As filed with the Securities and Exchange Commission on March 14, 2003
Securities Act File No. 333-_____
Investment Company Act File No. 811-21129
U.S. Securities And Exchange Commission
Washington, D.C. 20549
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FORM N-2
(CHECK APPROPRIATE BOX OR BOXES)
[x] REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
[ ] Pre-Effective Amendment No.
[ ] Post-Effective Amendment No.
and/or
[x] REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
[x] Amendment No. 3
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F&C/Claymore Preferred Securities Income Fund Incorporated
(Exact Name of Registrant as Specified In Charter)
-------------------
301 E. Colorado Boulevard
Pasadena, California 91101
(Address of Principal Executive Offices)
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)
-------------------
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 Rate Preferred Stock, 40 shares $25,000 $1,000,000 $80.90
$0.01 par value
(1) As calculated pursuant to Rule 457(c) under the Securities Act of 1933, as
amended.
(2) Transmitted prior to filing.
-------------------
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
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.
SUBJECT TO COMPLETION
PRELIMINARY PROSPECTUS DATED , 2003
PROSPECTUS
[F&C LOGO] [CLAYMORE LOGO]
$
F&C/CLAYMORE PREFERRED SECURITIES
INCOME FUND INCORPORATED
AUCTION RATE PREFERRED SHARES ("PREFERRED SHARES")
SHARES, SERIES M
SHARES, SERIES T
SHARES, SERIES W
SHARES, SERIES TH
SHARES, SERIES F
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 Auction Rate Preferred Shares
("Preferred Shares") in [ ] separate series: Series M, Series T,
Series W, Series Th and Series F. The Preferred Shares will not be
listed on any exchange. Generally, investors may only buy and sell the Preferred
Shares 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 Preferred Shares, 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 PREFERRED SHARES INVOLVES RISKS THAT ARE DESCRIBED IN
"RISKS OF THE FUND" BEGINNING ON PAGE OF THIS PROSPECTUS. CERTAIN OF THESE
RISKS ARE SUMMARIZED IN "PROSPECTUS SUMMARY--RISKS OF THE FUND" BEGINNING ON
PAGE OF THE PROSPECTUS. THE MINIMUM PURCHASE AMOUNT OF THE PREFERRED SHARES IS
$25,000.
----------------
PER SHARE TOTAL
--------- -----
Public offering price............................ $25,000 $
Sales load....................................... $250 $
Proceeds, before expenses, to the Fund(1)........ $24,750 $
------------------
(1) Not including offering expenses payable by the Fund estimated to be
$ .
The public offering price per share will be increased by the amount of
dividends, if any, that have accumulated from the date the Preferred Shares 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 Preferred Shares subject to various
conditions. The underwriters expect to deliver the Preferred Shares, in
book-entry form, through the facilities of The Depository Trust Company on or
about , 2003.
----------------------------
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 , 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 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 Preferred Shares will be entitled to receive cash dividends
at an annual rate that may vary for the successive dividend periods for the
Preferred Shares. The dividend rate for the initial dividend period for each
Series will be as follows: Series M -- %, Series T -- %, Series W -- %,
Series Th -- % and Series F -- %. The initial dividend period for the
Preferred Shares is from the date of issuance through the following applicable
dates: Series M -- May , 2003; Series T -- May , 2003; Series W -- May ,
2003; Series Th -- May , 2003; and Series F -- June , 2003. For subsequent
dividend periods, the Preferred Shares will pay dividends based on a rate
generally set at auctions held every seven days for Series , , , and and
every 28 days for Series . After the initial rate period described in this
prospectus, investors may generally only buy or sell Preferred Shares through an
order placed at an auction with or through a broker-dealer in accordance with
the procedures specified in this prospectus. 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
Preferred Shares 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 Preferred Shares will be maintained in book-entry form by
or through The Depository Trust Company (or any successor securities
depository).
The Preferred Shares, which have no history of public trading, are not
listed on an exchange. Broker-dealers may maintain a secondary trading market in
the Preferred Shares outside of the auctions; however, they have no obligation
to do so, and there can be no assurance that a secondary market for the
Preferred Shares 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 Preferred Shares, and an investor that sells
Preferred Shares between auctions may receive a price per share of less than
$25,000.
The Preferred Shares 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 Preferred Shares have a
liquidation preference of $25,000 per share, plus any accumulated, unpaid
dividends. The Preferred Shares also have priority over the Common Shares as to
distribution of assets. See "Description of Preferred Shares." The Fund may
redeem Preferred Shares as described under "Description of Preferred
Shares-Redemption." It is a condition of closing this offering that the
Preferred Shares be offered with a rating of "Aaa" from Moody's Investors
Service, Inc. ("Moody's") and of " " from (" ").
The Preferred Shares 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
----
Table of Contents................................. 3
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 Preferred Shares................... 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 PREFERRED SHARES. 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 April , 2003, the Fund had Common
Shares outstanding and assets of approximately $ .
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 Preferred Shares, $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 Preferred Shares. separate series
are being offered: Series M, Series T, Series W,
Series Th and Series F. The Preferred Shares are being
offered by a group of underwriters led by
(" ").
The Preferred Shares entitle their holders to receive cash
dividends at an annual rate that may vary for the
successive dividend periods for the Preferred Shares. In
general, except as described under "Description of
Preferred Shares--Dividends and Rate Periods," the
dividend period for the Series , , , and Preferred
Shares will be seven days and the dividend period for the
Series Preferred Shares 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 Preferred Shares are not listed on an exchange.
Instead, investors will generally buy or sell Preferred
Shares in an auction by submitting orders to
broker-dealers that have entered into an agreement with
the auction agent.
Generally, investors in Preferred Shares 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
Preferred Shares in book-entry form. An investor's
broker-dealer, in turn, will maintain records of that
investor's beneficial ownership of Preferred Shares.
ADVISER AND Flaherty & Crumrine Incorporated (the "Adviser"), a
SERVICING AGENT... registered investment adviser, acts as the Fund's
investment adviser. The Adviser has been active in the
management of portfolios of
4
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 $ 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
Preferred Shares 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
Preferred Shares 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 Preferred Shares
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 and 0.03% on assets in excess of $500 million. 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 and 0.005% on
assets above $500 million. See "Management of the
Fund--Administrative Services."
5
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 "short
position in a futures contract"), (3) entering into
interest rate swap agreements as a "fixed rate payer",
and/or
6
(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.
CONVERTIBLE SECURITIES AND COMMON STOCK. Certain
traditional and hybrid preferred securities are
convertible into the common stock
7
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 Preferred Shares, the Preferred Shares
(together with any other outstanding forms of leverage)
will represent approximately % of the Fund's total man-
aged assets. This amount may vary, but the Fund will not
incur leverage (including Preferred Shares 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 Preferred Shares)
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 Preferred Shares
offered in this prospectus.
As an alternative to Preferred Shares (during periods in
which no Preferred Shares are outstanding), the Fund may
incur leverage through the issuance of commercial paper or
notes or other borrowings. Any Preferred Shares 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 Preferred Shares and other leverage), the Adviser
has a financial incentive for the Fund to issue the
Preferred Shares 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 Preferred Shares and the Fund, you should
consider the risks carefully. The following paragraphs
summarize certain important risks to which the Fund and
the Preferred Shares are subject. For a more detailed
discussion of these risks, see "Risks of the Fund."
RISKS OF INVESTING IN THE PREFERRED SHARES
The primary risks of investing in the Preferred Shares
include:
DIVIDEND PAYMENT RISK. The Fund will not be permitted to
declare dividends or other distributions with respect to
the Preferred Shares 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
Preferred Shares.
REDEEMABILITY. Unlike shares of an open-end mutual fund,
including a money market mutual fund, the Preferred Shares
may not be redeemed at the option of the holder.
INTEREST RATE RISK. The Preferred Shares 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, fluc-
tuate. If shorter-term interest rates rise, dividend rates
on Preferred Shares may rise so that the amount of
dividends paid to holders of Preferred Shares 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 Preferred Shares offering) is available to pay divi-
dends on Preferred Shares, however, dividend rates on
Preferred Shares 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 Preferred
Shares 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 Preferred Shares.
AUCTION RISK. You may not be able to sell your Preferred
Shares at an auction if the auction fails, i.e., if there
are more Preferred Shares offered for sale than there are
buyers for those shares. Also, if you place a bid order
(an order to retain Preferred Shares) 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 Preferred Shares, and you will not
retain your Preferred Shares. Additionally, if you buy
Preferred Shares or elect to retain Preferred Shares
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 Preferred Shares than the market rate for
similar investments. The dividend period for the
9
Preferred Shares may be changed by the Fund, subject to
certain conditions and with notice to the holders of the
Preferred Shares, which could also affect the liquidity of
your investment. See "Description of Preferred Shares" and
"The Auction."
SECONDARY MARKET RISK. If you try to sell your Preferred
Shares 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
Preferred Shares in the secondary market, particularly if
the Fund has designated a special rate period (a dividend
period of more than seven days for Series , , and and of
more than 28 days for Series ). Broker-dealers that
maintain a secondary trading market (if any) for the
Preferred Shares 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 Preferred Shares are not
registered on a stock exchange or The Nasdaq Stock
Market, Inc. ("NASDAQ"). If you sell your Preferred
Shares 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 assigns a rating of " " to
the Preferred Shares, these ratings do not eliminate or
necessarily mitigate the risks of investing in Preferred
Shares. In addition, Moody's, or another rating
agency rating the Preferred Shares could downgrade the
Preferred Shares, which may make your shares less liquid
at an auction or in the secondary market. If a rating
agency downgrades the Preferred Shares, 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 Preferred Shares. In addition, the Fund may be forced
to redeem your Preferred Shares to meet regulatory or
rating agency requirements. The Fund may also voluntarily
redeem Preferred Shares under certain circumstances. See
"Description of Preferred Shares--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
Preferred Shares--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 Preferred Shares, both by the
1940 Act and by requirements
10
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 Preferred Shares 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 Preferred Shares. In addition, the
value of the Fund's investment portfolio may decline,
reducing the asset coverage for the Preferred Shares. 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
Preferred Shares and make it more difficult for the Fund
to pay dividends on the Preferred Shares.
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
Preferred Shares. 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 Preferred
Shares. 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
11
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 Preferred Shares may
tend to magnify interest rate risk. See "Investment
Objective and Policies--Risks of the Fund."
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 Preferred Shares. 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 Preferred Shares. 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
12
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 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.
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
13
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 amendments or
supplements thereto, including any articles supplemen-
tary, the "Articles" or "Articles of Incorporation") to
convert the Fund to an open-end investment company, which
would result in the redemption of any Preferred Shares
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 Preferred Shares. 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
14
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.
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 Preferred Shares.
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 Preferred Shares 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
Preferred Shares 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 Preferred Shares will not be listed on a stock
exchange. Instead, you may buy or sell Preferred Shares 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 Preferred Shares, but
may
15
discontinue this activity at any time. You may transfer
Preferred Shares 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 Preferred Shares will
develop or, if it does develop, that it will provide
holders of Preferred Shares with liquidity of investment.
See "The Auction."
RATINGS............. The Fund will issue the Preferred Shares only if the
Preferred Shares have received a credit quality rating of
"Aaa" from Moody's and of " " from . 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
do not eliminate or mitigate the risks of investing
in the Preferred Shares. These ratings may be changed,
suspended or withdrawn in the rating agencies' dis-
cretion. 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 Preferred Shares. For
subsequent dividend periods, the Preferred Shares will
normally pay dividends based on a rate set at auctions
held every seven days for Series , , and and every 28
days for Series . 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 maximum rate. See "Description of Preferred
Shares--Dividends and Rate Periods."
Dividends on the Preferred Shares 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
------ -------- ------------ --------------- -----------
M % , 2003 Every Monday
T % , 2003 Every Tuesday
W % , 2003 Every Wednesday
Th % , 2003 Every Thursday
F % , 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 , , and Preferred Shares and more than 28
days for the Series Preferred Shares. The Fund
may not designate a special rate period unless
sufficient clearing
16
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
or any substitute rating agency that the
proposed special rate period will not adversely
affect such agency's then-current rating on the
Preferred Shares and the lead Broker-Dealer
designated by the Fund, initially , 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 Preferred Shares--Dividends and
Rate Periods."
LIQUIDATION PREFERENCE............................ If the Fund is liquidated, the Fund must pay to
holders of Preferred Shares $25,000 per share,
plus accumulated but unpaid dividends, if any,
whether or not earned or declared. See
"Description of Preferred Shares--Liquidation."
ASSET MAINTENANCE................................. Under the Fund's Articles Supplementary (the
"Articles Supplementary"), which establish and fix
the rights and preferences of the Preferred
Shares, the Fund must maintain:
- asset coverage on the Preferred Shares as
required by the rating agencies rating the
Preferred Shares, and
- asset coverage of at least 200% with respect to
senior securities that are stock, including the
Preferred Shares, as discussed in "Description
of Preferred Shares--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 Preferred Shares will be
subject to mandatory redemption. Please see the
Articles Supplementary, which is attached as
Appendix B to the SAI. See "Description of
Preferred Shares--Redemption."
Based on the composition of the Fund's portfolio
as of , 2003, the Fund estimates that
the asset coverage of the Preferred Shares, as
measured pursuant to the 1940 Act and the
rules and regulations thereunder, would be
approximately % if the Fund were to issue all
of the Preferred Shares offered in this
prospectus, representing approximately % 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 Preferred
Shares if it fails to meet the asset coverage
tests required by the 1940 Act or the rating
agencies rating the Preferred Shares and fails to
correct such a failure in a timely manner. The
Fund may voluntarily redeem Preferred Shares, in
whole or in part, under certain circumstances. See
"Description of Preferred Shares--
17
Redemption." Although the Preferred Shares are
subject to redemption under certain circumstances,
unlike the shares of an open-end investment
company, the Preferred Shares may not be redeemed
at a shareholder's option.
VOTING RIGHTS..................................... The 1940 Act requires that the holders of
Preferred Shares 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 Preferred Shares or any other preferred
shares are unpaid until all unpaid dividends on
the Preferred Shares and any other preferred
shares are paid or otherwise provided for by the
Fund. The holders of Preferred Shares 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 Preferred Shares--Voting Rights."
Each Common Share, each share of Preferred Shares,
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 Preferred
Shares (other than certain distributions in
redemption of Preferred Shares) 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
Preferred Shares. 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.
will act as auction agent,
transfer agent, dividend paying agent and
redemption agent for the Preferred Shares.
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).................................... $
Less Offering Costs Charged to Additional Paid
in Capital....................................
--------
--------
Net Investment Income(2)........................
Net Realized and Unrealized Gain (Loss) on
Investments...................................
--------
Total from Investment Operations................
--------
Net Asset Value, End of Period (Common
Shares)....................................... $
========
Market Value, End of Period (Common Shares)..... $
Total Return on Market Value (%)(3).............
Total Return on Net Asset Value (%)(3)..........
RATIOS/SUPPLEMENTAL DATA:
Ratio of Expenses to Average Net Assets
Applicable to Common Shares (%)............... (4)
Ratio of Net Investment Income to Average Net
Assets (%).................................... (4)
Portfolio Turnover Rate (%).....................
Net Assets Applicable to Common Shares, End of
Period (000).................................. $
-------------------
* Commencement of operations.
(1) Net asset value at beginning of period reflects the deduction of the sales
load of $1.125 per share paid by the shareholder from the $25.00 offering
price.
(2) Computed using average Common Shares outstanding.
(3) 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 paid by the
shareholder on the first day 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 first day and a 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.
(4) 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 , 2003, respectively, such underwriters
purchased, at a price of $23.875 per Common Share, an additional 2,500,000 and
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 Preferred Shares will be approximately
$ , 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
Preferred Shares offered hereby (including estimated offering expenses and sales
load of $ ).
ACTUAL AS ADJUSTED
------ -----------
Preferred Shares, $0.01 par value
(no shares issued;
shares issued, as adjusted, at
$25,000 per share liquidation
preference)..................... $ 0 $
Common Shares, $0.01 par value,
240,000,000 shares authorized,
shares issued and
outstanding..................... $ $
Undistributed net investment
income.......................... $ $
Accumulated net realized gain/loss
on investment transactions...... $ $
Net unrealized
appreciation/(depreciation) on
investments..................... $ $
Net assets attributable to Common
Shares plus liquidation value of
Preferred Shares................ $ $
PORTFOLIO COMPOSITION
As of March 31, 2003, % of the market value of the Fund's portfolio was
invested in preferred securities, % in money market securities, % in
common equity securities and % in debt. 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 Preferred
Shares), voting as a separate class. See "Description of Preferred
Shares--Voting Rights" for additional information with respect to the voting
rights of holders of Preferred Shares. No assurance can be given that the Fund's
investment objective will be achieved.
The Fund pursues its investment objective by investing in a diversified
portfolio primarily consisting of preferred securities. In seeking its
objective, the Fund will normally invest at least 80% of its total assets in a
diversified portfolio of preferred securities. Under current market conditions,
the Fund expects that its portfolio of preferred securities will consist
principally of "hybrid" or taxable preferreds. 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. The Fund may invest
in other types of preferred securities--such as auction rate preferred stocks
and
21
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 Preferred Shares. The Fund may invest up to 5% of its
total assets in each of options on securities and options on stock indices, up
to 10% of its total assets in each of initial margin deposits on futures
contracts and premiums paid for options thereon, and up to 5% of its total
assets for time premiums paid for swaptions. However, under current market
conditions, it is expected that up to an aggregate of 15% of the Fund's total
assets could be invested in options on securities and stock indices, initial
margin deposits and option premiums paid in connection with futures
transactions, and initial margin deposits and options premiums paid in
connection with interest rate swaps and swaptions. (See "Investment
Techniques--Futures Contracts and Options on Futures Contracts" for a discussion
of the limitations and risks associated with investments in futures contracts
and options on futures contracts. See also "Investment Techniques--Interest Rate
Swaps and Options Thereon ("Swaptions")" for a discussion of the limitations and
risks associated with positions in interest rate swaps and options thereon.) The
portion of the Fund's assets not invested in preferred securities and hedging
instruments may be invested in, among other securities, money market
instruments, money market mutual funds, corporate debt securities, asset-backed
securities, and securities issued or guaranteed by the U.S. Government, its
agencies or instrumentalities ("Government Securities"), which, depending on
market conditions, may at times have a higher or lower yield than preferred
securities in which the Fund invests. Under normal conditions, the Fund's
investments in such debt securities is limited to 20% of its total assets. Under
normal conditions, the Fund may also invest up to 15% of its total assets in
common stocks or convertible securities which trade in close relationship to
their underlying associated common stocks.
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 Preferred
Shares.
Coupon rates on fixed rate preferred and debt securities held by the Fund,
as their name implies, would be fixed regardless of the direction of interest
rates. In addition, the market prices of such securities would tend to
(1) decline as interest rates rose and (2) rise as interest rates fell.
Adjustable rate securities pay income that generally rises as interest rates
rise and falls as interest rates decline, often subject to minimum income floors
and maximum income ceilings (often called "collars"). All other things being
equal, adjustable rate preferreds will tend to have somewhat less price
variability than would fixed rate securities of comparable maturity.
Nevertheless, changing interest rate conditions may still affect adjustable rate
preferred stocks' principal value, which may expose the Fund to risk of loss.
See "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 Preferred Shares 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 Preferred Shares. 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 Preferred Shares 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 Preferred Shares. 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 Preferred
Shares, 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 Preferred Shares, 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 Preferred Shares would be expected
to rise while coupon rates on the Fund's holdings of fixed rate and adjustable
rate securities would remain unchanged (with certain exceptions in the case of
adjustable rate securities whose income would rise if short term rates were to
exceed long term rates by a sufficiently wide margin). See "Investment Objective
and Policies--Portfolio Investments--Adjustable Rate Preferred Stock."
However, such a hypothesized change in the relationship between short-term
and long-term rates also would be expected to reduce the cost of hedging
preferred and debt securities, regardless of whether such hedges were in futures
contracts, interest rate swaps, long positions in put options, or holdings of
pay fixed swaptions. The combined impact of the foregoing factors on the Fund's
net income would depend in large measure on the relative size of the Fund's
holdings of hedged preferred and debt securities and the hedging instruments
utilized.
In the opposite case, namely, a decline in short-term rates with long-term
rates remaining unchanged, the income from fixed rate and, for the most part,
adjustable rate securities would be unaffected. Under certain circumstances, the
income from adjustable rate securities may be adversely affected. The cost of
the Fund's outstanding Preferred Shares would be expected to fall. On balance,
these various movements would contribute to a higher net return to the Fund.
However, in this interest rate environment, there would be an expected increase
in the cost of hedging preferred and debt securities. The combined impact of the
foregoing factors on the Fund, as under the scenario 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 Preferred Shares imposed by Moody's or 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 Preferred Shares, and to facilitate the payment of
expenses and settlement of trades. As noted above, pending investment of the net
proceeds of this offering in accordance with the Fund's investment objective and
policies, the Fund may invest without limitation in money market instruments. In
addition, when the Adviser believes that economic circumstances warrant a
temporary defensive posture, the Fund may invest in short-term money market
instruments without regard to the normal 15% limitation. To the extent the Fund
invests in short-term money market instruments, it may not be pursuing its
investment objective of high current income.
Money market instruments that the Fund may acquire will be securities rated
in the highest short-term rating category by Moody's or S&P or the equivalent
from another major rating service, securities of issuers that have received such
ratings with respect to other short-term debt or comparable unrated securities.
Money market instruments in which the Fund typically expects to invest include:
Government Securities; bank obligations (including certificates of deposit, time
deposits and bankers' acceptances of U.S. or foreign banks); commercial paper
rated P-1 by Moody's or A-1 by S&P; and repurchase agreements. Money market
funds in which the Fund may invest, are expected to be rated "Aaa" by one or
more rating agencies.
As indicated above, the Fund may invest normally up to 15% of its total
assets in money market instruments but, under certain circumstances, may invest
without limit in money market instruments. Subject to these limits, the Fund may
invest up to 25% of its total assets in U.S. dollar-denominated money market
obligations of foreign banks or foreign branches of U.S. banks but will do so
only if the Adviser determines that the obligation presents minimal credit
risks. These obligations entail risks that are different from those of
investments in obligations of U.S. banks. These risks include foreign economic
and political developments, foreign governmental restrictions that may adversely
affect payment of principal and interest on the obligations, foreign exchange
controls and foreign withholding or other taxes on income. Foreign branches of
U.S. banks are not necessarily subject to the same or similar regulatory
requirements that apply to the domestic operations of U.S. banks, such as
mandatory reserve requirements, loan limitations and accounting, auditing and
financial record-keeping requirements. In addition, less information may be
publicly available about a foreign branch of a U.S. bank than about a U.S. bank.
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 Preferred Shares), voting as a separate class, as described under
"Description of Preferred Shares--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 Preferred Shares. See "Description of Preferred Shares--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 Preferred Shares 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 Preferred Shares, 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 Preferred Shares, so long
as the relevant rating agency(ies) has given written notice that such revisions
would not adversely affect the rating of the Preferred Shares then in effect.
The Board of Directors has currently limited the Fund's use of interest rate
swaps and swaptions as follows: (1) swaps and swaptions must be U.S. dollar
denominated and used for hedging purposes only; (2) no more than 5% of the
Fund's total assets, at the time of purchase, may be invested in time premiums
paid for swaptions; (3) swaps and swaptions must conform to the standards of the
ISDA Master Agreement; and (4) the counterparty must be a bank or broker/dealer
firm regulated under the laws of the United States of America that is (a) on a
list approved by the Fund's Board, (b) with capital of at least $100 million,
and (c) which is rated investment grade by both Moody's and S&P. These criteria
can be modified by the Board at any time in its discretion.
The Fund's Adviser expects that the Fund will be subject to the initial and
subsequent mark-to-market collateral requirements that are standard among ISDA
participants. These requirements help insure that the party who is a net obligor
at current market value has pledged for safekeeping, to the counterparty,
sufficient collateral to cover any losses should the obligor become incapable,
for whatever reason, of fulfilling its commitments under the swap or swaption
agreements. This is analogous, in many respects, to the collateral requirements
in place on regular futures and options exchanges. As long as the Fund is a
purchaser of swaptions, 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
38
replacement will not be as favorable as on the expiring transaction. If this
occurs, it could have a negative impact on the performance of the Fund.
While the Fund may utilize interest rate swaps and swaptions for hedging
purposes, their use might result in poorer overall performance for the Fund than
if it had not engaged in any such transactions. If, for example, the Fund had
insufficient cash, it might have to sell or pledge a portion of its underlying
portfolio of securities in order to meet daily mark-to-market collateralization
requirements at a time when it might be disadvantageous to do so. There may be
an imperfect correlation between the Fund's portfolio holdings and swaps or
swaptions entered into by the Fund, which may prevent the Fund from achieving
the intended hedge or expose the Fund to risk of loss. Further, the Fund's use
of swaps and swaptions to reduce risk involves costs and will be subject to the
Adviser's ability to predict correctly changes in interest rate relationships or
other factors. No assurance can be given that the Adviser's judgment in this
respect will be correct.
OPTIONS ON SECURITIES. In order to hedge against adverse market shifts, the
Fund may utilize up to 5% of its total assets to purchase put and call options
on securities. In addition, the Fund may seek to increase its income or may
hedge a portion of its portfolio investments through writing (i.e., selling)
covered put and call options. A put option embodies the right of its purchaser
to compel the writer of the option to purchase from the option holder an
underlying security or its equivalent at a specified price at any time during
the option period. In contrast, a call option gives the purchaser the right to
buy the underlying security or its equivalent covered by the option or its
equivalent from the writer of the option at the stated exercise price. Under
interpretations of the Commission currently in effect, which may change from
time to time, a "covered" call option means that so long as the Fund is
obligated as the writer of the option, it will own (1) the underlying
instruments subject to the option, (2) instruments convertible or exchangeable
into the instruments subject to the option or (3) a call option on the relevant
instruments with an exercise price no higher than the exercise price on the call
option written.
Similarly, the Commission currently requires that, to support its obligation
to purchase the underlying instruments if a put option written by the Fund is
exercised, the Fund either (a) deposit with its custodian in a segregated
account liquid securities having a value at least equal to the exercise price of
the underlying securities, (b) continue to own an equivalent number of puts of
the same "series" (that is, puts on the same underlying security having the same
exercise prices and expiration dates as those written by the Fund), or an
equivalent number of puts of the same "class" (that is, puts on the same
underlying security) with exercise prices greater than those it has written (or,
if the exercise prices of the puts it holds are less than the exercise prices of
those it has written, it will deposit the difference with its custodian in a
segregated account) or (c) sell short the securities underlying the put option
at the same or a higher price than the exercise price on the put option written.
The Fund will receive a premium when it writes put and call options, which
increases the Fund's return on the underlying security in the event the option
expires unexercised or is closed out at a profit. By writing a call, the Fund
will limit its opportunity to profit from an increase in the market value of the
underlying security above the exercise price of the option for as long as the
Fund's obligation as the writer of the option continues. Upon the exercise of a
put option written by the Fund, the Fund may suffer an economic loss equal to
the difference between the price at which the Fund is required to purchase the
underlying security and its market value at the time of the option exercise,
less the premium received for writing the option. Upon the exercise of a call
option written by the Fund, the Fund may suffer an economic loss equal to an
amount not less than the excess of the security's market value at the time of
the option exercise over the Fund's acquisition cost of the security, less the
sum of the premium received for writing the option and the difference, if any,
between the call price paid to the Fund and the Fund's acquisition cost of the
security. Thus, in some
39
periods the Fund might receive less total return and in other periods greater
total return from its hedged positions than it would have received from its
underlying securities unhedged.
The Fund may purchase and write options on securities that are listed on
national securities exchanges or are traded over the counter, although it
expects, under normal circumstances, to effect such transactions on national
securities exchanges.
As a holder of a put option, the Fund will have the right to sell the
securities underlying the option and as the holder of a call option, the Fund
will have the right to purchase the securities underlying the option, in each
case at their exercise price at any time prior to the option's expiration date.
The Fund may choose to exercise the options it holds, permit them to expire or
terminate them prior to their expiration by entering into closing sale
transactions. In entering into a closing sale transaction, the Fund would sell
an option of the same series as the one it has purchased. The ability of the
Fund to enter into a closing sale transaction with respect to options purchased
and to enter into a closing purchase transaction with respect to options sold
depends on the existence of a liquid secondary market. There can be no assurance
that a closing purchase or sale transaction can be effected when the Fund so
desires. The Fund's ability to terminate option positions established in the
over-the-counter market may be more limited than in the case of exchange-traded
options and may also involve the risk that securities dealers participating in
such transactions would fail to meet their obligations to the Fund.
In purchasing a put option, the Fund will seek to benefit from a decline in
the market price of the underlying security, while in purchasing a call option,
the Fund will seek to benefit from an increase in the market price of the
underlying security. If an option purchased is not sold or exercised when it has
remaining value, or if the market price of the underlying security remains equal
to or greater than the exercise price, in the case of a put, or remains equal to
or below the exercise price, in the case of a call, during the life of the
option, the option will expire worthless. For the purchase of an option to be
profitable, the market price of the underlying security must decline
sufficiently below the exercise price, in the case of a put, and must increase
sufficiently above the exercise price, in the case of a call, to cover the
premium and transaction costs. Because option premiums paid by the Fund are
small in relation to the market value of the instruments underlying the options,
buying options can result in large amounts of leverage. The leverage offered by
trading in options could cause the Fund's net asset value to be subject to more
frequent and wider fluctuation than would be the case if the Fund did not invest
in options.
OPTIONS ON STOCK INDICES. The Fund may utilize up to 5% of its total assets
to purchase put and call options on domestic stock indices to hedge against
risks of market-wide price movements affecting its assets. In addition, the Fund
may write covered put and call options on stock indices. A stock index measures
the movement of a certain group of stocks by assigning relative values to the
common stocks included in the index. Options on stock indices are similar to
options on securities. Because no underlying security can be delivered, however,
the option represents the holder's right to obtain from the writer, in cash, a
fixed multiple of the amount by which the exercise price exceeds (in the case of
a put) or is less than (in the case of a call) the closing value of the
underlying index on the exercise date. The advisability of using stock index
options to hedge against the risk of market-wide movements will depend on the
extent of diversification of the Fund's investments and the sensitivity of its
investments to factors influencing the underlying index. The effectiveness of
purchasing or writing stock index options as a hedging technique will depend
upon the extent to which price movements in the Fund's securities, investments
correlate with price movements in the stock index selected. In addition,
successful use by the Fund of options on stock indices will be subject to the
ability of the Adviser to predict correctly changes in the relationship of the
underlying index to the Fund's portfolio holdings. No assurance can be given
that the Adviser's judgment in this respect will be correct.
40
When the Fund writes an option on a stock index, it will establish a
segregated account with its custodian in which the Fund will deposit liquid
securities in an amount equal to the market value of the option, and will
maintain the account while the option is open.
WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS. New issues of preferred and
debt securities may be offered on a when-issued or delayed delivery basis, which
means that delivery and payment for the security normally take place within 45
days after the date of the commitment to purchase. The payment obligation and
the dividends that will be received on the security are fixed at the time the
buyer enters into the commitment. The Fund will make commitments to purchase
securities on a when-issued or delayed delivery basis only with the intention of
acquiring the securities, but may sell these securities before the settlement
date if the Adviser deems it advisable. No additional when-issued or delayed
delivery commitments will be made if more than 20% of the Fund's total assets
would be so committed. Securities purchased on a when-issued or delayed delivery
basis may be subject to changes in value based upon the public's perception of
the creditworthiness of the issuer and changes, real or anticipated, in the
level of interest rates. Securities purchased or sold on a when-issued or
delayed delivery basis may expose the Fund to risk because they may experience
these fluctuations prior to their actual delivery. The Fund will not accrue
income with respect to a debt security it has purchased on a when-issued or
delayed delivery basis prior to its stated delivery date but will accrue income
on a delayed delivery security it has sold. Purchasing or selling securities on
a when-issued or delayed delivery basis can involve the additional risk that the
yield available in the market when the delivery takes place actually may be
higher than that obtained in the transaction itself. A segregated account of the
Fund consisting of liquid securities equal at all times to the amount of the
Fund's when-issued and delayed delivery purchase commitments will be established
and maintained with the Fund's custodian placing securities rather than cash in
the segregated account may have a leveraging effect on the Fund's net asset
value per share; that is, to the extent that the Fund remains substantially
fully invested in securities at the same time that it has committed to purchase
securities on a when-issued or delayed delivery basis, greater fluctuations in
its net asset value per share may occur than if it has set aside cash to satisfy
its purchase commitments.
LENDING PORTFOLIO SECURITIES. The Fund is authorized to lend securities it
holds to brokers, dealers and other financial organizations, although it has no
current intention of doing so. Loans of the Fund's securities, if and when made,
may not exceed 33-1/3% of the Fund's assets taken at value. The Fund's loans of
securities will be collateralized by cash, letters of credit or Government
Securities that will be maintained at all times in a segregated account with the
Fund's custodian in an amount at least equal to the current market value of the
loaned securities. From time to time, the Fund may pay a part of the interest
earned from the investment of collateral received for securities loaned to the
borrower and/ or a third party that is unaffiliated with the Fund and that is
acting as a "finder."
By lending its portfolio securities, the Fund can increase its income by
continuing to receive interest on the loaned securities, by investing the cash
collateral in short-term instruments or by obtaining yield in the form of
interest paid by the borrower when Government Securities are used as collateral.
The risk in lending portfolio securities, as with other extensions of credit,
consists of the possible delay in recovery of the securities or the possible
loss of rights in the collateral should the borrower fail financially. The Fund
will adhere to the following conditions whenever it lends its securities:
(1) the Fund must receive at least 100% cash collateral or equivalent securities
from the borrower, which will be maintained by daily marking-to-market; (2) the
borrower must increase the collateral whenever the market value of the
securities loaned rises above the level of the collateral; (3) the Fund must be
able to terminate the loan at any time; (4) the Fund must receive reasonable
interest on the loan, as well as any dividends, interest or other distributions
on the loaned securities, and any increase in market value; (5) the Fund may pay
only reasonable custodian fees in connection with the loan; and (6) voting
rights on the loaned securities may pass to the borrower, except that, if a
material, event
41
adversely affecting the investment in the loaned securities occurs, the Fund's
Board of Directors must terminate the loan and regain the Fund's right to vote
the securities.
SHORT SALES AGAINST THE BOX. The Fund may make short sales of securities in
order to reduce market exposure and/or to increase its income if, at all times
when a short position is open, the Fund owns an equal or greater amount of such
securities or owns preferred securities, debt or warrants convertible or
exchangeable into an equal or greater number of the shares of common stock sold
short. Short sales of this kind are referred to as short sales of securities
"against the box." The broker-dealer that executes a short sale generally
invests the cash proceeds of the sale until they are paid to the Fund.
Arrangements may be made with the broker-dealer to obtain a portion of the
interest earned by the broker on the investment of short sale proceeds. The Fund
will segregate the securities against which short sales against the box have
been made in a special account with its custodian. Not more than 10% of the
Fund's total assets (taken at current value) may be held as collateral for such
sales at any one time.
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 Preferred Shares), 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 on the Preferred
Shares. 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 Preferred
Shares--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 Preferred Shares--Voting
Rights" for additional information with respect to the voting rights of holders
of Preferred Shares.
RATING AGENCY REQUIREMENTS
In connection with their rating the Preferred Shares, Moody's and
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 Preferred Shares--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 Preferred Shares.
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.
42
RISKS OF INVESTING IN THE PREFERRED SHARES
DIVIDEND PAYMENT RISK. The Fund will not be permitted to declare dividends
or other distributions with respect to the Preferred Shares 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 Preferred Shares.
REDEEMABILITY. Unlike shares of a open-end mutual fund, including a money
market mutual fund, the Preferred Shares may not be redeemed at the option of
the holder.
INTEREST RATE RISK. The Preferred Shares 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 Preferred Shares may rise so
that the amount of dividends paid to holders of Preferred Shares 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 Preferred Shares offering) is available to pay
dividends on Preferred Shares, however, dividend rates on Preferred Shares 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 Preferred Shares 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 Preferred Shares.
AUCTION RISK. You may not be able to sell your Preferred Shares at an
auction if the auction fails, i.e., if there are more Preferred Shares offered
for sale than there are buyers for those shares. Also, if you place a bid order
(an order to retain Preferred Shares) 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 Preferred Shares, and you will not retain your
Preferred Shares. Additionally, if you buy Preferred Shares or elect to retain
Preferred Shares 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 Preferred Shares than the market rate
for similar investments. The dividend period for the Preferred Shares may be
changed by the Fund, subject to certain conditions and with notice to the
holders of the Preferred Shares, which could also affect the liquidity of your
investment. See "Description of Preferred Shares" and "The Auction."
SECONDARY MARKET RISK. If you try to sell your Preferred Shares 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 Preferred Shares in the secondary market, particularly if the Fund
has designated a special rate period (a dividend period of more than seven days,
or 28 days in the case of Series ). Broker-dealers that maintain a secondary
trading market (if any) for the Preferred Shares 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
Preferred Shares are not listed on a stock exchange or NASDAQ. If you sell your
Preferred Shares 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 assigns a
rating of " " to the Preferred Shares, these ratings do not eliminate or
necessarily mitigate the risks of investing in Preferred Shares. In
43
addition, Moody's, or another rating agency rating the Preferred
Shares could downgrade the Preferred Shares, which may make your shares less
liquid at an auction or in the secondary market. If a rating agency downgrades
the Preferred Shares, 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
Preferred Shares to meet regulatory or rating agency requirements. The Fund may
also voluntarily redeem Preferred Shares under certain circumstances. See
"Description of Preferred Shares--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 Preferred Shares--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 Preferred Shares, 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 Preferred Shares 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 Preferred Shares. In
addition, the value of the Fund's investment portfolio may decline, reducing the
asset coverage for the Preferred Shares. 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 Preferred Shares and make it more difficult for the Fund to pay
dividends on the Preferred Shares.
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 Preferred Shares. 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
44
securities to enable the Fund to buy or sell preferred securities at prices that
the Adviser believes to be suitable.
HEDGING STRATEGY RISK. Certain of the investment techniques that the Fund
may employ for hedging or, under certain circumstances, to increase income will
expose the Fund to risks. In addition to the hedging techniques described
elsewhere, i.e., positions in Treasury Bond or Treasury Note futures contracts,
use of options on these positions, positions in interest rate swaps, and options
thereon ("swaptions"), these investment techniques may include entering into
interest rate and stock index futures contracts and options on interest rate and
stock index futures contracts, purchasing and selling put and call options on
securities and stock indices, purchasing and selling securities on a when-issued
or delayed delivery basis, entering into repurchase agreements, lending
portfolio securities and making short sales of securities "against the box." The
Fund intends to company with regulations of the Commission involving "covering"
or segregating assets in connection with the Fund's use of options and futures
contracts.
ILLIQUIDITY. Preferred securities, which will constitute the principal
portion of the Fund's assets, may be substantially less liquid than many other
securities such as common stocks or Government Securities. At any particular
time, a preferred security may not be actively traded in the secondary market,
even though it may be listed on the New York Stock Exchange or other securities
exchange. Many preferred securities currently outstanding are listed on the New
York Stock Exchange, although secondary market transactions in preferred
securities are frequently effected in the over-the-counter market, even in those
preferred securities that are listed. The prices of illiquid securities may be
more volatile than more actively traded securities and the absence of a liquid
secondary market may adversely affect the ability of the Fund to buy or sell its
preferred securities holdings at the times and prices desired and the ability of
the Fund to determine its net asset value.
LEVERAGE RISK. The Fund's use of leverage through the issuance of Preferred
Shares creates an opportunity for increased Common 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 Preferred Shares. If the Fund's
current net investment income and capital gains are not sufficient to meet
dividend requirements on outstanding Preferred Shares, 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 Preferred Shares or to satisfy certain
guidelines established by the rating agencies may result in mandatory partial or
full redemption of Preferred Shares, 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
Preferred Shares and the principal amount of any borrowings used for leverage).
As a result, the Adviser has a financial incentive for the Fund to issue
Preferred Shares 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."
45
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 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.
46
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.
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 Preferred
47
Shares then outstanding and the potential subsequent sale of Fund assets during
unfavorable market conditions. In addition, the Board may consider taking
actions designed to eliminate the discount whenever it deems it to be
appropriate, which could result in a reduction in the asset coverage for
Preferred Shares. 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 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 Preferred Shares. 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 Preferred Shares 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 Preferred Shares 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.
48
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 $ 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
$ million in aggregate total assets. In managing the day-to-day operations of
the Fund, the Adviser relies on the expertise of its team of money management
professionals, consisting of Messrs. 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 PREFERRED SHARES) 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 PREFERRED SHARES IS NOT
TREATED AS A LIABILITY.)
The Advisory Agreement provides that the Adviser shall not be liable for any
error of judgment or mistake of law or for any loss suffered by the Fund in
connection with the matters to which the Advisory Agreement relates, except
liability resulting from willful misfeasance, bad faith or gross negligence on
the Adviser's part in the performance of its duties or from reckless disregard
of its obligations and duties under the Advisory Agreement ("disabling
conduct"). The Advisory Agreement also provides that the Fund will indemnify the
Adviser for any loss, claim, damage, liability or expense not resulting from
disabling conduct on the part of the Adviser.
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.
49
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 Fund's average
weekly total managed assets and 0.03% on the Fund's average weekly total managed
assets above $500 million. (For purposes of calculating such fee, the Fund's
total managed assets means the total assets of the Fund (including any assets
attributable to any preferred shares (which include the liquidation preference
on the Preferred Shares 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 Preferred Shares 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 and 0.005% on the Fund's average weekly net assets attributable to
the Common Shares above $500 million (which for purposes of calculating such
fee, will be deemed to be the average weekly value of the Fund's total assets
minus the sum of the Fund's liabilities (which liabilities include the aggregate
liquidation preference of the Fund's outstanding Preferred Shares) and
accumulated dividends, if any, on the Preferred Shares), 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
50
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 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 Preferred Shares,
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 Preferred Shares (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 $ . 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 Preferred Shares will be payable upon
the completion of the offering of the Preferred Shares 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,
Pierce Fenner & Smith Incorporated ("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
Preferred Shares 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 PREFERRED SHARES
THE FOLLOWING IS A BRIEF DESCRIPTION OF THE TERMS OF THE PREFERRED SHARES.
FOR A MORE COMPLETE DESCRIPTION OF THE PREFERRED SHARES, PLEASE REFER TO THE
DETAILED DESCRIPTION OF THE PREFERRED SHARES 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.
51
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 Preferred Shares are preferred shares with $0.01 par value per
share. The Preferred Shares 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). The Preferred Shares 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 Preferred Shares carry one
vote per share on all matters on which such shares are entitled to vote. The
Preferred Shares, 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 Preferred Shares repurchased or
redeemed by the Fund will be classified as authorized and unissued preferred
shares without designation as to series. The Preferred Shares 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 Preferred Shares. The initial rate periods for the Preferred
Shares will be , , , , and days, respectively, for the Series M,
T, W, Th and F shares, and the dividend rates for this period will be %,
%, %, % and %, respectively. Subsequent rate periods generally will
be seven days for Series , , , and shares and 28 days for Series
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 Preferred Shares 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
Preferred Shares 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 Preferred Shares ("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.
52
CALCULATION OF DIVIDEND PAYMENT. The Fund computes the dividend per share of
Preferred Shares by multiplying the applicable rate then in effect for the
Preferred Shares by a fraction. The numerator of this fraction will normally be
seven for Series , , , and and 28 days for Series (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.
Dividends on the Preferred Shares will accumulate from the date of their
original issue, which is , 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 Preferred Shares by Moody's or on the auction date
for such period. If Moody's or 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 [ ] APPLICABLE PERCENTAGE
-------------------------------- -------------------- ---------------------
"Aa3" or higher AA- or higher %
"A3" to "A1" A- to A+ %
"Baa3" to "Baa1" BBB- to BBB+ %
Below "Baa3" Below BBB- %
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 Preferred Shares. 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 Preferred Shares or any other shareholder of the Fund, but only with
confirmation from each rating agency then rating the Preferred
53
Shares that such action will not impair such agency's then-current rating of the
Preferred Shares, 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 Preferred Shares 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 purchase
Common Shares or other shares ranking junior to the Preferred Shares 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 Preferred Shares 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 Preferred Shares) 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 Preferred Shares 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 Preferred Shares 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 Preferred Shares unless the Fund has declared
and paid the lesser of full cumulative dividends or the same proportionate share
of dividends on the Preferred Shares through the most recent dividend payment
date. When the Fund has not paid dividends in full upon the Preferred Shares
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
Preferred Shares through their most recent respective dividend payment dates,
the amount of dividends declared per share on the Preferred Shares 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 Preferred Shares 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
), declare a special rate period on the Preferred Shares. 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 Preferred Shares 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 or any substitute rating agency that the proposed
special rate period will not impair such agency's then-current rating of the
Preferred Shares 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 Preferred Shares at the Fund's option during a special rate
period, the Fund must pay to holders of the Preferred Shares a "redemption
premium" in addition to the redemption price per share of $25,000 plus an amount
54
equal to the accumulated but unpaid dividends. A notice of special rate period
will specify whether the Preferred Shares 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 Preferred Shares in an auction for a
corresponding longer period of time. If you sell your Preferred Shares 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.
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 Preferred Shares 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 Preferred
Shares, 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 Preferred Shares, 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 Preferred
Shares, 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 Preferred Shares 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 Preferred Shares with respect to
payment of dividends or the distribution of assets on liquidation, or
authorize, create or issue additional Preferred Shares, unless, in each
case, the Fund obtains written confirmation from Moody's (if Moody's is
then rating the Preferred Shares) and (if is then rating
the Preferred Shares) that such authorization,
55
creation or issuance 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;
(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 Preferred Shares, unless, in each case, the Fund obtains
written confirmation from Moody's (if Moody's is then rating the
Preferred Shares) and (if is then rating the Preferred
Shares) that such authorization, creation or issuance 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; or
(c) authorize the Fund's conversion from a closed-end to an open-end
investment company.
For purposes of the foregoing, no matter shall be deemed adversely to affect
any preference, right or power of a holder of Preferred Shares 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 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 Preferred Shares 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 Preferred Shares, 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 Preferred Shares), voting as a single
class, and of at least 80% of the votes of the preferred stock (including the
Preferred Shares) 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 Preferred
Shares 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 Preferred Shares 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 with respect to the Preferred Shares, the Fund is
required to maintain assets having in
56
the aggregate a discounted value at least equal to the Preferred Shares Basic
Maintenance Amount. The Preferred Shares Basic Maintenance Amount includes the
sum of (a) the aggregate liquidation preference of any preferred shares then
outstanding (including the Preferred Shares) 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 Preferred Shares).
Moody's and 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
Preferred Shares 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 Preferred Shares
("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 , 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 Preferred Shares offered hereby and
giving effect to the deduction of the related offering costs and sales load
estimated at $ , would have been computed as follows:
Value of Fund assets less
liabilities
not constituting senior
securities = $ = %
------------------------------ -----------
Senior securities representing $
indebtedness
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 Preferred Shares, the Fund will be required to
redeem Preferred Shares 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 of 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 . 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 Preferred Shares 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 , 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 Preferred Shares.
As recently described by Moody's and , a preferred stock rating is an
assessment of the capacity and willingness of an issuer to pay preferred stock
obligations. The rating on the Preferred Shares 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
Preferred Shares will be able to sell such shares in an auction or otherwise.
The ratings are based on current information furnished to Moody's and 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 Preferred Shares only so long
as the rating agency is rating the shares. The Fund will pay certain fees to
Moody's and for rating the Preferred Shares. A more detailed description
of how Moody's and 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 Preferred Shares 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 Preferred Shares 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 Preferred Shares, an amount equal to the liquidation preference
with respect to such Preferred Shares ($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 Preferred Shares, no distribution
shall be made on any shares of any other class or series of preferred shares
ranking on a parity with the Preferred Shares with respect to the distribution
of assets upon such liquidation unless proportionate distributive amounts shall
be paid on the Preferred Shares, 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
Preferred Shares of the full preferential amounts provided for as described
herein, the holders of Preferred Shares 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
58
- the merger or consolidation of any corporation, business trust or other
entity into or with the Fund.
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 Preferred Shares. 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 Preferred Shares. 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 Preferred Shares 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 Preferred Shares and any other preferred shares of
the Fund subject to redemption or retirement. The mandatory redemption will be
limited to the number of Preferred Shares 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 Preferred
Shares, 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 Preferred Shares may be redeemed
if the redemption would cause the Fund to violate the 1940 Act. The Fund has the
authority to redeem the Preferred Shares for any reason and may redeem all or
part of the outstanding Preferred Shares 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 Preferred Shares, subject to certain limitations. The
optional redemption of Preferred Shares will, if less than all the Preferred
Shares 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
Preferred Shares by reason of the redemption of the Preferred Shares 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
Preferred Shares (whether or not earned or declared), no Preferred Shares shall
be redeemed (by either mandatory redemption or optional redemption) unless all
outstanding Preferred Shares 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 Preferred Shares.
59
Although the Preferred Shares are subject to redemption under certain
circumstances as described above and under "--Mandatory Redemption," unlike the
shares of an open-end mutual fund, the Preferred Shares may not be redeemed at a
shareholder's option.
THE AUCTION
GENERAL
Under the Articles Supplementary, the applicable rate for the Preferred
Shares 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 Preferred Shares regardless of the rate set
by the auction or offer to purchase or sell Preferred Shares 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, ) 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
Preferred Shares so long as the applicable rate for the Preferred Shares 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 Preferred Shares ("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
Preferred Shares 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 Preferred Shares or upon termination of the auction agency
agreement.
AUCTION PROCEDURES
Prior to the submission deadline on each auction date for the Preferred
Shares, 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
Preferred Shares may submit the following types of orders with respect to
Preferred Shares to that Broker-Dealer:
60
1. Hold Order--indicating its desire to hold Preferred Shares without
regard to the applicable rate for the next rate period.
2. Bid--indicating its desire to purchase or hold the indicated number
of Preferred Shares 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 Preferred Shares 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 Preferred Shares at
$25,000 per share without regard to the applicable rate for the next
rate period.
A beneficial owner of Preferred Shares may submit different types of orders
to its Broker-Dealer with respect to different Preferred Shares 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 Preferred Shares subject to the sell order. A beneficial owner that
offers to become the beneficial owner of additional Preferred Shares 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 Preferred Shares but that wishes to purchase Preferred
Shares or a beneficial owner that wishes to purchase additional Preferred
Shares. A potential holder may submit bids to its Broker-Dealer in which it
offers to purchase Preferred Shares 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 Preferred
Shares 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
Preferred Shares 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.
61
There are sufficient clearing bids in an auction if the number of Preferred
Shares 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 Preferred
Shares subject to sell orders submitted or deemed submitted to the auction agent
by Broker-Dealers for existing holders and the number of Preferred Shares
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 Preferred Shares 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 Preferred Shares available for purchase in the auction.
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 Preferred Shares 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 Preferred Shares 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 Preferred Shares 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 , , , and Preferred Shares will normally
be held every seven days and those for the Series Preferred Shares will
normally be held every 28 days, and each subsequent rate period will normally
begin on the following business day.
The first auction for the Series , , , and Preferred Shares will
be held on May , 2003 and that for the Series Preferred Shares on
June , 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 , , and Preferred Shares normally
will be held every seven days thereafter and auctions for the Series
Preferred Shares normally will be held every 28 days thereafter, and each
subsequent dividend period for a Series of Preferred Shares 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
62
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 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 Preferred Shares 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 Preferred Shares
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 Preferred Shares
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 PREFERRED SHARES
The underwriters are not required to make a market in the Preferred Shares.
The Broker-Dealers (including the underwriters) may maintain a secondary trading
market for the Preferred Shares outside
63
of auctions, but they are not required to do so. There can be no assurance that
a secondary trading market for Preferred Shares will develop or, if it does
develop, that it will provide holders of Preferred Shares with liquidity of
investment. The Preferred Shares will not be registered on any stock exchange or
on the NASDAQ market. Investors who purchase Preferred Shares 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 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 Preferred Shares 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 Preferred Shares in the name of a
Broker-Dealer, a sale or transfer of your Preferred Shares 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 Preferred Shares
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 Preferred Shares and (iii) accumulated and
unpaid dividends on the outstanding Preferred Shares.
Securities listed on a national securities exchange are valued on the basis
of the last sale on such exchange on the day of valuation, except as described
hereafter. In the absence of sales of listed securities and with respect to
(a) securities for which the most recent sale prices are not deemed to represent
fair market value and (b) unlisted securities (other than money market
instruments), securities are valued at the mean between the closing bid and
asked prices when quoted prices for investments are readily available.
Investments in over-the-counter derivative instruments, such as interest rate
swaps and options thereon ("swaptions"), are valued at the prices obtained from
the broker/dealer or bank that is the counterparty to such instrument, subject
to comparison of such valuation with a valuation obtained from a broker/dealer
or bank that is not a counterparty to the particular derivative instrument.
Investments for which market quotations are not readily available or for which
management determines that the prices are not reflective of current market
conditions are valued at fair value as determined in good faith by or under the
direction of the Board of Directors, including reference to valuations of other
securities which are comparable in quality, maturity and type. Investments in
money market instruments, which mature in 60 days or less, are valued at
amortized cost. Investments in money market funds are valued at their net asset
value.
DESCRIPTION OF CAPITAL STRUCTURE
The Fund is a corporation organized under the laws of the State of Maryland.
64
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 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 Series M, Series T,
Series W, Series Th and Series F shares.)
For a description of the Preferred Shares, see "Description of Preferred
Shares."
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 , 2003.
NUMBER HELD BY
NUMBER OR FOR THE ACCOUNT NUMBER
TITLE OF CLASS AUTHORIZED OF THE FUND OUTSTANDING
-------------- ----------- ------------------ -------------------
Common Shares 240,000,000 0
Series M Preferred Shares * 0 0
Series T Preferred Shares * 0 0
Series W Preferred Shares * 0 0
Series Th Preferred Shares * 0 0
Series F Preferred Shares * 0 0
-------------------
* Assumes authorization of Preferred Shares by the Board of Directors
prior to the issuance of the Preferred Shares.
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 Preferred Shares. Neither Common Shareholders nor holders of
Preferred Shares 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 Preferred Shares and
any other outstanding preferred shares on each matter submitted to a vote of
Common Shareholders, except as described
65
under "Description of Preferred Shares--Voting Rights" and except as otherwise
required by the Articles of Incorporation, the Articles Supplementary or
applicable law.
Shareholders of each class or series are entitled to one vote for each share
held. Except as provided under "Description of Preferred Shares--Voting Rights"
and except as otherwise required by the Articles of Incorporation, the Articles
Supplementary or applicable law, holders of preferred shares, including the
Preferred Shares, 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 Preferred Shares), voting as a single
class.
Under the 1940 Act, so long as any Preferred Shares 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 Preferred Shares 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 Preferred Shares from rating
agencies. These requirements include an asset coverage test more stringent than
under the 1940 Act. See "Description of Preferred Shares--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 , 2003, the net asset value per Common
Share was $ , and the closing price per Common Share on the New York Stock
Exchange was $ .
OTHER ISSUES RELATING TO THE PREFERRED SHARES
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 Preferred Shares have pre-emptive
rights to purchase any Preferred Shares 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
66
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 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 Preferred Shares are outstanding, the Fund
may not purchase, redeem or otherwise acquire any of its Common Shares unless
(1) all accumulated dividends on Preferred Shares have been declared and paid
and (2) at the time of the purchase, redemption or acquisition, the net asset
value of the Fund's portfolio (determined after deducting the acquisition price
of the Common Shares) is at least 200% of the liquidation value of the then
outstanding Preferred Shares (expected to equal the original purchase price per
share plus any accumulated and unpaid dividends thereon).
If the Fund converted to an open-end company, it would be required to redeem
all Preferred Shares 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 Preferred
Shares) remain outstanding, the amendment would need to be approved by the
affirmative vote of at least 80% of the votes entitled to be cast by any
Preferred Stock (including Preferred Shares) outstanding, voting as a separate
class. If an amendment providing for the conversion of the Fund to an open-end
investment company has been previously approved by a vote of 80% of the
Continuing Directors (as defined below), only a majority of the votes entitled
to be cast by holders of Common Shares and Preferred Shares outstanding, voting
together as a single class, would be required to approve the conversion.
"Continuing Director" means any member of the Board of Directors of the Fund who
(a) is not an Interested Party or an affiliate or associate of an Interested
Party and has been a member of the Board of Directors for a period of at least
12 months (or since the Fund's commencement of operations, if that is less than
12 months); or (b) is a successor of a Continuing Director who is not an
67
Interested Party or an affiliate or an associate of an Interested Party and is
recommended to succeed a Continuing Director by a majority of the Continuing
Directors then on the Board of Directors; or (c) is elected to the Board of
Directors to be a Continuing Director by a majority of the Continuing Directors
then on the Board of Directors and who is not an Interested Party or an
affiliate or associate of an Interested Party. "Interested Party" means any
person, other than the Fund's investment adviser or any of its affiliates, which
enters into, or proposes to enter into, a business combination with the Fund or
which individually or together with any other persons beneficially owns or is
deemed to own, directly or indirectly, more than 5% of any class of the Fund's
securities.
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 Preferred Shares
to be eligible to be treated as capital gain dividends, the Preferred Shares
must be treated as equity for federal income tax purposes. Based on advice from
counsel, the Fund believes that the Preferred Shares 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 Preferred Shares represents equity. If the IRS were to
assert successfully that variable rate preferred stock such as the Preferred
Shares should be treated as debt for federal income tax purposes, distributions
on Preferred Shares (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.
68
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, 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 Preferred Shares and that upon such redemption the holders of
the Preferred Shares 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
69
than not to redeem such Preferred Shares during the special rate period, and
(iii) the premium to be paid upon redemption during such special rate period
exceeds a specified DE MINIMIS amount, it is possible that the holders of the
Preferred Shares 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 of at least 80% of the Directors
and at least 80% of the votes entitled to be cast by holders of
70
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
, 2003, the underwriters named below have agreed to purchase, and the
Fund has agreed to sell to such underwriters, the number of Preferred Shares set
forth below.
NUMBER OF PREFERRED SHARES
----------------------------------------------------------------
UNDERWRITER SERIES M SERIES T SERIES W SERIES TH SERIES F
----------- ----------- ----------- ----------- ------------ -----------
Total..........
========== ========== ========== =========== ==========
The purchase agreement provides that the obligations of the underwriters to
purchase the Preferred Shares 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 " " ratings on the Preferred Shares from Moody's and ,
respectively, as of the time of the closing of the offering. The underwriters
are obligated to purchase all the Preferred Shares sold under the purchase
agreement if any of the Preferred Shares 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 Preferred Shares
directly to the public at the public offering price set forth on the cover page
of this prospectus and some of the Preferred Shares 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 Preferred Shares. After the initial public offering, the
underwriters may change the public offering price and the concession. Investors
must pay for any Preferred Shares purchased on or before , 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 Preferred Shares will be
, 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 address of is .
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.
, , New York, New York , serves as
the auction agent, transfer agent, registrar, dividend paying agent and
redemption agent for the Preferred Shares.
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 . 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 Preferred Shares 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
----
Table of Contents................................. 2
Fundamental Investment Restrictions............... 3
Investment Objective and Policies................. 4
Management of the Fund............................ 16
Investment Advisory Services...................... 22
Portfolio Transactions and Brokerage.............. 26
Determination of Net Asset Value.................. 28
Distributions..................................... 29
Description of Shares............................. 32
Additional Information Concerning the Auctions for
Preferred Shares................................ 33
Taxation.......................................... 40
Performance-Related and Comparative and Other
Information..................................... 47
Counsel and Independent Accountants............... 48
Additional Information............................ 48
Financial Statements.............................. 49
Appendix A--Ratings of Investments................ A-1
Appendix B--Articles Supplementary................ B-1
74
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
$
F&C/CLAYMORE PREFERRED SECURITIES INCOME FUND INCORPORATED
AUCTION RATE PREFERRED SHARES ("PREFERRED SHARES")
SHARES, SERIES M
SHARES, SERIES T
SHARES, SERIES W
SHARES, SERIES TH
SHARES, SERIES F
LIQUIDATION PREFERENCE $25,000 PER SHARE
----------
PROSPECTUS
----------
, 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 _____ __, 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
__________ __, 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 M, T,
W, Th and F Auction Market Preferred Shares ("Preferred Shares") of the Fund
is not a prospectus, but should be read in conjunction with the prospectus of
the Fund, dated ______ __, 2003 (the "Prospectus"). This Statement of Additional
Information does not include all information that a prospective investor should
consider before purchasing Preferred Shares, 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 PREFERRED SHARES 20
TAXATION 22
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
APPENDIX B - ARTICLES SUPPLEMENTARY B
This Statement of Additional Information is dated ______ __, 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 Preferred Shares) 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 Preferred
Shares be offered with a credit quality rating of "Aaa" from Moody's and "___"
from ___________. 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 ____ 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 Preferred Shares.
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 the 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 Preferred Shares. 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 Preferred
Shares (when issued), voting as a single class, will elect two Directors and
holders of the Common Shares and the Preferred Shares(when issued), voting
as a single class, will elect the remaining Directors, subject to the provisions
of the 1940 Act and the Fund's Articles, which will permit the holders of
Preferred Shares to elect the minimum number of additional Directors that
when combined with the two Directors elected by the holders of Preferred
Shares would give the holders of Preferred Shares a majority of the
Directors when dividends are in arrears for two full years. Messrs. Gust and
Dalmaso are expected to represent the holders of Preferred Shares, and the
remaining Directors are subject to election by holders of the Common Shares and
the Preferred Shares(when issued), voting as a single class. Directors
elected by holders of Common Shares and Preferred Shares will be apportioned
among the classes of Directors. The Fund's Articles of Incorporation limit the
liability of Directors and officers of the Fund to the Fund or its shareholders
for damages, and require that the Fund indemnify its Directors and officers
against liabilities and expenses incurred by reason of their services to the
Fund, to the fullest extent permitted by Maryland law. These provisions do not
apply to liabilities or expenses incurred as a result of any Director's or
officer's willful misfeasance, bad faith, gross negligence or reckless disregard
of his duties. The Fund, at its expense, provides liability insurance for the
benefit of its Directors and officers.
Overall responsibility for management and supervision of the Fund rests
with the Fund's Board of Directors. The Directors approve all significant
agreements between the Fund and the persons or companies that furnish services
to the Fund, including agreements with its investment adviser, servicing agent,
administrator, custodian and transfer agent. The day-to-day operations of the
Fund are delegated to the Adviser.
The Audit Committee is comprised of all of the independent directors of
the Fund (Messrs. Brody, Gale, Gust and Wulf). The role of the Fund's Audit
Committee is to assist the Board of Directors in its oversight of the Fund's
financial reporting process. The Audit Committee operates pursuant to a Charter
that was approved by the Board of Directors of the Fund on December 16, 2002. As
set forth in the Charter, management is responsible for the preparation,
presentation and integrity of the Fund's financial statements, and for the
procedures designed to ensure compliance with accounting standards and
applicable laws and regulations. The independent accountants are responsible for
planning and carrying out 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 $___ $___
David Gale
Director $___ $___
Morgan Gust
Director $___ $___
Robert F. Wulf
Director $___ $___
-----------------
* 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 __, 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 __, 2003
------------------------------------------------------------------------------------------------------------------
Cede & Co. _______ ____%
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
Preferred Shares and the principal amount of any borrowings
used for leverage, the Adviser has a financial incentive for the
Fund to issue Preferred Shares 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 Preferred Shares. 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 Preferred Shares - 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
Preferred Shares 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 Preferred Shares 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 Preferred
Shares 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 Preferred
Shares, (3) the Fund has redeemed the full number of Preferred Shares 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 Preferred Shares
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
Preferred Shares are outstanding, Common Shareholders will not be entitled
to receive any distributions from the Fund unless all accrued dividends on
Preferred Shares have been paid, asset coverage (as defined in the 1940 Act)
with respect to Preferred Shares 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 Preferred
Shares have been met. See " - Preferred Shares" below. See "Description of
Preferred Shares - 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.
PREFERRED SHARES
See "Description of Preferred Shares" and "Description of Capital
Structure" in the Prospectus for information relating to the Preferred
Shares. The Articles Supplementary, which establishes many of the terms of the
Preferred Shares, is set forth in its entirety in Appendix B to this
Statement of Additional Information.
ADDITIONAL INFORMATION CONCERNING
THE AUCTIONS FOR PREFERRED SHARES
GENERAL
AUCTION AGENCY AGREEMENT. The Fund will enter into an auction agency
agreement with the auction agent (currently, ______________) 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 Preferred Shares 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
Preferred Shares.
SECURITIES DEPOSITORY. The Depository Trust Company ("DTC") will act
as securities depository for the agent members (defined below) with respect to
the Preferred Shares. One certificate for the Preferred Shares will be
registered in the name of Cede & Co., as nominee of DTC. Such certificate will
bear a legend to the effect that such certificate is issued subject to the
provisions restricting transfers of Preferred Shares 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 Preferred Shares - Voting Rights" in the Prospectus, Cede &
Co. will be the holder of record of all Preferred Shares, and owners of the
Preferred Shares will not be entitled to receive certificates representing
their ownership interest in the Preferred Shares.
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
Preferred Shares, 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 Preferred Shares, 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 Preferred Shares, 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 Preferred Shares 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 ______________, 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 Preferred Shares 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 Preferred
Shares 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 Preferred Shares. Since the
Fund's current and accumulated earnings and profits will first be used to pay
dividends on the Preferred Shares, 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 Preferred Shares
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
Preferred Shares 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 Preferred Shares, 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 Preferred Shares 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 April __, 2003, the Fund's net increase in net assets
resulting from investment operations was $_______.
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)
[To Come]
F&C/CLAYMORE PREFERRED SECURITIES INCOME FUND INCORPORATED
STATEMENT OF ASSETS AND LIABILITIES
AS OF MARCH 31, 2003 (UNAUDITED)
[To Come]
2
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)
[To Come]
3
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)
[To Come]
4
F&C/CLAYMORE PREFERRED SECURITIES INCOME FUND INCORPORATED
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
[To Come]
5
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 -
ARTICLES SUPPLEMENTARY
B-1
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 Pre-Effective Amendment No. 1 to the
registrant's Registration Statement on Form N-2, filed December 23, 2002.
*** Incorporated by reference to Pre-Effective Amendment No. 2 to the
registrant's Registration Statement on Form N-2, filed January 28, 2003.
**** To be filed by amendment.
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 $
Printing Expenses $
Legal Fees and Expenses $
Auditing Fees and Expenses $
Rating Agency Fees $
Miscellaneous $
------------------
Total $
==================
ITEM 27. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT
None.
ITEM 28. NUMBER OF HOLDERS OF SECURITIES
As of ______, 2003
TITLE OF CLASS NUMBER OF RECORD HOLDERS
------------------------------------------ ------------------------
Common Stock, par value $.01 per share __
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
March, 2003.
F&C/CLAYMORE PREFERRED SECURITIES
INCOME FUND INCORPORATED
By: /s/ Donald F. Crumrine
----------------------
Donald F. Crumrine
Chief Executive Officer
POWER OF ATTORNEY
Each person whose signature appears below, hereby makes, constitutes
and appoints each of Peter C. Stimes and Donald F. Crumrine, with full power to
act without the other, as his agent and attorney-in-fact for the purpose of
executing in his name, in his capacity as a Director of the F&C/Claymore
Preferred Securities Income Fund Incorporated, all amendments to the
registration statement on Form N-2 to be filed with the United States Securities
and Exchange Commission pursuant to the Securities Act of 1933, as amended, and
the Investment Company Act of 1940, as amended, and the rules and regulations
promulgated thereunder.
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed below by the following persons in the
capacities and on the date indicated:
Signature Title Date
--------- ----- ----
/s/ Donald F. Crumrine Director, Chairman of March 14, 2003
---------------------- the Board and
Donald F. Crumrine Chief Executive Officer
/s/ Peter C. Stimes Chief Financial Officer March 14, 2003
----------------------
Peter C. Stimes
/s/ Martin Brody Director March 14, 2003
----------------------
Martin Brody
/s/ Nicholas Dalmaso Director March 14, 2003
----------------------
Nicholas Dalmaso
/s/ David Gale Director March 14, 2003
----------------------
David Gale
/s/ Morgan Gust Director March 14, 2003
----------------------
Morgan Gust
/s/ Robert F. Wulf Director March 14, 2003
----------------------
Robert F. Wulf