i) at least 50% of the market value of the Fund's
assets is represented by cash and cash items (including receivables), U.S.
Government securities, the securities of other regulated investment companies
and other securities, with such other securities of any one issuer limited for
the purposes of this calculation to an amount not 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 (ii) not more than 25% of the value of its total
assets is invested in the securities (other than U.S. Government securities or
the securities of other regulated investment companies) of a single issuer, or
two or more issuers which the Fund controls and are engaged in the same, similar
or related trades or businesses; and (c) distribute at least 90% of the sum of
its investment company taxable income (as that term is defined in the Code, but
without regard to the deduction for dividends paid) and net tax-exempt interest
each taxable year.
22
As a regulated investment company that is accorded special tax
treatment, the Fund generally will not be subject to U.S. federal income tax on
its investment company taxable income (which includes, among other items,
dividends, interest and net short-term capital gain in excess of net long-term
capital loss) and net capital gain (the excess of net long-term capital gain
over net short-term capital loss), if any, that it distributes to shareholders.
The Fund intends to distribute to its shareholders, at least annually, all or
substantially all of its investment company taxable income and net capital gain.
However, if the Fund retains any net capital gain or any investment company
taxable income, it will be subject to tax at regular corporate rates on the
amount retained. If the Fund retains any net capital gain, it may designate the
retained amount as undistributed capital gains in a notice to its shareholders
who, if subject to federal income tax on long-term capital gains, (i) will be
required to include in income for federal income tax purposes, as long-term
capital gain, their share of such undistributed amount, and (ii) will be
entitled to credit their proportionate shares of the tax paid by the Fund on
such undistributed amount against their federal income tax liabilities, if any,
and to claim refunds to the extent the credit exceeds such liabilities. For
federal income tax purposes the tax basis of shares owned by a shareholder of
the Fund will be increased by an amount equal to the difference between the
amount of undistributed capital gains included in the shareholder's gross income
and the tax deemed paid by the shareholder under clause (ii) of the preceding
sentence.
If the Fund fails to distribute in a calendar year an amount equal to
the sum of (1) at least 98% of its ordinary income (not taking into account any
capital gains or losses) for the calendar year, (2) at least 98% of its capital
gains in excess of its capital losses (adjusted for certain ordinary losses) for
the one-year period ending on October 31 of the calendar year, and (3) any
ordinary income and capital gains for previous years that was not distributed
during those years, the Fund will be subject to a 4% excise tax on the
undistributed amount. A distribution will be treated as paid on December 31 of
the current calendar year if it is declared by the Fund in October, November or
December with a record date in such a month and paid by the Fund during January
of the following calendar year. Such distributions will be taxable to
shareholders in the calendar year in which the distributions are declared,
rather than the calendar year in which the distributions are received. To
prevent application of the excise tax, the Fund intends to make its
distributions in accordance with the calendar year distribution requirement.
If the Fund failed to qualify as a regulated investment company or
failed to satisfy the 90% distribution requirement in any taxable year, the Fund
would be subject to tax on its taxable income at corporate rates (even if such
income were distributed to its shareholders), and all distributions out of
earnings and profits (including distributions of net capital gain) would be
taxed to shareholders as ordinary income. In addition, the Fund could be
required to recognize unrealized gains, pay substantial taxes and interest and
make substantial distributions before requalifying as a regulated investment
company that is accorded special tax treatment.
DISTRIBUTIONS
Dividends paid out of the Fund's current and accumulated earnings and
profits will, except in the case of capital gain dividends described below, be
taxable to a U.S. shareholder as ordinary income to the extent of the Fund's
earnings and profits, whether paid in cash or reinvested in additional shares.
Although such dividends generally will not qualify for the dividends received
deduction available to corporations under Section 243 of the Code, if a
23
portion of the Fund's income consists of qualifying dividends paid by U.S.
corporations (other than REITs), a portion of the dividends paid by the Fund to
corporate shareholders may be eligible for the corporate dividends received
deduction. Distributions of net capital gain (the excess of net long-term
capital gain over net short-term capital loss), if any, properly designated as
capital gain dividends are taxable to a shareholder as long-term capital gains,
regardless of how long the shareholder has held Fund shares. A distribution of
an amount in excess of the Fund's current and accumulated earnings and profits
will be treated by a shareholder as a return of capital which is applied against
and reduces the shareholder's basis in his or her shares. A return of capital is
not taxable, but it reduces a shareholder's tax basis in his or her shares, thus
reducing any loss or increasing any gain on a subsequent taxable disposition by
the shareholder of his or her shares. To the extent that the amount of any such
distribution exceeds the shareholder's basis in his or her shares, the excess
will be treated by the shareholder as gain from a sale or exchange of the
shares.
Dividends and distribution on the Fund's shares are generally subject
to federal income tax as described herein to the extent they do not exceed the
Fund's realized income and gains, 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).
The Internal Revenue Service ("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). Accordingly, the Fund intends each year
to allocate capital gain dividends between its Common Shares and AMPS in
proportion to the total dividends paid out of earnings and 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. Distributions in excess of the Fund's current and
accumulated earnings and profits, if any, however, will not be allocated
proportionately among the Common Shares and AMPS. Since the Fund's current
and accumulated earnings and profits will first be used to pay dividends on
the AMPS, distributions in excess of such earnings and profits, if any, will
be made disproportionately to Common Shareholders.
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.
Shareholders will be notified annually as to the U.S. federal tax
status of distributions.
24
SALE OR EXCHANGE OF FUND SHARES
Upon the sale, exchange or redemption 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 the 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 replaced (including through reinvestment of dividends) within a period of
61 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 credited as undistributed
capital gains) with respect to such shares.
From time to time, the Fund may make a tender offer for its Common
Shares. It is expected that the terms of any such offer will require a
tendering shareholder to tender all Common Shares and dispose of all AMPS
held, or considered under certain attribution rules of the Code to be held,
by such shareholder. Shareholders who tender all Common Shares and dispose of
all AMPS held, or considered to be held, by them will be treated as having
sold their shares and generally will realize a capital gain or loss. If a
shareholder tenders fewer than all of its Common Shares, or retains a
substantial portion of its AMPS, such shareholder may be treated as having
received a taxable dividend upon the tender of its Common Shares. In such a
case there is a risk that non-tendering shareholders will be treated as
having received taxable distributions from the Fund. Likewise, if the Fund
redeems some but not all of the AMPS held by a Preferred Shareholder and such
shareholder is treated as having received a taxable dividend upon such
redemption, there is a risk that Common Shareholders and non-redeeming
Preferred Shareholders will be treated as having received taxable
distributions from the Fund. To the extent that the Fund recognizes net gains
on the liquidation of portfolio securities to meet such tenders of Common
Shares, the Fund will be required to make additional distributions to its
Common Shareholders.
NATURE OF FUND'S INVESTMENTS
Certain of the Fund's investment practices are subject to special and
complex federal income tax provisions that may, among other things, (i)
disallow, suspend or otherwise limit the allowance of certain losses or
deductions, (ii) convert lower taxed long-term capital gain into higher taxed
short-term capital gain or ordinary income, (iii) convert an ordinary loss or a
deduction into a capital loss (the deductibility of which is more limited), (iv)
cause the Fund to recognize income or gain without a corresponding receipt of
cash, (v) adversely affect the time as to when a purchase or sale of stock or
securities is deemed to occur and (vi) adversely alter the characterization of
certain complex financial transactions. The Fund will monitor its transactions
and may make certain tax elections in order to mitigate the effect of these
provisions.
25
ORIGINAL ISSUE DISCOUNT SECURITIES, MARKET DISCOUNT SECURITIES AND
PAYMENT-IN-KIND SECURITIES
The Fund may acquire debt obligations that are treated as issued
originally at a discount or having acquisition discount. Current federal tax law
requires a regulated investment company that holds a U.S. Treasury or other
fixed income zero-coupon security to accrue as income each year a portion of the
discount at which the security was issued, even though the holder receives no
interest payment in cash on the security during the year. In addition,
payment-in-kind securities will give rise to income which is required to be
distributed and is taxable even though the Fund holding the security receives no
interest payment in cash on the security during the year. Generally, the amount
of the discount is treated as interest income and is included in income over the
term of the debt security, even though payment of that amount is not received
until a later time, usually when the debt security matures. A portion of the
original issue discount includable in income with respect to certain high-yield
corporate debt obligations (including certain payment-in-kind securities) may be
treated as a dividend for certain U.S. federal income tax purposes. With respect
to certain short-term debt obligations, the Fund may make one or more elections
which could affect the character and timing of recognition of income.
Some of the debt obligations (with a fixed maturity date of more than
one year from the date of issuance) that may be acquired by the Fund in the
secondary market may be treated as having market discount. Generally, any gain
recognized on the disposition of, and any partial payment of principal on, a
debt security having market discount is treated as ordinary income to the extent
the gain, or principal payment, does not exceed the "accrued market discount" on
such debt security. Market discount generally accrues in equal daily
installments. The Fund may make one or more of the elections applicable to debt
obligations having market discount, which could affect the character and timing
of recognition of income.
If the Fund holds the foregoing kinds of securities, it may be required
to pay out as an income distribution each year an amount which is greater than
the total amount of cash interest the Fund actually received. Such distributions
may be made from the cash assets of the Fund or by liquidation of portfolio
securities, if necessary. The Fund may realize gains or losses from such
liquidations. In the event the Fund realizes net capital gains from such
transactions, its shareholders may receive a larger capital gain distribution
than they would in the absence of such transactions.
FOREIGN SHAREHOLDERS
U.S. taxation of a shareholder who, as to the United States, is a
nonresident alien individual, a foreign trust or estate, a foreign corporation
or foreign partnership ("foreign shareholder") depends on whether the income of
the Fund is "effectively connected" with a U.S. trade or business carried on by
the shareholder.
INCOME NOT EFFECTIVELY CONNECTED. If the income from the Fund is not
"effectively connected" with a U.S. trade or business carried on by the foreign
shareholder, distributions of investment company taxable income generally will
be subject to a U.S. tax of 30% (or lower treaty rate), which tax is generally
withheld from such distributions.
26
Capital gain dividends and any amounts retained by the Fund which are
designated as undistributed capital gains will not be subject to U.S. tax at the
rate of 30% (or lower treaty rate) unless the foreign shareholder is a
nonresident alien individual and is physically present in the United States for
more than 182 days during the taxable year and meets certain other requirements.
However, this 30% tax on capital gains of nonresident alien individuals who are
physically present in the United States for more than the 182 day period only
applies in exceptional cases because any individual present in the United States
for more than 182 days during the taxable year is generally treated as a
resident for U.S. income tax purposes; in that case, he or she would be subject
to U.S. income tax on his or her worldwide income at the graduated rates
applicable to U.S. citizens, rather than the 30% U.S. tax. In the case of a
foreign shareholder who is a nonresident alien individual, the Fund may be
required to withhold U.S. income tax on distributions of net capital gain unless
the foreign shareholder certifies his or her non-U.S. status under penalties of
perjury or otherwise establishes an exemption. See "Taxation-Backup
Withholding," below. Any gain that a foreign shareholder realizes upon the sale
or exchange of such shareholder's shares of the Fund will ordinarily be exempt
from U.S. tax unless (i) in the case of a shareholder that is a nonresident
alien individual, the gain is U.S. source income and such shareholder is
physically present in the United States for more than 182 days during the
taxable year and meets certain other requirements, or (ii) at any time during
the shorter of the period during which the foreign shareholder held shares of
the Fund and the five year period ending on the date of the disposition of those
shares, the Fund was a "U.S. real property holding corporation" and the foreign
shareholder held more than 5% of the shares of the Fund, in which event the gain
would be taxed in the same manner as for a U.S. shareholder as discussed above
and a 10% U.S. withholding tax would be imposed on the amount realized on the
disposition of such shares to be credited against the foreign shareholder's U.S.
income tax liability on such disposition. A corporation is a "U.S. real property
holding corporation" if the fair market value of its U.S. real property
interests equals or exceeds 50% of the fair market value of such interests plus
its interests in real property located outside the United States plus any other
assets used or held for use in a business. In the case of the Fund, "U.S. real
property interests" include interests in stock in U.S. real property holding
corporations (other than an interest in stock of a REIT controlled by U.S.
persons at all times during the five-year period prior to the disposition and
holdings of 5% or less in the stock of publicly traded U.S. real property
holding corporations) and certain participating debt securities.
INCOME EFFECTIVELY CONNECTED. If the income from the Fund is
"effectively connected" with a U.S. trade or business carried on by a foreign
shareholder, then distributions of investment company taxable income and capital
gain dividends, any amounts retained by the Fund which are designated as
undistributed capital gains and any gains realized upon the sale or exchange of
shares of the Fund will be subject to U.S. income tax at the graduated rates
applicable to U.S. citizens, residents and domestic corporations. Foreign
corporate shareholders may also be subject to the branch profits tax imposed by
the Code.
The tax consequences to a foreign shareholder entitled to claim the
benefits of an applicable tax treaty may differ from those described herein.
Foreign shareholders are advised to consult their own tax advisers with respect
to the particular tax consequences to them of an investment in the Fund.
BACKUP WITHHOLDING
27
The Fund generally is required to withhold U.S. federal income tax on
all taxable distributions and redemption proceeds payable to any non-corporate
shareholder who fails to provide the Fund with a correct taxpayer identification
number (TIN) or to make required certifications to the Fund that he or she is
not subject to withholding, or who has been notified by the IRS that he or she
is subject to backup withholding. Pursuant to tax legislation enacted in 2001,
the backup withholding tax rate will be (i) 30% for amounts paid during 2003,
(ii) 29% for amounts paid during 2004 and 2005, and (iii) 28% for amounts paid
during 2006 through 2010. This legislation will expire and the backup
withholding rate will be 31% for amounts paid after December 31, 2010, unless
Congress enacts tax legislation providing otherwise. The Bush Administration has
announced a proposal to accelerate reductions in tax rates which may change the
backup withholding rate as well.
In order for a foreign shareholder to qualify for exemption from the
backup withholding tax rates and for reduced withholding tax rates under income
tax treaties, the foreign shareholder must comply with special certification and
filing requirements. Foreign shareholders in the Fund should consult their tax
advisers in this regard.
Corporate shareholders and certain other shareholders specified in the
Code generally are exempt from such backup withholding. Backup withholding is
not an additional tax. Any amounts withheld may be credited against the
shareholder's U.S. federal income tax liability.
OTHER TAXATION
Fund shareholders may be subject to state, local and foreign taxes on
their Fund distributions. Shareholders are advised to consult their own tax
advisers with respect to the particular tax consequences to them of an
investment in the Fund.
PERFORMANCE-RELATED AND COMPARATIVE AND OTHER 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
28
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.
From time to time, the Fund may quote the Fund's total return,
aggregate total return, yield or other measures of performance in advertisements
or in reports and other communications to shareholders. The Fund's performance
will vary depending upon market conditions, the composition of its portfolio,
its operating expenses and other factors. Consequently, any given performance
quotation should not be considered representative of the Fund's performance in
the future. In addition, because performance will fluctuate, it may not provide
a basis for comparing an investment in the Fund with certain bank deposits or
other investments that pay a fixed yield for a stated period of time. Investors
comparing the Fund's performance with that of other investment companies should
give consideration to the quality and maturity of the respective investment
companies' portfolio securities.
From time to time, the Fund and/or the Adviser may report to
shareholders or to the public in advertisements concerning the performance of
the Adviser or on the comparative performance or standing of the Adviser in
relation to other money managers. The Adviser also may provide current or
prospective private account clients performance information for the Fund
gross and/or net of fees and expenses for the purpose of assisting such
clients in evaluating similar performance information provided by other
investment managers or institutions. Comparative information may be compiled
or provided by independent ratings services or by news organizations. Any
performance information, whether related to the Fund or the Adviser, should
be considered in light of the Fund's investment objective and policies,
portfolio characteristics and quality of the Fund, and the market conditions
during the time period indicated, and should not be considered to be
representative of what may be achieved in the future. Performance information
for the Fund may be compared to various unmanaged indexes.
The Fund may quote certain performance-related information and may
compare certain aspects of its portfolio and structure to other closed-end funds
based on data available through Lipper, Inc. ("Lipper"), Morningstar Inc. or
other independent services. Comparison of the Fund to an alternative investment
should be made with consideration of differences in features and expected
performance. The Fund may obtain data from sources or reporting services, such
as Bloomberg Financial ("Bloomberg") and Lipper, that the Fund believes to be
generally accurate.
Past performance is not necessarily indicative of future results.
From the period from January 31, 2003 (commencement of the Fund's
operations) through March 31, 2003, the Fund's net increase in net assets
resulting from investment operations was $4,435,998.
29
COUNSEL AND INDEPENDENT ACCOUNTANTS
Willkie Farr & Gallagher serves as counsel to the Fund, and is located
at 787 Seventh Avenue, New York, New York 10019. KPMG LLP, located at 99 High
Street, Boston, Massachusetts 02110, has been appointed as independent
accountants for the Fund. The Statement of Assets and Liabilities of the Fund as
of January 21, 2003 incorporated by reference into this Statement of Additional
Information has been so included in reliance on the report of KPMG LLP,
independent accountants, given on the authority of the firm as experts in
auditing and accounting.
ADDITIONAL INFORMATION
A Registration Statement on Form N-2, including amendments thereto,
relating to the shares offered hereby has been filed by the Fund with the SEC,
Washington, D.C. The Prospectus and this Statement of Additional Information do
not contain all the information set forth in the Registration Statement,
including any exhibits and schedules thereto. For further information with
respect to the Fund and the shares offered hereby, reference is made to the
Registration Statement. Statements contained in the Prospectus and this
Statement of Additional Information as to the contents of any contract or other
document referred to are not necessarily complete and in each instance reference
is made to the copy of such contract or other document filed as an exhibit to
the Registration Statement, each such statement being qualified in all respects
by such reference. You may also review and copy the Registration Statement by
visiting the SEC's Public Reference Room in Washington, D.C. Information on the
operation of the Public Reference Room may be obtained by calling the SEC at
202-942-8090. In addition, copies of the Registration Statement may be obtained,
after mailing the appropriate duplicating fee, by writing to the SEC's Public
Reference Section, 450 5th Street, N.W., Washington, DC 20549-0102 or by e-mail
request at publicinfo@sec.gov.
30
FINANCIAL STATEMENTS
The Statement of Assets and Liabilities of the Fund dated as of January
21, 2003, including the Notes thereto, and the report of KPMG LLP thereon dated
January 23, 2003, included in the Fund's Prospectus dated January 28, 2003,
relating to the Common Shares, is hereby incorporated by reference into this
Statement of Additional Information, which means that such Statement of Assets
and Liabilities and the Notes thereto are considered to be a part of this
Statement of Additional Information. The Prospectus for the Common Shares was
filed electronically with the SEC on January 30, 2003 (Accession No.
0001047469-03-003308). You may request a free copy of the Prospectus for the
Common Shares by calling (800) 345-7999 or by writing to the Fund.
31
F&C/CLAYMORE PREFERRED SECURITIES INCOME FUND INCORPORATED
SCHEDULE OF INVESTMENTS AS OF MARCH 31, 2003 (UNAUDITED)
F&C/Claymore Preferred Securities Income Fund
PORTFOLIO OF INVESTMENTS
March 31, 2003 (Unaudited)
VALUE
SHARES/$ PAR (NOTE 1)
--------------- -------------
PREFERRED SECURITIES -- 56.4%
ADJUSTABLE RATE PREFERRED SECURITIES -- 1.1%
BANKING -- 0.7%
$3,000,000 BankBoston Capital Trust III,
Adj. Rate Pfd. $ 2,575,050
50,000 J.P. Morgan Chase & Co.,
Series A, Adj. Rate Pfd. 4,325,000*
-------------
TOTAL BANKING ADJUSTABLE RATE PREFERRED
SECURITIES 6,900,050
-------------
UTILITES -- 0.4%
$5,000,000 Public Service Enterprise Group, Inc.,
Enterprise Capital Trust II, Adj. Rate
Pfd. 2,650,000
$3,140,000 TXU Gas Capital I,
Adj. Rate Pfd. 1,683,825
-------------
TOTAL UTILITES ADJUSTABLE RATE PREFERRED
SECURITIES 4,333,825
-------------
TOTAL ADJUSTABLE RATE PREFERRED SECURITIES 11,233,875
-------------
FIXED RATE PREFERRED SECURITIES -- 55.3%
BANKING -- 23.9%
108,197 Abbey National Group,
7.375% Pfd. 2,804,466
Bank One Corporation:
$5,600,000 First Chicago NBD Capital A,
7.95% 12/01/26 Capital Security 6,434,736
480,935 Citigroup Capital IX,
6.00% Pfd. 11,970,472
Comerica, Incorporated:
27,900 Comerica (Imperial) Capital Trust I,
7.60% Pfd. 740,605
$11,000,000 Cullen/Frost Capital Trust I,
8.42% 2/01/27 Capital Security, Series A 12,362,405
Deutsche Bank:
$500,000 BT Capital Trust B,
7.90% 1/15/27 Capital Security, Series B1 546,402
Fleet Boston Financial Corporation:
$1,240,000 BankBoston Capital Trust I,
8.25% 12/15/26 Capital Security 1,408,287
$15,300,000 BankBoston Capital Trust II,
7.75% 12/15/26 Capital Security Series B 16,689,240
47,000 Fleet Capital Trust III,
7.05% Pfd. 1,180,170
40,000 Fleet Capital Trust IV,
7.17% Pfd. 1,004,400
55,000 Fleet Capital Trust VII,
7.20% Pfd. 1,425,325
79,100 Fleet Capital Trust VIII,
7.20% Pfd. 2,053,832
GreenPoint Financial Corporation:
$34,050,000 GreenPoint Capital Trust I,
9.10% 6/01/27 Capital Security 39,191,720
HSBC USA, Inc.:
$8,600,000 Republic of New York Capital I,
7.750% 11/15/26 Capital Security 9,623,099
$16,200,000 Republic New York Capital II,
7.53% 12/04/26 STOPS 17,812,062
J.P. Morgan Chase & Co.:
$4,000,000 Chase Capital I,
7.67% 12/01/26 Capital Security 4,363,200
$13,262,000 J.P. Morgan Capital Trust I,
7.54% 01/15/27 Capital Security 14,268,122
$5,461,000 J.P. Morgan Capital Trust II,
7.95% 02/27/27 Capital Security 6,067,171
$3,000,000 Keycorp Institutional Capital A,
7.826% 12/01/26 Capital Security,
Series A 3,374,175
Marshall & Ilsley Corporation:
$25,280,000 M&I Capital Trust A,
7.65% 12/01/26 Capital Security 28,233,968
North Fork Bancorporation:
$1,000,000 North Fork Capital Trust II,
8.00% 12/15/27 Capital Security 1,118,395
Union Planters Corporation:
60 Union Planter Preferred Funding,
7.75% Pfd., Series 144A*** 5,735,920
$8,000,000 Union Planters Capital Trust,
8.20% 12/15/26 Capital Security 9,015,080
US Bancorp:
8,000 7.20% TOPrS 200,600
6,000 7.35% Pfd. 158,790
437,800 Wachovia Corporation,
Wachovia Preferred Funding,
7.25% Pfd., Series A 11,601,700
Washington Mutual, Inc.:
$500,000 Great Western Finance Trust II,
8.206% 2/01/27 Capital Security,
Series A 567,078
$20,750,000 8.36% 12/01/26 Capital Security,
144A*** 23,825,254
-------------
TOTAL BANKING FIXED RATE PREFERRED
SECURITIES 233,776,674
-------------
FINANCIAL SERVICES -- 12.8%
CIT Group, Inc.:
30,000 Corporate-Backed Trust Certificates,
7.75% Pfd., Series CIT 763,200
$15,200,000 Countrywide Capital I,
8.00% 12/15/26 Capital Security 16,782,092
799,000 General Electric Capital Corporation,
5.875% Pfd, 20,106,835
Household International, Inc.:
141,500 7.50% Pfd., Series 2001-A 3,582,072*
264,000 7.60% Pfd. 6,683,160*
517,800 7.625% Pfd. 13,108,107*
Lehman Brothers Holdings, Inc.:
1,530,000 Lehman Capital Trust III,
6.375% Pfd. Series K 38,043,450
Morgan Stanley:
87,900 MSDW Capital Trust I,
7.10% Pfd. TOPrS 2,226,068
957,900 Morgan Stanley Capital Trust III,
6.25% Pfd. 23,784,657
-------------
TOTAL FINANCIAL SERVICES FIXED RATE
PREFERRED SECURITIES 125,079,641
-------------
INSURANCE -- 7.4%
The Hartford Financial Services Group,
11,300 Inc.:
Hartford Life Capital I,
7.20% Pfd. Series A 286,624
564,000 ING Groep NV,
7.20% Pfd. 14,534,280
326,235 RenaissanceRe Holding,
7.30% Pfd. Series B 8,274,951
The accompanying notes are an integral part of the financial statements.
32
F&C/Claymore Preferred Securities Income Fund
PORTFOLIO OF INVESTMENTS
March 31, 2003 (Unaudited)
VALUE
SHARES/$ PAR (NOTE 1)
--------------- -------------
PREFERRED SECURITIES (CONTINUED)
FIXED RATE PREFERRED SECURITIES (CONTINUED)
INSURANCE (CONTINUED)
SAFECO Corporation:
$19,989,000 SAFECO Capital Trust I, $ 21,489,674
8.072% 7/15/37 Capital Security
The St. Paul Companies, Inc.:
$2,200,000 MMI Capital Trust I,
7.625% 12/15/27 Capital Security, Series B 2,184,919
12,285 St. Paul Capital Trust I,
7.60% Pfd. 314,312
$500,000 USF&G Capital,
8.312% 7/01/46 Capital Security, Pvt. 144A*** 524,363
$16,750,000 USF&G Capital I,
8.50% 12/15/45 144A*** 17,842,016
UnumProvident Corporation:
$8,000,000 Provident Financing Trust I,
7.405% 3/15/38 Capital Security 5,584,240
37,000 Corts-UnumProvident Corporation,
8.50% Pfd. 682,280
18,000 XL Capital Ltd.,
8.00% Pfd. Series A 475,830
-------------
TOTAL INSURANCE FIXED RATE PREFERRED
SECURITIES 72,193,489
-------------
OIL AND GAS -- 2.7%
9,700 EOG Resources, Inc.,
7.195% Pfd., Series B 10,769,570*
$13,315,000 Phillips 66 Capital Trust II,
8.00% 01/15/37 Capital Security 15,151,871
-------------
TOTAL OIL AND GAS FIXED RATE PREFERRED
SECURITIES 25,921,441
-------------
UTILITIES-- 7.4%
AEP Texas Central Company:
11,700 CPL Capital I,
8.00% Pfd. Series A 294,606
AGL Resources, Inc.:
$3,750,000 AGL Capital Trust,
8.17% 06/01/37 Capital Security 4,152,112
10,000 Allete Capital I,
8.05% QUIPS 254,100
CenterPoint Energy, Inc.:
$11,200,000 Houston Light & Power, Capital Trust II,
8.257%, 2/01/37 Capital Security, Series B 9,809,968
Commonwealth Edison Company:
$4,700,000 COMED Financing II,
8.50% 01/27/07 Capital Security,
Series B 5,442,553
$26,220,000 COMED Financing III,
6.35% 3/15/33 Capital Security 25,497,770
Consolidated National Gas Company:
50,000 Dominion CNG Cap Trust I,
7.80% Pfd. 1,309,250
Duke Energy Corporation:
10,000 7.04% Pfd. Series Y 1,039,650*
7,800 Duke Energy Capital Trust II,
7.20% TOPrS 196,989
10,240 Entergy Arkansas, Inc.,
4.56% Pfd. Series 1965 644,147*
Indiana Michigan Power Company:
30,000 6.875% Pfd. Sinking Fund 3,095,550*
8,100 7.60% Pfd. Series B 203,836
70,000 Indianapolis Power & Light Company,
5.65% Pfd. 5,674,900*
10,000 Interstate Power & Light Company,
7.875% Pfd. Series A 250,300
The Laclede Group, Inc.:
32,300 Laclede Capital Trust I,
7.70% Pfd. 845,291
Northern States Power Company:
89,251 NSP Financing I, 7.875% Pfd. TOPrS 2,216,549
OGE Energy Corporation:
3,800 OGE Energy Capital Trust I,
8.375% Pfd. 100,852
$2,300,000 PECO Energy Capital Trust III,
$7.38 4/06/28, Capital Security, Series D 2,477,997
11,000 Potomac Electric Power Trust I,
7.375% Pfd. TOPrS 277,035
Public Service Company of Oklahoma:
53,300 PSO Capital I,
8.00% TOPrS 1,341,028
Public Service Enterprise Group, Inc.:
140,550 PSEG Funding Trust II,
8.75% Pfd. 3,665,544
Puget Energy, Inc.:
$2,000,000 Puget Capital Trust,
8.231% 6/01/27 Capital Security, Series B 2,062,700
49,100 Southwestern Public Service Capital I,
7.85% Pfd. Series A 1,218,908
$500,000 Union Electric Company,
7.69% 12/15/36 Capital Security, Series A 550,578
-------------
TOTAL UTILITIES FIXED RATE PREFERRED
SECURITIES 72,622,213
-------------
MISCELLANEOUS INDUSTRIES -- 1.1%
4,750 Centaur Funding Corporation,
9.08% Pfd, 144A 5,361,230
19,100 Equity Office Property Trust,
7.75% Pfd. Series G 506,150
54,000 Ocean Spray Cranberries, Inc.,
6.25% Pfd., Pvt., 144A*** 4,678,290*
14,700 Public Storage, Inc.,
7.625% Pfd. 375,364
-------------
TOTAL MISCELLANEOUS INDUSTRIES FIXED RATE
PREFERRED SECURITIES 10,921,034
-------------
TOTAL FIXED RATE PREFERRED SECURITIES 540,514,492
-------------
TOTAL PREFERRED SECURITIES
(Cost $546,639,014) 551,748,367
-------------
CORPORATE DEBT SECURITIES -- 16.9%
FINANCIAL SERVICES -- 2.3%
General Motors Acceptance Corporation:
20,000 7.25% 2/07/33 PINES 491,000
$20,000,000 8.00% 11/01/31 Senior Bonds 19,482,200
$2,200,000 Morgan Stanley Finance,
8.03% 02/28/17 Capital Units 2,426,083
-------------
TOTAL FINANCIAL SERVICES CORPORATE DEBT
SECURITIES 22,399,283
-------------
The accompanying notes are an integral part of the financial statements.
33
F&C/Claymore Preferred Securities Income Fund
PORTFOLIO OF INVESTMENTS
March 31, 2003 (Unaudited)
VALUE
SHARES/$ PAR (NOTE 1)
--------------- -------------
CORPORATE DEBT SECURITIES (CONTINUED)
INSURANCE -- 2.8%
$27,000,000 Travelers Property Casualty,
6.375% 03 /15 /33 Capital Security, 144A*** $ 27,013,365
-------------
OIL AND GAS -- 1.0%
$9,295,000 KN Energy, Inc.,
7.45% 3/01/98 9,736,792
-------------
UTILITIES-- 10.3%
$14,000,000 AEP Texas Central Company,
6.65% 2/15/33 Capital Security 144A*** 14,422,380
$4,000,000 CenterPoint Energy, Inc.,
6.95% 3/15/33 Capital Security Pvt.
144A*** 4,175,720
$10,000,000 Constellation Energy Group,
7.60% 4/01/32 Senior Notes 11,484,050
$1,000,000 DTE Energy Company,
6.375% 4/15/33 Capital Security, Senior
Notes 1,016,685
Duke Capital Corporation:
$11,179,000 6.75% 2/15/32 Senior Notes 9,490,803
$10,000,000 8.00% 10/01/19 Senior Notes 9,944,900
$18,220,000 PSEG Power LLC,
8.625% 4/15/31 Capital Security 22,436,746
TXU US Holding Company:
$10,000,000 Oncor Electric,
7.25% 1/15/33 Pvt. 144A*** 11,238,100
$15,000,000 TXU Energy Company,
7.00% 3/15/13 Capital Security 144A*** 15,219,075
66,000 Virginia Power Capital Trust,
7.375% 7/30/42 1,735,140
-------------
TOTAL UTILITIES CORPORATE DEBT SECURITIES 101,163,599
-------------
MISCELLANEOUS -- 0.5% BellSouth Corporation:
15,780 Corporate-Backed Trust Certificates,
7.00% 12/1/95 Series BLS 411,779
$390,000 BellSouth Telecommunication,
7.0% 12/01/95 Capital Security 439,331
$5,000,000 Ford Motor Company,
7.45% 7/16/31 Capital Security 3,866,300
-------------
TOTAL MISCELLANEOUS CORPORATE DEBT
SECURITIES 4,717,410
-------------
TOTAL CORPORATE DEBT SECURITIES
(Cost $163,159,426) 165,030,449
-------------
COMMON STOCKS AND CONVERTIBLE SECURITIES -- 3.2%
UTILITIES -- 3.2%
65,000 Alltel Corporation,
7.75% Pfd. Convertible 3,087,175
170,700 Ameren Corporation,
9.75% Pfd. Convertible 4,468,926
215,000 American Electric Power,
9.25% Pfd. Convertible 7,875,450
300,000 Duke Energy Corporation 4,402,500*
85,000 FPL Group, Inc.,
8.50% Pfd. Convertible 4,695,825
245,000 TXU Corporation,
8.75% Pfd.Convertible
6,852,650
-------------
TOTAL UTILITIES COMMON STOCKS AND
CONVERTIBLE SECURITIES 31,382,526
-------------
TOTAL COMMON STOCKS AND CONVERTIBLE
SECURITIES
(Cost $30,849,326) 31,382,526
-------------
U.S. GOVERNMENT AND AGENCY DEBT SECURITIES -- 21.5%
$25,000,000 Fannie Mae, 6.625% 11/15/30 29,484,500
$125,000,000 Freddie Mac, 4.50% 1/15/13 126,822,500
$50,000,000 U.S. Treasury Bond, 5.375% 2/15/31 54,118,500
-------------
TOTAL U.S. GOVERNMENT AND AGENCY DEBT
SECURITIES
(Cost $215,217,178) 210,425,500
-------------
OPTION CONTRACTS -- 0.4% (Cost $5,607,048)
6,250 Put Options on U.S. Treasury Bond June
Futures,
Expiring 05/24/2003 3,960,937
-------------
MONEY MARKET FUNDS -- 1.9% (Cost $17,943,983)
17,943,983 BlackRock Provident Institutional
TempFund, 1.19% 17,943,983
-------------
TOTAL INVESTMENTS (Cost $979,415,975**) 100.3% 980,491,762
OTHER ASSETS AND LIABILITIES (Net) (0.3)% (2,704,497)
------------ -------------
TOTAL NET ASSETS AVAILABLE TO
COMMON STOCK 100.0%++ $ 977,787,265
============ =============
-----------------------------------
* Securities eligible for the Dividends Received Deduction.
** Aggregate cost of securities held.
*** Securities exempt from registration under Rule 144A of the Securities Act
of 1933. These securities may by resold in transactions exempt from
registration to qualified institutional buyers.
+ Non-income producing.
++ The percentage shown for each investment category is the total value of
that category as a percentage of net assets.
ABBREVIATIONS:
PINES -- Public Income Notes
QUIPS -- Quarterly Income Preferred Securities
STOPS -- Semi-Annual Trust Originated Pass Through Securities
TOPRS -- Trust Originated Preferred Securities
PFD. -- Preferred securities
PVT. -- Private Placement securities
Capital Securities are treated as debt instruments for financial
statement purposes and the amounts shown in the Shares/$ Par column
are dollar amounts of par value.
The accompanying notes are an integral part of the financial statements.
34
F&C/CLAYMORE PREFERRED SECURITIES INCOME FUND INCORPORATED
STATEMENT OF ASSETS AND LIABILITIES
AS OF MARCH 31, 2003 (UNAUDITED)
ASSETS:
Investments, at value (Cost $979,415,975)
(See accompanying schedule) $980,491,762
Cash 1
Dividends and interest receivable 11,943,061
Prepaid Expenses 46,586
------------
Total Assets 992,481,410
------------
LIABILITIES:
Offering cost payable 1,161,785
Investment purchase payable 12,889,094
Investment advisory fee payable 354,862
Servicing agent fees payable 85,617
Professional fees payable 22,330
Accrued expenses and other payables 180,457
------------
Total Liabilities 14,694,145
------------
NET ASSETS AVAILABLE TO COMMON STOCK $977,787,265
============
NET ASSETS AVAILABLE TO COMMON STOCK consist of:
Undistributed net investment income $5,243,711
Accumulated net realized loss on investments sold (1,883,500)
Unrealized appreciation on investments 1,075,787
Par value of Common Stock 408,542
Paid-in capital in excess of par value of Common Stock 972,942,725
------------
Total Net Assets Available to Common Stock $977,787,265
============
NET ASSETS VALUE PER SHARE OF COMMON STOCK:
Common Stock (40,854,198 shares outstanding) $23.93
============
The accompanying notes are an integral part of the financial statements.
35
F&C/CLAYMORE PREFERRED SECURITIES INCOME FUND INCORPORATED
STATEMENT OF OPERATIONS
FOR THE PERIOD JANUARY 31, 2003 (COMMENCEMENT OF OPERATIONS)
TO MARCH 31, 2003
(UNAUDITED)
INVESTMENT INCOME:
Dividends $ 2,120,124
Interest 4,259,854
-----------
Total Investment Income 6,379,978
EXPENSES:
Investment advisory fees 670,809
Servicing agent fees 161,142
Administration fees 73,324
Transfer agent fees and expenses 63,342
Insurance expense 37,634
Professional fees 22,330
Custodian fees and expenses 13,226
Directors' fees and expenses 11,893
Other 82,567
-----------
Total expenses 1,136,267
-----------
NET INVESTMENT INCOME 5,243,711
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS
Net realized loss on investments sold during the period (1,883,500)
Change in net unrealized appreciation of investments
during the period 1,075,787
NET REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS (807,713)
-----------
NET INCREASE IN NET ASSETS AVAILABLE TO COMMON STOCK RESULTING
FROM OPERATIONS $ 4,435,998
===========
The accompanying notes are an integral part of the financial statements.
36
F&C/CLAYMORE PREFERRED SECURITIES INCOME FUND INCORPORATED
STATEMENT OF CHANGES IN NET ASSETS
FOR THE PERIOD JANUARY 31, 2003 (COMMENCEMENT OF OPERATIONS)
TO MARCH 31, 2003
(UNAUDITED)
PERIOD ENDED
MARCH 31, 2003
OPERATIONS:
Net investment income $ 5,243,711
Net realized loss on investments sold during the period (1,883,500)
Change in net unrealized appreciation of investments during
the period 1,075,787
------------
Net increase in net assets available to Common Stock
resulting from operations 4,435,998
FUND SHARE TRANSACTIONS:
Increase from Common Stock transactions 975,293,750
Cost of Common Stock Offering (2,042,500)
------------
Net increase in net assets available to Common Stock
resulting from Fund share transactions 973,251,250
------------
NET INCREASE IN NET ASSETS AVAILABLE TO COMMON STOCK FOR THE PERIOD. 977,687,248
NET ASSETS AVAILABLE TO COMMON STOCK:
Beginning of period 100,017
------------
End of period (including undistributed net investment of
$5,243,711) $ 977,787,265
=============
The accompanying notes are an integral part of the financial statements.
37
F&C/CLAYMORE PREFERRED SECURITIES INCOME FUND INCORPORATED
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
1. ORGANIZATION
F&C/Claymore Preferred Securities Income Fund Incorporated (the "Fund")
was incorporated as a Maryland corporation on May 23, 2002, and commenced
operations on January 31, 2003 as a diversified, closed-end management
investment company under the Investment Company Act of 1940, as amended.
The Fund's investment objective is to provide its common shareholders
with high current income consistent with preservation of capital. The Fund's
investment adviser intends to achieve its objective by pursuing 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.
2. SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of significant accounting policies
consistently followed by the Fund in the preparation of its financial
statements. The preparation of financial statements is in conformity with
accounting principles generally accepted in the United States of America and
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities in the financial statements and the reported
amounts of increases and decreases in net assets from operations during the
reporting period. Actual results could differ from those estimates.
PORTFOLIO VALUATION: The net asset value of the Fund's Common Stock is
determined by the Fund's Administrator no less frequently than on the last
business day of each week and month. 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 the
Fund's liabilities.
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 of the Fund, including reference to
valuations of other securities which are comparable in quality, maturity and
type. Investments in money
38
market instruments, which mature in 60 days or less, are valued at amortized
cost. Investments in money market funds are valued at the net asset value of
such funds.
SECURITIES TRANSACTIONS AND INVESTMENT INCOME: Securities transactions
are recorded as of the trade date. Realized gains and losses from securities
sold are recorded on the identified cost basis. Dividend income is recorded on
ex-dividend dates. Interest income is recorded on the accrual basis.
Furthermore, in recording investment income, the Fund also amortizes premiums
and accretes discounts on those fixed income securities, such as capital
securities, which trade and are quoted on an "accrued income" basis.
OPTIONS: Upon the purchase of an option by the Fund, the total purchase
price paid is recorded as an investment. The market valuation is determined as
set forth in the preceding portfolio valuation paragraph. When the Fund enters
into a closing sale transaction, the Fund will record a gain or loss depending
on the difference between the purchase and sale price. The risks associated with
purchasing options and the maximum loss the Fund would incur are limited to the
purchase price originally paid.
REPURCHASE AGREEMENTS: The Fund may engage in repurchase agreement
transactions. The Fund's Investment Adviser reviews and approves the eligibility
of the banks and dealers with which the Fund may enter into repurchase agreement
transactions. The value of the collateral underlying such transactions is at
least equal at all times to the total amount of the repurchase obligations,
including interest. The Fund maintains possession of the collateral through its
custodian and, in the event of counterparty default, the Fund has the right to
use the collateral to offset losses incurred. There is the possibility of loss
to the Fund in the event the Fund is delayed or prevented from exercising its
rights to dispose of the collateral securities.
DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS: The Fund expects to
declare dividends on a monthly basis to shareholders of Common Stock.
Distributions to shareholders are recorded on the ex-dividend date. Any net
realized short-term capital gains will be distributed to shareholders at least
annually. Any net realized long-term capital gains may be distributed to
shareholders at least annually or may be retained by the Fund as determined by
the Fund's Board of Directors. Capital gains retained by the Fund are subject to
tax at the capital gains corporate tax rate. Subject to the Fund's qualifying as
a regulated investment company, any taxes paid by the Fund on such net realized
long-term gains may be used by the Fund's shareholders as a credit against their
own tax liabilities.
FEDERAL INCOME TAXES: The Fund intends to continue to qualify as a
regulated investment company by complying with the requirements under subchapter
M of the Internal Revenue Code of 1986, as amended, applicable to regulated
investment companies and intends to distribute all of its taxable income to its
shareholders. In addition, by distributing in each calendar year substantially
all its net investment income, capital gains and certain other amounts, if any,
the Fund will not be subject to Federal excise tax. Therefore, no Federal income
or excise tax provision will be required.
39
3. INVESTMENT ADVISORY FEE, SERVICING AGENT FEE, ADMINISTRATION FEE,
CUSTODIAN FEE, TRANSFER AGENT FEE, AND DIRECTORS' FEES
Flaherty & Crumrine Incorporated (the "Adviser") serves as the Fund's
Investment Adviser. The Fund pays the Adviser a monthly fee at an annual rate of
0.525% on the first $200 million of the Fund's average weekly total managed
assets, 0.45% of 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 and the fees to the Servicing
Agent, the Administrator and the Custodian (each described below), the Fund's
average weekly total managed assets means the total assets of the Fund
(including assets attributable to any 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
any preferred shares issued by the Fund is not treated as a liability.
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. As compensation for its services, the Fund pays the Servicing Agent a fee
computed and paid monthly at the annual rate of 0.025% of the first $200 million
of the Fund's average weekly total managed assets, 0.10% of the next $300
million of the Fund's average weekly total managed assets and 0.15% of the
Fund's average weekly total managed assets above $500 million.
PFPC Inc., a member of the PNC Financial Services Group, Inc. ("PNC
Financial Services"), serves as the Fund's Administrator and Transfer Agent. As
Administrator, PFPC Inc. calculates the net asset value of the Fund's shares and
generally assists in all aspects of the Fund's administration and operation. As
compensation for PFPC Inc.'s services as Administrator, the Fund pays PFPC Inc.
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 next $500 million of
the Fund's average weekly total managed assets and 0.02% on the Fund's average
weekly total managed assets above $1 billion. PFPC Inc. also serves as the
Fund's Common Stock transfer agent, dividend-paying agent and registrar and, as
compensation for PFPC Inc.'s services as such, the Fund pays PFPC Inc. a fee 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 next $500 million of the Fund's average weekly net assets
attributable to the Common Stock and 0.0025% on the Fund's average weekly net
assets attributable to the Common Stock above $1 billon, plus certain
out-of-pocket expenses.
For purpose of calculating such fee, the Fund's average weekly net
assets attributable to the Common Stock will be deemed to be the average weekly
value of the Fund's total assets minus the sum of the Fund's liabilities and
accumulated dividends, if any, on any
40
preferred shares. For purposes of this calculation, the Fund's liabilities
are assumed to include the aggregate liquidation preference of any outstanding
Fund preferred shares.
PFPC Trust Company ("PFPC Trust") serves as the Fund's Custodian. PFPC
Trust is an indirect subsidiary of PNC Financial Services. As compensation for
PFPC Trust's services as custodian, the Fund pays PFPC Trust a monthly fee at
the annual rate of 0.010% on the first $200 million of the Fund's average weekly
total managed assets, 0.008% on the next $300 million of the Fund's average
weekly total managed assets, 0.006% on the next $500 million of the Fund's
average weekly total managed assets, and 0.005% on the Fund's average weekly
total managed assets above $1 billion.
The Fund currently pays each Director who is not a director, officer or
employee of the Adviser or the Servicing Agent 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 telephone meeting. In addition, the Fund will reimburse all
Directors for travel and out-of-pocket expenses incurred in connection with such
meetings.
4. PURCHASES AND SALES OF SECURITIES
Costs of purchases and proceeds from sales of securities for the period
ended March 31, 2003, excluding short-term investments, aggregated
$1,017,566,233 and $59,472,878, respectively.
At March 31, 2003, aggregate gross unrealized appreciation for all
securities in which there is an excess of value over tax cost was $10,074,026
and aggregate gross unrealized depreciation for all securities in which there is
an excess of tax cost over value was $8,998,239.
5. COMMON STOCK
There are 250,000,000 shares of capital stock authorized of which
240,000,000 are classified as Common Stock, par value $0.01 per share. At March
31, 2003, there were 40,854,198 shares of Common Stock issued and outstanding.
ORGANIZATION EXPENSES AND OFFERING COSTS: Organization expenses
relating to organizing the Fund of $24,113 have been paid by the Adviser.
Offering costs are estimated to be approximately $2,042,500. The Adviser has
also agreed to pay offering costs (excluding sales charges) that exceed $0.05
per share. Offering costs up to $0.05 per share and sales charges will be borne
by the Fund and its shareholders and will be accounted for as a reduction to
paid-in capital. Based on the initial offering of 36,500,000 shares, and the
subsequent offering of 4,350,000 shares through exercise of the underwriter's
over-allotment option in connection with the initial offering, all of the
offering costs will be borne by the Fund.
Common Stock transactions are reflected in the following table:
41
TWO MONTHS ENDED 3/31/03
SHARES GROSS AMOUNT SALES LOAD NET AMOUNT
Beginning Capitalization 4,198 $100,017 $0 $100,017
Initial Public Offering on 3/31/03 36,500,000 912,500,000 41,062,500 871,437,500
Shares offered through exercise of
Underwriters over-allotment option
On 2/18/03 2,500,000 62,500,000 2,812,500 59,687,500
On 3/19/03 1,850,000 46,250,000 2,081,250 44,168,750
---------- -------------- ----------- ------------
Total 40,854,198 $1,021,350,017 $45,956,250 $975,393,767
6. PORTFOLIO INVESTMENTS, CONCENTRATION AND INVESTMENT QUALITY
The Fund invests primarily in diversified portfolio of preferred
securities. This includes fully taxable ("hybrid") preferred securities and
traditional preferred stocks eligible for the inter-corporate Dividends Received
Deduction ("DRD"). Under normal market conditions, at least 80% of the value of
the Fund's total assets will be invested in preferred securities. Under current
market conditions, the Fund expects that its portfolio of preferred securities
will consist principally of "hybrid" or taxable preferreds. Also, under normal
market conditions, the Fund invests at least 25% of its total assets in
securities issued by companies in the utilities industry and at least 25% of its
total assets in securities issued by companies in the banking industry. Because
of the Fund's concentration of investments in the utility industry and in the
banking industry, the ability of the Fund to maintain its dividend and the value
of the Fund's investments could be adversely affected by the possible inability
of companies in these industries to pay dividends and interest on their
securities and the ability of holders of securities of such companies to realize
any value from the assets of the issuer upon liquidation or bankruptcy.
The Fund may invest up to 20% of its total assets in securities rated
below investment grade. These securities must be rated at least either "Ba3" by
Moody's Investors Service, Inc. or "BB-" by Standard & Poor's or judged to be
comparable in quality, in either case at the time of purchase; however, these
securities must be issued by an issuer having a class of senior debt rated
investment grade outstanding.
The Fund may invest up to 15% of its total assets in common stocks,
which total includes those convertible securities that trade in close
relationship to the underlying common stock of an issuer, and may invest up to
20% of its total assets in debt securities. Certain of its investments in
hybrid, i.e., fully taxable, preferred securities, such as TOPrS, QUIPS, MIPs,
TrUPS, QUIDS, QUIBS, CorTS, Trust Preferred Securities, capital securities, and
other similar or related investments, will be subject to the foregoing 20%
limitation to the extent that, in the opinion of the Fund's Investment Adviser,
such investments are deemed to be debt-like in key characteristics. Typically, a
security will not be considered debt-like (a) if an issuer can defer payment of
income for eighteen months or more without triggering an event of default and
(b) if such issue is a junior and fully subordinated liability of an issuer or
its ultimate guarantor.
42
7. SPECIAL INVESTMENT TECHNIQUES
The Fund may employ certain investment techniques in accordance with
its fundamental investment policies. These may include the use of when-issued
and delayed delivery transactions. Securities purchased or sold on a when-issued
or delayed delivery basis may be settled within 45 days after the date of the
transaction. Such transactions may expose the Fund to credit and market
valuation risk greater than that associated with regular trade settlement
procedures. The Fund may also enter into transactions, in accordance with its
fundamental investment policies, involving any or all of the following: lending
of portfolio securities, short sales of securities, futures contracts, interest
rate swaps, options on futures contracts, options on securities and swaptions.
As in the case of when-issued securities, the use of over-the-counter
derivatives, such as interest rate swaps and swaptions, may expose the Fund to
greater credit, operations, and market value risk than is the case with
regulated, exchange traded futures and options. With the exception of purchasing
securities on a when-issued or delayed delivery basis or lending portfolio
securities, these transactions are used for hedging or other appropriate
risk-management purposes or, under certain other circumstances, to increase
income. As of March 31, 2003, the Fund owned put options on U.S. Treasury bond
futures contracts. No assurance can be given that such transactions will achieve
their desired purposes or will result in an overall reduction of risk to the
Fund.
43
APPENDIX A -
RATINGS OF INVESTMENTS
Description of certain ratings assigned by Moody's and S&P:
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-1) 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.
A-1
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.
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
APPENDIX B
F&C/CLAYMORE PREFERRED SECURITIES INCOME FUND INCORPORATED
ARTICLES SUPPLEMENTARY ESTABLISHING AND FIXING
THE RIGHTS AND PREFERENCES OF AUCTION MARKET PREFERRED STOCK
F&C/Claymore Preferred Securities Income Fund Incorporated (the "Fund"), a
Maryland corporation having its principal Maryland office in the City of
Baltimore in the State of Maryland, certifies to the State Department of
Assessments and Taxation of Maryland that:
First: Pursuant to authority expressly vested in the Board of Directors of
the Fund by Article V of its Articles of Amendment and Restatement (which as
hereafter amended, restated and supplemented from time to time, is together with
these Articles Supplementary, the "Charter"), and the Maryland General
Corporation Law (the "MGCL"), the Board of Directors has duly classified out of
the Fund's authorized and unissued preferred stock, and authorized the creation
and issuance of 21,680 shares of the Fund's Auction Market Preferred Stock, par
value $.01 per share, liquidation preference $25,000 per share, having such
designations as to series, and such number of shares per series, as is set forth
under "Designations" below (each a "Series" of Auction Market Preferred Stock
and, together, the "Preferred Shares").
Second: Pursuant to Section 2-411 of the MGCL and authority granted by
Article 3 of the Fund's By-laws, the Board of Directors of the Fund has
appointed a pricing committee (the "Pricing Committee") and has authorized such
Pricing Committee to fix the terms of the Preferred Shares for each Series, as
set forth herein.
Third: The preferences, rights, voting powers, restrictions, limitations as
to dividends, qualifications, and terms and conditions of redemption of the
shares of each Series of Preferred Shares are as follows:
DESIGNATION
Series M7: A series of 3,200 Preferred Shares, liquidation preference
$25,000 per share, is designated "Series M7 Auction Market Preferred Stock"
("Series M7"). The Initial Rate Period for Series M7 shall be the period from
and including the Date of Original Issue thereof to but excluding __, 2003.
Each share of Series M7 shall have an Applicable Rate for its Initial Rate
Period equal to ____% per annum and an Initial Dividend Payment Date of
__, 2003, and each share of Series M7 shall have such other preferences, rights,
voting powers, restrictions, limitations as to dividends, qualifications and
terms and conditions of redemption, in addition to those required by applicable
law or set forth in the Charter applicable to preferred stock of the Fund, as
are set forth in Part I and Part II of these Articles Supplementary. The Series
M7 shall constitute a separate series of Preferred Shares of the Fund.
Series T7: A series of 3,200 Preferred Shares, liquidation preference
$25,000 per share, is designated "Series T7 Auction Market Preferred Stock"
("Series T7"). The Initial Rate Period for Series T7 shall be the period from
and including the Date of Original Issue thereof to but excluding __,
2003. Each share of Series T7 shall have an Applicable Rate for its Initial Rate
Period equal to ____% per annum and an Initial Dividend Payment Date of
__, 2003,
and each share of Series T7 shall have such other preferences, rights, voting
powers, restrictions, limitations as to dividends, qualifications and terms and
conditions of redemption, in addition to those required by applicable law or set
forth in the Charter applicable to preferred stock of the Fund, as are set forth
in Part I and Part II of these Articles Supplementary. The Series T7 shall
constitute a separate series of Preferred Shares of the Fund.
Series W7: A series of 3,200 Preferred Shares, liquidation preference
$25,000 per share, is designated "Series W7 Auction Market Preferred Stock"
("Series W7"). The Initial Rate Period for Series W7 shall be the period from
and including the Date of Original Issue thereof to but excluding __,
2003. Each share of Series W7 shall have an Applicable Rate for its Initial Rate
Period equal to ____% per annum and an Initial Dividend Payment Date of
__, 2003, and each share of Series W7 shall have such other preferences, rights,
voting powers, restrictions, limitations as to dividends, qualifications and
terms and conditions of redemption, in addition to those required by applicable
law or set forth in the Charter applicable to preferred stock of the Fund, as
are set forth in Part I and Part II of these Articles Supplementary. The Series
W7 shall constitute a separate series of Preferred Shares of the Fund.
Series TH7: A series of 3,200 Preferred Shares, liquidation preference
$25,000 per share, is designated "Series TH7 Auction Market Preferred Stock"
("Series TH7"). The Initial Rate Period for Series TH7 shall be the period from
and including the Date of Original Issue thereof to but excluding __,
2003. Each share of Series TH7 shall have an Applicable Rate for its Initial
Rate Period equal to ____% per annum and an Initial Dividend Payment Date of
__, 2003, and each share of Series TH7 shall have such other preferences,
rights, voting powers, restrictions, limitations as to dividends, qualifications
and terms and conditions of redemption, in addition to those required by
applicable law or set forth in the Charter applicable to preferred stock of the
Fund, as are set forth in Part I and Part II of these Articles Supplementary.
The Series TH7 shall constitute a separate series of Preferred Shares of the
Fund.
Series F7: A series of 3,200 Preferred Shares, liquidation preference
$25,000 per share, is designated "Series F7 Auction Market Preferred Stock"
("Series F7"). The Initial Rate Period for Series F7 shall be the period from
and including the Date of Original Issue thereof to but excluding 3,200 __,
2003. Each share of Series F7 shall have an Applicable Rate for its Initial Rate
Period equal to ____% per annum and an Initial Dividend Payment Date of 3,200
__, 2003, and each share of Series F7 shall have such other preferences, rights,
voting powers, restrictions, limitations as to dividends, qualifications and
terms and conditions of redemption, in addition to those required by applicable
law or set forth in the Charter applicable to preferred stock of the Fund, as
are set forth in Part I and Part II of these Articles Supplementary. The Series
F7 shall constitute a separate series of Preferred Shares of the Fund.
Series T28: A series of 2,840 Preferred Shares, liquidation preference
$25,000 per share, is designated "Series T28 Auction Market Preferred Stock"
("Series T28"). The Initial Rate Period for Series T28 shall be the period from
and including the Date of Original Issue thereof to but excluding __,
2003. Each share of Series T28 shall have an Applicable Rate for its Initial
Rate Period equal to ____% per annum and an Initial Dividend Payment Date of
__, 2003, and each share of Series T28 shall have such other preferences,
rights, voting powers, restrictions, limitations as to dividends, qualifications
and terms and conditions of redemption, in addition to those required by
applicable law or set forth in the Charter applicable to preferred
B-2
stock of the Fund, as are set forth in Part I and Part II of these Articles
Supplementary. The Series T28 shall constitute a separate series of Preferred
Shares of the Fund.
Series W28: A series of 2,840 Preferred Shares, liquidation preference
$25,000 per share, is designated "Series W28 Auction Market Preferred Stock"
("Series W28"). The Initial Rate Period for Series W28 shall be the period from
and including the Date of Original Issue thereof to but excluding __,
2003. Each share of Series W28 shall have an Applicable Rate for its Initial
Rate Period equal to ____% per annum and an Initial Dividend Payment Date of
__, 2003, and each share of Series W28 shall have such other preferences,
rights, voting powers, restrictions, limitations as to dividends, qualifications
and terms and conditions of redemption, in addition to those required by
applicable law or set forth in the Charter applicable to preferred stock of the
Fund, as are set forth in Part I and Part II of these Articles Supplementary.
The Series W28 shall constitute a separate series of Preferred Shares of the
Fund.
The Board of Directors of the Fund may, in the future, authorize the
issuance of additional shares of the Fund's Preferred Shares as Series M7, T7,
W7, TH7, F7, T28 and/or W28 with (except to the extent otherwise determined by
the Board of Directors) the same preferences, rights, voting powers,
restrictions, limitations as to dividends, qualifications and terms and
conditions of redemption and other terms of the respective series herein
described, except that the Applicable Rate for its Initial Rate Period, its
Initial Dividend Payment Date and any other changes in the terms herein set
forth shall be as set forth in Articles Supplementary with respect to such
additional shares.
DEFINITIONS
As used in Parts I and II of these Articles Supplementary, the following
terms shall have the following meanings (with terms defined in the singular
having comparable meanings when used in the plural and vice versa), unless
otherwise defined or unless the context otherwise requires:
(a) "`AA' Financial Composite Commercial Paper Rate" on any date shall
mean (i) (A) in the case of any Rate Period of 7 Rate Period Days or fewer,
the interest equivalent of the 7-day rate and, in the case of any Rate
Period of eight or more but fewer than 49 Rate Period Days, the interest
equivalent of the 30-day rate; and (B) in the case of any Special Rate
Period of (1) 49 or more but fewer than 70 Rate Period Days, the interest
equivalent of the 60-day rate, (2) 70 or more but fewer than 85 Rate Period
Days, the arithmetic average of the interest equivalent of the 60-day and
90-day rates, (3) 85 or more but fewer than 99 Rate Period Days, the
interest equivalent of the 90-day rate, (4) 99 or more but fewer than 120
Rate Period Days, the arithmetic average of the interest equivalent of the
90-day and 120-day rates, (5) 120 or more but fewer than 141 Rate Period
Days, the interest equivalent of the 120-day rate, (6) 141 or more but
fewer than 162 Rate Period Days, the arithmetic average of the 120-day and
180-day rates, and (7) 162 or more but fewer than 184 Rate Period Days, the
interest equivalent of the 180-day rate, in each of the above cases on
commercial paper placed on behalf of financial issuers whose corporate
bonds are rated "AA" by S&P or the equivalent of such rating by S&P or
another Rating Agency selected by the Fund, as made available on a discount
basis or
B-3
otherwise by the Federal Reserve Bank of New York for the Business Day next
preceding such date; or (ii) in the event that the Federal Reserve Bank of
New York does not make available any such rate, then the arithmetic average
of such rates, as quoted on a discount basis or otherwise, by the
Commercial Paper Dealers to the Auction Agent for the close of business on
the Business Day next preceding such date. If any Commercial Paper Dealer
does not quote a rate required to determine the "AA" Financial Composite
Commercial Paper Rate, the "AA" Financial Composite Commercial Paper Rate
shall be determined on the basis of the quotation or quotations furnished
by the remaining Commercial Paper Dealer or Commercial Paper Dealers and
any Substitute Commercial Paper Dealer or Substitute Commercial Paper
Dealers selected by the Fund to provide such rate or rates not being
supplied by any Commercial Paper Dealer or Commercial Paper Dealers, as the
case may be, or, if the Fund does not select any such Substitute Commercial
Paper Dealer or Substitute Commercial Paper Dealers, by the remaining
Commercial Paper Dealer or remaining Commercial Paper Dealers. For purposes
of this definition, the "interest equivalent" of a rate stated on a
discount basis (a "discount rate") for commercial paper of a given number
of days' maturity shall be equal to the quotient (rounded upwards to the
next higher one-thousandth (.001) of 1%) of (A) the discount rate divided
by (B) the difference between (x) 1.00 and (y) a fraction, the numerator of
which shall be the product of the discount rate times the number of days
until such commercial paper matures and the denominator of which shall be
360.
(b) "Accountant's Confirmation" shall have the meaning specified in
paragraph 6(c) of Part I of these Articles Supplementary.
(c) "Affiliate" shall mean, when used with respect to the Fund, any
Person known to the Auction Agent to be controlled by, in control of or
under common control with the Fund; provided, however, that no corporation
or Person controlled by, in control of or under common control with such
corporation, a Director, director or executive officer of which is a
Director, shall be deemed to be an Affiliate solely because such Director,
director or executive officer is also a Director.
(d) "Agent Member" shall mean a member of or participant in the
Securities Depository that will act on behalf of a Bidder.
(e) "Applicable Rate" shall have the meaning specified in paragraph
2(e)(i) of Part I of these Articles Supplementary.
(f) "Approved Foreign Nation" has the meaning set forth in "Fitch
Eligible Assets."
(g) "Auction" shall mean each periodic implementation of the Auction
Procedures.
(h) "Auction Agent" means Wilmington Trust Company unless and until
another commercial bank, Fund company or other institution appointed by a
resolution of the Board of Directors of the Fund or a duly authorized
committee thereof enters into an agreement with the Fund to follow the
Auction Procedures for the purpose of determining
B-4
the Applicable Rate and to act as transfer agent, registrar, dividend
disbursing agent and redemption agent for the Preferred Shares.
(i) "Auction Date," with respect to any Rate Period, shall mean the
Business Day next preceding the first day of such Rate Period.
(j) "Auction Procedures" shall mean the procedures for conducting
Auctions set forth in Part II of these Articles Supplementary, as such
procedures may be amended from time to time.
(k) "Available Preferred Shares" shall have the meaning specified in
paragraph 3(a) of Part II of these Articles Supplementary.
(l) "Beneficial Owner," with respect to any Preferred Shares, means a
customer of a Broker-Dealer who is listed on the records of that
Broker-Dealer (or, if applicable, the Auction Agent) as a holder of such
Preferred Shares.
(m) "Bid" and "Bids" shall have the respective meanings specified in
paragraph 1(a) of Part II of these Articles Supplementary.
(n) "Bidder" and "Bidders" shall have the respective meanings
specified in paragraph 1(a) of Part II of these Articles Supplementary;
provided, however, that neither the Fund nor any Affiliate thereof shall be
permitted to be a Bidder in an Auction, except that any Broker-Dealer that
is an Affiliate of the Fund may be a Bidder in an Auction, but only if the
Orders placed by such Broker-Dealer are not for its own account.
(o) "Broker-Dealer" shall mean any broker-dealer, commercial bank or
other entity permitted by law to perform the functions required of a
Broker-Dealer in Part II of these Articles Supplementary, that is a member
of, or a participant in, the Securities Depository or is an affiliate of
such member or participant, has been selected or approved by the Fund and
has entered into a Broker-Dealer Agreement that remains effective.
(p) "Broker-Dealer Agreement" shall mean an agreement between the
Auction Agent on behalf of the Fund and a Broker-Dealer pursuant to which
such Broker-Dealer agrees to follow the procedures specified in Part II of
these Articles Supplementary.
(q) "Business Day" shall mean a day on which the New York Stock
Exchange is open for trading and which is neither a Saturday nor a Sunday
nor any other day on which banks in The City of New York, New York, are
authorized by law to close.
(r) "Commercial Paper Dealers" shall mean Lehman Commercial Paper
Incorporated, Goldman, Sachs & Co., Merrill Lynch, Pierce, Fenner & Smith
Incorporated and any other commercial paper dealer selected by the Fund as
to which Moody's, Fitch or any Substitute Rating Agency then rating the
Preferred Shares shall not have objected or, in lieu of any thereof, their
respective affiliates or successors, if such entities are commercial paper
dealers.
B-5
(s) "Common Shares" shall mean the shares of common stock of the Fund.
(t) "Cure Date" shall mean the Preferred Shares Basic Maintenance Cure
Date or the 1940 Act Cure Date, as the case may be.
(u) "Date of Original Issue," with respect to the Preferred Shares,
shall mean the date on which the Fund initially issues the Preferred
Shares.
(v) "Debt Securities" has the meaning set forth in paragraph (iv) of
"Fitch Eligible Assets."
(w) "Default" has the meaning set forth in paragraph 2(e)(ii) of Part
I of these Articles Supplementary.
(x) "Default Period" has the meaning set forth in paragraph 2(e)(ii)
of Part I of these Articles Supplementary.
(y) "Default Rate" has the meaning set forth in paragraph 2(e)(ii) of
Part I of these Articles Supplementary.
(z) "Deposit Securities" shall mean cash and any obligations or
securities, including Short-Term Money Market Instruments that are Eligible
Assets, rated at least AAA, A-1 or SP-1 by S&P, except that, for purposes
of the restriction set forth in paragraph 8(a)(iii) of Part I of these
Articles Supplementary, obligations or securities will be considered
"Deposit Securities" only if they also are rated at least P-1 by Moody's.
(aa) "Directors" shall mean the directors of the Fund.
(bb) "Discounted Value," as of any Valuation Date, shall mean with
respect to a Fitch Eligible Asset or Moody's Eligible Asset the quotient of
the Market Value of an Eligible Asset divided by the Fitch Discount Factor
for a Fitch Eligible Asset or the Moody's Discount Factor for a Moody's
Eligible Asset, provided that with respect to an Eligible Asset that is
currently callable, Discounted Value will be equal to the quotient as
calculated above or the call price, whichever is lower, and that with
respect to an Eligible Asset that is prepayable, Discounted Value will be
equal to the quotient as calculated above or the face value, whichever is
lower; and provided further that, for so long as the Preferred Shares are
rated by Moody's or Fitch, unless Moody's or Fitch, respectively, advises
the Fund in writing that such action will not adversely affect its
then-current rating on the Preferred Shares, the Fund will assume that for
purposes of determining the Discounted Value, when the Fund has purchased
futures contracts or has written put options, ownership by the Fund of the
underlying asset, which will be the security resulting in the lowest
Discounted Value when delivery may be made to the Fund with any of a class
of securities.
(cc) "Dividend Default" has the meaning set forth in paragraph
2(e)(ii) of Part I of these Articles Supplementary.
B-6
(dd) "Dividend Payment Date" with respect to a Series of Preferred
Shares shall mean, for the Initial Rate Period of such Series, the Initial
Dividend Payment Date for such Series, and for any Subsequent Rate Period,
any date on which dividends are payable on a Series of Preferred Shares
pursuant to the provisions of paragraph 2(d) of Part I of these Articles
Supplementary.
(ee) "Dividend Period" with respect to a Series of Preferred Shares
shall mean the period from and including the Date of Original Issue of such
Series to but excluding the Initial Dividend Payment Date for such Series
and any period thereafter from and including one Dividend Payment Date for
such Series to but excluding the next succeeding Dividend Payment Date for
such Series.
(ff) "Eligible Asset" means a Fitch Eligible Asset or a Moody's
Eligible Asset, as applicable.
(gg) "Existing Holder" shall mean a Broker-Dealer (or any such other
Person as may be permitted by the Fund) that is listed on the records of
the Auction Agent as a holder of Preferred Shares.
(hh) "Fitch" means Fitch Ratings and its successors at law.
(ii) "Fitch Discount Factor" means, for purposes of determining the
Discounted Value of any Fitch Eligible Asset, the percentage determined as
follows. The Fitch Discount Factor for any Fitch Eligible Asset other than
the securities set forth below will be the percentage provided in writing
by Fitch.
(i) Preferred Securities: The percentage determined by references
to the rating of a non-convertible preferred security in accordance with
the table set forth below.
PREFERRED SECURITIES (1) DISCOUNT FACTOR
-------------------------------------------------------------- ---------------
AAA Taxable Preferred 130%
AA Taxable Preferred 133%
A Taxable Preferred 135%
BBB Taxable Preferred 139%
BB Taxable Preferred 154%
Not rated or below BB Taxable Preferred 161%
Investment Grade DRD Preferred 164%
Not rated or below Investment Grade DRD Preferred 200%
-------------
(1) If a security is not rated by Fitch but is rated by two other Rating
Agencies, then the lower of the ratings on the security from the two other
Rating Agencies will be used to determine the Fitch Discount Factor (e.g.,
where the S&P rating is A and the Moody's rating is Baa, a Fitch rating of
BBB will be used). If a security is not rated by Fitch but is rated by only
one other Rating Agency, then the rating on the security from the other
Rating Agency will be used to determine the Fitch Discount Factor (e.g.,
where the only rating on a security is an S&P rating of AAA, a Fitch rating
of AAA will be used, and where the only rating on a security is a Moody's
rating of Ba, a Fitch rating of BB will be used). If a security is not
rated by any Rating Agency, the Fund will use the percentage set forth
under "not rated" in this table.
B-7
(ii) Corporate Debt Securities: The percentage determined by reference
to the rating of a non-convertible corporate debt security in accordance
with the table set forth below.
REMAINING TERM TO MATURITY OF NOT
CORPORATE NON-CONVERTIBLE DEBT RATED OR
SECURITY(1) AAA AA A BBB BB B BELOW B
------------------------------------------- --------- ---------- ----------- ---------- -------- -------- ----------
3 years or less (but longer than 1 year) 106.38% 108.11% 109.89% 111.73% 129.87% 151.52% 200.00%
5 years or less (but longer than 3 years) 111.11% 112.99% 114.94% 116.96% 134.24% 151.52% 200.00%
7 years or less (but longer than 5 years) 113.64% 115.61% 117.65% 119.76% 135.66% 151.52% 200.00%
10 years or less (but longer than 7 years) 115.61% 117.65% 119.76% 121.95% 136.74% 151.52% 200.00%
15 years or less (but longer than 10 years) 119.76% 121.95% 124.22% 126.58% 139.05% 151.52% 200.00%
More than 15 years 124.22% 126.58% 129.03% 131.58% 144.55% 151.52% 200.00%
-------------
(1) If a security is not rated by Fitch but is rated by two other Rating
Agencies, then the lower of the ratings on the security from the two
other Rating Agencies will be used to determine the Fitch Discount
Factor (e.g., where the S&P rating is A and the Moody's rating is Baa, a
Fitch rating of BBB will be used). If a security is not rated by Fitch
but is rated by only one other Rating Agency, then the rating on the
security from the other Rating Agency will be used to determine the
Fitch Discount Factor (e.g., where the only rating on a security is an
S&P rating of AAA, a Fitch rating of AAA will be used, and where the
only rating on a security is a Moody's rating of Ba, a Fitch rating of
BB will be used). If a security is not rated by any Rating Agency, the
Fund will use the percentage set forth under "not rated" in this table.
The Fitch Discount Factors presented in the immediately preceding table apply to
non-convertible corporate debt securities. The Fitch Discount Factor for a
non-convertible corporate debt security issued by a limited partnership that is
not a Rule 144A debt or preferred Security shall be the Fitch Discount Factor
determined in accordance with the table set forth above multiplied by 105%.
(iii) Convertible Securities: The Fitch Discount Factor applied to
convertible securities is (A) 200% for investment grade convertibles and
(B) 222% for below investment grade convertibles.
If a security is not rated by Fitch but is rated by two other Rating Agencies,
then the lower of the ratings on the security from the two other Rating Agencies
will be used to determine the Fitch Discount Factor (e.g., where the S&P rating
is A and the Moody's rating is Baa, a Fitch rating of BBB will be used). If a
security is not rated by Fitch but is rated by only one other Rating Agency,
then the rating on the security from the other Rating Agency will be used to
determine the Fitch Discount Factor (e.g., where the only rating on a security
is an S&P rating of AAA, a Fitch rating of AAA will be used, and where the only
rating on a security is a Moody's rating of Ba, a Fitch rating of BB will be
used). If a security is not rated by any Rating Agency, the Fund will treat the
security as if it were below investment grade.
(iv) U.S. Government and Agency Securities and U.S. Treasury Strips:
TIME REMAINING TO MATURITY DISCOUNT FACTOR
----------------------------------------------------- ------------------
1 year or less 101.5%
2 years or less (but longer than 1 year) 103%
3 years or less (but longer than 2 years) 105%
B-8
TIME REMAINING TO MATURITY DISCOUNT FACTOR
----------------------------------------------------- ------------------
4 years or less (but longer than 3 years) 107%
5 years or less (but longer than 4 years) 109%
7 years or less (but longer than 5 years) 112%
10 years or less (but longer than 7 years) 114%
15 years or less (but longer than 10 years) 122%
20 years or less (but longer than 15 years) 130%
25 years or less (but longer than 20 years) 146%
Greater than 30 years 154%
(v) Short-Term Investments and Cash: The Fitch Discount Factor applied
to short-term portfolio securities, including without limitation Debt
Securities, Short-Term Money Market Instruments and municipal debt
obligations, will be (A) 100%, so long as such portfolio securities mature
or have a demand feature at par exercisable within the Fitch Exposure
Period; (B) 115%, so long as such portfolio securities mature or have a
demand feature at par not exercisable within the Fitch Exposure Period; and
(C) 125%, so long as such portfolio securities neither mature nor have a
demand feature at par exercisable within the Fitch Exposure Period. A Fitch
Discount Factor of 100% will be applied to cash.
(vi) Common Stock: The Fitch Discount Factor applied to Common Stock
will be 370%.
(vii) Rule 144A debt or preferred Securities: The Fitch Discount
Factor applied to Rule 144A debt or preferred Securities will be 110% of
the Fitch Discount Factor which would apply were the securities registered
under the Securities Act.
(viii) Foreign Bonds: The Fitch Discount Factor (A) for a Foreign Bond
the principal of which (if not denominated in U.S. dollars) is subject to a
currency hedging transaction will be the Fitch Discount Factor that would
otherwise apply to such Foreign Bonds in accordance with this definition
and (B) for (1) a Foreign Bond the principal of which (if not denominated
in U.S. dollars) is not subject to a currency hedging transaction and (2) a
bond issued in a currency other than U.S. dollars by a corporation, limited
liability company or limited partnership domiciled in, or the government or
any agency, instrumentality or political subdivision of, a nation other
than an Approved Foreign Nation, will be 370%.
(jj) "Fitch Eligible Asset" means:
(i) cash (including interest and dividends due on assets rated (A) BBB
or higher by Fitch or the equivalent by another Rating Agency if the
payment date is within five Business Days of the Valuation Date, (B) A or
higher by Fitch or the equivalent by another Rating Agency if the payment
date is within thirty days of the Valuation Date, and (C) A+ or higher by
Fitch or the equivalent by another Rating Agency if the payment date is
within the Fitch Exposure Period) and receivables for Fitch Eligible Assets
sold if the receivable is due within five
B-9
Business Days of the Valuation Date, and if the trades which generated such
receivables are settled within five business days;
(ii) Short-Term Money Market Instruments so long as (A) such
securities are rated at least F1+ by Fitch or the equivalent by another
Rating Agency, (B) in the case of demand deposits, time deposits and
overnight funds, the supporting entity is rated at least A by Fitch or the
equivalent by another Rating Agency, or (C) in all other cases, the
supporting entity (1) is rated at least A by Fitch or the equivalent by
another Rating Agency and the security matures within one month, (2) is
rated at least A by Fitch or the equivalent by another Rating Agency and
the security matures within three months or (3) is rated at least AA by
Fitch or the equivalent by another Rating Agency and the security matures
within six months;
(iii) U.S. Government [and Agency] Securities and U.S. Treasury
Strips;
(iv) debt securities if such securities have been registered under the
Securities Act or are public securities exempt from registration under the
Securities Act or are restricted as to resale under federal securities laws
but are eligible for resale pursuant to Rule 144A under the Securities Act;
and such securities are issued by (1) a U.S. corporation, limited liability
company or limited partnership, (2) a corporation, limited liability
company or limited partnership domiciled in Argentina, Australia, Brazil,
Chile, France, Germany, Italy, Japan, Korea, Mexico, Spain or the United
Kingdom (the "Approved Foreign Nations"), (3) the government of any
Approved Foreign Nation or any of its agencies, instrumentalities or
political subdivisions (the debt securities of Approved Foreign Nation
issuers being referred to collectively as "Foreign Bonds"), (4) a
corporation, limited liability company or limited partnership domiciled in
Canada or (5) the Canadian government or any of its agencies,
instrumentalities or political subdivisions (the debt securities of
Canadian issuers being referred to collectively as "Canadian Bonds").
Foreign Bonds held by the Fund will qualify as Fitch Eligible Assets only
up to a maximum of 20% of the aggregate Market Value of all assets
constituting Fitch Eligible Assets. Similarly, Canadian Bonds held by the
Fund will qualify as Fitch Eligible Assets only up to a maximum of 20% of
the aggregate Market Value of all assets constituting Fitch Eligible
Assets. Notwithstanding the limitations in the two preceding sentences,
Foreign Bonds and Canadian Bonds held by the Fund will qualify as Fitch
Eligible Assets only up to a maximum of 30% of the aggregate Market Value
of all assets constituting Fitch Eligible Assets. All debt securities
satisfying the foregoing requirements and restrictions of this paragraph
(iv) are herein referred to as "Debt Securities."
(v) Common stocks (i) (A) which are traded on the New York Stock
Exchange, the American Stock Exchange or in the over-the-counter market,
(B) which, if cash dividend paying, pay cash dividends in U.S. dollars, and
(C) which may be sold without restriction by the Fund; provided, however,
that (1) common
B-10
stock which, while a Fitch Eligible Asset owned by the Fund, ceases paying
any regular cash dividend will no longer be considered a Fitch Eligible
Asset until 60 calendar days after the date of the announcement of such
cessation, unless the issuer of the common stock has senior debt securities
rated at least A- by Fitch and (2) the aggregate Market Value of the Fund
's holdings of the common stock of any issuer in excess of 5% per US issuer
of the number of Outstanding shares times the Market Value of such common
stock shall not be a Fitch's Eligible Asset; (ii) securities denominated in
any currency other than the U.S. dollar and securities of issuers formed
under the laws of jurisdictions other than the United States, its states
and the District of Columbia for which there are dollar-denominated
American Depository Receipts ("ADRs") which are traded in the United States
on exchanges or over-the-counter and are issued by banks formed under the
laws of the United States, its states or the District of Columbia;
provided, however, that the aggregate Market Value of the Fund's holdings
of securities denominated in currencies other than the U.S. dollar and ADRs
in excess of 3% of the aggregate Market Value of the Outstanding shares of
common stock of such issuer or in excess of 10% of the Market Value of the
Fund's Fitch Eligible Assets with respect to issuers formed under the laws
of any single such non-U.S. jurisdiction other than the Approved Foreign
Nations shall not be a Fitch Eligible Asset;
(vi) Preferred securities if (i) such securities provide for the
periodic payment of dividends thereon in cash in U.S. dollars or euros,
(ii) the issuer of such a preferred security has common stock listed on
either the New York Stock Exchange or the American Stock Exchange or the
NASDAQ National Market System, and (iii) the issuer of such a preferred
security has a senior debt rating or preferred stock rating from Fitch of
BBB- or higher or the equivalent rating by another Rating Agency. In
addition, the preferred securities issue must be at least $50 million; and
(vii) Rule 144A debt or preferred Securities subject to the
limitations set forth in this section "Fitch Eligible Asset."
Financial contracts, as such term is defined in Section 3(c)(2)(B)(ii) of the
1940 Act, not otherwise provided for in this definition may be included in Fitch
Eligible Assets, but, with respect to any financial contract, only upon receipt
by the Fund of a writing from Fitch specifying any conditions on including such
financial contract in Fitch Eligible Assets and assuring the Fund that including
such financial contract in the manner so specified would not affect the credit
rating assigned by Fitch to the Preferred Shares.
Where the Fund sells an asset and agrees to repurchase such asset in the future,
the Discounted Value of such asset will constitute a Fitch Eligible Asset and
the amount the Fund is required to pay upon repurchase of such asset will count
as a liability for the purposes of the Preferred Shares Basic Maintenance
Amount. Where the Fund purchases an asset and agrees to sell it to a third party
in the future, cash receivable by the Fund thereby will constitute a Fitch
Eligible Asset if the long-term debt of such other party is rated at least A- by
Fitch or the equivalent by
B-11
another Rating Agency and such agreement has a term of 30 days or less;
otherwise the Discounted Value of such purchased asset will constitute a Fitch
Eligible Asset.
Notwithstanding the foregoing, an asset will not be considered a Fitch Eligible
Asset to the extent that it has been irrevocably deposited for the payment of
(i)(A) through (i)(E) under the definition of Preferred Basic Maintenance Amount
or to the extent it is subject to any Liens, except for (A) Liens which are
being contested in good faith by appropriate proceedings and which Fitch has
indicated to the Fund will not affect the status of such asset as a Fitch
Eligible Asset, (B) Liens for taxes that are not then due and payable or that
can be paid thereafter without penalty, (C) Liens to secure payment for services
rendered or cash advanced to the Fund by its investment manager or portfolio
manager, the Fund's custodian, transfer agent or registrar or the Auction Agent
and (D) Liens arising by virtue of any repurchase agreement.
Fitch Limitations on Convertible Debt and Preferred Securities:
Convertible debt and preferred securities will qualify as Fitch Eligible Assets
only up to a maximum of 20% of the aggregate Market Value of all assets
constituting Fitch Eligible Assets.
Fitch Diversification Limitations:
Portfolio holdings must be within the following diversification and issue size
requirements in order to be included in Fitch's Eligible Assets:
B-12
SECURITY RATED AT MAXIMUM SINGLE MAXIMUM SINGLE MINIMUM ISSUE SIZE
LEAST ISSUER(1) INDUSTRY(1),(2) ($ IN MILLION)(3)
AAA 100% 100% $100
AA- 20 75 100
A- 10 50 100
BBB- 6 25 100
BB- 4 16 50
B- 3 12 50
CCC 2 8 50
(1) Percentages represent a portion of the aggregate Market Value of Fitch's
Eligible Assets.
(2) Industries are determined according to Fitch's Industry Classifications.
(3) Preferred stock has a minimum issue size of $50 million.
(kk) "Fitch Exposure Period" means the period commencing on (and
including) a given Valuation Date and ending 24 days thereafter.
(ll) "Fund" shall have the meaning specified in the initial paragraph
of these Articles Supplementary.
(mm) "Holder," with respect to any Preferred Shares, shall mean the
registered holder of such shares as the same appears on the record books of
the Fund.
(nn) "Hold Order" and "Hold Orders" shall have the respective meanings
specified in paragraph 1(a) of Part II of these Articles Supplementary.
(oo) "Independent Accountant" shall mean a nationally recognized
accountant, or firm of accountants, retained by the Fund that is with
respect to the Fund an independent public accountant or firm of independent
public accountants under the Securities Act of 1933, as amended from time
to time.
(pp) "Initial Dividend Payment Date" with respect to a Series of
Preferred Shares shall mean the date on which dividends are payable on such
Series of Preferred Shares with respect to the Initial Rate Period of such
Series, as determined by the Directors of the Fund or pursuant to their
delegated authority.
(qq) "Initial Dividend Rate" with respect to a Series of Preferred
Shares shall mean the rate per annum applicable to the Initial Rate Period
for such Series of Preferred Shares, as determined by the Directors or
pursuant to their delegated authority.
(rr) "Initial Rate Period" with respect to a Series of Preferred
Shares shall be the period from and including the Date of Original Issue of
such Series to but excluding the Initial Dividend Payment Date for such
Series.
B-13
(ss) "Late Charge" shall have the meaning specified in paragraph
2(e)(iii) of Part I of these Articles Supplementary.
(tt) "Lead Broker-Dealer" shall mean a Broker-Dealer designated as
such (solely for purposes of these Articles Supplementary) by the Fund from
time to time in its discretion. Initially, the Lead Broker-Dealer shall be
Merrill Lynch, Pierce, Fenner & Smith Incorporated.
(uu) "Liquidation Preference," with respect to a given number of
Preferred Shares, means $25,000 times that number.
(vv) "Market Value" of any asset of the Fund shall mean:
(i) with respect to an investment which is listed on an exchange
or traded over-the-counter and quoted on the NASDAQ System, the last
sale price on the day of valuation (using prices as of the close of
trading) or, if there has been no sale that day, pursuant to the
provisions in the following clause (ii); and
(ii) with respect to an investment which is not listed on an
exchange or quoted on the NASDAQ System, the lower of the bid prices,
as of the close of business on the Business Day immediately preceding
the date of determination, quoted (at least one of such quotes being
in writing) to the Fund by two or more nationally recognized
securities dealers making a market in such investment at the time. If
there is no sale or bid price for an investment as provided in the
preceding sentence, an investment shall be deemed to have a Market
Value of zero. By resolution of the Board of Directors and without
amending the Articles, the calculation of Market Value may be made on
bases other than those set forth above if each Rating Agency then
rating the Preferred Shares has advised the Fund in writing that the
revised method of calculation of Market Values would not adversely
affect its then-current rating of the Preferred Shares, provided that
the Fund shall cause to be made available a written statement setting
forth such revised method for inspection by the Holders at the
principal executive office of the Fund.
(ww) "Maximum Rate" means, on any date on which the Applicable Rate is
determined, the applicable percentage (as determined pursuant to the chart
immediately below) of the Reference Rate on such date determined as set
forth below based on the lower of the credit rating assigned to the
Preferred Shares by Moody's or Fitch, subject to upward but not downward
adjustment in the discretion of the Directors (without the vote or consent
of the Holders of shares of preferred stock of any series, including the
Preferred Shares, or any other stockholder of the Fund, but with
confirmation from Moody's (if Moody's is then rating the Preferred Shares)
and Fitch (if Fitch is then rating the Preferred Shares) or any Substitute
Rating Agency then rating the Preferred Shares, and after consultation with
the Broker-Dealers and subject to paragraph 4(d) of Part I of these
Articles Supplementary), provided that immediately following any such
increase the Fund would be in compliance with the Preferred Shares Basic
Maintenance Amount.
B-14
If Moody's or Fitch or both shall not make such ratings available, the
rate shall be determined by reference to equivalent ratings issued by a
Substitute Rating Agency.
CREDIT RATINGS APPLICABLE
-------------------------------------------- PERCENTAGE:
MOODY'S FITCH
---------------- ------------- -----------
"Aa3" or higher AA- or higher 150%
"A3" to "A1" A- to A+ 200%
"Baa3" to "Baa1" BBB- to BBB+ 225%
Below "Baa3" Below BBB- 275%
(xx) "Minimum Rate Period" shall mean any Rate Period consisting of 7
Rate Period Days for Series M7, T7, W7, TH7 and F7 and of 28 Rate Period
Days for Series T28 and W28.
(yy) "Moody's" shall mean Moody's Investors Service, Inc., a Delaware
corporation, and its successors.
(zz) "Moody's Discount Factor" means, for purposes of determining the
Discounted Value of any Moody's Eligible Asset, the percentage determined
as follows. According to Moody's guidelines, in addition to standard
monthly reporting, the Fund must notify Moody's if the portfolio coverage
ratio of the discounted value of Moody's Eligible Assets to Preferred
Shares Basic Maintenance Amount is less than 130%. Computation of rating
agency asset coverage ratio requires use of the Diversification Table prior
to applying discount factors noted below and after identifying Moody's
eligible assets for purposes of completing basic maintenance tests. The
Moody's Discount Factor for any Moody's Eligible Asset other than the
securities set forth below will be the percentage provided in writing by
Moody's.
(i) Preferred Securities: The Moody's Discount Factor for
preferred securities shall be (A) for preferred securities issued by a
utility, 152%; (B) for preferred securities of industrial and
financial issuers, 197%; (C) for preferred securities issued by real
estate related issuers, 154%; and (D) for auction rate preferred
securities, 350%.
(ii) Corporate Debt Securities: The percentage determined by
reference to the rating on such asset with reference to the remaining
term to maturity of such asset, in accordance with the table set forth
below.
MOODY'S RATING CATEGORY(1)
----------------------------------------------------------------
TERMS TO MATURITY OF CORPORATE
DEBT SECURITY Aaa Aa A Baa Ba B UNRATED(2)
------------- --- -- - --- -- - ----------
1 year or less 109% 112% 115% 118% 137% 150% 250%
2 years or less (but longer than 1 year) 115 118 122 125 146 160 250
3 years or less (but longer than 2 years) 120 123 127 131 153 168 250
4 years or less (but longer than 3 years) 126 129 133 138 161 176 250
5 years or less (but longer than 4 years) 132 135 139 144 168 185 250
7 years or less (but longer than 5 years) 139 143 147 152 179 197 250
10 years or less (but longer than 7 years) 145 150 155 160 189 208 250
15 years or less (but longer than 10 years) 150 155 160 165 196 216 250
20 years or less (but longer than 15 years) 150 155 160 165 196 228 250
30 years or less (but longer than 20 years) 150 155 160 165 196 229 250
B-15
MOODY'S RATING CATEGORY(1)
----------------------------------------------------------------
TERMS TO MATURITY OF CORPORATE
DEBT SECURITY Aaa Aa A Baa Ba B UNRATED(2)
------------- --- -- - --- -- - ----------
Greater than 30 years................... 165 173 181 189 205 240 250
---------------
(1) If a corporate debt security is unrated by Moody's but is rated by S&P, a
rating two numeric ratings below the S&P rating will be used (e.g., where
the S&P rating is AAA, a Moody's rating of Aa2 will be used; where the S&P
rating is AA+, a Moody's rating of Aa3 will be used).
(2) Unrated corporate debt securities, which are corporate debt securities
rated by neither Moody's nor S&P, are limited to 10% of discounted Moody's
Eligible Assets. If a corporate debt security is unrated by both Moody's
and S&P, the Fund will use the percentage set forth under "Unrated" in this
table.
The Moody's Discount Factors presented in the immediately preceding table
will also apply to corporate debt securities that do not pay interest in U.S.
dollars or euros, provided that the Moody's Discount Factor determined from the
table shall be multiplied by a factor of 120% for purposes of calculating the
Discounted Value of such securities.
(iii) Common Stock: The Moody's Discount Factor applied to Common
Stock will be 350%.
(iv) U.S. Government Securities and U.S. Treasury Strips:
U.S. GOVERNMENT SECURITIES U.S. TREASURY
REMAINING TERM TO MATURITY DISCOUNT FACTOR STRIPS DISCOUNT FACTOR
-------------------------- --------------- ----------------------
1 year or less 107% 107%
2 years or less (but longer than 1 year) 113 115
3 years or less (but longer than 2 years) 118 121
4 years or less (but longer than 3 years) 123 128
5 years or less (but longer than 4 years) 128 135
7 years or less (but longer than 5 years) 135 147
10 years or less (but longer than 7 years) 141 163
15 years or less (but longer than 10 years) 146 191
20 years or less (but longer than 15 years) 154 218
30 years or less (but longer than 20 years) 154 244
(v) Short-Term Instruments and Cash: The Moody's Discount Factor
applied to short-term portfolio securities, including without
limitation short-term corporate debt securities, Short-Term Money
Market Instruments and short-term municipal debt obligations, will be
(A) 100%, so long as such portfolio securities mature or have a demand
feature at par exercisable within the Moody's Exposure Period; (B)
115%, so long as such portfolio securities mature or have a demand
feature at par not exercisable within the Moody's Exposure Period; and
(C) 125%, if such securities are not rated by Moody's, so long as such
portfolio securities are rated at least A-1+/AA or SP-1+/AA by S&P and
mature or have a demand feature at par exercisable within the Moody's
Exposure Period. A Moody's Discount Factor of 100% will be applied to
cash. Moody's rated money market
B-16
funds subject to Rule 2a-7 under the 1940 Act will also have a
discount factor of 100%.
(vi) Rule 144A debt or preferred Securities: The Moody's Discount
Factor applied to Rule 144A debt or preferred securities for Rule 144A debt
or preferred Securities will be 130% of the Moody's Discount Factor which
would apply were the securities registered under the Securities Act.
(vii) Convertible Securities:
(A) Convertible Securities:
MOODY'S RATING CATEGORY (1)
-----------------------------------------------------------------------------
INDUSTRY
CATEGORY Aaa Aa A Baa Ba B
-------- --- -- - --- -- -
Utility 162% 167% 172% 188% 195% 199%
Industrial 256% 261% 266% 282% 290% 293%
Financial 233% 238% 243% 259% 265% 270%
(1) If a corporate debt security is unrated by Moody's but is rated by S&P, a
rating two numeric ratings below the S&P rating will be used (e.g., where
the S&P rating is AAA, a Moody's rating of Aa2 will be used; where the S&P
rating is AA+, a Moody's rating of Aa3 will be used).
(B) Upon conversion to Common Stock, the Discount Factor of
350% will be applied to the Common Stock holdings.
(aaa) "Moody's Eligible Assets" means:
(i) cash (including interest and dividends due on assets rated
(A) Baa3 or higher by Moody's if the payment date is within five
Business Days of the Valuation Date, (B) A2 or higher if the payment
date is within thirty days of the Valuation Date, and (C) Al or higher
if the payment date is within the Moody's Exposure Period) and
receivables for Moody's Eligible Assets sold if the receivable is due
within five Business Days of the Valuation Date, and if the trades
which generated such receivables are (A) settled through clearing
house firms with respect to which the Fund has received prior written
authorization from Moody's or (B) (1) with counterparties having a
Moody's long-term debt rating of at least Baa3 or (2) with
counterparties having a Moody's Short-Term Money Market Instrument
rating of at least P-1;
(ii) Short-Term Money Market Instruments, so long as (A) such
securities are rated at least P-1, (B) in the case of demand deposits,
time deposits and overnight funds, the supporting entity is rated at
least A2, or (C) in all other cases, the supporting entity (1) is
rated A2 and the security matures within one month, (2) is rated Al
and the security matures within three months or (3) is rated at least
Aaa and the security matures within six months. In addition, Moody's
B-17
rated money market funds subject to Rule 2a-7 under the 1940 Act are
also eligible investments.
(iii) Common Stocks
(A) which are issued by issuers whose senior debt securities
are rated at least Baa by Moody's (or, in the event an issuer's
senior debt securities are not rated by Moody's, which are issued
by an issuer whose senior debt securities are rated at least A by
S&P and which for this purpose have been assigned a Moody's
equivalent rating of at least Baa);
(B) which are traded on the New York Stock Exchange, the
American Stock Exchange or the NASDAQ National Market System;
(C) which have a market capitalization greater than
$500,000,000;
(D) which are currently paying cash dividends and have paid
cash dividends or whose predecessors have paid cash dividends
regularly during the preceding three-year period; and
(E) which pay dividends in U.S. dollars;
PROVIDED, HOWEVER, that (1) the aggregate Market Value of the Fund's
holdings of the common stock of any eligible issuer (x) shall be less than 5% of
the number of outstanding shares times the Market Value of such common stock and
(y) shall not exceed 5% of the number of outstanding shares (less the number of
shares held by insiders, as determined in accordance with standards established
by Moody's) multiplied by the Market Value of such common stock and (2) the
number of shares of common stock of any eligible issuer held by the Fund shall
not exceed the average weekly trading volume of such common stock during the
preceding month.
(iv) U.S. Government Securities and U.S. Treasury Strips;
(v) Rule 144A debt or preferred Securities subject to the conditions
set forth in the rest of this section "Moody's Eligible Assets;"
(vi) Corporate debt securities if (A) such securities are rated B3 or
higher by Moody's; (B) such securities provide for the periodic payment of
interest in cash in U.S. dollars or euros, except that such securities that
do not pay interest in U.S. dollars or euros shall be considered Moody's
Eligible Assets if they are rated by Moody's or S&P; (C) for securities
which provide for conversion or exchange at the option of the issuer into
equity capital at some time over their lives, the issuer must be rated at
least B3 by Moody's; (D) for debt securities rated Bal and below, no more
than 10% of the original amount of such issue may constitute Moody's
Eligible Assets; (E) such securities have been registered under the
Securities Act or are restricted as to resale under federal securities laws
but are eligible for resale pursuant to Rule 144A under the Securities Act
as determined by the Fund's investment adviser or portfolio
B-18
manager acting pursuant to procedures approved by the Board of Directors,
except that such securities that are not subject to U.S. federal
securities laws shall be considered Moody's Eligible Assets if they are
publicly traded; and (F) such securities are not subject to extended
settlement.
In order to merit consideration as a Moody's Eligible Asset, debt
securities are issued by entities which:
- have not filed for bankruptcy within the past three years
- are current on all principal and interest in their fixed income
obligations
- are current on all preferred securities dividends
- possess a current, unqualified auditor's report without
qualified, explanatory language
(bbb) Corporate debt securities not rated by Moody's shall be
considered to be Moody's Eligible Assets only to the extent the Market
Value of such corporate debt securities does not exceed 10% of the
aggregate Market Value of all Moody's Eligible Assets.
(ccc) Preferred securities if (A) such preferred securities provide
for the periodic payment of dividends thereon in cash in U.S. dollars or
euros, (B) the issuer of such a preferred security has common stock listed
on either the New York Stock Exchange, the American Stock Exchange or the
NASDAQ National Market System and (C) such preferred security has paid
consistent cash dividends in U.S. dollars or euros over the last three
years or has a minimum rating of A1 (if the issuer of such preferred
security has other preferred issues outstanding that have been paying
dividends consistently for the last three years, then a preferred security
without such a dividend history would also be eligible). In addition, the
preferred securities must have the diversification requirements set forth
in the table below and the preferred security issue must be greater than
$50 million or $100 million, if such preferred security issue is
convertible into equity securities of the same issuer.
Diversification Table:
The table below establishes maximum limits for inclusion as Moody's
Eligible Assets prior to applying Moody's Discount Factors to Eligible
Securities:
MAXIMUM MAXIMUM SINGLE MINIMUM ISSUE SIZE
RATINGS(1) SINGLE(2)(3) INDUSTRY(3)(4) ($ IN MILLION)(5)
---------- -------------- ---------------- ------------------
Aaa 100% 100% $100
Aa 20 60 100
A 10 40 100
Baa 6 20 100
Ba 4 12 50
Bl-B2 3 8 50
B-19
MAXIMUM MAXIMUM SINGLE MINIMUM ISSUE SIZE
RATINGS(1) SINGLE(2)(3) INDUSTRY(3)(4) ($ IN MILLION)(5)
---------- -------------- ---------------- ------------------
B3 or below 2 5 50
---------------
(1) Refers to the preferred securities and senior debt rating of the portfolio
holding.
(2) Companies subject to common ownership of 25% or more are considered as one
issuer (except for the operating subsidiaries of regulated utility
companies, where approved in writing by Moody's).
(3) Percentages represent a portion of the aggregate Market Value of Moody's
Eligible Assets.
(4) Industries are determined according to Moody's Industry Classifications, as
defined herein.
(5) Except for preferred securities, which have a minimum issue size of $50
million (or $100 million, if such preferred security issue is convertible
into equity securities of the same issuer).
(i) Financial contracts, as such term is defined in Section
3(c)(2)(B)(ii) of the 1940 Act, not otherwise provided for in this
definition but only upon receipt by the Fund of a letter from Moody's
specifying any conditions on including such financial contract in
Moody's Eligible Assets and assuring the Fund that including such
financial contract in the manner so specified would not affect the
credit rating assigned by Moody's to the Preferred Shares.
Where the Fund sells an asset and agrees to repurchase such asset in the
future, the Discounted Value of such asset will constitute a Moody's Eligible
Asset and the amount the Fund is required to pay upon repurchase of such asset
will count as a liability for the purposes of the Preferred Share Basic
Maintenance Amount. Where the Fund purchases an asset and agrees to sell it to a
third party in the future, cash receivable by the Fund thereby will constitute a
Moody's Eligible Asset if the long-term debt of such other party is rated at
least A2 by Moody's and such agreement has a term of 30 days or less; otherwise
the Discounted Value of such purchased asset will constitute a Moody's Eligible
Asset. For the purposes of calculation of Moody's Eligible Assets, portfolio
securities which have been called for redemption by the issuer thereof shall be
valued at the lower of Market Value or the call price of such portfolio
securities.
Notwithstanding the foregoing, an asset will not be considered a Moody's
Eligible Asset to the extent that it has been irrevocably deposited for the
payment of (i)(A) through (i)(E) under the definition of Preferred Share Basic
Maintenance Amount or to the extent it is subject to any Liens, including assets
segregated under margin account requirements in connection with Fund engagement
in hedging transactions, except for (A) Liens which are being contested in good
faith by appropriate proceedings and which Moody's has indicated to the Fund
will not affect the status of such asset as a Moody's Eligible Asset, (B) Liens
for taxes that are not then due and payable or that can be paid thereafter
without penalty, (C) Liens to secure payment for services rendered or cash
advanced to the Fund by its investment adviser or portfolio manager, the Fund's
custodian, transfer agent or registrar or the Auction Agent and (D) Liens
arising by virtue of any repurchase agreement.
(ddd) "Moody's Exposure Period" means the period commencing on a given
Valuation Date and ending 24 days thereafter.
B-20
(eee) "NASDAQ System" means the electronic inter-dealer quotation
system operated by NASDAQ, Inc., a subsidiary of the National Association
of Securities Dealers, Inc.
(fff) "1940 Act" shall mean the Investment Company Act of 1940, as
amended from time to time.
(ggg) "1940 Act Cure Date," with respect to the failure by the Fund to
maintain the 1940 Act Preferred Shares Asset Coverage (as required by
paragraph 5 of Part I of these Articles Supplementary) as of the last
Business Day of each month, shall mean the last Business Day of the
following month.
(hhh) "1940 Act Preferred Shares Asset Coverage" shall mean asset
coverage, as defined in Section 18(h) of the 1940 Act, of at least 200%
with respect to all outstanding senior securities of the Fund which are
shares of capital stock, including all outstanding Preferred Shares (or
such other asset coverage as may in the future be specified in or under the
1940 Act as the minimum asset coverage for senior securities which are
shares or stock of a closed-end investment company as a condition of
declaring dividends on its common shares or stock), determined on the basis
of values calculated as of a time within 48 hours (not including Sundays or
holidays) next preceding the time of such determination.
(iii) "Non-Call Period" has the meaning set forth under the definition
of "Special Redemption Provisions."
(jjj) "Notice of Redemption" shall mean any notice with respect to the
redemption of Preferred Shares pursuant to paragraph 8(c) of Part I of
these Articles Supplementary.
(kkk) "Notice of Special Rate Period" shall mean any notice with
respect to a Special Rate Period of Preferred Shares pursuant to paragraph
3(b) of Part I of these Articles Supplementary.
(lll) "Order" and "Orders" shall have the respective meanings
specified in paragraph 1(a) of Part II of these Articles Supplementary.
(mmm) "Outstanding" shall mean, as of any date, the number of
Preferred Shares theretofore issued by the Fund except, without
duplication, (i) any Preferred Shares theretofore canceled, redeemed or
repurchased by the Fund, or delivered to the Auction Agent for
cancellation, redemption or repurchase or with respect to which the Fund
has given notice of cancellation, redemption or repurchase and irrevocably
deposited with the Auction Agent sufficient funds to redeem or repurchase
such shares and (ii) any Preferred Shares represented by any certificate in
lieu of which a new certificate has been executed and delivered by the
Fund. Notwithstanding the foregoing, (A) in connection with any Auction,
any Preferred Shares as to which the Fund or an Affiliate (other than an
Affiliate that is a Broker-Dealer) is the Existing Holder will be
disregarded and not deemed Outstanding; (B) for purposes of determining the
Preferred Shares Basic Maintenance
B-21
Amount, Preferred Shares held by the Fund will be disregarded and not
deemed Outstanding.
(nnn) "Person" shall mean and include an individual, a partnership, a
corporation, a Fund, an unincorporated association, a joint venture or
other entity or a government or any agency or political subdivision
thereof.
(ooo) "Potential Beneficial Owner" with respect to the Preferred
Shares, shall mean a customer of a Broker-Dealer that is not a Beneficial
Owner of Preferred Shares but that wishes to purchase Preferred Shares, or
that is a Beneficial Owner of Preferred Shares that wishes to purchase
additional Preferred Shares.
(ppp) "Potential Holder" with respect to the Preferred Shares, shall
mean a Broker-Dealer (or any such other person as may be permitted by the
Fund) that is not an Existing Holder of Preferred Shares or that is an
Existing Holder of Preferred Shares that wishes to become the Existing
Holder of additional Preferred Shares.
(qqq) "Preferred Shares" shall have the meaning set forth under
"DESIGNATION" above.
(rrr) "Preferred Shares Basic Maintenance Amount" as of any Valuation
Date, shall mean the dollar amount equal to the sum of:
(i) the sum of (A) the products resulting from multiplying the
number of Outstanding Preferred Shares on such date by the Liquidation
Preference (and applicable redemption premium, if any) per share; (B)
the aggregate amount of dividends that will have accumulated at the
Applicable Rate (whether or not earned or declared) for each
Outstanding Preferred Share to the 30th day after such Valuation Date
(or, with respect to a Special Rate Period, to the next Dividend
Payment Date); (C) the amount of anticipated non-interest expenses of
the Fund for the 90 days subsequent to such Valuation Date; (D) the
amount of the current outstanding balances of any indebtedness which
is senior to the Preferred Shares plus interest thereon actually
accrued to such Valuation Date, together with 30 days' additional
interest on the current outstanding balances calculated at the current
rate; (E) (i) with respect to Moody's Eligible Assets, the amount of
any liabilities described in the second full paragraph in Section
10(b) of Part I of these Articles Supplementary and (ii) with respect
to Fitch Eligible Assets, the amount of any liabilities described in
Section 10(d) of Part I of these Articles Supplementary; and (F) any
other current liabilities payable during the 30 days subsequent to
such Valuation Date, including, without limitation, other indebtedness
due within one year and any redemption premium due with respect to a
redemption of the Preferred Shares for which a Notice of Redemption
has been given, as of such Valuation Date, to the extent not reflected
in any of (i)(A) through (i)(E);
less
B-22
(ii) the sum of any cash plus the value of any of the Fund's
assets irrevocably deposited by the Fund for the payment of any (i)(B)
through (i)(E) ("value," for purposes of this clause (ii), means the
Discounted Value of the security, except that if a security matures
prior to the relevant redemption payment date and is either fully
guaranteed by the U.S. Government or is rated at least P-1 by Moody's,
it will be valued at its face value).
(sss) "Preferred Shares Basic Maintenance Cure Date," with respect to
the failure by the Fund to satisfy the Preferred Shares Basic Maintenance
Amount (as required by paragraph 6(a) of Part I of these Articles
Supplementary) as of a given Valuation Date, shall mean the tenth Business
Day following such Valuation Date.
(ttt) "Preferred Shares Basic Maintenance Report" shall mean a report
signed by the Chief Executive Officer, President, Chief Operating Officer,
Treasurer, Assistant Treasurer or any Vice President of the Fund which sets
forth, as of the related Valuation Date, the assets of the Fund, the Market
Value and the Discounted Value thereof (seriatim and in aggregate), and the
Preferred Shares Basic Maintenance Amount.
(uuu) "Premium Call Period" has the meaning set forth under the
definition of "Special Redemption Provisions."
(vvv) "Quarterly Valuation Date" shall mean the last Valuation Date of
each fiscal quarter of the Fund.
(www) "Rate Period" with respect to a Series of Preferred Shares shall
mean the Initial Rate Period of such Series and any Subsequent Rate Period
of such Series, including any Special Rate Period of such Series.
(xxx) "Rate Period Days," for any Rate Period or Dividend Period,
means the number of days that would constitute such Rate Period or Dividend
Period but for the application of paragraph 2(d) of Part I of these
Articles Supplementary.
(yyy) "Rating Agency" means a nationally recognized statistical rating
organization.
(zzz) "Redemption Default" has the meaning set forth in paragraph
2(e)(ii) of Part I of these Articles Supplementary.
(aaaa) "Redemption Price" shall mean the applicable redemption price
specified in paragraph 8(a) or paragraph 8(b), as the case may be, of Part
I of these Articles Supplementary.
(bbbb) "Reference Rate" means the applicable "AA" Financial Composite
Commercial Paper Rate (for a Dividend Period of fewer than 184 days) or the
applicable Treasury Index Rate (for a Dividend Period of 184 days or more).
(cccc) "Remaining Shares" shall have the meaning specified in
paragraph 4(a)(iv) of Part II of these Articles Supplementary.
B-23
(dddd) "S&P" shall mean Standard & Poor's, a division of The
McGraw-Hill Companies, Inc., or its successors.
(eeee) "Securities Act" shall mean the Securities Act of 1933, as
amended from time to time.
(ffff) "Securities Depository" shall mean The Depository Trust Company
and its successors and assigns or any other securities depository selected
by the Fund which agrees to follow the procedures required to be followed
by such securities depository in connection with the Preferred Shares.
(gggg) "Sell Order" and "Sell Orders" shall have the respective
meanings specified in paragraph 1(a) of Part II of these Articles
Supplementary.
(hhhh) "Short-Term Money Market Instruments" shall mean the following
types of instruments if, on the date of purchase or other acquisition
thereof by the Fund, the remaining term to maturity thereof is not in
excess of 180 days:
(i) commercial paper rated A-1 if such commercial paper matures
in 30 days or A-1+ if such commercial paper matures in over 30 days;
(ii) demand or time deposits in, and banker's acceptances and
certificates of deposit of (A) a depository institution or Fund
company incorporated under the laws of the United States of America or
any state thereof or the District of Columbia or (B) a United States
branch office or agency of a foreign depository institution (provided
that such branch office or agency is subject to banking regulation
under the laws of the United States, any state thereof or the District
of Columbia);
(iii) overnight funds; and
(iv) U.S. Government Securities.
(iiii) "Special Rate Period" shall have the meaning specified in
paragraph 3(a) of Part I of these Articles Supplementary. For the avoidance
of doubt, a Minimum Rate Period shall not be deemed to be a Special Rate
Period.
(jjjj) "Special Redemption Provisions" means, with respect to any
Special Rate Period of more than one year, either, or any combination of
(i) a period (a "Non-Call Period") determined by the Board of Directors
after consultation with the Broker-Dealers, during which the shares subject
to such Special Rate Period are not subject to redemption at the option of
the Fund and (ii) a period (a "Premium Call Period"), consisting of a
number of whole years as determined by the Board of Directors after
consultation with the Broker-Dealers, during each year of which the shares
subject to such Special Rate Period will be redeemable at the Fund's option
at a price per share equal to $25,000 plus accumulated but unpaid dividends
(whether or not earned or declared) to (but not including) the date fixed
for redemption plus a premium expressed as a percentage or
B-24
percentages of $25,000 or expressed as a formula using specified
variables, in each case as determined by the Board of Directors after
consultation with the Broker-Dealers.
(kkkk) "Submission Deadline" shall mean 1:30 P.M., New York City time,
on any Auction Date or such other time on any Auction Date by which
Broker-Dealers are required to submit Orders to the Auction Agent as
specified by the Auction Agent from time to time
(llll) "Submitted Bid" and "Submitted Bids" shall have the respective
meanings specified in paragraph 3(a) of Part II of these Articles
Supplementary.
(mmmm) "Submitted Hold Order" and "Submitted Hold Orders" shall have
the respective meanings specified in paragraph 3(a) of Part II of these
Articles Supplementary.
(nnnn) "Submitted Order" and "Submitted Orders" shall have the
respective meanings specified in paragraph 3(a) of Part II of these
Articles Supplementary.
(oooo) "Submitted Sell Order" and "Submitted Sell Orders" shall have
the respective meanings specified in paragraph 3(a) of Part II of these
Articles Supplementary.
(pppp) a "Subsequent Rate Period" shall mean the period from and
including the first day following the Initial Rate Period to but excluding
the next Dividend Payment Date and any period thereafter from and including
one Dividend Payment Date to but excluding the next succeeding Dividend
Payment Date; PROVIDED, HOWEVER, that if any Subsequent Rate Period is also
a Special Rate Period, such term shall mean the period commencing on the
first day of such Special Rate Period and ending on the last day of the
last Dividend Period thereof.
(qqqq) "Substitute Commercial Paper Dealer" shall mean Credit Suisse
First Boston or Morgan Stanley & Co., Incorporated or their respective
affiliates or successors, if such entities are commercial paper dealers;
PROVIDED, HOWEVER, that none of the entities named above shall be a
Commercial Paper Dealer.
(rrrr) "Substitute Rating Agency" means a Rating Agency selected by
the Fund to act as a substitute Rating Agency to determine the credit
rating of the Preferred Shares.
(ssss) "Sufficient Clearing Bids" shall have the meaning specified in
paragraph 3(a) of Part II of these Articles Supplementary.
(tttt) "Treasury Bill" shall mean a direct obligation of the U.S.
Government having a maturity at the time of issuance of 364 days or less.
(uuuu) "Treasury Index Rate" shall mean the average yield to maturity
for actively traded marketable U.S. Treasury fixed interest rate securities
having the same number of 30-day periods to maturity as the applicable
Dividend Period, determined, to the extent necessary, by linear
interpolation based upon the yield for such securities
B-25
having the next shorter and next longer number of 30-day periods to
maturity, treating all Dividend Periods with a length greater than the
longest maturity for such securities as having a length equal to such
longest maturity, in all cases based upon data set forth in the most recent
weekly statistical release published by the Board of Governors of the
Federal Reserve System (currently in H.15 (519)); PROVIDED, HOWEVER, if the
most recent such statistical release shall not have been published during
the 15 days preceding the date of computation, then the foregoing
computations shall be based upon the average of comparable data as quoted
to the Fund by at least three U.S. Government Securities Dealers.
(vvvv) "U.S. Government Securities" shall mean direct obligations of
the United States or of its agencies or instrumentalities that are entitled
to the full faith and credit of the United States and that, other than
Treasury Bills, provide for the periodic payment of interest and the full
payment of principal at maturity or call for redemption, including, without
limitation, U.S. Treasury Securities and U.S. Treasury Strips.
(wwww) "U.S. Government Securities Dealer" shall mean Lehman
Government Securities Incorporated, Goldman, Sachs & Co., Salomon Brothers
Inc., Morgan Guaranty Trust Company of New York and any other U.S.
Government Securities dealer selected by the Fund as to which Moody's (if
Moody's is then rating the Preferred Shares) or Fitch (if Fitch is then
rating the Preferred Shares) shall not have objected, and in each case
their respective affiliates or successors, if such entities are U.S.
Government Securities dealers.
(xxxx) "U.S. Treasury Securities" shall mean direct obligations of the
United States Treasury that are entitled to the full faith and credit of
the United States.
(yyyy) "U.S. Treasury Strips" shall mean securities based on U.S.
Treasury Securities created through the Separate Trading of Registered
Interest and Principal of Securities program of the U.S. Treasury.
(zzzz) "Valuation Date" shall mean, for purposes of determining
whether the Fund is maintaining the Preferred Shares Basic Maintenance
Amount, the last Business Day of each week or such other date as the Fund
and Moody's (if Moody's is then rating the Preferred Shares) and Fitch (if
Fitch is then rating the Preferred Shares) may agree to for purposes of
determining the Preferred Shares Basic Maintenance Amount.
(aaaaa) "Voting Period" shall have the meaning specified in paragraph
4(b)(i) of Part I of these Articles Supplementary.
(bbbbb) "Winning Bid Rate" shall have the meaning specified in
paragraph 3(a) of Part II of these Articles Supplementary.
B-26
PART I.
1. NUMBER OF AUTHORIZED SHARES.
The initial number of authorized shares constituting Series M7, Series T7,
Series W7, Series TH7, Series F7, Series T28 and Series W28 is 3,200, 3,200,
3,200, 3,200, 3,200, 2,840 and 2,840 shares, respectively.
2. DIVIDENDS.
(a) RANKING. The Preferred Shares shall rank on a parity with one
another and with shares of any other series of shares of preferred stock
issued by the Fund as to the payment of dividends by the Fund and the
distribution of assets upon liquidation of the Fund.
(b) CUMULATIVE CASH DIVIDENDS. The Holders of a Series of Preferred
Shares shall be entitled to receive, when, as and if declared by the
Directors, out of funds legally available therefor in accordance with the
Charter and applicable law, cumulative cash dividends at the Applicable
Rate for such Series, determined as set forth in paragraph 2(e) of this
Part I, and no more, payable on the Dividend Payment Dates determined
pursuant to paragraph 2(d) of this Part I. Holders of any Series of
Preferred Shares shall not be entitled to any dividend, whether payable in
cash, property or shares, in excess of full cumulative dividends, as herein
provided, on such Series of Preferred Shares. No interest, or sum of money
in lieu of interest, shall be payable in respect of any dividend payment or
payments on any Series of Preferred Shares which may be in arrears, and,
except to the extent set forth in paragraph 2(e)(iii) of this Part I, no
additional sum of money shall be payable in respect of any such arrearage.
(c) DIVIDENDS CUMULATIVE FROM DATE OF ORIGINAL ISSUE. Dividends on
each Series of Preferred Shares shall accumulate at the Applicable Rate for
such Series from the Date of Original Issue thereof.
(d) DIVIDEND PAYMENT DATES AND ADJUSTMENT THEREOF. Dividends shall be
payable on each Series of Preferred Shares for the Initial Rate Period on
the Initial Dividend Payment Date for such Series, and on each 7th day
thereafter for Series M7, T7, W7, TH7 and F7 and on each 28th day
thereafter for Series T28 and W28 (each date being a "Dividend Payment
Date"); provided, however, that:
(i) if the day on which dividends would otherwise be payable is
not a Business Day, then such dividends shall be payable on the first
Business Day that falls after such day (subject to paragraph 7 of Part
II of these Articles Supplementary); and
(ii) notwithstanding this paragraph 2(d), the Dividend Payment
Dates with respect to a Special Rate Period shall be determined in the
discretion of the Fund and set forth in the Notice of Special Rate
Period relating to such Special Rate Period, as delivered to the
Auction Agent, which Notice of Special Rate Period shall be filed with
the Secretary of the Fund; provided, however, that with
B-27
respect to any Special Rate Period consisting of more than 30 days,
dividends shall be payable on first Business Day of each calendar
month within such Special Rate Period, if applicable, and on the
Business Day following the last day of such Special Rate Period.
(iii) Each Dividend Payment Date determined pursuant to this
paragraph 2(d) shall be a Business Day when determined (and if not a
Business Day at the time of payment, the provisions of clause (i)
above will apply, subject to paragraph 7 of Part II of these Articles
Supplementary);
(iv) Although any particular Dividend Payment Date may not occur
on the originally scheduled date because of the provisions hereof, the
next succeeding Dividend Payment Date, subject to such provisions,
will occur on the next following originally scheduled date; and
(v) notwithstanding the above, if for any reason a Dividend
Period for any Series of Preferred Shares is scheduled to begin on the
same day and end on the same day as a Dividend Period for any other
series of shares of preferred stock of the Fund, then the last day of
such Dividend Period for such other series of shares of preferred
stock shall be the second Business Day next succeeding such scheduled
day unless the Fund obtains the opinion of tax counsel referred to in
this paragraph. Subject to the limitation in the next sentence, if for
any reason a Dividend Payment Date cannot be fixed as described above,
then the Directors shall otherwise fix the Dividend Payment Date. In
no event, however, may the Dividend Period of any Series of Preferred
Shares be co-extensive with any dividend period of any other series of
shares of preferred stock unless the Fund has received an opinion of
tax counsel that having such co-extensive periods will not affect the
deductibility, for federal income tax purposes, of dividends paid on
the different series of shares of preferred stock.
(e) DIVIDEND RATES AND CALCULATION OF DIVIDENDS.
(i) DIVIDEND RATES. The dividend rate on a Series of Preferred
Shares during the period from and after the Date of Original Issue to
and including the last day of the Initial Rate Period for that Series
shall be the Initial Dividend Rate for that Series. For each
Subsequent Rate Period thereafter, the dividend rate on a series of
Preferred Shares shall be equal to the rate per annum that results
from an Auction (but the rate set at the Auction may not exceed the
Maximum Rate) on the Auction Date for that Series next preceding such
Subsequent Rate Period; PROVIDED, HOWEVER, that if an Auction for any
such Subsequent Rate Period is not held for any reason (except as
provided in paragraph 7 of Part II of these Articles Supplementary),
the dividend rate for such Subsequent Rate Period will be the Maximum
Rate on the Auction Date therefor (except (A) during a Default Period
when the dividend rate shall be the Default Rate, as set forth in
paragraph 2(e)(ii) below, or (B) after a Default Period and prior to
the beginning of the next Dividend Period, when the dividend rate
shall be the Maximum Rate at the close of business on the last day of
such Default Period). The rate per annum at which
B-28
dividends are payable on a Series of Preferred Shares for any Rate
Period thereof in accordance with these Articles Supplementary is
herein referred to as the "Applicable Rate" for that Series.
(ii) DEFAULT PERIOD. Subject to the cure provisions in paragraph
2(e)(iii) below, a "Default Period" will commence on any date the Fund
fails to deposit irrevocably in trust with the Auction Agent, not
later than 12:00 Noon, New York City time, (A) on any Dividend Payment
Date, in funds available on such Dividend Payment Date in The City of
New York, New York, the full amount of any dividend (whether or not
earned or declared) to be paid on such Dividend Payment Date on the
relevant Series of Preferred Shares (a "Dividend Default") or (B) on
any redemption date set by the Fund with respect to any Preferred
Shares, in funds available on such redemption date in The City of New
York, New York, the full amount of any Redemption Price to be paid on
such redemption date for any Preferred Shares with respect to which a
Notice of Redemption has been mailed pursuant to paragraph 8(c) of
Part I of these Articles Supplementary (a "Redemption Default," and
together with a Dividend Default, hereinafter referred to as a
"Default"); provided, however, that the foregoing clause (B) shall not
apply to the Fund's failure to pay the Redemption Price in respect of
Preferred Shares when the related Notice of Redemption provides that
redemption of such shares is subject to one or more conditions
precedent and any such condition precedent shall not have been
satisfied at the time or times and in the manner specified in such
Notice of Redemption.
Subject to the cure provisions of paragraph 2(e)(iii) below, a
Default Period with respect to a Dividend Default or a Redemption
Default shall end on the Business Day on which, by 12:00 noon, New
York City time, all unpaid dividends and any unpaid Redemption Price,
as applicable, shall have been deposited irrevocably in trust in
same-day funds with the Auction Agent. The Applicable Rate for a
Series for each Dividend Period commencing during a Default Period
will be equal to the Default Rate, and each subsequent Dividend Period
commencing during a Default Period shall be a Minimum Rate Period;
provided, however, that the commencement of a Default Period will not
by itself cause the commencement of a new Dividend Period. No Auction
for a Series shall be held during a Default Period for that Series.
The "Default Rate" shall be equal to the Reference Rate multiplied by
three (3).
(iii) CURING A DEFAULT. No Default Period with respect to a
Dividend Default or Redemption Default shall be deemed to commence if
the amount of any dividend or any Redemption Price due (if such
default is not solely due to the willful failure of the Fund to pay
such dividend or Redemption Price) is deposited irrevocably in trust,
in same-day funds with the Auction Agent by 12:00 noon, New York City
time, within three Business Days after the applicable Dividend Payment
Date or redemption date set by the Fund, together with an amount equal
to the Default Rate applied to the amount of such non-payment based on
the actual number of days comprising the period beginning on the
applicable Dividend Payment Date or redemption date and ending on the
date of such
B-29
deposit, divided by 360 (a "Late Charge"). In the case of a default
that is solely due to the willful failure of the Fund to pay a
dividend or Redemption Price when due, the provisions of paragraph
2(e)(ii) above shall apply.
(iv) CALCULATION OF DIVIDENDS. The amount of dividends per share
payable on a Series of Preferred Shares on any date on which dividends
shall be payable on that Series of Preferred Shares shall be computed
by multiplying the Applicable Rate for that Series in effect for such
Dividend Period or Dividend Periods or part thereof for which
dividends have not been paid by a fraction, the numerator of which
shall be the number of days in such Dividend Period or Dividend
Periods or part thereof that such share was outstanding and the
denominator of which shall be 360; and multiplying the rate obtained
by $25,000, and rounding the amount so obtained to the nearest cent.
(f) DIVIDEND PAYMENTS BY FUND TO AUCTION AGENT. The Fund shall pay to
the Auction Agent, not later than 12:00 noon, New York City time, on each
Dividend Payment Date for a Series of Preferred Shares, an aggregate amount
of funds available on such Dividend Payment Date equal to the dividends to
be paid to all Holders of that Series of Preferred Shares on such Dividend
Payment Date. The Fund shall not be required to establish any reserves for
payment of dividends on the Preferred Shares.
(g) AUCTION AGENT AS TRUSTEE OF DIVIDEND PAYMENTS BY FUND. All moneys
paid to the Auction Agent for the payment of dividends or any Redemption
Price (or for the payment of any Late Charge) shall be held in trust for
the payment of such dividends or any Redemption Price (and any such Late
Charge) by the Auction Agent for the benefit of the Holders specified in
paragraph 2(h) of this Part I of these Articles Supplementary. Any moneys
paid to the Auction Agent in accordance with the foregoing but not applied
by the Auction Agent to the payment of such dividends or Redemption Price
(and any such Late Charge) will, to the extent permitted by law, be repaid
to the Fund at the end of 90 days from the date on which such moneys were
so to have been applied.
(h) DIVIDENDS PAID TO HOLDERS. Each dividend on a series of Preferred
Shares shall be paid on the Dividend Payment Date therefor to the Holders
thereof as their names appear on the record books of the Fund on the
Business Day next preceding such Dividend Payment Date.
(i) DIVIDENDS CREDITED AGAINST EARLIEST ACCUMULATED BUT UNPAID
DIVIDENDS. Any dividend payment made on a Series of Preferred Shares shall
first be credited against the earliest accumulated but unpaid dividends due
with respect to such shares. Dividends in arrears for any past Dividend
Period may be declared and paid on any date as may be fixed by the
Directors, without reference to any regular Dividend Payment Date, to the
Holders as their names appear on the record books of the Fund on the record
date fixed by the Directors, not exceeding 15 days preceding the payment
date thereof.
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3. DESIGNATION OF SPECIAL RATE PERIODS.
(a) LENGTH OF AND PRECONDITIONS FOR SPECIAL RATE PERIOD. The Fund, in
consultation with the Lead Broker-Dealer, may designate any succeeding
Subsequent Rate Period for a Series of Preferred Shares as a "Special Rate
Period" consisting of a specified number of Rate Period Days evenly
divisible by 7 and not more than 1,820. A designation of a Special Rate
Period for a Series shall be effective only if (A) notice thereof shall
have been given as provided herein, (B) an Auction for such Series shall
have been held on the Auction Date immediately preceding the first day of
such proposed Special Rate Period and Sufficient Clearing Bids shall have
existed in such Auction, (C) if any Notice of Redemption shall have been
mailed by the Fund pursuant to paragraph 8(c) of this Part I with respect
to any shares of such Series, the Redemption Price with respect to such
shares shall have been deposited with the Auction Agent and, if such
redemption is subject to one or more conditions precedent, each such
condition shall have been satisfied at the time or times and in the manner
specified in such Notice of Redemption, (D) full cumulative dividends on
such Series of Preferred Shares shall have been paid in full or deposited
with the Auction Agent, (E) the Fund shall have obtained written
confirmation from Moody's, if Moody's is then rating the Preferred Shares,
Fitch, if Fitch is then rating the Preferred Shares, and from any
Substitute Rating Agency then rating the Preferred Shares, that such
proposed Special Rate Period will not impair the rating then assigned by
Moody's, Fitch or such Substitute Rating Agency to such Series of Preferred
Shares, and (F) the Lead Broker-Dealer shall not have objected to the
declaration of the proposed Special Rate Period in writing.
(b) NOTICE OF PROPOSED SPECIAL RATE PERIOD. If the Fund proposes to
designate any succeeding Rate Period as a Special Rate Period pursuant to
paragraph 3(a) of this Part I, not fewer than seven Business Days (or two
Business Days in the event the duration of the Dividend Period prior to
such Special Rate Period is fewer than eight days) nor more than 30
Business Days prior to the date the Fund proposes to designate as the first
day of such Special Rate Period, notice shall be (i) made by press release
and (ii) communicated by the Fund by telephonic or other means to the
Auction Agent, Moody's, if Moody's is then rating the Preferred Shares,
Fitch, if Fitch is then rating the Preferred Shares, and each Broker-Dealer
and confirmed in writing promptly thereafter. Each such notice (a "Notice
of Special Rate Period") shall state (A) that the Fund proposes to exercise
its option to designate a Special Rate Period for a specified Series,
specifying the first and last days thereof and the Maximum Rate for such
Special Rate Period and (B) that the Fund will by 3:00 P.M., New York City
time, on the second Business Day next preceding the first day of such
Special Rate Period, notify the Auction Agent, who will promptly notify the
Broker-Dealers, of either (x) its determination, subject to certain
conditions, to proceed with such Special Rate Period, subject to the terms
of any Special Redemption Provisions, or (y) its determination not to
proceed with such Special Rate Period, in which latter event the succeeding
Dividend Period shall be a Minimum Rate Period. No later than 3:00 P.M.,
New York City time, on the second Business Day next preceding the first day
of any proposed Special Rate Period, the Fund shall deliver to the Auction
Agent, who will promptly deliver to the Broker-Dealers and Existing
Holders, either:
B-31
(I) a notice stating (A) that the Fund has determined to
designate the next succeeding Rate Period for a Series as a Special
Rate Period, specifying the first and last days thereof and (B) the
terms of any Special Redemption Provisions; or
(II) a notice stating that the Fund has determined not to
exercise its option to designate a Special Rate Period.
If the Fund fails to deliver the notices required by this provision with
respect to any designation of any proposed Special Rate Period to the Auction
Agent by 3:00 P.M., New York City time, on the second Business Day next
preceding the first day of such proposed Special Rate Period, the Fund shall be
deemed to have delivered a notice to the Auction Agent with respect to such
Dividend Period to the effect set forth in clause (II) above.
(c) SPECIAL REDEMPTION PROVISIONS. Subject to the next sentence, the
Notice of Special Rate Period relating to a Special Rate Period of a Series
of Preferred Shares, as delivered to the Auction Agent and Broker-Dealers
and filed with the Secretary of the Fund, shall set forth any Special
Redemption Provisions with respect to such Special Rate Period. A Notice of
Special Rate Period may contain Special Redemption Provisions only if the
Directors, after consultation with the Broker-Dealers, determine that such
Special Redemption Provisions are in the best interest of the Fund.
4. VOTING RIGHTS.
(a) ONE VOTE PER SHARE OF PREFERRED SHARES. Except as otherwise
provided herein or in the Charter or as otherwise required by law, (i) each
Holder of Preferred Shares shall be entitled to one vote for each Preferred
Share held by such Holder on each matter submitted to a vote of
shareholders of the Fund, and (ii) the holders of outstanding shares of
preferred stock of the Fund, including the Preferred Shares, and of Common
Shares shall vote together as a single class; provided, however, that,
subject to the division of the Directors into classes with respect to their
respective terms of office, as provided in the Charter, at any meeting of
the shareholders of the Fund held for the election of Directors, the
holders of outstanding shares of preferred stock of the Fund, including the
Preferred Shares, represented in person or by proxy at said meeting shall
be entitled, as a class, to the exclusion of the holders of all other
securities and classes of shares of capital stock of the Fund, to elect two
Directors of the Fund, each Preferred Share entitling the holder thereof to
one vote. Subject to paragraph 4(b) of this Part I, the holders of
outstanding Common Shares and shares of preferred stock, including the
Preferred Shares, voting together as a single class, shall elect the
balance of the Directors.
(b) VOTING FOR ADDITIONAL DIRECTORS.
(i) VOTING PERIOD. Except as otherwise provided in the Charter or
as otherwise required by law, during any period in which any one or
more of the conditions described in subparagraphs (A) or (B) of this
subparagraph (b)(i) shall exist (such period being referred to herein
as a "Voting Period"), the number of directors constituting the
Directors shall be automatically increased by the
B-32
smallest number that, when added to the two Directors elected
exclusively by the holders of shares of preferred stock, including the
Preferred Shares, would constitute a majority of the Directors as so
increased by such smallest number, and the holders of shares of
preferred stock, including the Preferred Shares, shall be entitled,
voting as a class on a one-vote-per-share basis (to the exclusion of
the holders of all other securities and classes of shares of capital
stock of the Fund), to elect such smallest number of additional
Directors, together with the two Directors that such holders are in
any event entitled to elect. A Voting Period shall commence:
(A) if at the close of business on any Dividend Payment Date
accumulated dividends (whether or not earned or declared) on any
outstanding shares of preferred stock, including the Preferred
Shares, equal to at least two full years' dividends shall be due
and unpaid and sufficient cash or specified securities shall not
have been deposited with the Auction Agent for the payment of
such accumulated dividends; or
(B) if at any time holders of shares of preferred stock,
including the Preferred Shares, are entitled under the 1940 Act
to elect a majority of the Directors of the Fund.
Upon the termination of a Voting Period, the voting rights
described in this subparagraph (b)(i) shall cease, subject always,
however, to the revesting of such voting rights in the holders of
shares of preferred stock upon the further occurrence of any of the
events described in this subparagraph (b)(i).
(ii) NOTICE OF SPECIAL MEETING. As soon as practicable after the
accrual of any right of the holders of shares of preferred stock,
including the Preferred Shares, to elect additional Directors as
described in paragraph 4(b)(i) of this Part I, the Fund shall so
notify the Auction Agent and a special meeting of such holders shall
be called by mailing a notice of such special meeting to such holders,
such meeting to be held not less than 10 nor more than 80 days after
the date of mailing of such notice. If the Fund fails to send such
notice to the Auction Agent or if such special meeting is not called,
it may be called by any such holder on like notice. The record date
for determining the holders entitled to notice of and to vote at such
special meeting shall be the close of business on the fifth Business
Day preceding the day on which such notice is mailed. At any such
special meeting and at each meeting of holders of shares of preferred
stock, including the Preferred Shares, held during a Voting Period at
which Directors are to be elected, such holders, voting together as a
class (to the exclusion of the holders of all other securities and
classes of shares of capital stock of the Fund), shall be entitled to
elect the number of Directors prescribed in paragraph 4(b)(i) of this
Part I on a one-vote-per-share basis.
(iii) TERMS OF OFFICE OF EXISTING DIRECTORS. Except as provided
in the next succeeding sentence, the terms of office of all persons
who are Directors of the Fund at the time of a special meeting of
Holders and holders of other shares of
B-33
preferred stock to elect Directors shall continue, notwithstanding the
election at such meeting by the Holders and such other holders of the
number of Directors that they are entitled to elect, and the persons
so elected by the Holders and such other holders, together with the
two incumbent Directors elected by the Holders and such other holders
of shares of preferred stock and the remaining incumbent Directors
elected by the holders of the Common Shares and shares of preferred
stock, shall constitute the duly elected Directors. If the election of
additional Directors by the holders of shares of preferred stock,
including the Preferred Shares, would cause the number of Directors to
exceed 12, then the terms of office of a number of Directors elected
by the holders of Common Shares and preferred stock, voting as a
single class, shall terminate at the time of the special meeting to
elect such additional Directors such that the sum of the number of
remaining Directors and the number of additional Directors does not
exceed 12 and the number of additional Directors and the two Directors
elected by the holders of shares of preferred stock, including the
Preferred Shares constitute a majority of the entire Board of
Directors.
(iv) TERMS OF OFFICE OF CERTAIN DIRECTORS TO TERMINATE UPON
TERMINATION OF VOTING PERIOD. Simultaneously with the termination of a
Voting Period, the terms of office of the additional Directors elected
by the Holders and holders of other Preferred Shares pursuant to
paragraph 4(b)(i) of this Part I shall automatically terminate, the
remaining Directors shall constitute the Directors of the Fund and the
voting rights of the Holders and such other holders to elect
additional Directors pursuant to paragraph 4(b)(i) of this Part I
shall cease, subject to the provisions of the last sentence of
paragraph 4(b)(i) of this Part I.
(c) HOLDERS OF PREFERRED SHARES TO VOTE ON CERTAIN OTHER MATTERS.
(i) INCREASE IN CAPITALIZATION; VOLUNTARY PETITION FOR
BANKRUPTCY. So long as any Preferred Shares are outstanding, the Fund
shall not, without the affirmative vote or consent of the Holders of
at least a "majority of the outstanding" Preferred Shares (unless a
higher percentage is provided for herein or in the Charter or by
applicable law), in person or by proxy, either in writing or at a
meeting, voting as a separate class, authorize, create or issue any
class or series of shares ranking prior to or on a parity with the
Preferred Shares with respect to the payment of dividends or the
distribution of assets upon dissolution, liquidation or winding up of
the affairs of the Fund, or authorize, create or issue additional
Preferred Shares (except that, notwithstanding the foregoing, but
subject to the provisions of these Articles Supplementary, the
Directors, without the vote or consent of the Holders of Preferred
Shares, may from time to time authorize and create, and the Fund may
from time to time issue, additional Preferred Shares or classes or
series of other shares of preferred stock ranking on a parity with
Preferred Shares with respect to the payment of dividends and the
distribution of assets upon dissolution, liquidation or winding up of
the affairs of the Fund if the Fund receives written confirmation from
Moody's (if Moody's is then rating the Preferred Shares) and Fitch (if
Fitch is then rating the Preferred Shares) and from any Substitute
Rating Agency then rating the Preferred Shares
B-34
that such authorization, creation or issuance would not impair the
rating then assigned by such Rating Agency to the Preferred Shares).
So long as any Preferred Shares are outstanding, the Fund shall not,
without the affirmative vote or consent of the Holders of at least a
"majority of the outstanding" Preferred Shares (unless a higher
percentage is provided for herein or in the Charter or by applicable
law), in person or by proxy, either in writing or at a meeting, voting
as a separate class, file a voluntary application for relief under
Federal bankruptcy law or any similar application under state law for
so long as the Fund is solvent and does not foresee becoming
insolvent.
For purposes of paragraph 4 of this Part I, "majority of the
outstanding" Preferred Shares (or any other series of shares of
preferred stock of the Fund, as applicable) means (i) 67% or more of
such shares present at a meeting or represented by proxy, if the
Holders of more than 50% of such shares are present or represented by
proxy, or (ii) more than 50% of such shares, whichever is less.
(ii) 1940 ACT MATTERS. Unless a higher percentage is provided for
herein or in the Charter or by applicable law, (A) the affirmative
vote of the Holders of at least a "majority of the outstanding"
Preferred Shares, voting as a separate class, shall be required to
approve any conversion of the Fund from a closed-end to an open-end
investment company and (B) the affirmative vote of the Holders of a
"majority of the outstanding" Preferred Shares, voting as a separate
class, shall be required to approve any plan of "reorganization" (as
such term is defined in Section 2(a)(33) of the 1940 Act) adversely
affecting such shares. The affirmative vote of the Holders of at least
a "majority of the outstanding" Preferred Shares, voting as a separate
class, shall also be required to approve any action not described in
the first sentence of this paragraph 4(c)(ii) requiring a vote of
security holders of the Fund under section 13(a) of the 1940 Act. In
the event a vote of Holders of Preferred Shares is required pursuant
to the provisions of Section 13(a) of the 1940 Act, the Fund shall,
not later than ten Business Days prior to the date on which such vote
is to be taken, notify Moody's (if Moody's is then rating the
Preferred Shares) and Fitch (if Fitch is then rating the Preferred
Shares) that such vote is to be taken and the nature of the action
with respect to which such vote is to be taken. The Fund shall, not
later than ten Business Days after the date on which such vote is
taken, notify Moody's (if Moody's is then rating the Preferred Shares)
and Fitch (if Fitch is then rating the Preferred Shares) of the
results of such vote.
(d) BOARD MAY TAKE CERTAIN ACTIONS WITHOUT SHAREHOLDER APPROVAL. The
Board of Directors, without the vote or consent of any Holders of Preferred
Shares or the holders of any other shares of preferred stock of the Fund,
or any other stockholder of the Fund, may from time to time amend, alter or
repeal the provisions of paragraph 10 of this Part I as well as any or all
of the definitions contained within these Articles Supplementary (and any
terms defined within, or related to, such definitions), add covenants and
other obligations of the Fund, or confirm the applicability of covenants
and other obligations set forth herein, all in connection with obtaining or
maintaining the rating of any Rating Agency with respect to the Preferred
Shares, and any such
B-35
amendment, alteration or repeal will be deemed not to affect the
preferences, rights or powers of the Holders of Preferred Shares or the
holders of any other shares of preferred stock of the Fund expressly set
forth in the Charter or these Articles Supplementary, provided that the
Board of Directors shall have obtained written confirmation from Moody's
(if Moody's is then rating the Preferred Shares) and Fitch (if Fitch is
then rating the Preferred Shares) and from any Substitute Rating Agency
then rating the Preferred Shares (with such confirmation in no event being
required to be obtained from a particular Rating Agency with respect to
definitions or other provisions relevant only to and adopted in connection
with another Rating Agency's rating of the Preferred Shares) that any such
amendment, alteration or repeal would not adversely affect the rating then
assigned by such Rating Agency.
(e) The affirmative vote of the Holders of a majority, as defined in
the 1940 Act, of the outstanding shares of preferred stock of any series,
including the Preferred Shares, voting separately from any other series,
shall be required with respect to any matter that materially and adversely
affects the rights, preferences or powers of that series in a manner
different from that of other series or classes of the Fund's shares of
capital stock. For purposes of the foregoing, no matter shall be deemed to
adversely affect any rights, preference or power unless such matter (i)
adversely alters or abolishes any preferential right of such series; (ii)
creates, adversely alters or abolishes any right in respect of redemption
of such series; or (iii) creates or adversely alters (other than to
abolish) any restriction on transfer applicable to such series. The vote of
holders of any series described in this Section (e) will in each case be in
addition to a separate vote of the requisite percentage of Common Shares
and/or preferred stock, if any, necessary to authorize the action in
question.
(f) The affirmative vote of the Holders of a majority, as defined in
the 1940 Act, of the Preferred Shares, voting as a separate class, shall be
required to amend, alter or repeal the provisions of the Articles
Supplementary if such amendment, alteration or repeal would affect
adversely the rights, preferences or powers expressly set forth in the
Articles of Incorporation or these Articles Supplementary of Holders of the
Preferred Shares, unless, in each case, the Fund obtains written
confirmation from Moody's (if Moody's is then rating the Preferred Shares)
and Fitch (if Fitch is then rating the Preferred Shares) or any Substitute
Rating Agency then rating the Preferred Shares that such amendment,
alteration or repeal would not impair the rating then assigned by such
rating agency to the Preferred Shares, in which case the vote or consent of
the Holders of the Preferred Shares is not required. For purposes of the
foregoing, no matter shall be deemed to adversely affect any rights,
preference or power unless such matter (i) adversely alters or abolishes
any preferential right of the Preferred Shares; (ii) creates, adversely
alters or abolishes any right in respect of redemption of the Preferred
Shares; or (iii) creates or adversely alters (other than to abolish) any
restriction on transfer applicable to the Preferred Shares. The vote of
holders of any Preferred Shares described in this Section (f) will in each
case be in addition to a separate vote of the requisite percentage, if any,
of Common Shares and/or preferred stock necessary to authorize the action
in question.
B-36
(g) RIGHTS AND PREFERENCES SET FORTH IN THESE ARTICLES SUPPLEMENTARY
ARE SOLE RIGHTS AND PREFERENCES. Unless otherwise required by law, the
Holders of Preferred Shares shall not have any relative rights or
preferences or other special rights other than those specifically set forth
in these Articles Supplementary.
(h) NO PREEMPTIVE RIGHTS OR CUMULATIVE VOTING. The Holders of
Preferred Shares shall have no preemptive rights or rights to cumulative
voting.
(i) VOTING FOR DIRECTORS SOLE REMEDY FOR FUND'S FAILURE TO PAY
DIVIDENDS. In the event that the Fund fails to pay any dividends on the
Preferred Shares, the exclusive remedy of the Holders shall be the right to
vote for Directors pursuant to the provisions of this paragraph 4.
(j) HOLDERS ENTITLED TO VOTE. For purposes of determining any rights
of the Holders to vote on any matter, whether such right is created by
these Articles Supplementary, by provisions of the Charter, by statute or
otherwise, no Holder shall be entitled to vote any Preferred Share and no
Preferred Share shall be deemed to be "outstanding" for the purpose of
voting or determining the number of shares required to constitute a quorum
if, prior to or concurrently with the time of determination of shares
entitled to vote or shares deemed outstanding for quorum purposes, as the
case may be, the requisite Notice of Redemption with respect to such shares
shall have been mailed as provided in paragraph 8(c) of this Part I and the
Redemption Price for the redemption of such shares shall have been
deposited in trust with the Auction Agent for that purpose. No Preferred
Shares held by the Fund shall have any voting rights or be deemed to be
outstanding for voting or other purposes.
5. 1940 ACT PREFERRED SHARES ASSET COVERAGE.
The Fund shall maintain, as of the last Business Day of each month in which
any Preferred Shares are outstanding, the 1940 Act Preferred Shares Asset
Coverage.
6. PREFERRED SHARES BASIC MAINTENANCE AMOUNT.
(a) So long as Preferred Shares are outstanding, the Fund shall
maintain, on each Valuation Date, and shall verify to its satisfaction that
it is maintaining on such Valuation Date, Moody's Eligible Assets having an
aggregate Discounted Value equal to or greater than the Preferred Shares
Basic Maintenance Amount (if Moody's is then rating the Preferred Shares)
and Fitch Eligible Assets having an aggregate Discounted Value equal to or
greater than the Preferred Shares Basic Maintenance Amount (if Fitch is
then rating the Preferred Shares).
(b) (i) On or before 5:00 P.M., New York City time, on the third
Business Day after a Valuation Date on which the Fund fails to satisfy the
Preferred Shares Basic Maintenance Amount, and on the third Business Day
after the Preferred Shares Basic Maintenance Cure Date with respect to such
Valuation Date, the Fund shall complete and deliver to Moody's (if Moody's
is then rating the Preferred Shares and the Fund failed to maintain Moody's
Eligible Assets having an aggregate Discounted Value equal to or greater
than the Preferred Shares Basic Maintenance Amount) and Fitch (if Fitch is
then
B-37
rating the Preferred Shares and the Fund failed to maintain Fitch Eligible
Assets having an aggregate Discounted Value equal to or greater than the
Preferred Shares Basic Maintenance Amount) and the Auction Agent (if either
Moody's or Fitch is then rating the Preferred Shares) a Preferred Shares
Basic Maintenance Report as of the date of such failure or such Preferred
Shares Basic Maintenance Cure Date, as the case may be, which will be
deemed to have been delivered to each such party if such party receives a
copy or telecopy, telex or other electronic transcription thereof and on
the same day the Fund mails to such party for delivery on the next Business
Day the full Preferred Shares Basic Maintenance Report.
(ii) The Fund shall also deliver a Preferred Shares Basic
Maintenance Report to Moody's (if Moody's is then rating the Preferred
Shares) and Fitch (if Fitch is then rating the Preferred Shares):
(A) As of the last Valuation Date of each calendar month
(or, if such day is not a Business Day, the immediately preceding
Business Day), and
(B) As of any Quarterly Valuation Date, in each case on or
before the third Business Day after such day.
A failure by the Fund to deliver a Preferred Shares Basic Maintenance
Report pursuant to the preceding sentence shall be deemed to be delivery of a
Preferred Shares Basic Maintenance Report indicating the Discounted Value for
all assets of the Fund is less than the Preferred Shares Basic Maintenance
Amount, as of the relevant Valuation Date.
(c) Within ten Business Days after the date of delivery of a Preferred
Shares Basic Maintenance Report in accordance with paragraph 6(b)(ii)(B) of
this Part I relating to a Quarterly Valuation Date, the Fund shall deliver
to Moody's (if Moody's is then rating the Preferred Shares), Fitch (if
Fitch is then rating the Preferred Shares) and the Auction Agent (if either
Moody's or Fitch is then rating the Preferred Shares) a letter from the
Independent Accountant (an "Accountant's Confirmation") regarding the
mathematical accuracy of the calculations reflected in such Preferred
Shares Basic Maintenance Report (and in any other Preferred Shares Basic
Maintenance Report, randomly selected by the Independent Accountant, that
was prepared by the Fund during the quarter ending on such Quarterly
Valuation Date).
(d) Within ten Business Days after the date of delivery of a Preferred
Shares Basic Maintenance Report in accordance with paragraph 6(b)(i) of
this Part I relating to any Valuation Date on which the Fund failed to
satisfy the Preferred Shares Basic Maintenance Amount, and relating to the
Preferred Shares Basic Maintenance Cure Date with respect to such failure
to satisfy the Preferred Shares Basic Maintenance Amount, the Fund shall
cause the Independent Accountant to provide to Moody's (if Moody's is then
rating the Preferred Shares and has received such Preferred Shares Basic
Maintenance Report in accordance with paragraph 6(b)(i) of this Part I),
Fitch (if Fitch is then rating the Preferred Shares and has received such
Preferred Shares Basic Maintenance Report in accordance with paragraph
6(b)(i) of this Part I) and the Auction
B-38
Agent (if either Moody's or Fitch is then rating the Preferred Shares) an
Accountant's Confirmation regarding the mathematical accuracy of the
calculations set forth in such Preferred Shares Basic Maintenance Report.
(e) If any Accountant's Confirmation delivered pursuant to paragraph
6(c) or 6(d) of this Part I shows that an error was made in the Preferred
Shares Basic Maintenance Report for a particular Valuation Date for which
such Accountant's Confirmation was required to be delivered, or shows that
a lower aggregate Discounted Value for the aggregate of all Moody's
Eligible Assets (if Moody's is then rating the Preferred Shares) or Fitch
Eligible Assets (if Fitch is then rating the Preferred Shares), as the case
may be, of the Fund was determined by the Independent Accountant, the
calculation or determination made by such Independent Accountant shall be
final and conclusive and shall be binding on the Fund.
(f) On or before 5:00 p.m., New York City time, on the first Business
Day after the Date of Original Issue of the Preferred Shares, the Fund
shall complete and deliver to Moody's (if Moody's is then rating the
Preferred Shares) and Fitch (if Fitch is then rating the Preferred Shares)
a Preferred Shares Basic Maintenance Report as of the close of business on
the Valuation Date immediately prior to such Date of Original Issue, but
assuming in such Preferred Shares Basic Maintenance Report the issuance of
the Preferred Shares. Within ten Business Days of such Date of Original
Issue, the Fund shall cause the Independent Accountant to deliver in
writing to Moody's (if Moody's is then rating the Preferred Shares) and
Fitch (if Fitch is then rating the Preferred Shares) an Accountant's
Confirmation regarding the mathematical accuracy of the calculations
reflected in such Preferred Shares Basic Maintenance Report.
(g) On or before 5:00 p.m., New York City time, on the third Business
Day after:
(i) the Fund shall have redeemed Common Shares,
(ii) the ratio of the Discounted Value of Moody's Eligible Assets
to the Preferred Shares Basic Maintenance Amount is less than or equal
to 130%, if Moody's is then rating the Preferred Shares,
(iii) the ratio of the Discounted Value of Fitch Eligible Assets
to the Preferred Shares Basic Maintenance Amount is less than or equal
to 115%, if Fitch is then rating the Preferred Shares, or
(iv) a written request by Moody's (if Moody's is then rating the
Preferred Shares) or Fitch (if Fitch is then rating the Preferred
Shares),
the Fund shall complete and deliver to Moody's (if Moody's is then rating
the Preferred Shares) or Fitch (if Fitch is then rating the Preferred
Shares), as the case may be, a Preferred Shares Basic Maintenance Report as
of the date of such event.
7. RESTRICTIONS ON DIVIDENDS AND OTHER DISTRIBUTIONS.
B-39
(a) DIVIDENDS ON PARITY SHARES. Except as set forth in the next
sentence, no dividends shall be declared or paid or set apart for payment
on the shares of any class or series of shares of capital stock of the Fund
ranking, as to the payment of dividends, on a parity with any Series of
Preferred Shares for any period unless full cumulative dividends have been
or contemporaneously are declared and paid on all Preferred Shares through
their most recent Dividend Payment Date. When dividends are not paid in
full upon any Series of Preferred Shares through their most recent Dividend
Payment Date or upon the shares of any other class or series of shares of
capital stock of the Fund ranking on a parity as to the payment of
dividends with any Series of Preferred Shares through their most recent
respective dividend payment dates, all dividends declared upon the
Preferred Shares and any other such class or series of shares of capital
stock ranking on a parity as to the payment of dividends with any Series of
Preferred Shares shall be declared pro rata so that the amount of dividends
declared per share on the Preferred Shares and such other class or series
of shares of capital stock shall in all cases bear to each other the same
ratio that accumulated dividends per share on the Preferred Shares and such
other class or series of shares of capital stock bear to each other.
(b) DIVIDENDS AND OTHER DISTRIBUTIONS WITH RESPECT TO COMMON SHARES
UNDER THE 1940 ACT. The Directors shall not declare any dividend (except a
dividend payable in Common Shares), or declare any other distribution, upon
the Common Shares, or purchase Common Shares, unless in every such case the
Fund maintains, at the time of any such declaration or purchase, the 1940
Act Preferred Shares Asset Coverage after deducting the amount of such
dividend, distribution or purchase price, as the case may be.
(c) OTHER RESTRICTIONS ON DIVIDENDS AND OTHER DISTRIBUTIONS. For so
long as any Preferred Shares are outstanding, and except as otherwise
contemplated by these Articles Supplementary, (A) the Fund shall not
declare, pay or set apart for payment any dividend or other distribution
(other than a dividend or distribution paid in shares of, or in options,
warrants or rights to subscribe for or purchase, Common Shares or other
shares, if any, ranking junior to the Preferred Shares as to the payment of
dividends and the distribution of assets upon dissolution, liquidation or
winding up) in respect of the Common Shares or any other shares of the Fund
ranking junior to the Preferred Shares as to the payment of dividends or
the distribution of assets upon dissolution, liquidation or winding up, or
call for redemption, redeem, purchase or otherwise acquire for
consideration any Common Shares or any other such junior shares (except by
conversion into or exchange for shares of the Fund ranking junior to the
Preferred Shares as to the payment of dividends and the distribution of
assets upon dissolution, liquidation or winding up), unless (i) full
cumulative dividends on the Preferred Shares through their most recently
ended Dividend Period shall have been paid or shall have been declared and
sufficient funds for the payment thereof deposited with the Auction Agent
and (ii) the Fund has redeemed the full number of Preferred Shares required
to be redeemed by any provision for mandatory redemption pertaining
thereto, and (iii) immediately after such transaction the Discounted Value
of Moody's Eligible Assets (if Moody's is then rating the Preferred Shares)
and Fitch Eligible Assets (if Fitch is then rating the Preferred Shares)
would each at least equal the Preferred Shares Basic Maintenance Amount.
B-40
8. REDEMPTION.
(a) OPTIONAL REDEMPTION.
(i) Subject to the provisions of subparagraph (iii) of this
paragraph 8(a) and to any applicable Special Redemption Provisions,
Preferred Shares may be redeemed from time to time, at the option of
the Fund, in whole or in part, on any Dividend Payment Date, out of
funds legally available therefor, at a redemption price per share
equal to the sum of $25,000 plus an amount equal to accumulated but
unpaid dividends thereon (whether or not earned or declared but
excluding any interest thereon) to (but not including) the date fixed
for redemption; provided, however, that Preferred Shares may not be
redeemed at the option of the Fund during the Initial Rate Period.
(ii) If fewer than all of the outstanding Preferred Shares of a
Series are to be redeemed pursuant to subparagraph (i) of this
paragraph 8(a), the shares to be redeemed shall be selected by lot or
using such other method as the Board of Directors shall deem fair and
reasonable.
(iii) The Fund may not on any date give a Notice of Redemption
pursuant to paragraph 8(c) of this Part I in respect of a redemption
contemplated to be effected pursuant to this paragraph (a) unless on
such date (1) the Fund has available Deposit Securities with maturity
or tender dates not later than the day preceding the applicable
redemption date and having a value not less than the amount (including
any applicable premium) due to Holders of Preferred Shares by reason
of the redemption of such shares on such redemption date and (2) the
Discounted Value of Moody's Eligible Assets (if Moody's is then rating
the Preferred Shares) and Fitch Eligible Assets (if Fitch is then
rating the Preferred Shares) each at least equals the Preferred Shares
Basic Maintenance Amount and would at least equal the Preferred Shares
Basic Maintenance Amount immediately subsequent to such redemption if
such redemption were to occur on such date. The Fund shall not be
required to have available Deposit Securities as described in clause
(1) of this subparagraph (iii) in respect of a redemption of the
Preferred Shares, in whole or in part, contemplated to be effected
pursuant to paragraph 8(a) where such redemption is subject to the
issuance of shares of any other series of shares of preferred stock of
the Fund.
(b) MANDATORY REDEMPTION. The Fund shall redeem Preferred Shares, at a
redemption price equal to $25,000 per share plus accumulated but unpaid
dividends thereon (whether or not earned or declared but excluding any
interest thereon) to (but not including) the date fixed by the Directors
for redemption, if the Fund fails to have either Moody's Eligible Assets
(if Moody's is then rating the Preferred Shares) or Fitch Eligible Assets
(if Fitch is then rating the Preferred Shares) with a Discounted Value
greater than or equal to the Preferred Shares Basic Maintenance Amount or
fails to maintain the 1940 Act Preferred Shares Asset Coverage, in each
case in accordance with the terms of these Articles Supplementary, and such
failure is not cured on or before the Preferred Shares
B-41
Basic Maintenance Cure Date or the 1940 Act Cure Date, as the case may be.
The number of Preferred Shares to be redeemed shall be equal to the lesser
of:
(i) the minimum number of Preferred Shares, together with all
other shares of preferred stock subject to redemption or retirement,
the redemption of which, if deemed to have occurred immediately prior
to the opening of business on the Preferred Shares Basic Maintenance
Cure Date or the 1940 Act Cure Date, as the case may be, would have
resulted in the Fund's (A) having Moody's Eligible Assets (if Moody's
is then rating the Preferred Shares) and Fitch Eligible Assets (if
Fitch is then rating the Preferred Shares) with a Discounted Value
greater than or equal to the Preferred Shares Basic Maintenance Amount
or (B) maintaining the 1940 Act Preferred Shares Asset Coverage, as
the case may be, on such Cure Date (provided, however, that if there
is no such minimum number of Preferred Shares and other shares of
preferred stock the redemption or retirement of which would have had
such result, all Preferred Shares and other shares of preferred stock
then outstanding shall be redeemed), and
(ii) the maximum number of Preferred Shares, together with all
other shares of preferred stock subject to redemption or retirement,
that can be redeemed out of funds expected to be legally available
therefor in accordance with the Charter and applicable law.
In determining the Preferred Shares required to be redeemed in
accordance with the foregoing, the Fund shall allocate the number required
to be redeemed to satisfy the Preferred Shares Basic Maintenance Amount or
the 1940 Act Preferred Shares Asset Coverage, as the case may be, pro rata
among Preferred Shares and other shares of preferred stock (and, then, pro
rata among the Preferred Shares) subject to redemption or retirement.
The Fund shall effect such redemption on the date fixed by the Fund
therefor, which date shall not be earlier than 20 days nor later than 30
days after such Cure Date, except that if the Fund does not have funds
legally available for the redemption of all of the required number of the
Preferred Shares and other shares of preferred stock that are required to
be redeemed pursuant to (i) above but which cannot be redeemed because of
the operation of (ii) above or the Fund otherwise is unable to effect such
redemption on or prior to 40 days after such Cure Date, the Fund shall
redeem those Preferred Shares and other shares of preferred stock which it
was unable to redeem on the earliest practicable date on which it is able
to effect such redemption. If fewer than all of the outstanding Preferred
Shares are to be redeemed pursuant to this paragraph 8(b), the Preferred
Shares to be redeemed shall be selected by lot or using such other method
as the Board of Directors shall deem fair and reasonable.
(c) NOTICE OF REDEMPTION. If the Fund shall determine or be required
to redeem Preferred Shares pursuant to paragraph 8(a) or 8(b) of this Part
I, it shall mail a notice (a "Notice of Redemption") with respect to such
redemption by first-class mail, postage prepaid, to each Holder of the
relevant Series of Preferred Shares, at such Holder's address as the same
appears on the record books of the Fund on the record date
B-42
established by the Directors, and shall provide such notice to the Auction
Agent, Moody's (if Moody's is then rating the Preferred Shares) and Fitch
(if Fitch is then rating the Preferred Shares). Such Notice of Redemption
shall be so mailed not less than 20 nor more than 30 days prior to the date
fixed for redemption. Each such Notice of Redemption shall state:
1. the redemption date;
2. the number of Preferred Shares of the specified Series to
be redeemed;
3. the CUSIP number for the Preferred Shares;
4. the Redemption Price;
5. that dividends on the Preferred Shares to be redeemed
will cease to accumulate on such redemption date; and
6. the provisions of this paragraph 8 under which such
redemption is made.
If fewer than all the Preferred Shares of a Series held by any Holder
are to be redeemed, the Notice of Redemption mailed to such Holder shall
also specify the number of Preferred Shares of that Series to be redeemed
from such Holder. The Fund may provide in any Notice of Redemption relating
to a redemption contemplated to be effected pursuant to paragraph 8(a) of
this Part I that such redemption is subject to one or more conditions
precedent and that the Fund shall not be required to effect such redemption
unless each such condition shall have been satisfied at the time or times
and in the manner specified in such Notice of Redemption. No defect in the
Notice of Redemption or in the transmittal or mailing thereof will affect
the validity of the redemption proceedings, except as required by
applicable law.
(d) NO REDEMPTION UNDER CERTAIN CIRCUMSTANCES.
(i) Notwithstanding the provisions of paragraphs 8(a) or 8(b) of
this Part I, if any dividends on the Preferred Shares (whether or not
earned or declared) are in arrears, no Preferred Shares shall be
redeemed unless all outstanding Preferred Shares are simultaneously
redeemed, and the Fund shall not purchase or otherwise acquire any
Preferred Shares; provided, however, that the foregoing shall not
prevent the purchase or acquisition of outstanding Preferred Shares
pursuant to the successful completion of an otherwise lawful purchase
or exchange offer made on the same terms to Holders of all outstanding
Preferred Shares.
(ii) To the extent that any redemption for which a Notice of
Redemption has been mailed is not made by reason of the absence of
legally available funds therefor in accordance with the Charter and
applicable law, such redemption shall be made as soon as practicable
to the extent such funds become
B-43
available. Failure to redeem Preferred Shares shall be deemed to exist
at any time there is a Redemption Default with respect to a redemption
specified in a Notice of Redemption.
Notwithstanding the fact that the Fund may not have redeemed Preferred
Shares for which a Notice of Redemption has been mailed, dividends may be
declared and paid on Preferred Shares and shall include those Preferred
Shares for which a Notice of Redemption has been mailed.
(e) AUCTION AGENT AS TRUSTEE OF REDEMPTION PAYMENTS BY FUND. All
moneys paid to the Auction Agent for payment of the Redemption Price of
Preferred Shares called for redemption shall be held in trust by the
Auction Agent for the benefit of Holders of shares so to be redeemed.
(f) SHARES FOR WHICH NOTICE OF REDEMPTION HAS BEEN GIVEN ARE NO LONGER
OUTSTANDING. Provided a Notice of Redemption has been mailed pursuant to
paragraph 8(c) of this Part I, upon the deposit with the Auction Agent (not
later than 12:00 Noon, New York City time, on the date fixed for redemption
thereby, in funds available on such date in The City of New York, New York)
of funds sufficient to redeem the Preferred Shares that are the subject of
such notice, dividends on such shares shall cease to accumulate and such
shares shall no longer be deemed to be Outstanding for any purpose, and all
rights of the Holders of the shares so called for redemption shall cease
and terminate (including without limitation voting rights), except the
right of such Holders to receive the Redemption Price, but without any
interest or other additional amount, except as provided in subparagraph
2(e)(iii) of this Part I. Upon surrender in accordance with the Notice of
Redemption of the certificates for any shares so redeemed (properly
endorsed or assigned for transfer, if the Directors shall so require and
the Notice of Redemption shall so state), the Redemption Price shall be
paid by the Auction Agent to the Holders of Preferred Shares subject to
redemption. In the case that fewer than all of the shares represented by
any such certificate are redeemed, a new certificate shall be issued,
representing the unredeemed shares, without cost to the Holder thereof. The
Fund shall be entitled to receive from the Auction Agent, promptly after
the date fixed for redemption, any cash deposited with the Auction Agent in
excess of:
(i) the aggregate Redemption Price of the Preferred Shares called
for redemption on such date, and
(ii) all other amounts to which Holders of Preferred Shares
called for redemption may be entitled.
Any funds so deposited that are unclaimed at the end of 90 days
from such redemption date shall, to the extent permitted by law, be
repaid to the Fund, after which time the Holders of Preferred Shares
so called for redemption may look only to the Fund for payment of the
Redemption Price and all other amounts to which they may be entitled.
The Fund shall be entitled to receive, from time to time after the
date fixed for redemption, any interest on the funds so deposited.
B-44
(g) COMPLIANCE WITH APPLICABLE LAW. In effecting any redemption
pursuant to this paragraph 8, the Fund shall use its best efforts to comply
with all applicable conditions precedent to effecting such redemption under
the 1940 Act and any applicable Maryland law, and shall effect no
redemption except in accordance with the 1940 Act and any applicable
Maryland law.
(h) ONLY WHOLE PREFERRED SHARES MAY BE REDEEMED. In the case of any
redemption pursuant to this paragraph 8, only whole Preferred Shares shall
be redeemed, and in the event that any provision of the Charter would
require redemption of a fractional share, the Auction Agent shall be
authorized to round up so that only whole shares are redeemed.
9. LIQUIDATION RIGHTS.
(a) RANKING. The Preferred Shares shall rank on a parity with one
another and with shares of any other series of shares of preferred stock as
to the distribution of assets upon dissolution, liquidation or winding up
of the affairs of the Fund.
(b) DISTRIBUTIONS UPON LIQUIDATION. Upon the dissolution, liquidation
or winding up of the affairs of the Fund, whether voluntary or involuntary,
the Holders of Preferred Shares then outstanding shall be entitled to
receive and to be paid out of the assets of the Fund available for
distribution to its shareholders, before any payment or distribution shall
be made on the Common Shares or on any other class of shares of the Fund
ranking junior to the Preferred Shares upon dissolution, liquidation or
winding up, an amount equal to the Liquidation Preference with respect to
such shares plus an amount equal to all dividends thereon (whether or not
earned or declared but excluding any interest thereon) accumulated but
unpaid to (but not including) the date of final distribution in same-day
funds. After the payment to the Holders of the Preferred Shares of the full
preferential amounts provided for in this paragraph 9(b), the Holders of
Preferred Shares as such shall have no right or claim to any of the
remaining assets of the Fund.
(c) PRO RATA DISTRIBUTIONS. In the event the assets of the Fund
available for distribution to the Holders of Preferred Shares upon any
dissolution, liquidation, or winding up of the affairs of the Fund, whether
voluntary or involuntary, shall be insufficient to pay in full all amounts
to which such Holders are entitled pursuant to paragraph 9(b) of this Part
I, no such distribution shall be made on account of any shares of any other
class or series of shares of preferred stock ranking on a parity with the
Preferred Shares with respect to the distribution of assets upon such
dissolution, liquidation or winding up unless proportionate distributive
amounts shall be paid on account of the Preferred Shares, ratably, in
proportion to the full distributable amounts for which holders of all such
parity shares are respectively entitled upon such dissolution, liquidation
or winding up.
(d) RIGHTS OF JUNIOR SHARES. Subject to the rights of the holders of
shares of any series or class or classes of shares ranking on a parity with
the Preferred Shares with respect to the distribution of assets upon
dissolution, liquidation or winding up of the
B-45
affairs of the Fund, after payment shall have been made in full to the
Holders of the Preferred Shares as provided in paragraph 9(b) of this Part
I, but not prior thereto, any other series or class or classes of shares
ranking junior to the Preferred Shares with respect to the distribution of
assets upon dissolution, liquidation or winding up of the affairs of the
Fund shall, subject to the respective terms and provisions (if any)
applying thereto, be entitled to receive any and all assets remaining to be
paid or distributed, and the Holders of the Preferred Shares shall not be
entitled to share therein.
(e) CERTAIN EVENTS NOT CONSTITUTING LIQUIDATION. Neither the sale of
all or substantially all, or any portion of, the property or business of
the Fund, nor the merger or consolidation of the Fund into or with any
corporation, business trust or other entity nor the merger or consolidation
of any corporation, business trust or other entity into or with the Fund
shall be a dissolution, liquidation or winding up, whether voluntary or
involuntary, for the purposes of this paragraph 9.
10. CERTAIN OTHER RESTRICTIONS. (a) So long as any Preferred Shares are
Outstanding and Moody's or Fitch so requires, the Fund will not, unless it
has received written confirmation from Moody's (if Moody's is then rating
the Preferred Shares) and Fitch (if Fitch is then rating the Preferred
Shares) that any such action would not impair the rating then assigned by
such Rating Agency to the Preferred Shares, engage in any one or more of
the following transactions:
(i) enter into options and futures transactions except, with
respect to Moody's, as set forth in paragraph (b) of this Section 10
and, with respect to Fitch, as set forth in paragraph (d) of this
Section 10;
(ii) make short sales of securities unless at all times when a
short position is open, the Fund owns an equal or greater amount of
such securities or owns preferred stock, debt or warrants convertible
or exchangeable into an equal or greater number of the shares of
common stocks sold short;
(iii) overdraw any bank account (except as may be necessary for
the clearance of security transactions); or
(iv) except in connection with a refinancing of the Preferred
Shares, borrow money or issue senior securities (as defined in the
1940 Act) other than the Preferred Shares.
(b) For so long as the Preferred Shares are rated by Moody's, the Fund
(i) may buy call or put option contracts on securities or related indices,
(ii) may write only covered call options on securities or related indices,
(iii) may write put options on securities or related indices, (iv) may only
sell futures contracts as a bona fide hedge of assets held by the Fund, (v)
may only engage in futures transactions on an exchange where the exchange
or its clearinghouse takes the opposite side of the transaction, (vi) may
buy call or put options on futures contracts, (vii) may write put options
on futures contracts and may only write call options on futures contracts
if such call options are covered by: (1) purchased futures contracts
underlying the option, (2) call positions
B-46
owned on the futures contracts underlying the call option written, or (3)
holdings of securities for which the written call options are a bona fide
hedge, (viii) may purchase futures contracts as a hedge, (ix) may buy call
or put options on interest rate swaps (commonly known as swaptions), (x)
may buy credit default protection derivatives, (xi) to the extent an asset
or financial instrument is used to cover a particular option, futures
contract or option on a futures contract, will not be able to use such
asset or financial instrument to cover any additional option, futures
contract or option on a futures contract, and (xii) will only engage in
common equity index-based futures or options transactions if Moody's
advises the Fund in writing that such transactions will not adversely
affect its then-current rating on the Preferred Shares.
For so long as the Preferred Shares are rated by Moody's, unless, in
each case, Moody's advises the Fund in writing that such action or actions
will not adversely affect its then-current rating on the Preferred Shares,
in determining the Preferred Shares Basic Maintenance Amount, the Fund
shall include as a liability (i) 10% of the exercise value of a written
call option on securities or related indices, (ii) 100% of the exercise
value of any written put option on securities or related indices, (iii) 10%
of the settlement value of the assets underlying futures contracts sold or
call options written on futures contracts, (iv) 100% of the settlement
value of the assets underlying futures contracts purchased and (v) 100% of
the settlement value of the assets underlying the futures contracts based
on exercise price if the Fund writes put options on futures contracts.
Also, for so long as the Preferred Shares are rated by Moody's,
unless, in each case, Moody's advises the Fund in writing that such action
or actions will not adversely affect its then-current rating on the
Preferred Shares, the Fund (i) will limit its transactions in futures
contracts and written options thereon to those relating to U.S. Treasury
Bonds, U.S. Treasury Notes, debt securities of agencies of the U.S.
Government and debt securities of Government Sponsored Enterprises of the
U.S. Government, (ii) will not engage in options and futures transactions
for leveraging or speculative purposes, (iii) will not enter into an
options or futures transaction unless after giving effect to such
transaction the Fund is in compliance with the provisions of these Articles
Supplementary relating to the Preferred Shares Basic Maintenance Amount,
(iv) shall not include in Moody's Eligible Assets any assets pledged in
margin accounts in connection with futures transactions, (v) will assume
for purposes of determining the Discounted Value, when the Fund has
purchased futures contracts or has written put options, ownership by the
Fund of the underlying asset, which will be the security resulting in the
lowest Discounted Value when delivery may be made to the Fund with any of a
class of securities, (vi) will engage only in exchange traded futures
contracts and written options thereon on exchanges approved by Moody's in
writing, which, as of the date of these Articles Supplementary, consist of
the Chicago Board of Trade, the Chicago Mercantile Exchange and the
Financial Exchange, (vii) will limit the transactions in futures contracts
sold and call options written on futures contracts so that the settlement
value of the underlying futures contracts does not in total exceed 65% of
the value of the Moody's Eligible Assets of the Fund rated the equivalent
of Baa3 or better by Moody's and not otherwise hedged by a written call and
(viii) will only take positions in futures which are deliverable in the
nearby and next following contract months that are not any later than
B-47
three months after such nearby contract month and will close out such
futures positions by the fifth business day of the delivery month.
(c) For so long as the Preferred Shares are rated by Moody's, unless,
in each case, Moody's advises the Fund in writing that such action or
actions will not adversely affect its then-current rating on the Preferred
Shares:
(i) the composition of the Fund's portfolio will not be altered
if the effect of any such alteration would be to cause the Fund,
immediately after giving effect to the transaction, to have a
Preferred Shares Basic Maintenance Amount equal to or in excess of the
Discounted Value of Moody's Eligible Assets as of the previous
Valuation Date;
(ii) if the Preferred Shares Basic Maintenance Amount exceeds the
Discounted Value of Moody's Eligible Assets, the Fund will invest the
proceeds of the sale or other disposition of a Moody's Eligible Asset
in an investment having a greater Discount Factor or in an issuer in a
different industry from the investment sold or otherwise disposed of
only if the effect of such transaction immediately after giving effect
thereto would be to reduce the excess of the Preferred Shares Basic
Maintenance Amount over the Discounted Value; and
(iii) at such time that the Discounted Value of Moody's Eligible
Assets is less than 25% greater than the Preferred Shares Basic
Maintenance Amount, the composition of the Fund 's portfolio will not
be altered if, in the Fund 's reasonable judgment, the result of such
alteration would cause the Fund to fail to be in compliance with the
provisions of these Articles Supplementary relating to the Preferred
Shares Basic Maintenance Amount.
(d) For so long as the Preferred Shares are rated by Fitch, the Fund
(i) may buy call or put option contracts on securities or related indices,
(ii) may write only covered call options on securities or related indices,
(iii) may write put options on securities or related indices, (iv) may only
sell futures contracts as a bona fide hedge of assets held by the Fund, (v)
may only engage in futures transactions on an exchange where the exchange
or its clearinghouse takes the opposite side of the transaction, (vi) may
buy call or put options on futures contracts, (vii) may write put options
on futures contracts and may only write call options on futures contracts
if such call options are covered by: (1) purchased futures contracts
underlying the option, (2) call positions owned on the futures contracts
underlying the call option written, or (3) holdings of securities for which
the written call options are a bona fide hedge, (viii) may purchase futures
contracts as a hedge, (ix) may buy call or put options on interest rate
swaps (commonly known as swaptions), (x) may buy credit default protection
derivatives, (xi) to the extent an asset or financial instrument is used to
cover a particular option, futures contract or option on a futures
contract, will not be able to use such asset or financial instrument to
cover any additional option, futures contract or option on a futures
contract, and (xii) will only engage in common equity index-based futures
or options transactions if Fitch advises the Fund in writing that such
transactions will not adversely affect its then-current rating on the
Preferred Shares.
B-48
For so long as the Preferred Shares are rated by Fitch, unless, in
each case, Fitch advises the Fund in writing that such action or actions
will not adversely affect its then-current rating on the Preferred Shares,
in determining the Preferred Shares Basic Maintenance Amount, the Fund
shall include as a liability (i) 10% of the exercise value of a written
call option on securities or related indices, (ii) 100% of the exercise
value of any written put option on securities or related indices, (iii) 10%
of the settlement value of the assets underlying futures contracts sold or
call options written on futures contracts, (iv) 100% of the settlement
value of the assets underlying futures contracts purchased and (v) 100% of
the settlement value of the assets underlying the futures contracts based
on exercise price if the Fund writes put options on futures contracts.
Also, for so long as the Preferred Shares are rated by Fitch, unless,
in each case, Fitch advises the Fund in writing that such action or actions
will not adversely affect its then-current rating on the Preferred Shares,
the Fund (i) will limit its transactions in futures contracts and written
options thereon to those relating to U.S. Treasury Bonds, U.S. Treasury
Notes, debt securities of agencies of the U.S. Government and debt
securities of Government Sponsored Enterprises of the U.S. Government, (ii)
will not engage in options and futures transactions for leveraging or
speculative purposes, (iii) will not enter into an options or futures
transaction unless after giving effect to such transaction the Fund is in
compliance with the provisions of these Articles Supplementary relating to
the Preferred Shares Basic Maintenance Amount, (iv) shall not include in
Fitch Eligible Assets any assets pledged in margin accounts in connection
with futures transactions, (v) will assume for purposes of determining the
Discounted Value, when the Fund has purchased futures contracts or has
written put options, ownership by the Fund of the underlying asset, which
will be the security resulting in the lowest Discounted Value when delivery
may be made to the Fund with any of a class of securities, (vi) will engage
only in exchange traded futures contracts and written options thereon on
exchanges approved by Fitch in writing, which, as of the date of these
Articles Supplementary, consist of the Chicago Board of Trade, the Chicago
Mercantile Exchange and the Financial Exchange, (vii) will limit the
transactions in futures contracts sold and call options written on futures
contracts so that the settlement value of the underlying futures contracts
does not in total exceed 65% of the value of the Fitch Eligible Assets of
the Fund rated the equivalent of BBB- or better by Fitch and not otherwise
hedged by a written call and (viii) will only take positions in futures
which are deliverable in the nearby and next following contract months that
are not any later than three months after such nearby contract month and
will close out such futures positions by the fifth business day of the
delivery month.
(e) For so long as the Preferred Shares are rated by Fitch, unless, in
each case, Fitch advises the Fund in writing that such action or actions
will not adversely affect its then-current rating on the Preferred Shares:
(i) the composition of the Fund's portfolio will not be altered
if the effect of any such alteration would be to cause the Fund,
immediately after giving effect to the transaction, to have a
Preferred Shares Basic Maintenance Amount equal to or in excess of the
Discounted Value of Fitch Eligible Assets as of the previous Valuation
Date;
B-49
(ii) if the Preferred Shares Basic Maintenance Amount exceeds the
Discounted Value of Fitch Eligible Assets, the Fund will invest the
proceeds of the sale or other disposition of a Fitch Eligible Asset in
an investment having a greater Discount Factor or in an issuer in a
different industry from the investment sold or otherwise disposed of
only if the effect of such transaction immediately after giving effect
thereto would be to reduce the excess of the Preferred Shares Basic
Maintenance Amount over the Discounted Value; and
(iii) at such time that the Discounted Value of Fitch Eligible
Assets is less than 25% greater than the Preferred Shares Basic
Maintenance Amount, the composition of the Fund 's portfolio will not
be altered if, in the Fund 's reasonable judgment, the result of such
alteration would cause the Fund to fail to be in compliance with the
provisions of these Articles Supplementary relating to the Preferred
Shares Basic Maintenance Amount.
11. MISCELLANEOUS.
(a) NO FRACTIONAL SHARES. No fractional Preferred Shares shall be
issued.
(b) STATUS OF PREFERRED SHARES REDEEMED, EXCHANGED OR OTHERWISE
ACQUIRED BY THE FUND. Preferred Shares which are redeemed, exchanged or
otherwise acquired by the Fund shall return to the status of authorized and
unissued shares of preferred stock without designation as to series.
(c) BOARD MAY RESOLVE AMBIGUITIES. To the extent permitted by
applicable law, the Directors may interpret or adjust the provisions of
these Articles Supplementary to resolve any inconsistency or ambiguity or
to remedy any formal defect, and may amend these Articles Supplementary
with respect to the Preferred Shares prior to the issuance of the Preferred
Shares.
(d) HEADING NOT DETERMINATIVE. The headings contained in these
Articles Supplementary are for convenience of reference only and shall not
affect the meaning or interpretation of these Articles Supplementary.
(e) NOTICES. All notices or communications to be given pursuant to
these Articles Supplementary, unless otherwise specified in these Articles
Supplementary, shall be sufficiently given if in writing and delivered in
person or mailed by first-class mail, postage prepaid.
PART II.
1. ORDERS. Unless otherwise permitted by the Fund, Beneficial Owners and
Potential Beneficial Owners may only participate in Auctions through their
Broker-Dealers. Broker-Dealers will submit the Orders of their respective
customers who are Beneficial Owners and Potential Beneficial Owners to the
Auction Agent, designating themselves as Existing Holders in respect of
shares subject to Orders submitted or deemed submitted to them by
Beneficial Owners and as Potential Holders in respect of shares subject to
Orders submitted to them by Potential Beneficial Owners. A Broker-Dealer
may also hold in its
B-50
own account as a Beneficial Owner; provided, however, that a Broker-Dealer
that is an Affiliate of the Fund may not hold Preferred Shares in its own
account as a Beneficial Owner. A Broker-Dealer may thus submit Orders to
the Auction Agent as a Beneficial Owner or a Potential Beneficial Owner and
therefore participate in an Auction as an Existing Holder or Potential
Holder on behalf of both itself and its customers. A Broker-Dealer that is
an Affiliate of the Fund may submit Orders to the Auction Agent as provided
herein, but only if such Orders are not for its own account.
(a) Prior to the Submission Deadline on each Auction Date for a Series
of Preferred Shares:
(i) each Beneficial Owner of such Series of Preferred Shares may
submit to its Broker-Dealer by telephone or otherwise information as
to:
(A) the number of Outstanding Preferred Shares, if any, of
such Series held by such Beneficial Owner which such Beneficial
Owner desires to continue to hold without regard to the
Applicable Rate for such Series of Preferred Shares for the next
succeeding Rate Period of such Series;
(B) the number of Outstanding Preferred Shares, if any, of
such Series held by such Beneficial Owner which such Beneficial
Owner offers to sell if the Applicable Rate for Preferred Shares
for the next succeeding Rate Period for such Series of Preferred
Shares shall be less than the rate per annum specified by such
Beneficial Owner; and/or
(C) the number of Outstanding Preferred Shares, if any, of
such Series held by such Beneficial Owner which such Beneficial
Owner offers to sell without regard to the Applicable Rate for
such Series of the Preferred Shares for the next succeeding Rate
Period of such Series; and
(ii) one or more Broker-Dealers, using lists of Potential
Beneficial Owners, shall in good faith, for the purpose of conducting
a competitive Auction in a commercially reasonable manner, contact
Potential Beneficial Owners (by telephone or otherwise), including
Persons that are not Beneficial Owners, on such lists to determine the
number of Preferred Shares, if any, of such Series which each such
Potential Beneficial Owner offers to purchase if the Applicable Rate
for such Series of Preferred Shares for the next succeeding Rate
Period shall not be less than the rate per annum specified by such
Potential Beneficial Owner.
For the purposes hereof, the communication by a Beneficial Owner or
Potential Beneficial Owner to a Broker-Dealer, or by a Broker-Dealer to the
Auction Agent, of information referred to in clause (i)(A), (i)(B), (i)(C) or
(ii) of this paragraph 1(a) is hereinafter referred to as an "Order" and
collectively as "Orders," and each Beneficial Owner and each Potential
Beneficial Owner placing an Order with a Broker-Dealer, and such Broker-Dealer
placing an order with the Auction Agent, is hereinafter referred to as a
"Bidder" and collectively as "Bidders"; an Order containing the information
referred to in clause (i)(A) of this paragraph
B-51
(a) is hereinafter referred to as a "Hold Order" and collectively as "Hold
Orders"; an Order containing the information referred to in clause (i)(B) or
(ii) of this paragraph (a) is hereinafter referred to as a "Bid" and
collectively as "Bids"; and an Order containing the information referred to in
clause (i)(C) of this paragraph (a) is hereinafter referred to as a "Sell Order"
and collectively as "Sell Orders." Inasmuch as a Broker-Dealer participates in
an Auction as an Existing Holder or a Potential Holder only to represent the
interests of a Beneficial Owner or Potential Beneficial Owner, whether it be its
customers or itself, all discussion herein relating to the consequences of an
Auction for Existing Holders and Potential Holders also applies to the
underlying beneficial ownership interests represented.
(b) (i) A Bid by a Beneficial Owner or an Existing Holder of a Series
of Preferred Shares subject to an Auction on any Auction Date shall
constitute an irrevocable offer to sell:
(A) the number of Outstanding Preferred Shares of such
Series specified in such Bid if the Applicable Rate for Preferred
Shares of such Series determined on such Auction Date shall be
less than the rate specified therein;
(B) such number or a lesser number of Outstanding Preferred
Shares of such Series to be determined as set forth in clause
(iv) of paragraph 4(a) of this Part II if the Applicable Rate for
Preferred Shares of such Series determined on such Auction Date
shall be equal to the rate specified therein; or
(C) the number of Outstanding Preferred Shares of such
Series specified in such Bid if the rate specified therein shall
be higher than the Maximum Rate for Preferred Shares of such
Series, or such number or a lesser number of Outstanding
Preferred Shares of such Series to be determined as set forth in
clause (iii) of paragraph 4(b) of this Part II if the rate
specified therein shall be higher than the Maximum Rate for
Preferred Shares of such Series and Sufficient Clearing Bids for
the Preferred Shares of such Series do not exist.
(ii) A Sell Order by a Beneficial Owner or an Existing Holder of
a Series of Preferred Shares subject to an Auction on any Auction Date
shall constitute an irrevocable offer to sell:
(A) the number of Outstanding Preferred Shares of such
Series specified in such Sell Order; or
(B) such number or a lesser number of Outstanding Preferred
Shares of such Series as set forth in clause (iii) of paragraph
4(b) of this Part II if Sufficient Clearing Bids for the
Preferred Shares of such Series do not exist; PROVIDED, HOWEVER,
that a Broker-Dealer that is an Existing Holder with respect to
Preferred Shares of such Series shall not be liable to any Person
for failing to sell such shares pursuant to a Sell Order
B-52
described in the proviso to paragraph 2(c) of this Part II if (1)
such shares were transferred by the Beneficial Owner thereof
without compliance by such Beneficial Owner or its transferee
Broker-Dealer (or other transferee person, if permitted by the
Fund) with the provisions of paragraph 5 of this Part II or (2)
such Broker-Dealer reasonably believes it is not the Existing
Holder of such shares, and such Broker-Dealer has informed the
Auction Agent of such belief pursuant to the terms of its
Broker-Dealer Agreement.
(iii) A Bid by a Potential Beneficial Holder or a Potential Holder of
Preferred Shares of a Series subject to an Auction on any Auction Date
shall constitute an irrevocable offer to purchase:
(A) the number of Outstanding Preferred Shares of such
Series specified in such Bid if the Applicable Rate for Preferred
Shares of such Series determined on such Auction Date shall be
higher than the rate specified therein; or
(B) such number or a lesser number of Outstanding Preferred
Shares of such Series as set forth in clause (v) of paragraph
4(a) of this Part II if the Applicable Rate for Preferred Shares
of such Series determined on such Auction Date shall be equal to
the rate specified therein.
(c) No Order for any number of Preferred Shares other than whole
shares shall be valid.
2. SUBMISSION OF ORDERS BY BROKER-DEALERS TO AUCTION AGENT.
(a) Each Broker-Dealer shall submit in writing or through the Auction
Agent's auction processing system to the Auction Agent prior to the
Submission Deadline on each Auction Date all Orders for Preferred Shares of
a Series subject to an Auction on such Auction Date obtained by such
Broker-Dealer, designating itself (unless otherwise permitted by the Fund)
as an Existing Holder in respect of shares subject to Orders submitted or
deemed submitted to it by Beneficial Owners and as a Potential Holder in
respect of shares subject to Orders submitted to it by Potential Beneficial
Owners, and shall specify with respect to each Order for such shares:
(i) the name of the Bidder placing such Order (which shall be the
Broker- Dealer unless otherwise permitted by the Fund);
(ii) the aggregate number of Outstanding Preferred Shares of the
relevant Series that are the subject of such Order;
(iii) to the extent that such Bidder is an Existing Holder of
Preferred Shares:
B-53
(A) the number of Preferred Shares, if any, of such Series
subject to any Hold Order of such Existing Holder;
(B) the number of Preferred Shares, if any, of such Series
subject to any Bid of such Existing Holder and the rate specified
in such Bid; and
(C) the number of Preferred Shares, if any, of such Series
subject to any Sell Order of such Existing Holder; and
(iv) to the extent such Bidder is a Potential Holder of Preferred
Shares, the rate and number of Preferred Shares of such Series
specified in such Potential Holder's Bid.
(b) If any rate specified in any Bid contains more than three figures
to the right of the decimal point, the Auction Agent shall round such rate
up to the next highest one thousandth (.001) of 1%.
(c) If an Order or Orders covering all of the outstanding Preferred
Shares of a Series held by any Existing Holder is not submitted to the
Auction Agent prior to the Submission Deadline, the Auction Agent shall
deem a Hold Order to have been submitted by or on behalf of such Existing
Holder covering the number of Outstanding Preferred Shares of such Series
held by such Existing Holder and not subject to Orders submitted to the
Auction Agent; PROVIDED, HOWEVER, that if an Order or Orders covering all
of the Outstanding Preferred Shares held by any Existing Holder is not
submitted to the Auction Agent prior to the Submission Deadline for an
Auction relating to a Special Rate Period consisting of more than 91 Rate
Period Days, the Auction Agent shall deem a Sell Order to have been
submitted by or on behalf of such Existing Holder covering the number of
Outstanding Preferred Shares of such Series held by such Existing Holder
and not subject to Orders submitted to the Auction Agent.
(d) If one or more Orders of an Existing Holder are submitted to the
Auction Agent covering in the aggregate more than the number of Outstanding
Preferred Shares of a Series subject to an Auction held by such Existing
Holder, such Orders shall be considered valid in the following order of
priority:
(i) all Hold Orders shall be considered valid, but only up to and
including in the aggregate the number of Outstanding Preferred Shares
of such Series held by such Existing Holder, and if the number of
Preferred Shares of such Series subject to such Hold Orders exceeds
the number of Outstanding Preferred Shares of such Series held by such
Existing Holder, the number of shares subject to each such Hold Order
shall be reduced pro rata to cover exactly the number of Outstanding
Preferred Shares of such Series held by such Existing Holder;
(ii) (A) any Bid for shares of a Series shall be considered valid
up to and including the excess of the number of Outstanding Preferred
Shares of such
B-54
Series held by such Existing Holder over the Preferred Shares subject
to any Hold Orders referred to in clause (i) above;
(B) subject to subclause (A), if more than one Bid of an
Existing Holder for Preferred Shares of such Series is submitted
to the Auction Agent with the same rate and the number of
Outstanding Preferred Shares of such Series subject to such Bids
is greater than the excess of the number of Outstanding Preferred
Shares of such Series held by such Existing Holder over the
Preferred Shares subject to any Hold Orders referred to in clause
(i) above, such Bids shall be considered valid up to and
including the amount of such excess, and the number of Preferred
Shares subject to each Bid with the same rate shall be reduced
pro rata to cover exactly the number of Preferred Shares of such
Series equal to such excess;
(C) subject to subclauses (A) and (B), if more than one Bid
of an Existing Holder for Preferred Shares of such Series is
submitted to the Auction Agent with different rates, such Bids
shall be considered valid in the ascending order of their
respective rates up to and including the amount of the excess of
the number of Outstanding Preferred Shares of such Series held by
such Existing Holder over the Preferred Shares of such Series
subject to any Hold Orders referred to in clause (i) above; and
(D) in any such event, the number, if any, of such
Outstanding Preferred Shares of such Series subject to any
portion of Bids considered not valid in whole or in part under
this clause (ii) shall be treated as the subject of a Bid for
Preferred Shares of such Series by or on behalf of a Potential
Holder at the rate therein specified; and
(iii) all Sell Orders shall be considered valid up to and
including the excess of the number of Outstanding Preferred Shares of
such Series held by such Existing Holder over the sum of the Preferred
Shares of such Series subject to valid Hold Orders referred to in
clause (i) above and valid Bids referred to in clause (ii) above.
(e) If more than one Bid for one or more shares of a Series is
submitted to the Auction Agent by or on behalf of any Potential Holder,
each such Bid submitted shall be a separate Bid, with the rate and number
of shares therein specified.
(f) Any Order submitted by a Beneficial Owner or a Potential
Beneficial Owner to its Broker-Dealer, or by a Broker-Dealer to the Auction
Agent, prior to the Submission Deadline on any Auction Date, shall be
irrevocable.
(g) The Fund shall not be responsible for a Broker-Dealer's failure to
act in accordance with the instructions of Beneficial Owners or Potential
Beneficial Owners or failure to comply with the Auction Procedures
contained in this Part II of these Articles Supplementary.
B-55
3. DETERMINATION OF SUFFICIENT CLEARING BIDS, WINNING BID RATE AND APPLICABLE
RATE.
(a) Not earlier than the Submission Deadline on each Auction Date for
a Series of Preferred Shares, the Auction Agent shall assemble all valid
Orders submitted or deemed submitted to it by the Broker-Dealers in respect
of shares of such Series (each such Order as submitted or deemed submitted
by a Broker-Dealer being hereinafter referred to individually as a
"Submitted Hold Order," a "Submitted Bid" or a "Submitted Sell Order," as
the case may be, or as a "Submitted Order" and collectively as "Submitted
Hold Orders," "Submitted Bids" or "Submitted Sell Orders," as the case may
be, or as "Submitted Orders") and shall determine:
(i) the excess of the number of Outstanding Preferred Shares of
such Series over the number of Outstanding Preferred Shares of such
Series subject to Submitted Hold Orders (such excess being hereinafter
referred to as the "Available Preferred Shares" of such Series);
(ii) from the Submitted Orders for shares of such Series whether:
(A) the number of Outstanding Preferred Shares of such
Series subject to Submitted Bids of Potential Holders specifying
one or more rates equal to or lower than the Maximum Rate;
exceeds or is equal to the sum of:
(B) the number of Outstanding Preferred Shares of such
Series subject to Submitted Bids of Existing Holders specifying
one or more rates higher than the Maximum Rate; and
(C) the number of Outstanding Preferred Shares of such
Series subject to Submitted Sell Orders
(in the event such excess or such equality exists (other than
because the number of Preferred Shares of such Series in
subclauses (B) and (C) above is zero because all of the
Outstanding Preferred Shares of such Series are subject to
Submitted Hold Orders), such Submitted Bids in subclause (A)
above being hereinafter referred to collectively as "Sufficient
Clearing Bids"); and
(iii) if Sufficient Clearing Bids for shares of such Series
exist, the lowest rate specified in such Submitted Bids (the "Winning
Bid Rate" for such Series) which if:
(A) (I) each such Submitted Bid of Existing Holders
specifying the Winning Bid Rate and (II) all other such Submitted
Bids of Existing Holders specifying lower rates were rejected,
thus entitling such Existing Holders to continue to hold the
Preferred Shares of such Series that are subject to such
Submitted Bids; and
B-56
(B) (I) each such Submitted Bid of Potential Holders
specifying such Winning Bid Rate and (II) all other such
Submitted Bids of Potential Holders specifying lower rates were
accepted, thus entitling such Potential Holders to purchase the
number of Preferred Shares that are subject to such Submitted
Bids;
would result in such Existing Holders described in subclause (A)
above continuing to hold an aggregate number of Outstanding
Preferred Shares of such Series which, when added to the number
of Outstanding Preferred Shares of such Series to be purchased by
such Potential Holders described in subclause (B) above, would
equal not less than the Available Preferred Shares of such
Series.
(b) Promptly after the Auction Agent has made the determinations
pursuant to paragraph 3(a) of this Part II, the Auction Agent shall advise
the Fund of the Maximum Rate for the Series of Preferred Shares for which
an Auction is being held on the Auction Date and, based on such
determination, the Applicable Rate for Preferred Shares of such Series for
the next succeeding Rate Period thereof as follows:
(i) if Sufficient Clearing Bids for Preferred Shares of such
Series exist, that the Applicable Rate for all Preferred Shares of
such Series for the next Succeeding Rate Period thereof shall be equal
to the Winning Bid Rate of such Series so determined;
(ii) if Sufficient Clearing Bids for shares of such Series do not
exist (other than because all of the Outstanding Preferred Shares of
such Series are subject to Submitted Hold Orders), that the Applicable
Rate for all Preferred Shares of such Series for the next succeeding
Rate Period thereof shall be equal to the Maximum Rate for shares of
such Series; or
(iii) if all of the Outstanding Preferred Shares of such Series
are subject to Submitted Hold Orders, that the Dividend Period next
succeeding the Auction for shares of such Series shall automatically
be the same length as the immediately preceding Dividend Period and
the Applicable Rate for all Preferred Shares of such Series for the
next succeeding Dividend Period thereof shall be 80% of the Reference
Rate.
4. ACCEPTANCE AND REJECTION OF SUBMITTED BIDS AND SUBMITTED SELL ORDERS AND
ALLOCATION OF SHARES.
Existing Holders shall continue to hold the Preferred Shares that are
subject to Submitted Hold Orders, and, based on the determinations made pursuant
to paragraph 3(a) of this Part II, the Submitted Bids and Submitted Sell Orders
shall be accepted or rejected by the Auction Agent and the Auction Agent shall
take such other action as set forth below:
(a) If Sufficient Clearing Bids for shares of a Series have been made,
all Submitted Sell Orders shall be accepted with respect to shares of such
Series and, subject to the provisions of paragraphs 4(d) and 4(e) of this
Part II, Submitted Bids with respect
B-57
to shares of such Series shall be accepted or rejected as follows in the
following order of priority and all other Submitted Bids with respect to
shares of such Series shall be rejected:
(i) Existing Holders' Submitted Bids for shares of such Series
specifying any rate that is higher than the Winning Bid Rate for such
Series shall be accepted, thus requiring each such Existing Holder to
sell the Preferred Shares subject to such Submitted Bids;
(ii) Existing Holders' Submitted Bids for shares of such Series
specifying any rate that is lower than the Winning Bid Rate for shares
of such Series shall be rejected, thus entitling each such Existing
Holder to continue to hold the Preferred Shares subject to such
Submitted Bids;
(iii) Potential Holders' Submitted Bids for shares of such Series
specifying any rate that is lower than the Winning Bid Rate for shares
of such Series shall be accepted;
(iv) Each Existing Holder's Submitted Bid for shares of such
Series specifying a rate that is equal to the Winning Bid Rate for
shares of such Series shall be rejected, thus entitling such Existing
Holder to continue to hold the Preferred Shares subject to such
Submitted Bid, unless the number of Outstanding Preferred Shares
subject to all such Submitted Bids shall be greater than the number of
Preferred Shares ("Remaining Shares") equal to the excess of the
Available Preferred Shares of such Series over the number of Preferred
Shares subject to Submitted Bids described in clauses (ii) and (iii)
of this paragraph 4(a), in which event such Submitted Bid of such
Existing Holder shall be rejected in part, and such Existing Holder
shall be entitled to continue to hold Preferred Shares subject to such
Submitted Bid, but only in an amount equal to the number of Preferred
Shares of such Series obtained by multiplying the number of Remaining
Shares by a fraction, the numerator of which shall be the number of
Outstanding Preferred Shares held by such Existing Holder subject to
such Submitted Bid and the denominator of which shall be the aggregate
number of Outstanding Preferred Shares subject to such Submitted Bids
made by all such Existing Holders that specified a rate equal to the
Winning Bid Rate for shares of such Series; and
(v) each Potential Holder's Submitted Bid for shares of such
Series specifying a rate that is equal to the Winning Bid Rate for
shares of such Series shall be accepted but only in an amount equal to
the number of Preferred Shares of such Series obtained by multiplying
the number of shares in the excess of the Available Preferred Shares
of such Series over the number of Preferred Shares subject to
Submitted Bids described in clauses (ii) through (iv) of this
paragraph 4(a) by a fraction, the numerator of which shall be the
number of Outstanding Preferred Shares subject to such
B-58
Submitted Bid and the denominator of which shall be the aggregate
number of Outstanding Preferred Shares subject to such Submitted Bids
made by all such Potential Holders that specified a rate equal to the
Winning Bid Rate for shares of such Series.
(b) If Sufficient Clearing Bids for shares of a Series have not been
made (other than because all of the Outstanding Preferred Shares of such
Series are subject to Submitted Hold Orders), subject to the provisions of
paragraph 4(d) of this Part II, Submitted Orders for shares of such Series
shall be accepted or rejected as follows in the following order of priority
and all other Submitted Bids for shares of such Series shall be rejected:
(i) Existing Holders' Submitted Bids for shares of such Series
specifying any rate that is equal to or lower than the Maximum Rate
for shares of such Series shall be rejected, thus entitling such
Existing Holders to continue to hold the Preferred Shares subject to
such Submitted Bids;
(ii) Potential Holders' Submitted Bids for shares of such Series
specifying any rate that is equal to or lower than the Maximum Rate
for shares of such Series shall be accepted; and
(iii) Each Existing Holder's Submitted Bid for shares of such
Series specifying any rate that is higher than the Maximum Rate for
shares of such Series and the Submitted Sell Orders of each Existing
Holder shall be accepted, thus entitling each Existing Holder that
submitted or on whose behalf was submitted any such Submitted Bid or
Submitted Sell Order to sell the shares of such Series subject to such
Submitted Bid or Submitted Sell Order, but in both cases only in an
amount equal to the number of Preferred Shares of such Series obtained
by multiplying the number of Preferred Shares of such Series subject
to Submitted Bids described in clause (ii) of this paragraph (b) by a
fraction, the numerator of which shall be the number of Outstanding
Preferred Shares of such Series held by such Existing Holder subject
to such Submitted Bid or Submitted Sell Order and the denominator of
which shall be the aggregate number of Outstanding Preferred Shares of
such Series subject to all such Submitted Bids and Submitted Sell
Orders.
(c) If all of the Outstanding Preferred Shares of a Series are subject
to Submitted Hold Orders, all Submitted Bids for shares of such Series
shall be rejected.
(d) If, as a result of the procedures described in clause (iv) or (v)
of paragraph 4(a) or clause (iii) of paragraph 4(b) of this Part II, any
Existing Holder would be entitled or required to sell, or any Potential
Holder would be entitled or required to purchase, a fraction of a share of
a Series of Preferred Share on any Auction Date, the Auction Agent shall,
in such manner as it shall determine in its sole discretion, round up or
down the number of Preferred Shares of such Series to be purchased or sold
by any Existing Holder or Potential Holder on such Auction Date as a result
of such procedures so that the number of shares so purchased or sold by
each Existing Holder or Potential Holder on such Auction Date shall be
whole Preferred Shares.
B-59
(e) If, as a result of the procedures described in clause (v) of
paragraph 4(a) of this Part II, any Potential Holder would be entitled or
required to purchase less than a whole share of a Series of Preferred Share
on any Auction Date, the Auction Agent shall, in such manner as it shall
determine in its sole discretion, allocate Preferred Shares of such Series
for purchase among Potential Holders so that only whole shares of Preferred
Shares of such Series are purchased on such Auction Date as a result of
such procedures by any Potential Holder, even if such allocation results in
one or more Potential Holders not purchasing Preferred Shares of such
Series on such Auction Date.
(f) Based on the results of each Auction for shares of a Series of
Preferred Shares, the Auction Agent shall determine the aggregate number of
Preferred Shares of such Series to be purchased and the aggregate number of
Preferred Shares of such Series to be sold by Potential Holders and
Existing Holders and, with respect to each Potential Holder and Existing
Holder, to the extent that such aggregate number of shares to be purchased
and such aggregate number of shares to be sold differ, determine to which
other Potential Holder(s) or Existing Holder(s) they shall deliver, or from
which other Potential Holder(s) or Existing Holder(s) they shall receive,
as the case may be, Preferred Shares of such Series. Notwithstanding any
provision of the Auction Procedures to the contrary, in the event an
Existing Holder or Beneficial Owner of shares of a Series of Preferred
Shares with respect to whom a Broker-Dealer submitted a Bid to the Auction
Agent for such shares that was accepted in whole or in part, or submitted
or is deemed to have submitted a Sell Order for such shares that was
accepted in whole or in part, fails to instruct its Agent Member to deliver
such shares against payment therefor, partial deliveries of Preferred
Shares that have been made in respect of Potential Holders' or Potential
Beneficial Owners' Submitted Bids for shares of such Series that have been
accepted in whole or in part shall constitute good delivery to such
Potential Holders and Potential Beneficial Owners.
(g) Neither the Fund nor the Auction Agent nor any affiliate of either
shall have any responsibility or liability with respect to the failure of
an Existing Holder, a Potential Holder, a Beneficial Owner, a Potential
Beneficial Owner or its respective Agent Member to deliver Preferred Shares
of any Series or to pay for Preferred Shares of any Series sold or
purchased pursuant to the Auction Procedures or otherwise.
5. TRANSFER OF PREFERRED SHARES.
Unless otherwise permitted by the Fund, a Beneficial Owner or an Existing
Holder may sell, transfer or otherwise dispose of Preferred Shares only in whole
shares and only pursuant to a Bid or Sell Order placed with the Auction Agent in
accordance with the procedures described in this Part II or to a Broker-Dealer;
provided, however, that (a) a sale, transfer or other disposition of Preferred
Shares from a customer of a Broker-Dealer who is listed on the records of that
Broker-Dealer as the holder of such shares to that Broker-Dealer or another
customer of that Broker-Dealer shall not be deemed to be a sale, transfer or
other disposition for purposes of this paragraph 5 if such Broker-Dealer remains
the Existing Holder of the shares so sold, transferred or disposed of
immediately after such sale, transfer or disposition and (b) in the case of all
transfers other than pursuant to Auctions, the Broker-Dealer (or other Person,
if permitted by the Fund) to whom such transfer is made shall advise the Auction
Agent of such transfer.
B-60
6. GLOBAL CERTIFICATE.
Prior to the commencement of a Voting Period, (i) all of the Preferred
Shares of a Series outstanding from time to time shall be represented by one
global certificate registered in the name of the Securities Depository or its
nominee and (ii) no registration of transfer of Preferred Shares shall be made
on the books of the Fund to any Person other than the Securities Depository or
its nominee.
7. FORCE MAJEURE.
(a) Notwithstanding anything else set forth herein, if an Auction Date
is not a Business Day because the New York Stock Exchange is closed for
business due to an act of God, natural disaster, extreme weather, act of
war, civil or military disturbance, act of terrorism, sabotage, riots or a
loss or malfunction of utilities or communications services, or if the
Auction Agent is not able to conduct an Auction in accordance with the
Auction Procedures for any such reason, then the Applicable Rate for the
next Dividend Period shall be the Applicable Rate determined on the
previous Auction Date.
(b) Notwithstanding anything else set forth herein, if a Dividend
Payment Date is not a Business Day because the New York Stock Exchange is
closed for business due to an act of God, natural disaster, extreme
weather, act of war, civil or military disturbance, act of terrorism,
sabotage, riots or a loss or malfunction of utilities or communications
services, or if the dividend payable on such date can not be paid for any
such reason, then:
(i) The Dividend Payment Date for the affected Dividend Period
shall be the next Business Day on which the Fund and the Auction Agent
are able to cause the dividend to be paid using commercially
reasonable best efforts;
(ii) The affected Dividend Period shall end on the day it would
have ended had such event not occurred and the Dividend Payment Date
had remained the scheduled date; and
(iii) The next Dividend Period will begin and end on the dates on
which it would have begun and ended had such event not occurred and
the Dividend Payment Date remained the scheduled date
8. AUCTION AGENT. For so long as any Preferred Shares are outstanding, the
Auction Agent, duly appointed by the Fund so to act, shall be in each case
a commercial bank, Fund company or other institution independent of the
Fund and its Affiliates (which, however, may engage or have engaged in
business transactions with the Fund or its Affiliates), and at no time
shall the Fund or any of its Affiliates act as the Auction Agent in
connection with the Auction Procedures. If the Auction Agent resigns or for
any reason its appointment is terminated during any period that any
Preferred Shares are outstanding, the Directors shall attempt to appoint
another qualified commercial bank, Fund company or other institution to act
as the Auction Agent. The Auction Agent's registry of Existing Holders of
the Preferred Shares shall be conclusive and binding on the Broker-Dealers.
B-61
IN WITNESS WHEREOF, F&C/CLAYMORE PREFERRED SECURITIES INCOME FUND
INCORPORATED has caused these presents to be signed on April __, 2003 in its
name and on its behalf by its Chief Executive Officer, and its corporate seal to
be hereunto affixed and attested by its Secretary.
The undersigned, who executed on behalf of the Fund the foregoing Articles
Supplementary, hereby acknowledges the foregoing Articles Supplementary to be
the corporate act of the Fund and hereby certifies to the best of his knowledge,
information, and belief that the matters and facts set forth herein with respect
to the authorization and approval thereof are true in all material respects
under the penalties of perjury.
By: /s/ Donald F. Crumrine
------------------------------------
Chief Executive Officer
ATTEST:
/s/ R. Eric Chadwick
----------------------------------
Secretary
B-62
PART C
OTHER INFORMATION
ITEM 24. FINANCIAL STATEMENTS AND EXHIBITS
(1) Financial Statements:
Part A -- None
Part B -- Report of Independent Accountants
-- Schedule of Investments as of March 31, 2003 (unaudited)
-- Statement of Assets and Liabilities as of
March 31, 2003 (unaudited)
-- Statement of Operations for the Period January 31, 2003
(commencement of operations) to March 31, 2003 (unaudited)
-- Statement of Changes in Net Assets for the Period
January 31, 2003 (commencement of operations) to
March 31, 2003 (unaudited)
(2) Exhibits:
(a) (1) Articles of Incorporation*
(2) Amended and Restated Articles of Incorporation***
(3) Form of Articles Supplementary
(b) (1) By-Laws***
(2) Amendment to By-Laws***
(c) Not applicable.
(d) (1) Specimen certificate for Common Stock, par value $.01 per
share***
(2) Form of specimen stock certificate representing shares of
preferred stock
(e) Dividend Reinvestment and Cash Purchase Plan
(f) Not applicable.
(g) Investment Advisory Agreement between the Fund and Flaherty &
Crumrine Incorporated ("F&C")
(h) (1) Purchase Agreement with Merrill Lynch & Co. for the issuance
of common stock
(2) Purchase Agreement with Merrill Lynch & Co. for the issuance
of preferred stock
(i) Not applicable.
(j) (1) Custodian Services Agreement between the Fund and PFPC Trust
Company
(k) (1) Transfer Agency and Registrar Agreement between the Fund and
PFPC Inc.
(2) Administration Agreement between the Fund and PFPC Inc.
(3) Services Agreement between the Fund and Claymore Securities,
Inc. ("Claymore")
(4) Form of Auction Agency Agreement between the Fund and
Deutsche Bank Trust Company Americas
(5) Form of Broker-Dealer Agreement between the Fund and Merrill
Lynch & Co.
(6) Form of Letter of Representations
(7) Additional Compensation Agreement between F&C and Merrill
Lynch & Co.***
(l) (1) Opinion and Consent of Willkie Farr & Gallagher
(2) Opinion and Consent of Venable, Baetjer and Howard, LLP
(m) Not applicable.
C-1
(n) (1) Consent of KPMG, LLP
(2) Power of Attorney**
(o) Not applicable.
(p) Purchase Agreement
(q) Not applicable.
(r) (1) Code of Ethics of the Fund***
(2) Code of Ethics of F&C***
(3) Code of Ethics of Claymore***
---------------------
* Incorporated by reference to the registrant's Registration Statement on
Form N-2, filed June 26, 2002.
** Incorporated by reference to registrant's Registration Statement on
Form N-2, filed March 14, 2003.
*** Incorporated by reference to Pre-Effective Amendment No. 2 to the
registrant's Registration Statement on Form N-2, filed January 28, 2003.
ITEM 25. MARKETING ARRANGEMENTS
Reference is made to the Form of Purchase Agreement for the Preferred
Shares to be filed as Exhibit h(2).
ITEM 26. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The approximate expenses in connection with the offering, all of which
are being borne by the Registrant, are as follows:
SEC Registration Fees $47,696
Printing Expenses $35,000
Legal Fees and Expenses $165,000
Auditing Fees and Expenses $25,000
Rating Agency Fees $165,000
Miscellaneous $37,304
------------------
Total $475,000
==================
ITEM 27. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT
None.
ITEM 28. NUMBER OF HOLDERS OF SECURITIES
As of April 11, 2003
TITLE OF CLASS NUMBER OF RECORD HOLDERS
------------------------------------------ ------------------------
Common Stock, par value $.01 per share 94
Preferred Stock, par value $.01 per share 0
C-2
ITEM 29. INDEMNIFICATION
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).
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)
C-3
PFPC, Inc.
P.O. Box 8030
Boston, MA 02266
(with respect to its services as Administrator, Transfer
Agent, Registrar and Dividend-Paying Agent with respect to the
Fund's Common Stock)
PFPC Trust Company
P.O. Box 8030
Boston, MA 02266
(with respect to its services as Custodian for the Fund's assets)
ITEM 32. MANAGEMENT SERVICES
Not applicable.
ITEM 33. UNDERTAKINGS
(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.
C-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 14th day of
April, 2003.
F&C/CLAYMORE PREFERRED SECURITIES
INCOME FUND INCORPORATED
By: /s/ Donald F. Crumrine
----------------------
Donald F. Crumrine
Chief Executive Officer
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/ Donald F. Crumrine Director, Chairman of April 14, 2003
---------------------- the Board and
Donald F. Crumrine Chief Executive Officer
/s/ Peter C. Stimes Chief Financial Officer April 14, 2003
----------------------
Peter C. Stimes
/s/ Martin Brody* Director April 14, 2003
----------------------
Martin Brody
/s/ Nicholas Dalmaso* Director April 14, 2003
----------------------
Nicholas Dalmaso
/s/ David Gale* Director April 14, 2003
----------------------
David Gale
/s/ Morgan Gust* Director April 14, 2003
----------------------
Morgan Gust
/s/ Robert F. Wulf* Director April 14, 2003
----------------------
Robert F. Wulf
* Signatures affixed by Donald F. Crumrine pursuant to a power of attorney
dated March 14, 2003, which was filed with the Registrant's Registration
Statement on Form N-2 (File Nos. 333-103841 and 811-21129) on March 14, 2003.