PROSPECTUS October 18, 2002
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2,240 SHARES SERIES M
2,240 SHARES SERIES T
2,240 SHARES SERIES W
2,240 SHARES SERIES TH
2,240 SHARES SERIES F
[JHF LOGO]
JOHN HANCOCK PREFERRED INCOME FUND
AUCTION PREFERRED SHARES
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John Hancock Preferred Income Fund (the "Fund") is offering 2,240 Series M
Auction Preferred Shares, 2,240 Series T Auction Preferred Shares, 2,240 Series
W Auction Preferred Shares, 2,240 Series TH Auction Preferred Shares, and 2,240
Series F Auction Preferred Shares (collectively, the "Preferred Shares" or
"APS"). The Fund is a newly organized, diversified, closed-end management
investment company.
INVESTMENT OBJECTIVES. The primary investment objective of the Fund is to
provide a high level of current income, consistent with preservation of capital.
The Fund's secondary investment objective is to provide growth of capital to the
extent consistent with its primary investment objective.
PORTFOLIO CONTENTS. The Fund seeks to achieve its objectives by investing in
securities that, in the opinion of the Fund's investment adviser, may be
undervalued relative to similar securities in the marketplace. Under normal
market conditions, the Fund invests at least 80% of its assets (net assets plus
borrowing for investment purposes) in preferred stocks and other preferred
securities, including convertible preferred securities. The Fund allocates its
investments among various industry sectors and among issuers in such sectors
based on the investment adviser's evaluation of market and economic conditions.
The Fund expects to emphasize investments in preferred securities issued or
guaranteed by U.S. corporations in the utilities sector and will be subject to
certain risks due to such emphasis. The Fund will not invest 25% or more of its
total assets in any one industry, except that the Fund will invest 25% or more
of its total assets in the industries comprising the utilities sector. The Fund
will invest at least 80% of its total assets in preferred securities and other
fixed income securities which are rated investment grade (i.e., at least "Baa"
by Moody's Investors Service, Inc. ("Moody's") or "BBB" by Standard & Poor's
Rating Group ("S&P")) or in unrated securities determined by the investment
adviser to be of comparable credit quality. The Fund may invest up to 20% of its
total assets in (i) preferred securities or other fixed income securities rated
below investment grade ("B" or higher) or unrated preferred securities or
unrated fixed income securities determined by the Fund's investment adviser to
be of comparable quality and (ii) common stocks or other equity securities that
are not considered preferred securities. The weighted average credit rating of
the Fund's portfolio of preferred securities and other fixed income securities
will be at least investment grade. There can be no assurance that the Fund will
achieve its investment objectives.
INVESTMENT ADVISER. John Hancock Advisers, LLC (the "Adviser") is the Fund's
investment adviser and administrator.
BEFORE BUYING ANY PREFERRED SHARES YOU SHOULD READ THE DISCUSSION OF THE
MATERIAL RISKS OF INVESTING IN THE FUND IN "RISK FACTORS" BEGINNING ON PAGE 23.
THESE RISKS ARE SUMMARIZED IN "PROSPECTUS SUMMARY--SPECIAL RISK CONSIDERATIONS"
BEGINNING ON PAGE 4.
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.
PRICE TO PUBLIC SALES LOAD PROCEEDS TO FUND(1)
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Per share $ 25,000 $ 250 $ 24,750
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Total $280,000,000 $2,800,000 $277,200,000
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(1) Plus accumulated dividends, if any, from the date the APS are issued, but
before offering expenses payable by the Fund estimated to be $482,000
The APS are being offered by the underwriters subject to certain conditions. The
underwriters reserve the right to withdraw, cancel or modify the offering in
whole or in part. It is expected that the APS will be delivered to the nominee
of The Depository Trust Company on or about October 23, 2002.
UBS WARBURG MERRILL LYNCH & CO.
PRUDENTIAL SECURITIES
Investors in APS will be entitled to receive cash dividends at an annual rate
that may vary for successive Dividend Periods for such shares. The dividend rate
on the Series M APS for the initial period from and including the date of issue
to, but excluding, November 5, 2002 will be 1.85% per year. The dividend rate on
the Series T APS for the initial period from and including the date of issue to,
but excluding, November 6, 2002 will be 1.85% per year. The dividend rate on the
Series W APS for the initial period from and including the date of issue to, but
excluding, April 24, 2003 will be 1.95% per year. The dividend rate on the
Series TH APS for the initial period from and including the date of issue to,
but excluding, November 8, 2002 will be 1.85% per year. The dividend rate on the
Series F APS for the initial period from and including the date of issue to, but
excluding, November 2, 2002 will be 1.85% per year. For each subsequent period,
the Auction Agent will determine the dividend rate for a particular period by an
Auction conducted in accordance with the procedures described in this Prospectus
and, in further detail, in Appendix C to the Statement of Additional
Information.
The APS, which have no history of public trading, will not be listed on an
exchange or automated quotation system. Broker-Dealers may maintain a secondary
trading market in the APS outside of Auctions; however they have no obligation
to do so, and there can be no assurance that a secondary market for the APS 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 APS, and a selling shareholder that sells APS between Auctions may receive a
price per share of less than $25,000. The Fund may redeem APS as described under
"Description of Preferred Shares--REDEMPTION."
The APS will be senior in liquidation and distribution rights to the Fund's
outstanding common shares. The Fund's common shares are traded on the New York
Stock Exchange under the symbol "HPI." This offering is conditioned upon the APS
receiving a rating of "Aaa" from Moody's.
You should read this Prospectus, which contains important information about the
Fund, before deciding whether to invest and retain it for future reference. A
Statement of Additional Information, dated October 18, 2002 containing
additional information about the Fund, has been filed with the Securities and
Exchange Commission and is incorporated by reference in its entirety into this
Prospectus, which means that it is part of the Prospectus for legal purposes.
You can review the table of contents of the Statement of Additional Information
on page 57 of this Prospectus. You may request a free copy of the Statement of
Additional Information by calling 1-800-225-5291 or by writing to the Fund, or
obtain a copy (and other information regarding the Fund) from the Securities and
Exchange Commission's web site (http://www.sec.gov).
The APS do not represent a deposit or obligation of, and are not guaranteed or
endorsed by, any bank or other insured depository institution and are not
federally insured by the Federal Deposit Insurance Corporation, the Federal
Reserve Board or any other government agency.
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
anyone 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 of these securities in any
state where the offer is not permitted. You should not assume that the
information contained in this Prospectus is accurate as of any date other than
the date on the front of this Prospectus. The Fund's business, financial
condition, results of operations and prospects may have changed since that date.
Certain capitalized terms used in this Prospectus are defined in the Glossary
that appears at the end of the Prospectus.
Until November 12, 2002 (25 days after the date of this Prospectus), all dealers
that buy, sell or trade the APS, whether or not participating in this offering,
may be required to deliver a Prospectus. This is in addition to the dealers'
obligation to deliver a Prospectus when acting as underwriter and with respect
to their unsold allotments or subscriptions.
TABLE OF CONTENTS
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Prospectus summary........................... 1
Financial highlights (unaudited)............. 13
The Fund..................................... 14
Use of proceeds.............................. 14
Capitalization (unaudited)................... 15
Portfolio composition........................ 15
Investment objectives and principal
investment strategies...................... 16
Risk factors................................. 23
Description of Preferred Shares.............. 32
The Auction.................................. 41
Management of the Fund....................... 48
Net asset value.............................. 50
U.S. federal income tax matters.............. 50
Description of shares........................ 53
Certain provisions of the Agreement and
Declaration of Trust and By-laws........... 54
Underwriting................................. 56
Legal matters................................ 57
Table of contents for Statement of Additional
Information................................ 57
Glossary..................................... 58
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II
Prospectus summary
This is only a summary. This summary does not contain all of the information
that you should consider before investing in the APS, especially the information
set forth under the heading "Risk factors." You should read the more detailed
information contained in this Prospectus, the Statement of Additional
Information and the Fund's By-laws. Certain capitalized terms used in this
Prospectus are defined in the Glossary that appears at the end of this
Prospectus.
THE FUND
John Hancock Preferred Income Fund (the "Fund") is a recently organized,
diversified, closed-end management investment company registered under the
Investment Company Act of 1940, as amended (the "1940 Act"). See "The Fund."
John Hancock Advisers, LLC (the "Adviser") acts as the Fund's investment adviser
and administrator. The Fund's common shares ("Common Shares") are traded on the
New York Stock Exchange under the symbol "HPI." As of September 30, 2002, the
Fund had 25,006,409 Common Shares outstanding and net assets of $593,533,092.
THE OFFERING
The Fund is offering an aggregate of 2,240 Series M APS, 2,240 Series T APS,
2,240 Series W APS, 2,240 Series TH APS and 2,240 Series F APS, each at a
purchase price of $25,000 per share plus accumulated dividends, if any, from the
date of original issue. The APS are being offered through a group of
underwriters led by UBS Warburg LLC and Merrill Lynch, Pierce, Fenner & Smith
Incorporated (collectively, the "Underwriters"). See "Underwriting."
The APS entitle their holders to receive cash dividends at an annual rate that
may vary for the successive Dividend Periods. In general, except as described
under "DIVIDENDS AND DIVIDEND PERIODS" below and "Description of Preferred
Shares--DIVIDENDS AND DIVIDEND PERIODS," the Dividend Period for the APS will be
seven days. Deutsche Bank Trust Company Americas (the "Auction Agent") will
determine the Applicable Rate for a particular period by an Auction conducted on
the Business Day immediately prior to the start of that Dividend Period. See
"The Auction."
The APS are not listed on an exchange. Instead, investors may buy or sell APS in
an Auction that normally is held weekly, by submitting orders to Broker-Dealers
that have entered into an agreement with the Auction Agent and the Fund or to
certain other Broker-Dealers. The Auction Agent reviews orders from
Broker-Dealers on behalf of Existing Holders that wish to sell, or hold at the
auction rate, or hold only at a specified Applicable Rate, and on behalf of
Potential Holders that wish to buy, APS. The Auction Agent then determines the
lowest Applicable Rate that will result in all of the outstanding APS continuing
to be held. The first Auction Date for Series M APS will be November 4, 2002,
for Series T APS will be November 5, 2002, for Series W APS will be April 23,
2003, for Series TH APS will be November 7, 2002, and for Series F APS will be
November 1, 2002, each being the Business Day before the Initial Dividend
Payment Date for the Initial Dividend Period for the relevant series of APS,
November 5, 2002 for Series M APS, November 6, 2002 for Series T APS, April 24,
2003 for Series W APS, November 8, 2002 for Series TH APS and November 4, 2002
for Series F APS. The Auction Date for Series M APS generally will be Monday,
for Series T APS generally will be Tuesday, for Series W APS generally will be
Wednesday, for Series TH APS generally will be Thursday, and for Series F APS
generally will be Friday, unless the then-current Dividend Period is a Special
Dividend Period, or the day that normally would be the Auction Date or the first
day of the subsequent Dividend Period is not a Business Day.
Generally, investors in the APS 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 APS in book-entry form. An
investor's Broker-Dealer, in turn, will maintain records of that investor's
beneficial ownership of the APS.
1
INVESTMENT OBJECTIVES AND POLICIES
INVESTMENT OBJECTIVES
The Fund's primary investment objective is to provide a high level of current
income, consistent with preservation of capital. The Fund's secondary investment
objective is to provide growth of capital to the extent consistent with its
primary investment objective. There can be no assurance that the Fund will
achieve its investment objectives.
PORTFOLIO CONTENTS
The Fund seeks to achieve its objectives by investing in securities that, in the
opinion of the Adviser, may be undervalued relative to similar securities in the
marketplace. Under normal market conditions, the Fund invests at least 80% of
its assets (net assets plus borrowing for investment purposes) in preferred
stocks and other preferred securities, including convertible preferred
securities. The Fund will invest at least 80% of its total assets in preferred
securities and other fixed income securities which are rated investment grade
(i.e., at least "Baa" by Moody's Investors Service, Inc. ("Moody's") or "BBB" by
Standard & Poor's Rating Group ("S&P")) or in unrated securities determined by
the investment adviser to be of comparable credit quality. The Fund may invest
up to 20% of its total assets in (i) preferred securities or other fixed income
securities rated below investment grade ("B" or higher) or unrated preferred
securities or unrated fixed income securities determined by the investment
adviser to be of comparable quality and (ii) common stocks or other equity
securities that are not considered preferred securities. The weighted average
credit rating of the Fund's portfolio of preferred securities and other fixed
income securities will be at least investment grade. The Fund intends to invest
primarily in fully taxable preferred securities. The Fund's portfolio may
include both fixed rate and adjustable rate securities. The allocation of the
Fund's assets in various types of preferred, debt and equity securities may vary
from time to time depending on the Adviser's assessment of market conditions.
The Adviser will perform its own investment analysis when making investment
decisions for the Fund and will not rely solely on the ratings assigned to rated
securities. Securities ratings are based largely on an issuer's historical
financial information and each rating agency's investment analysis at the time
of rating. Consequently, the rating assigned to any particular security is not
necessarily a reflection of the issuer's current financial condition, which may
be better or worse than the rating indicates. The Adviser's analysis may include
consideration of the issuer's experience and managerial strength, changing
financial condition, borrowing requirements or debt maturity schedules, and its
responsiveness to changes in business conditions and interest or dividend rates.
The Adviser will also consider relative values based on anticipated cash flow,
interest or dividend coverage, asset coverage, earnings prospects, current yield
and price stability. The Adviser seeks to produce superior results by focusing
on the business cycle and individual security fundamentals and less so on
interest rates and duration. In structuring the portfolio, the Adviser seeks to
add investment value in two ways:
+ by anticipating the broader, more gradual changes in the business cycle, and
then investing in those industries and sectors that are expected to benefit
from the changes
+ by looking within those industries and sectors for issuers and companies that
are undervalued and mispriced relative to the market
INDUSTRY AND ISSUER CONCENTRATION
The Fund intends to emphasize investments in preferred securities issued or
guaranteed by U.S. corporations in the utilities sector and will be subject to
certain risks due to such emphasis. The Fund will not invest 25% or more of its
total assets in any one industry, except that the Fund will invest 25% or more
of its total assets in the industries comprising the utilities sector. The Fund
will allocate its investments among industry sectors and among issuers in such
sectors, based on the Adviser's evaluation of market and economic conditions.
2
FOREIGN SECURITIES
Although the Fund will invest primarily in the securities of U.S. issuers, the
Fund may invest up to 20% of its total assets in securities of corporate and
governmental issuers located outside the United States that are traded or
denominated in U.S. dollars.
ILLIQUID SECURITIES
The Fund may invest up to 20% of its total assets in illiquid securities, which
are securities that can not be disposed of by the Fund within seven days in the
ordinary course of business at approximately the amount at which the Fund values
the securities. The Fund may invest in securities that are sold in direct
private placement transactions and are neither listed on an exchange nor traded
in the over-the-counter market.
OTHER SECURITIES
Normally, the Fund will invest substantially all of its assets to meet its
investment objectives. The Fund may invest the remainder of its assets in
securities with remaining maturities of less than one year, cash equivalents or
may hold cash. For temporary defensive purposes, the Fund may depart from its
principal investment strategies and invest part or all of its assets in
securities with remaining maturities of less than one year or cash equivalents
or may hold cash. During such periods, the Fund may not be able to achieve its
investment objectives.
HEDGING AND INTEREST RATE TRANSACTIONS
The Fund may, but is not required to, use various hedging and interest rate
transactions to earn income, facilitate portfolio management and mitigate risks.
The Fund may purchase and sell derivative instruments such as exchange-listed
and over-the-counter put and call options on securities, equity, fixed income
and interest rate indices, and other financial instruments, purchase and sell
financial futures contracts and options thereon, enter into various interest
rate transactions such as swaps, caps, floors or collars or credit transactions
and credit default swaps. The Fund also may purchase derivative instruments that
combine features of these instruments. The Fund generally seeks to use these
instruments and transactions as a portfolio management or hedging technique to
seek to protect against possible adverse changes in the market value of
securities held in or to be purchased for the Fund's portfolio, protect the
value of the Fund's portfolio, facilitate the sale of certain securities for
investment purposes, manage the effective interest rate exposure of the Fund,
manage the effective maturity or duration of the Fund's portfolio, or establish
positions in the derivatives markets as a temporary substitute for purchasing or
selling particular securities. The Fund may use these transactions to enhance
potential gain, although no more than 5% of the Fund's total assets will be
committed to initial margin for such transactions entered into for non-hedging
purposes.
THE INVESTMENT ADVISER AND ADMINISTRATOR
John Hancock Advisers, LLC is the Fund's investment adviser and administrator.
The Adviser is responsible on a day-to-day basis for investment of the Fund's
portfolio in accordance with its investment objectives and policies. The Adviser
makes all investment decisions for the Fund and places purchase and sale orders
for the Fund's portfolio securities. The Adviser also provides office space to
the Fund and administrative and clerical services relating to the Fund's books
and records and preparation of reports.
The Adviser serves as the investment adviser to the Patriot Group of Trusts,
consisting of Patriot Premium Dividend Fund I, Patriot Premium Dividend Fund II,
Patriot Select Dividend Trust, Patriot Preferred Dividend Fund and Patriot
Global Dividend Fund. Each Patriot Fund is a leveraged dual-class, closed-end
investment company, which focuses on investing in preferred stocks and other
securities. The Adviser was organized in 1968 and had, as of June 30, 2002
approximately $26 billion in assets under management, of which approximately
$1.4 billion was invested in preferred securities. The Adviser is an indirect
wholly-owned subsidiary of John Hancock Financial Services, Inc., a financial
services company.
3
LEVERAGE
The Fund expects to utilize financial leverage on an ongoing basis for
investment purposes. After completion of the offering of APS, the Fund
anticipates its total leverage from the issuance of APS will be approximately
33 1/3% of the Fund's total assets. This amount may change, but total leverage
will not exceed 50% of the Fund's total assets. Although the Fund may in the
future offer other preferred shares, the Fund does not currently intend to do
so.
The Fund generally will not utilize leverage if it anticipates that it would
result in a lower return to common shareholders over time. 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 net asset value and market price of the
shares and of dividends), and there can be no assurance that a leveraging
strategy will be successful during any period in which it is employed. Because
the fees paid to the Adviser will be calculated on the basis of the Fund's
managed assets, the fees will be higher when leverage (including the APS) is
utilized, giving the Adviser an incentive to utilize leverage. See "Risks
factors--RISKS OF INVESTMENT IN PREFERRED SHARES--Leverage risk."
SPECIAL RISK CONSIDERATIONS
Risks of investing in the Preferred Shares:
THE PRIMARY RISKS
+ If an Auction fails you may not be able to sell some or all of your APS and
the Fund is not obligated to redeem your APS if the Auction fails
+ Because of the nature of the market for APS, you may receive less than the
price you paid for your shares if you sell them outside of the Auction,
especially when market interest rates are rising
+ A rating agency could downgrade the rating assigned to the APS, which could
affect liquidity
+ The Fund may be forced to redeem APS to meet regulatory or rating agency
requirements or may voluntarily redeem the APS in certain circumstances
+ In certain circumstances, the Fund may not earn sufficient income from its
investments to pay dividends on the APS
+ If interest rates rise, the value of the Fund's investment portfolio
generally will decline, reducing the asset coverage for the APS
LEVERAGE RISK
The Fund's leveraged capital structure creates special risks not associated with
unleveraged funds having similar investment objectives and policies. These
include the possibility of higher volatility of the net asset value of the Fund
and the APS' asset coverage.
INTEREST RATE RISK
The APS pay dividends based on shorter-term interest rates. The Fund invests the
proceeds from the issuance of the APS principally in preferred stocks and other
preferred securities, which bear intermediate- to longer-term dividend or
interest rates. The yields on preferred stocks and other preferred securities
are typically, although not always, higher than shorter-term interest rates.
Shorter-term interest rates may rise so that the amount of dividends to be paid
to holders of APS exceeds the income from the preferred stocks and other
preferred securities and other investments purchased by the Fund with the
proceeds from the sale of the APS. Because income from the Fund's entire
investment portfolio (not just the portion of the portfolio purchased with the
proceeds of the APS offering) is available to pay dividends on the APS, however,
dividend rates on the APS would need to exceed the rate of return on the Fund's
investment portfolio by a wide margin before the Fund's ability to pay dividends
on the APS would be jeopardized. If intermediate- to longer-term interest rates
rise, this could negatively impact the value of the Fund's investment portfolio,
reducing the amount of assets serving as asset coverage for the APS.
4
AUCTION RISK
The dividend rate for the APS normally is set through an Auction process. In the
Auction, Existing Holders of APS may indicate the dividend rate at which the
Existing Holders would be willing to hold or sell their APS or purchase
additional APS. The Auction also provides liquidity for the sale of APS. An
Auction fails if there are more APS offered for sale than there are buyers. You
may not be able to sell your APS at an Auction if the Auction fails. Also, if
you place hold orders (orders to retain shares) at an Auction only at a
specified dividend rate, and that rate exceeds the rate set at the Auction, you
will not retain your APS. Additionally, if you buy APS or elect to retain APS
without specifying a dividend rate below which you would not wish to buy or
continue to hold those APS, you could receive a lower rate of return on your
shares than the market rate. Finally, the Dividend Period for the APS may be
changed by the Fund, subject to certain conditions with notice to the holders of
APS, which could also affect the liquidity of your investment.
SECONDARY MARKET RISK
If you try to sell your APS between Auctions you may not be able to sell any or
all of your APS or you may not be able to sell them for $25,000 per share or
$25,000 per share plus accumulated dividends. If the Fund has designated a
Special Dividend Period, changes in interest rates could affect the price you
would receive if you sold your APS in the secondary market.
You may transfer APS outside of auctions only to or through a Broker-Dealer that
has entered into an agreement with the Auction Agent and the Fund or other
person as the Fund permits.
RATINGS AND ASSET COVERAGE RISK
While it is expected that Moody's will assign a rating of "Aaa" to the APS, such
rating does not eliminate or necessarily mitigate the risks of investing in APS.
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 the APS, both by
the 1940 Act and by requirements imposed by rating agencies, might impair the
Fund's ability to satisfy minimum distribution requirements that it must satisfy
to maintain its qualification as a regulated investment company for federal
income tax purposes.
General risks of investing in the Fund include:
LIMITED OPERATING HISTORY
The Fund is a recently organized closed-end management investment company which
has been operational for less than two months.
INTEREST RATE RISK
Interest rate risk is the risk that fixed income securities such as preferred
securities and debt securities will decline in value because of changes in
market interest rates. When market interest rates rise, the market value of such
securities generally will fall. The Fund's investment in preferred securities
means that the net asset value and market price of the common shares will tend
to decline if market interest rates rise.
During periods of declining interest rates, an issuer may exercise its option to
redeem preferred securities or prepay principal of debt securities earlier than
scheduled, forcing the Fund to reinvest in lower yielding securities. This is
known as call or prepayment risk. During periods of rising interest rates, the
average life of certain types of securities may be extended because of slower
than expected principal payments. This may lock in a below market interest rate,
increase the security's duration and reduce the value of the security. This is
known as extension risk.
CREDIT RISK
Credit risk is the risk that preferred securities or debt securities in the
Fund's portfolio will decline in price or fail to make dividend payments when
due because the issuer of the security experiences a decline in its financial
status. The weighted average credit rating of the Fund's portfolio of preferred
5
securities and other fixed income securities will be at least investment grade.
Although the Fund will primarily invest in investment grade securities, the Fund
is authorized to invest up to 20% of its total assets in preferred securities
and other fixed income securities that are rated below investment grade at the
time of acquisition. These securities may be rated as low as B by Moody's and
S&P. Securities rated "Baa" by Moody's are considered by Moody's as medium to
lower medium grade securities; they are neither highly protected nor poorly
secured; dividend or interest payments and capital or principal security, as the
case may be, appear to Moody's to be adequate for the present but certain
protective elements may be lacking or may be characteristically unreliable over
time; and in the opinion of Moody's, securities in this rating category lack
outstanding investment characteristics and in fact have speculative
characteristics as well. Securities rated "BBB" by S&P are regarded by S&P as
having an adequate capacity to pay dividends or interest and repay capital or
principal, as the case may be; whereas such securities normally exhibit adequate
protection parameters, adverse economic conditions or changing circumstances are
more likely, in the opinion of S&P, to lead to a weakened capacity to pay
dividends or interest and repay capital or principal for securities in this
category than in higher rating categories. Below investment grade securities and
comparable unrated securities involve substantial risk of loss, are considered
speculative with respect to the issuer's ability to pay interest and any
required redemption or principal payments and are susceptible to default or
decline in market value due to adverse economic and business developments. The
ratings of Moody's and S&P represent their opinions as to the quality of those
securities that they rate; ratings are relative and subjective and are not
absolute standards of quality.
SPECIAL RISKS RELATED TO PREFERRED SECURITIES
There are special risks associated with the Fund's investments in preferred
securities:
+ LIMITED VOTING RIGHTS. Generally, holders of preferred securities (such as
the Fund) have no voting rights with respect to the issuing company unless
preferred dividends have been in arrears for a specified number of periods,
at which time the preferred security holders may elect a number of directors
to the issuer's board. Generally, once the issuer pays all the arrearages,
the preferred security holders no longer have voting rights.
+ SPECIAL REDEMPTION RIGHTS. In certain varying circumstances, an issuer of
preferred securities may redeem the securities prior to a specified date. For
instance, for certain types of preferred securities, a redemption may be
triggered by a change in federal income tax or securities laws. As with call
provisions, a special redemption by the issuer may negatively impact the
return of the security held by the Fund.
+ DEFERRAL. Preferred securities may include provisions that permit the
issuer, at its discretion, to defer distributions for a stated period without
any adverse consequences to the issuer. If the Fund owns a preferred security
that is deferring its distributions, the Fund may be required to report
income for federal income tax purposes although it has not yet received such
income in cash.
+ 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.
DIVIDENDS RECEIVED DEDUCTION
The income from taxable preferred securities in which the Fund intends to invest
does not qualify for the dividends received deduction (the "Dividends Received
Deduction") under Section 243 of the Internal Revenue Code of 1986, as amended
(the "Code"). The Dividends Received Deduction generally allows corporations to
deduct from their income 70% of dividends received from domestic corporations.
Accordingly, any corporate shareholder should assume that none of the
distributions it receives from the Fund will qualify for the Dividends Received
Deduction.
6
SECTOR RISK
Under normal market conditions, the Fund will emphasize investments in preferred
securities issued or guaranteed by U.S. corporations in the utilities sector.
However, the Fund will not invest 25% or more of its total assets in issuers
engaged in any one industry, except that the Fund will invest 25% or more of its
total assets in the industries comprising the utilities sector.
The utilities industries in which the Fund may invest include companies engaged
in:
+ the generation, transmission, sale or distribution of electric energy
+ the distribution, purification and treatment of water
+ the provision of sewage management, treatment or other sanitary services
+ the production, transmission or distribution of natural gas
+ the provision of pollution control or abatement services
+ telecommunications, including telephone, telegraph, satellite, microwave and
other communications media (but not companies engaged primarily in the public
broadcasting industry)
The Fund's emphasis on securities of utilities issuers makes it more susceptible
to adverse conditions affecting such industries than a fund that does not have
its assets invested to a similar degree in such issuers. Issuers in the
utilities sector are subject to a variety of factors that may adversely affect
their business or operations, including:
+ high interest costs in connection with capital construction programs
+ governmental regulation of rates charged to customers
+ costs associated with environmental and other regulations
+ the effects of economic slowdowns and surplus capacity
+ increased competition from other providers of utility services
+ uncertainties concerning the availability of fuel at reasonable prices
+ the effects of energy conservation policies
Issuers in the utilities sector may also be subject to regulation by various
governmental authorities and may be affected by the imposition of special
tariffs and changes in tax laws, regulatory policies and accounting standards.
Generally, prices charged by utilities are also regulated in the United States
with the intention of protecting the public while ensuring that the rate of
return earned by such companies is sufficient to allow them to attract capital
in order to grow and continue to provide appropriate services. There can be no
assurance that such pricing policies or rates of return will continue in the
future. The nature of regulation of industries in the utilities sector is
evolving. Changes in regulation increasingly allow participants in the utilities
sector to provide services and products outside their traditional geographic
areas and lines of business, creating new areas of competition within such
industries. The emergence of competition may result in certain companies being
forced to defend their core businesses which may cause such companies to be less
profitable.
While the Fund will not invest 25% or more of its total assets in any one of the
industries comprising the financial services sector, from time to time the Fund
may have significant exposure to issuers in the financial services sector. These
industries include bank holding companies, banks, securities brokers and dealers
and life, property, casualty and multi-line insurance companies. These
industries are subject to extensive regulation at the federal and/or state level
and, to the extent that they operate internationally. Each of these industries
may also be significantly affected by changes in prevailing interest rates,
general economic conditions and industry specific risks. The enactment of new
legislation and regulation, as well as changes in the interpretation and
enforcement of existing laws and regulations, may directly affect the manner of
operations and profitability of participants in the financial services sector.
From time to time, changes in law and regulation have permitted greater
diversification of their financial products, but their ability to expand by
acquisition or branching across
7
state lines and to engage in non-banking activities continues to be limited.
Federal or state law and regulations require banks, bank holding companies,
broker-dealers and insurance companies to maintain minimum levels of capital and
liquidity. Bank regulators have broad authority and can impose sanctions,
including conservatorship or receivership, on non-complying banks even when
these banks continue to be solvent, thereby possibly resulting in the
elimination of stockholders' equity.
CONVERTIBLE SECURITIES
The preferred securities and other fixed income securities in which the Fund
invests may be convertible into the issuer's or a related party's common shares.
Convertible securities generally offer lower dividend yields or interest rates
than non-convertible securities of similar quality. As with all fixed income
securities, the market values of convertible securities tend to decline as
interest rates increase and, conversely, to increase as interest rates decline.
However, when the market price of the common stock underlying a convertible
security exceeds the conversion price, the convertible security tends to reflect
the market price of the underlying common stock. As the market price of the
underlying common stock declines, the convertible security tends to trade
increasingly on a yield basis and thus may not decline in price to the same
extent as the underlying common stock.
COMMON STOCKS
The common stocks and other non-preferred equity securities in which the Fund
invests may experience substantially more volatility in their market value than
the Fund's investments in preferred securities. Such securities may also be more
susceptible to adverse changes in market value due to issuer specific events,
such as unfavorable earnings reports. The market values of common stocks are
also generally sensitive to general movements in the equities markets.
ILLIQUID SECURITIES
The Fund may invest up to 20% of its total assets in illiquid securities.
Illiquid securities may be difficult to dispose of at a fair price at the times
when the Adviser believes it is desirable to do so. The market price of illiquid
securities generally is more volatile than that of more liquid securities, which
may adversely affect the price that the Fund pays for or recovers upon the sale
of illiquid securities. Illiquid securities are also more difficult to value and
the Adviser's judgment may play a greater role in the valuation process.
Investment of the Fund's assets in illiquid securities may restrict the Fund's
ability to take advantage of market opportunities. The risks associated with
illiquid securities may be particularly acute in situations in which the Fund's
operations require cash and could result in the Fund borrowing to meet its
short-term needs or incurring losses on the sale of illiquid securities.
FOREIGN SECURITIES
Although the Fund will only invest in securities of non-U.S. issuers that are
traded or denominated in U.S. dollars, the Fund's investments in non-U.S.
issuers may involve unique risks compared to investing in securities of U.S.
issuers. These risks are more pronounced to the extent that the Fund invests a
significant portion of its non-U.S. investments in one region or in the
securities of emerging market issuers. These risks may include:
+ less information about non-U.S. issuers or markets may be available due to
less rigorous disclosure or accounting standards or regulatory practices
+ many non-U.S. markets are smaller, less liquid and more volatile. In a
changing market, the Adviser may not be able to sell the Fund's portfolio
securities at times, in amounts and at prices it considers reasonable
+ adverse effect of currency exchange rates or controls on the value of the
Fund's investments
+ the economies of non-U.S. countries may grow at slower rates than expected or
may experience a downturn or recession
+ economic, political and social developments may adversely affect the
securities markets
+ withholding and other non-U.S. taxes may decrease the Fund's return
8
DERIVATIVES
The Fund's hedging and interest rate transactions have risks, including the
imperfect correlation between the value of such instruments and the underlying
assets of the Fund, the possible default of the other party to the transaction
or illiquidity of the derivative instruments. Furthermore, the ability to use
successfully hedging and interest rate transactions depends on the Adviser's
ability to predict pertinent market movements, which cannot be assured. Thus,
the use of derivatives for hedging and interest rate management purposes may
result in losses greater than if they had not been used, may require the Fund to
sell or purchase portfolio securities at inopportune times or for prices other
than current market values, may limit the amount of appreciation the Fund can
realize on an investment, or may cause the Fund to hold a security that it might
otherwise sell. Additionally, amounts paid by the Fund as premiums and cash or
other assets held in margin accounts with respect to hedging and interest rate
transactions are not otherwise available to the Fund for investment purposes.
FEDERAL INCOME TAXATION
The Fund intends to take the position that under present law the APS will
constitute stock of the Fund. Distributions with respect to the APS (other than
distributions in redemption of the APS that are treated as exchanges of stock
under Section 302(b) of the Code) will constitute dividends to the extent of the
Fund's current or accumulated earnings and profits as calculated for U.S.
federal income tax purposes. Such dividends generally will be taxable as
ordinary income to shareholders. Distributions of net capital gain that are
designated by the Fund as capital gain dividends will be treated as long-term
capital gains without regard to the length of time the shareholder has held
shares of the Fund.
TRADING MARKET
The APS will not be listed on an exchange. Instead, you may buy or sell APS at
an Auction that normally is held every seven days by submitting orders to a
Broker-Dealer that has entered into an agreement with the Auction Agent and the
Fund, or to a Broker-Dealer that has entered into a separate agreement with a
Broker-Dealer. In addition to the Auctions, Broker-Dealers and other
broker-dealers may maintain a secondary trading market in APS outside of
Auctions, but may discontinue this activity at any time. There is no assurance
that a secondary market will provide shareholders with liquidity. You may
transfer APS outside of Auctions only to or through a Broker-Dealer or a
broker-dealer that has entered into a separate agreement with a Broker-Dealer.
DIVIDENDS AND DIVIDEND PERIODS
The APS will entitle their holders to receive cash dividends at a rate per annum
that may vary for the successive Dividend Periods for such shares. In general,
except as described below, each Dividend Period for each series of APS
subsequent to the Initial Dividend Period will be seven days in length. The
Applicable Rate for a particular Dividend Period will be determined by an
Auction conducted on the Business Day immediately preceding the start of such
Dividend Period.
The table below shows the initial dividend rate, the Dividend Payment Date and
the number of days for the Initial Dividend Period on each series of the APS
offered in this Prospectus. For subsequent Dividend Periods, the APS will pay
dividends based on a rate set at Auctions, normally held every seven days. In
most instances, dividends are payable on the first Business Day following the
end of the Dividend Period. The rate set at Auction will not exceed the Maximum
Applicable Rate. See "Description of Preferred Shares--DIVIDENDS AND DIVIDEND
PERIODS." Dividends on the APS will be cumulative from the date the APS are
first issued and will be paid out of legally available funds.
DATE OF DIVIDEND PAYMENT NUMBER OF DAYS OF
INITIAL DIVIDEND ACCUMULATION AT DATE FOR INITIAL SUBSEQUENT DIVIDEND INITIAL DIVIDEND
RATE INITIAL RATE DIVIDEND PERIOD PAYMENT DAY PERIOD
-------------------------------------------------------------------------------------------------------------------------------
Series M............. 1.85% November 4, 2002 November 5, 2002 Normally every 7 days 13
Series T............. 1.85% November 5, 2002 November 6, 2002 Normally every 7 days 14
Series W............. 1.95% April 23, 2003 Monthly Normally every 7 days 183
Series TH............ 1.85% November 7, 2002 November 8, 2002 Normally every 7 days 16
Series F............. 1.85% November 1, 2002 November 4, 2002 Normally every 7 days 10
9
After the Initial Dividend Period, each subsequent Dividend Period will
generally consist of seven days; provided, however, that prior to any Auction,
the Fund may elect, subject to certain limitations described herein, after
giving notice to the holders of one or more series of APS, to declare a Special
Dividend Period with respect to such series. A "Special Dividend Period" is a
Dividend Period consisting of a specified number of days, evenly divisible by
seven and not fewer than 14 nor more than 364 (a "Short Term Dividend Period")
or a Dividend Period of one year or more but not greater than five years (a
"Long Term Dividend Period"). A requested Special Dividend Period will not be
effective unless Sufficient Clearing Bids were made in the Auction immediately
preceding the Special Dividend Period. In addition, full cumulative dividends,
any amounts due with respect to mandatory redemptions and any additional
dividends payable prior to such date must be paid in full. See "Description of
Preferred Shares--DIVIDENDS AND DIVIDEND PERIODS--Designation of Special
Dividend Periods" and "The Auction."
Dividends for the APS will be paid through the Securities Depository on each
Dividend Payment Date. The Securities Depository's normal procedures provide for
it to distribute dividends in same-day funds to Agent Members, who are in turn
expected to distribute such dividends to the person for whom they are acting as
agent in accordance with the instructions of such person. See "Description of
Preferred Shares--DIVIDENDS AND DIVIDEND PERIODS."
MAXIMUM APPLICABLE RATE
Except during a Non-Payment Period, the Applicable Rate for any Dividend Period
for APS will not be more than the Maximum Applicable Rate applicable to such
shares. The Maximum Applicable Rate for each series of APS will depend on the
credit rating assigned to such series and on the duration of the Dividend
Period. The Maximum Applicable Rate will be the Applicable Percentage of the
Reference Rate. The Reference Rate is (i) with respect to any seven day Dividend
Period or any Short Term Dividend Period having 182 or fewer days, the
applicable "AA" Financial Composite Commercial Paper Rate, (ii) with respect to
any Short Term Dividend Period having 183 or more but fewer than 364 days, the
applicable U.S. Treasury Bill Rate and (iii) with respect to any Long Term
Dividend Period, the applicable U.S. Treasury Note Rate. The Applicable
Percentage will be determined based on the credit rating assigned on such date
to the APS by Moody's (or, if Moody's shall not make such rating available, the
equivalent of such rating by a Substitute Rating Agency).
APPLICABLE PERCENTAGE PAYMENT TABLE
MOODY'S CREDIT RATINGS APPLICABLE PERCENTAGE
-----------------------------------------------------------------------------------
Aa3 or higher................................................................ 150%
A3 to A1..................................................................... 200%
Baa3 to Baa1................................................................. 225%
Below Baa3................................................................... 275%
RATINGS
The APS are expected to receive a rating of "Aaa" from Moody's. This rating is
an assessment of the capacity and willingness of an issuer to pay preferred
stock obligations. The ratings are not a recommendation to purchase, hold or
sell APS inasmuch as the rating does not comment as to market price or
suitability for a particular investor. The rating also does not address the
likelihood that an owner of APS will be able to sell such APS in an Auction or
otherwise. The rating is based on information obtained from the Fund and other
sources. The rating may be changed, suspended or withdrawn in the Moody's
discretion as a result of changes in, or the unavailability of, such
information. See "Description of Preferred Shares--RATING AGENCY GUIDELINES AND
ASSET COVERAGE."
10
REDEMPTION
The Fund is required to redeem APS if the Fund does not meet an asset coverage
ratio required by the 1940 Act or the rating agency guideline in a timely
manner. The Fund may voluntarily redeem APS, in whole or in part, under certain
conditions. Unless otherwise established in connection with a Special Dividend
Period, the redemption price per Preferred Share will be $25,000 plus
accumulated and unpaid dividends through the date of redemption. See
"Description of Preferred Shares--REDEMPTION" and "Description of Preferred
Shares--RATING AGENCY GUIDELINES AND ASSET COVERAGE."
ASSET MAINTENANCE
Under the By-laws which establish and fix the rights and preferences of the APS,
the Fund must maintain:
+ asset coverage of the APS as required by the rating agency or agencies rating
the APS; and
+ asset coverage of at least 200% with respect to senior securities of the Fund
that are stock, including the APS.
In the event that the Fund does not maintain or cure these coverage tests, some
or all of the APS will be subject to mandatory redemption. See "Description of
Preferred Shares--REDEMPTION." Based on the composition of the Fund's portfolio
as of September 30, 2002 (adjusted for the exercise of the over-allotment option
on October 4, 2002) the asset coverage of the APS as measured pursuant to the
1940 Act would be approximately 316% if the Fund were to issue APS offered
hereby.
LIQUIDATION PREFERENCE
The liquidation preference for shares of each series of APS will be $25,000 per
share plus accumulated but unpaid dividends, if any, whether or not earned or
declared. See "Description of Preferred Shares--LIQUIDATION."
VOTING RIGHTS
The holders of preferred shares, including the APS, voting as a separate class,
have the right to elect at least two Trustees of the Fund at all times. Such
holders also have the right to elect a majority of the Trustees in the event
that two years' dividends on the preferred shares are unpaid. In each case, the
remaining Trustees will be elected by holders of common shares. The holders of
preferred shares, including the APS, will vote as a separate class or classes on
certain other matters required under the Declaration of the Trust, the By-laws,
the 1940 Act and Massachusetts law. See "Description of Preferred Shares--VOTING
RIGHTS," and "Certain provisions of the Agreement and Declaration of Trust and
By-laws."
AUCTION PROCEDURES
Unless otherwise permitted by the Fund, Beneficial Owners and Potential
Beneficial Owners of APS may only participate in Auctions through their
Broker-Dealers. Broker-Dealers will submit the Orders of their respective
customers who are Beneficial Owners and Potential Beneficial Owners to the
Auction Agent, designating themselves as Existing Holders in respect of APS
subject to Orders submitted or deemed submitted to them by Beneficial Owners and
as Potential Holders in respect of APS subject to Orders submitted to them by
Potential Beneficial Owners. On or prior to each Auction Date for the APS of a
series (the Business Day immediately preceding the first day of each Dividend
Period), each Beneficial Owner may submit Orders to its Broker-Dealer as
follows:
+ Hold Order--indicating its desire to hold the APS of such series without
regard to the Applicable Rate for the next Dividend Period for such APS.
+ Bid--indicating its desire to hold the APS of such series, provided that the
Applicable Rate for the next Dividend Period for such APS is not less than
the rate per annum specified in such Bid.
11
+ Sell Order--indicating its desire to sell the APS of such series without
regard to the Applicable Rate for the next Dividend Period for such APS.
A Beneficial Owner may submit different types of Orders to its Broker-Dealer
with respect to the APS of a series then held by such Beneficial Owner, provided
that the total number of APS covered by such Orders does not exceed the number
of APS of such series held by such Beneficial Owner. If, however, a Beneficial
Owner offers through its Broker-Dealer to purchase additional APS of a series in
such Auction, such Beneficial Owner, for purposes of such offer to purchase
additional shares, will be treated as a Potential Beneficial Owner as described
below. Bids by Beneficial Owners through their Broker-Dealers with rates per
annum higher than the Maximum Applicable Rate will be treated as Sell Orders. A
Hold Order (in the case of an Auction relating to a Dividend Period of 91 days
or less) or a Sell Order (in the case of an Auction relating to a Special
Dividend Period of longer than 91 days) shall be deemed to have been submitted
on behalf of a Beneficial Owner if an Order with respect to the APS then held by
such Beneficial Owner is not submitted on behalf of such Beneficial Owner for
any reason, including the failure of a Broker-Dealer to submit such Beneficial
Owner's Order to the Auction Agent.
Potential Beneficial Owners of APS may submit Bids through their Broker-Dealers
in which they offer to purchase APS, provided that the Applicable Rate for the
next Dividend Period for such APS is not less than the rate per annum specified
in such Bid. A Bid by a Potential Beneficial Owner with a rate per annum higher
than the Maximum Applicable Rate will not be considered.
Neither the Fund nor the Auction Agent will be responsible for a Broker-Dealer's
failure to act in accordance with the instructions of Beneficial Owners or
Potential Beneficial Owners or failure to comply with any of the foregoing.
If Sufficient Clearing Bids exist in an Auction for the APS of a series (that
is, in general, the number of APS subject to Bids by Potential Holders with
rates equal to or lower than the Maximum Applicable Rate is at least equal to
the number of APS subject to Sell Orders by Existing Holders), the Applicable
Rate will be the lowest rate per annum specified in the Submitted Bids which,
taking into account such rate per annum and all lower rates per annum bid by
Existing Holders and Potential Holders, would result in Existing Holders and
Potential Holders owning all of the APS available for purchase in the Auction.
If Sufficient Clearing Bids do not exist, the Applicable Rate will be the
Maximum Applicable Rate, and in such event, Existing Holders that have submitted
Sell Orders will not be able to sell in the Auction all, and may not be able to
sell any, APS subject to such Sell Orders. Thus, in certain circumstances,
Existing Holders and the Beneficial Owners they represent, may not have
liquidity of investment. If all of the applicable outstanding APS are subject to
submitted hold orders (or hold orders deemed to have been submitted), then the
Dividend Period will be a seven day Dividend Period and the Applicable Rate for
the next Dividend Period will be the 'AA' Financial Composite Commercial Paper
Rate for a seven day Dividend Period.
A Sell Order by an Existing Holder will constitute an irrevocable offer to sell
the APS subject thereto, and a Bid placed by an Existing Holder also will
constitute an irrevocable offer to sell the APS subject thereto if the rate per
annum specified in the Bid is higher than the Applicable Rate determined in the
Auction, in each case at a price per Preferred Share equal to $25,000. A Bid
placed by a Potential Holder will constitute an irrevocable offer to purchase
the APS subject thereto at a price per share equal to $25,000 if the rate per
annum specified in such Bid is less than or equal to the Applicable Rate
determined in the Auction. Settlement of purchases and sales will be made on the
next Business Day (also a Dividend Payment Date) after the Auction Date through
the Securities Depository. Purchasers will make payment through their Agent
Members in same-day funds to the Securities Depository against delivery by
book-entry to their Agent Members. The Securities Depository will make payment
to the sellers' Agent Members in accordance with the Securities Depository's
normal procedures, which now provide for payment in same-day funds. See "The
Auction."
12
Financial highlights (unaudited)
Information contained in the table below shows the unaudited operating
performance of the Fund from the commencement of the Fund's investment
operations on August 27, 2002 through September 30, 2002. Since the Fund was
recently organized and commenced investment operations on August 27, 2002, the
table covers approximately one month of operations, during which a substantial
portion of the Fund's portfolio was held in temporary investments pending
investment in preferred stocks or other preferred securities that meet the
Fund's investment objectives and policies. Accordingly, the information
presented does not provide a meaningful picture of the Fund's future operating
performance.
FOR THE PERIOD
AUGUST 27, 2002(1)
THROUGH SEPTEMBER 30, 2002
(UNAUDITED)
----------------------------------------------------------------------
Per Common Share operating performance:
Net asset value, beginning of period(2)..................... $ 23.88
--------
Increase/(decrease) from investment operations:
Net investment income..................................... 0.20
Net realized and unrealized gain/(loss) on investments.... (0.31)
Dividends to preferred shareholders....................... --
--------
Net increase/(decrease) from investment operations.......... (0.11)
--------
Offering costs charged to capital........................... (0.03)
--------
Net asset value, end of period(3)........................... $ 23.74
========
Market value, end of period(3).............................. $ 25.07
========
Total investment return(4)............................. 4.98%(5)
========
Ratios to average net assets applicable to common
shareholders:
Ratio of expenses to average net assets..................... 0.71%(6)
Ratio of adjusted expenses to average net assets............ 0.91%(6)(7)
Net investment income before preferred share dividends...... 9.61%(6)
Preferred share dividends................................... --%(6)
Net investment income applicable to common shareholders..... 9.61%(6)
Supplemental data:
Average net assets of common shareholders (000)............. $541,756
Portfolio turnover.......................................... 80%
Net assets applicable to common shareholders, end of period
(000)..................................................... $593,533
Preferred shares outstanding (000).......................... --
(1) Commencement of investment operations
(2) Net asset value immediately after the closing of the first public offering
was $23.875
(3) Net asset value and market value are published in Barron's on Saturday, The
Wall Street Journal on Monday and The New York Times on Monday and Saturday
(4) Total investment return is calculated assuming a purchase of common shares
at the current market value on the first day and a sale at the current
market value on the last day of the period reported. Dividends and
distributions, if any, are assumed for purposes of this calculation to be
reinvested at prices obtained under the Fund's dividend reinvestment plan.
Total investment returns of less than a full period are not annualized.
Past performance is not a guarantee of future results
(5) Not annualized
(6) Annualized
(7) Does not take into consideration expense reductions during period
The information above represents the unaudited operating performance for a
Common Share outstanding, total investment return, ratios to average net assets
and other supplemental data for the periods indicated. This information has been
determined based upon financial information provided in the financial statements
and market value data for the Fund's Common Shares.
13
--------------------------------------------------------------------------------
The Fund
John Hancock Preferred Income Fund (the "Fund") is a recently organized,
diversified, closed-end management investment company. The Fund was organized
under the laws of the Commonwealth of Massachusetts on June 27, 2002, and has
registered under the 1940 Act. The Fund's principal office is located at 101
Huntington Avenue, Boston, Massachusetts 02199, and its telephone number is
(800) 843-0090.
On August 22, 2002, the Fund issued an aggregate of 22,500,000 Common Shares of
beneficial interest, no par value, pursuant to an initial public offering. The
Fund issued 2,500,000 Common Shares on September 17, 2002 and 583,900 Common
Shares on October 4, 2002 pursuant to an over-allotment provision. The Fund's
Common Shares are traded on the NYSE under the symbol "HPI."
The following provides information about the Fund's outstanding shares as of
September 30, 2002.
AMOUNT HELD
AMOUNT BY THE FUND OR AMOUNT
TITLE OF CLASS AUTHORIZED FOR ITS ACCOUNT OUTSTANDING
--------------------------------------------------------------------------------------------------
Common Shares......................................... Unlimited 0 25,006,409
Unlimited
for each
Auction Preferred Shares.............................. Series 0 0
Series M
Series T
Series W
Series TH
Series F
Use of proceeds
The net proceeds of this offering of APS will be approximately $276,718,000
after payment of offering costs (including sales load) estimated to be
approximately $3,282,000. The Fund will invest the net proceeds of the offering
in accordance with its investment objectives and policies as stated below under
"Investment objectives and principal investment strategies." The Fund expects
that there will be an initial investment period of up to three months following
the completion of this offering before all of the proceeds from the sale of the
APS are invested in accordance with its investment objectives and policies.
Pending such investment, the Fund anticipates that all or a portion of the
proceeds will be invested in U.S. government securities or high-grade,
short-term money market instruments. See "Investment objectives and principal
investment strategies."
--------------------------------------------------------------------------------
14
--------------------------------------------------------------------------------
Capitalization (unaudited)
The following table sets forth the capitalization of the Fund as of September
30, 2002, and as adjusted to give effect to (i) the issuance of the APS offered
hereby (including estimated offering expenses and a sales load of $250 per APS)
and (ii) the Common Shares issued on October 4, 2002 pursuant to an
over-allotment option.
ACTUAL AS ADJUSTED
-------------------------------------------------------------------------------------------
Auction Preferred Shares, no par value per share (no shares
issued; 11,200 shares issued, as adjusted at $25,000 per
share liquidation preference)............................. $ -- $ 280,000,000
============= =============
Shareholder's equity:
Common Shares, no par value per share; 25,006,409 shares
outstanding 25,590,309 shares outstanding as
adjusted(1)............................................. 596,209,015 606,867,628
------------- -------------
Paid-in surplus
Balance of undistributed net investment income............ 5,021,493 5,021,493
------------- -------------
Accumulated net realized gain/(loss) from investment
transactions............................................ 421,503 421,503
------------- -------------
Net unrealized appreciation/(depreciation) of
investments............................................. (8,118,919) (8,118,919)
------------- -------------
Net assets attributable to Common Shares.................. 593,533,092 604,191,705
============= =============
(1) None of these outstanding shares are held by or for the account of the Fund
Portfolio composition
As of September 30, 2002, approximately 74% of the market value of the Fund's
portfolio was invested in preferred stocks and other preferred securities and
approximately 26% of the market value of the Fund's portfolio was invested in
other securities and short-term instruments. The following table sets forth
certain information with respect to the composition of the Fund's investment
portfolio as of September 30, 2002, based on the highest rating assigned each
investment.
CREDIT RATING (MOODY'S/S&P) NUMBER OF ISSUES VALUE (000) PERCENT
--------------------------------------------------------------------------------------------------
Aaa/AAA................................................. 3 $ 75,537 12%
Aa/AA................................................... 4 18,489 3
A/A..................................................... 53 200,888 32
Baa/BBB................................................. 62 249,616 40
Ba/BB................................................... 14 69,205 11
B/B..................................................... 1 718 0
Unrated+................................................ 1 9,430 1
Short term.............................................. 1 4,999 1
---------------- ----------- -------
Total.............................................. 139 628,882 100
================ =========== =======
+ Refers to securities that have not been rated by Moody's or S&P. See
"Investment objectives and principal investment strategies--PORTFOLIO
CONTENTS AND PRINCIPAL INVESTMENT STRATEGIES"
--------------------------------------------------------------------------------
15
--------------------------------------------------------------------------------
Investment objectives and principal investment strategies
INVESTMENT OBJECTIVES
The Fund's primary investment objective is to provide a high level of current
income, consistent with preservation of capital. The Fund's secondary investment
objective is to provide growth of capital to the extent consistent with its
primary investment objective. The Fund seeks to achieve its objectives by
investing in securities that, in the opinion of the Adviser, may be undervalued
relative to similar securities in the marketplace. The Fund's investment
objectives are non-fundamental policies and may be changed without the approval
of a majority of the outstanding voting securities (as defined in the 1940 Act)
of the Fund. The Fund makes no assurance that it will realize its objectives.
PRINCIPAL INVESTMENT FOCUS AND PHILOSOPHY
Under normal market conditions, the Fund invests at least 80% of its assets (net
assets plus borrowing for investment purposes) in preferred stocks and other
preferred securities, including convertible preferred securities. This is a
non-fundamental policy and may be changed by the Board of Trustees of the Fund
provided that shareholders are provided with at least 60 days prior written
notice of any change as required by the rules under the 1940 Act. The Fund
intends to invest primarily in fully taxable preferred securities. The Fund's
portfolio of preferred securities may include both fixed rate and adjustable
rate securities. The allocation of the Fund's assets in various types of
preferred, debt and equity securities may vary from time to time depending upon
the Adviser's assessment of market conditions.
The Fund invests at least 80% of its total assets in preferred securities and
other fixed income securities which are rated investment grade (i.e., at least
"Baa" by Moody's Investors Service, Inc. ("Moody's") or "BBB" by Standard &
Poor's Rating Group ("S&P")) or in unrated securities determined by the Adviser
to be of comparable credit quality. The Fund may invest up to 20% of its total
assets in (i) preferred securities or other fixed income securities rated below
investment grade ("B" or higher) or unrated preferred securities or unrated
fixed income securities determined by the Adviser to be of comparable quality
and (ii) common stocks or other equity securities that are not considered
preferred securities. The weighted average credit rating of the Fund's portfolio
of preferred securities and other fixed income securities will be at least
investment grade.
Securities rated "BBB" by S&P are regarded by S&P as having an adequate capacity
to pay dividends or interest and repay capital or principal, as the case may be;
whereas such securities normally exhibit adequate protection parameters, adverse
economic conditions or changing circumstances are more likely, in the opinion of
S&P, to lead to a weakened capacity to pay dividends or interest and repay
capital or principal for securities in this category than in higher rating
categories. Securities rated "Baa" by Moody's are considered by Moody's as
medium to lower medium grade securities; they are neither highly protected nor
poorly secured; dividend or interest payments and capital or principal security,
as the case may be, appear to Moody's to be adequate for the present but certain
protective elements may be lacking or may be characteristically unreliable over
time; and in the opinion of Moody's, securities in this rating category lack
outstanding investment characteristics and in fact have speculative
characteristics as well. Below investment grade securities and comparable
unrated securities involve substantial risk of loss, are considered speculative
with respect to the issuer's ability to pay interest and any required redemption
or principal payments and are susceptible to default or decline in market value
due to adverse economic and business developments. The descriptions of the
investment grade rating categories by Moody's and S&P, including a description
of their speculative characteristics, are set forth in the statement of
additional information. All references to securities ratings by Moody's and S&P
in this Prospectus shall, unless otherwise indicated, include all securities
within each such rating category (i.e., (1), (2) and (3) in the case of Moody's
and (+) and (-) in the case of S&P). All percentage and ratings limitations on
securities in which the Fund may invest apply
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INVESTMENT OBJECTIVES AND PRINCIPAL INVESTMENT STRATEGIES
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at the time of making an investment and shall not be considered violated if an
investment rating is subsequently downgraded to a rating that would have
precluded the Fund's initial investment in such security or weighted average
portfolio. In the event of such security downgrade, the Fund will sell the
portfolio security as soon as the Adviser believes it to be prudent to do so in
order to again cause the Fund to be within the percentage and ratings
limitations set forth in this Prospectus. In the event that the Fund disposes of
a portfolio security subsequent to its being downgraded, the Fund may experience
a greater risk of loss than if such security had been sold prior to such
downgrading.
The Adviser will perform its own investment analysis when making investment
decisions for the Fund and will not rely solely on the ratings assigned to rated
securities. Securities ratings are based largely on an issuer's historical
financial information and each rating agency's investment analysis at the time
of rating. Consequently, the rating assigned to any particular security is not
necessarily a reflection of the issuer's current financial condition, which may
be better or worse than the rating indicates.
The Adviser seeks to produce superior results by focusing on the business cycle
and individual security fundamentals and less so on interest rate and duration.
In structuring the portfolio, the Adviser seeks to add investment value in two
ways:
+ by anticipating the broader, more gradual changes in the business cycle, and
then investing in those industries and sectors that are expected to benefit
from the changes
+ by looking within those industries and sectors for issuers and companies that
are undervalued and mispriced relative to the market
The Adviser believes that focusing on sectors, industries, issuers and
individual security fundamentals, rather than predicting the direction of
interest rates and duration, will lead to superior investment results over time.
The Adviser's analysis may include consideration of the issuer's experience and
managerial strength, changing financial condition, borrowing requirements or
debt maturity schedules, and its responsiveness to changes in business
conditions and interest or dividend rates. The Adviser will also consider
relative values based on anticipated cash flow, interest or dividend coverage,
asset coverage, earnings prospects, current yield and price stability.
PORTFOLIO CONTENTS AND PRINCIPAL INVESTMENT STRATEGIES
INDUSTRY AND ISSUER CONCENTRATION
The Fund intends to emphasize investments in preferred securities issued or
guaranteed by U.S. corporations in the utilities sector be subject to certain
risks due to such emphasis. The Fund will not invest 25% or more of its total
assets in any one industry, except that the Fund will invest 25% or more of its
total assets in the industries comprising the utilities sector. The Fund will
allocate its investments from time to time among industry sectors and among
issuers in such sectors, based on the Adviser's evaluation of market and
economic conditions.
TAXABLE PREFERRED SECURITIES
Pursuant to the Dividends Received Deduction, corporations generally may deduct
70% of the dividend income they receive from domestic corporations. Corporate
shareholders of a regulated investment company, for which status the Fund
intends to qualify, generally are permitted to claim a deduction with respect to
that portion of their distributions from a regulated investment company that are
attributable to amounts received by the regulated investment company that would
qualify for the Dividends Received Deduction. However, not all preferred
securities pay dividends that are eligible for the Dividends Received Deduction.
The Adviser intends to invest primarily in taxable preferred securities (often
referred to as "hybrid" preferred securities) the income from which will not
qualify for the Dividends Received Deduction. These types of taxable preferred
securities typically offer additional yield spread compared to other types of
preferred securities due to the fact that payments made with
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INVESTMENT OBJECTIVES AND PRINCIPAL INVESTMENT STRATEGIES
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respect to such preferred securities do not qualify for the Dividends Received
Deduction. Accordingly, any corporate shareholder should assume that none of the
distributions it receives from the Fund will qualify for the Dividends Received
Deduction.
Taxable preferred securities are a comparatively new asset class. Taxable
preferred securities include but are not limited to:
+ trust originated preferred securities
+ monthly income preferred securities
+ quarterly income bond securities
+ quarterly income debt securities
+ quarterly income preferred securities
+ corporate trust securities
+ public income notes
+ other trust preferred securities
Taxable preferred securities are typically issued by corporations. Taxable
preferred securities may also be issued by an affiliated business trust of a
corporation, generally in the form of beneficial interests in subordinated
debentures or similarly structured securities. The taxable preferred securities
market consists of both fixed and adjustable coupon rate securities that are
either perpetual in nature or have stated maturity dates. The taxable preferred
securities market 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 10
years of call protection (at premium prices) from the date of their original
issuance.
Taxable preferred securities normally constitute 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,
taxable preferred securities typically permit the issuer to defer the payment of
income for a specified period, which may be eighteen months or more, without
triggering an event of default. 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 taxable preferred securities
have not been made), issuers and investors generally treat taxable preferred
securities as close substitutes for traditional preferred securities. Taxable
preferred securities 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.
Taxable preferred securities are typically issued with a final maturity date,
although some are perpetual in nature. In certain instances, a final maturity
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 consequence 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. A portion of the
portfolio may include investments in non-cumulative preferred securities,
whereby the issuer does not have an obligation to make up any arrearages to its
shareholders. Should an issuer default on its obligations under such a security,
the amount of dividends the Fund pays may be adversely affected.
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INVESTMENT OBJECTIVES AND PRINCIPAL INVESTMENT STRATEGIES
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Many taxable preferred securities are issued by trusts or other special purpose
entities established by operating companies, and are not direct obligations of
the operating company. At the time a trust or special purpose entity sells its
preferred securities to investors, the trust or special purpose entity purchases
debt of the operating company (with terms comparable to those of the securities
issued by the trust or special purpose entity), which enables the operating
company to deduct for federal income tax purposes the interest paid on the debt
held by the trust or special purpose entity. The trust or special purpose entity
is generally required to be treated as transparent for federal income tax
purposes such that the holders of the taxable preferred securities are treated
as owning beneficial interests in the underlying debt of the operating company.
Accordingly, dividend payments made with respect to the taxable preferred
securities are treated as interest rather than dividends for federal income tax
purposes and, as such, are not eligible for the Dividends Received Deduction.
The trust or special purpose entity in turn would be a holder of the operating
company's debt and would have priority with respect to the operating company's
assets over the operating company's common shareholders, but would typically be
subordinated to other classes of the operating company's debt. Typically a
taxable preferred share has a rating that is slightly below that of its
corresponding operating company's senior debt securities.
TRADITIONAL PREFERRED SECURITIES
Fixed rate preferred stocks have fixed dividend rates. They can be perpetual,
with no mandatory redemption date, or issued with a fixed mandatory redemption
date. Certain issues of preferred stock are convertible into other equity
securities. Perpetual preferred stocks provide a fixed dividend throughout the
life of the issue, with no mandatory retirement provisions, but may be callable.
Sinking fund preferred 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. The value of fixed rate preferred stocks can be
expected to vary inversely with interest rates.
Adjustable rate preferred stocks have a variable dividend rate which is
determined periodically, typically quarterly, according to a formula based on a
specified premium or discount to the yield on particular U.S. Treasury
securities, typically the highest base-rate yield of one of three U.S. Treasury
securities: the 90-day Treasury bill; the 10-year Treasury note; and either the
20-year or 30-year Treasury bond or other index. The premium or discount to be
added to or subtracted from this base-rate yield is fixed at the time of
issuance and cannot be changed without the approval of the holders of the
adjustable rate preferred stock. Some adjustable rate preferred stocks have a
maximum and a minimum rate and in some cases are convertible into common stock.
Auction rate preferred stocks pay dividends that adjust based upon periodic
auctions. Such 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 least every
49 days, 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. Typically, the auction rate
preferred stock's dividend rate is limited to a specified maximum percentage of
an external commercial paper index as of the auction date. Further, the terms of
auction rate preferred stocks generally provide that they are redeemable by the
issuer at certain times or under certain conditions.
DEBT SECURITIES
The Fund may invest in debt securities with ratings equivalent to those of the
preferred securities in which the Fund may invest. Debt securities in which the
Fund may invest include: securities issued or guaranteed by the U.S. government,
its agencies or instrumentalities and custodial receipts therefor; securities
issued or guaranteed by a foreign government or any of its political
subdivisions, authorities, agencies or instrumentalities or by international or
supranational entities; corporate debt securities including notes, bonds and
debentures; certificates of deposit and bankers' acceptances issued or
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INVESTMENT OBJECTIVES AND PRINCIPAL INVESTMENT STRATEGIES
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guaranteed by, or time deposits maintained at, banks (including U.S. or foreign
branches of U.S. banks or U.S. or foreign branches of foreign banks) having
total assets of more than $1 billion; commercial paper; and mortgage related
securities. These securities may be of any maturity. The value of debt
securities can be expected to vary inversely with interest rates.
COMMON STOCKS
The Fund may invest in common stocks. Common stocks are shares of a corporation
or other entity that entitle the holder to a pro rata share of the profits, if
any, of the corporation without preference over any other shareholder or class
of shareholders, including holders of such entity's preferred stock and other
senior equity securities. Common stock usually carries with it the right to vote
and frequently an exclusive right to do so. 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.
FOREIGN SECURITIES
While the Fund primarily invests in the securities of U.S. issuers, the Fund may
invest up to 20% of its total assets in securities of corporate and governmental
issuers located outside the United States. The Fund only invests in securities
of foreign issuers that are traded or denominated in U.S. dollars.
ILLIQUID SECURITIES
The Fund may invest up to 20% of its assets in illiquid securities (i.e.,
securities that are not readily marketable). Illiquid securities include, but
are not limited to, restricted securities (securities the disposition of which
is restricted under the federal securities laws), securities that may only be
resold pursuant to Rule 144A under the Securities Act of 1933, as amended (the
"Securities Act") but that are deemed to be illiquid, and repurchase agreements
with maturities in excess of seven days. The Board of Trustees or its delegate
has the ultimate authority to determine, to the extent permissible under the
federal securities laws, which securities are liquid or illiquid. Restricted
securities may be sold only in privately negotiated transactions or in a public
offering with respect to which a registration statement is in effect under the
Securities Act. Where registration is required, the Fund may be obligated to pay
all or part of the registration expenses and a considerable period may elapse
between the time of the decision to sell and the time the Fund may be permitted
to sell a security under an effective registration statement. If, during such a
period, adverse market conditions were to develop, the Fund might obtain a less
favorable price than that which prevailed when it decided to sell. Illiquid
securities will be priced at fair value as determined in good faith by the Board
of Trustees or its delegate.
MONEY MARKET INSTRUMENTS
Money market instruments include short-term U.S. government securities, U.S.
dollar denominated, high quality commercial paper (unsecured promissory notes
issued by corporations to finance their short-term credit needs), certificates
of deposit, bankers' acceptances and repurchase agreements relating to any of
the foregoing. U.S. government securities include Treasury notes, bonds and
bills, which are direct obligations of the U.S. government backed by the full
faith and credit of the United States, and securities issued by agencies and
instrumentalities of the U.S. government, which may be guaranteed by the U.S.
Treasury, may be supported by the issuer's right to borrow from the U.S.
Treasury or may be backed only by the credit of the federal agency or
instrumentality itself.
U.S. GOVERNMENT SECURITIES
U.S. government securities in which the Fund invests include debt obligations of
varying maturities issued by the U.S. Treasury or issued or guaranteed by an
agency or instrumentality of the U.S. government, including the Federal Housing
Administration, Federal Financing Bank, Farmers Home Administration,
Export-Import Bank of the United States, Small Business Administration,
Government National Mortgage Association (GNMA), General Services
Administration, Central Bank for
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INVESTMENT OBJECTIVES AND PRINCIPAL INVESTMENT STRATEGIES
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Cooperatives, Federal Farm Credit Banks, Federal Home Loan Banks, Federal Home
Loan Mortgage Corporation (FHLMC), Federal National Mortgage Association (FNMA),
Maritime Administration, Tennessee Valley Authority, District of Columbia Armory
Board, Student Loan Marketing Association, Resolution Trust Corporation and
various institutions that previously were or currently are part of the Farm
Credit System (which has been undergoing reorganization since 1987). Some U.S.
government securities, such as U.S. Treasury bills, Treasury notes and Treasury
bonds, which differ only in their interest rates, maturities and times of
issuance, are supported by the full faith and credit of the United States.
Others are supported by: (i) the right of the issuer to borrow from the U.S.
Treasury, such as securities of the Federal Home Loan Banks; (ii) the
discretionary authority of the U.S. government to purchase the agency's
obligations, such as securities of the FNMA; or (iii) only the credit of the
issuer. No assurance can be given that the U.S. government will provide
financial support in the future to U.S. government agencies, authorities or
instrumentalities that are not supported by the full faith and credit of the
United States. Securities guaranteed as to principal and interest by the U.S.
government, its agencies, authorities or instrumentalities include: (i)
securities for which the payment of principal and interest is backed by an
irrevocable letter of credit issued by the U.S. government or any of its
agencies, authorities or instrumentalities; and (ii) participations in loans
made to non-U.S. governments or other entities that are so guaranteed. The
secondary market for certain of these participations is limited and, therefore,
may be regarded as illiquid.
REITS
The Fund may invest in common and preferred interests in real estate investment
trusts ("REITs"). REITs primarily invest in income producing real estate or real
estate related loans or interests. REITs are generally classified as equity
REITs, mortgage REITs or a combination of equity and mortgage REITs. Equity
REITs invest the majority of their assets directly in real property and derive
income primarily from the collection of rents. Equity REITs can also realize
capital gains by selling properties that have appreciated in value. Mortgage
REITs invest the majority of their assets in real estate mortgages and derive
income from the collection of interest payments. REITs are not taxed on income
distributed to shareholders provided they comply with the applicable
requirements of the Code. The Fund will in some cases indirectly bear its
proportionate share of any management and other expenses paid by REITs in which
it invests in addition to the expenses paid by the Fund. Debt securities issued
by REITs are, for the most part, general and unsecured obligations and are
subject to risks associated with REITs.
OTHER INVESTMENT COMPANIES
The Fund may invest in the securities of other investment companies to the
extent that such investments are consistent with the Fund's investment objective
and policies and permissible under the 1940 Act. Under the 1940 Act, the Fund
may not acquire the securities of other investment companies if, as a result,
(i) more than 10% of the Fund's total assets would be invested in securities of
other investment companies, (ii) such purchase would result in more than 3% of
the total outstanding voting securities of any one investment company being held
by the Fund and its affiliates, or (iii) more than 5% of the Fund's total assets
would be invested in any one investment company. These limitations do not apply
to the purchase of shares of any investment company in connection with a merger,
consolidation, reorganization or acquisition of substantially all the assets of
another investment company. The Fund, as a holder of the securities of other
investment companies, will bear its pro rata portion of the other investment
companies' expenses, including advisory fees. These expenses are in addition to
the direct expenses of the Fund's own operations.
HEDGING AND INTEREST RATE TRANSACTIONS
The Fund may, but is not required to, use various hedging and interest rate
transactions described below to earn income, facilitate portfolio management and
mitigate risks. Such transactions are generally accepted under modern portfolio
management and are regularly used by many mutual funds
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INVESTMENT OBJECTIVES AND PRINCIPAL INVESTMENT STRATEGIES
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and other institutional investors. Although the Adviser seeks to use the
practices to further the Fund's investment objectives, no assurance can be given
that these practices will achieve this result.
The Fund may purchase and sell derivative instruments such as exchange-listed
and over-the-counter put and call options on securities, financial futures,
equity, fixed-income and interest rate indices, and other financial instruments,
purchase and sell financial futures contracts and options thereon, enter into
various interest rate transactions such as swaps, caps, floors or collars or
credit transactions and credit default swaps. The Fund also may purchase
derivative instruments that combine features of these instruments. Collectively,
all of the above are referred to as "Strategic Transactions." The Fund generally
seeks to use Strategic Transactions as a portfolio management or hedging
technique to seek to protect against possible adverse changes in the market
value of securities held in or to be purchased for the Fund's portfolio, protect
the value of the Fund's portfolio, facilitate the sale of certain securities for
investment purposes, manage the effective interest rate exposure of the Fund,
including the effective yield paid on any preferred shares issued by the Fund,
manage the effective maturity or duration of the Fund's portfolio, or establish
positions in the derivatives markets as a temporary substitute for purchasing or
selling particular securities. The Fund may use Strategic Transactions to
enhance potential gain, although no more than 5% of the Fund's total assets will
be committed to initial margin for Strategic Transactions for non-hedging
purposes.
Strategic Transactions have risks, including the imperfect correlation between
the value of such instruments and the underlying assets, the possible default of
the other party to the transaction or illiquidity of the derivative instruments.
Furthermore, the ability to use successfully Strategic Transactions depends on
the Adviser's ability to predict pertinent market movements, which cannot be
assured. Thus, the use of Strategic Transactions may result in losses greater
than if they had not been used, may require the Fund to sell or purchase
portfolio securities at inopportune times or for prices other than current
market values, may limit the amount of appreciation the Fund can realize on an
investment, or may cause the Fund to hold a security that it might otherwise
sell. Additionally, amounts paid by the Fund as premiums and cash or other
assets held in margin accounts with respect to Strategic Transactions are not
otherwise available to the Fund for investment purposes.
A more complete discussion of Strategic Transactions and their risks is
contained in the Statement of Additional Information.
TEMPORARY DEFENSIVE STRATEGIES
There may be times when, in the Adviser's judgment, conditions in the securities
market would make pursuit of the Fund's investment strategy inconsistent with
achievement of the Fund's investment objectives. At such times, the Adviser may
employ alternative strategies primarily to seek to reduce fluctuations in the
value of the Fund's assets. In implementing these temporary defensive
strategies, depending on the circumstances, the Fund may invest an unlimited
portion of its portfolio in U.S. dollar denominated corporate debt securities,
short-term money market instruments, U.S. government securities and cash. It is
impossible to predict when, or for how long, the Fund may use these alternative
strategies.
OTHER INVESTMENT POLICIES
WHEN-ISSUED AND DELAYED DELIVERY PURCHASES
The Fund may make contracts to purchase securities on a "when-issued" or
"delayed delivery" basis. Pursuant to such contracts, delivery and payment for
the securities occurs at a date later than the customary settlement date. The
payment obligations and the interest rate on the securities will be fixed at the
time the Fund enters into the commitment, but interest will not accrue to the
Fund until delivery of and payment for the securities. An amount of cash or high
quality securities equal to the amount of the Fund's commitment will be
deposited in a segregated account at the Fund's custodian to secure the Fund's
obligation. Although the Fund would generally purchase securities on a
when-issued or delayed
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INVESTMENT OBJECTIVES AND PRINCIPAL INVESTMENT STRATEGIES
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delivery basis with the intention of actually acquiring the securities for its
portfolio (or for delivery pursuant to options or futures contracts it has
entered into) and not for leveraged purchases, the Fund could dispose of a
security prior to settlement if the Adviser deemed it advisable. The purchase of
securities on a when-issued or delayed delivery basis involves a risk of loss if
the value of the security to be purchased declines prior to the settlement date.
This risk is in addition to the risk of a decline in value of the Fund's other
assets. Furthermore, when such purchases are made through a dealer, the dealer's
failure to consummate the sale may result in the loss to the Fund of an
advantageous yield or price.
PORTFOLIO TURNOVER
The Fund may engage in portfolio trading when considered appropriate, but
short-term trading will not be used as the primary means of achieving the Fund's
investment objectives. Although the Fund cannot accurately predict its annual
portfolio turnover rate, it is not expected to exceed 25% under normal
circumstances. However, there are no limits on the rate of portfolio turnover,
and investments may be sold without regard to length of time held when, in the
opinion of the Adviser, investment considerations warrant such action. A higher
portfolio turnover rate results in correspondingly greater brokerage commissions
and other transactional expenses that are borne by the Fund. High portfolio
turnover may result in the realization of net short-term capital gains by the
Fund which, when distributed to shareholders, will be taxable as ordinary
income. See "U.S. federal income tax matters."
Risk factors
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 APS.
RISKS OF INVESTMENT IN PREFERRED SHARES
AUCTION RISK
The dividend rate for the APS normally is set through an auction process. In the
Auction, holders of APS may indicate the dividend rate at which they would be
willing to hold or sell their APS or purchase additional APS. The Auction also
provides liquidity for the sale of APS. You may not be able to sell your APS at
an Auction if the Auction fails. An Auction fails if there are more APS offered
for sale than there are buyers. If Sufficient Clearing Bids do not exist in an
Auction, the Applicable Rate will be the Maximum Applicable Rate, and in such
event, owners of APS wishing to sell will not be able to sell all, and may not
be able to sell any, of such APS in the Auction. As a result, your investment in
APS may be illiquid. Neither the Broker-Dealers nor the Fund is obligated to
purchase APS in an Auction or otherwise, nor is the Fund required to redeem APS
in the event of a failed Auction. Also, if you place hold orders (orders to
retain APS) at an Auction only at a specified rate and that bid rate exceeds the
Applicable Rate set at the Auction, you will not retain your APS. Additionally,
if you buy APS or elect to retain APS without specifying a dividend rate below
which you would not wish to buy or continue to hold those APS, you could receive
a lower rate of return on your APS than the market rate. Finally, the dividend
period for the APS may be changed by the Fund, subject to certain conditions
with notice to the holders of APS, which could also effect the liquidation of
your investment. See "Description of Preferred Shares" and "The Auction--AUCTION
PROCEDURES."
RATINGS AND ASSET COVERAGE RISK
While it is expected that Moody's will assign a rating of "Aaa" to the APS, such
rating does not eliminate or necessarily mitigate the risks of investing in APS.
Moody's could downgrade its rating of the APS or withdraw its rating of the APS
at any time, which may make your APS less liquid at an Auction or in the
secondary market. If Moody's downgrades the APS, the Fund may alter its
portfolio or redeem APS in an effort to improve the rating, although there is no
assurance that it will be able to
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RISK FACTORS
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do so to the extent necessary to restore the prior rating. If the Fund fails to
satisfy the asset coverage ratios discussed under "Description of Preferred
Shares--RATING AGENCY GUIDELINES AND ASSET COVERAGE," the Fund will be required
to redeem a sufficient number of APS in order to return to compliance with the
asset coverage ratios. The Fund may be required to redeem APS at a time when it
is not advantageous for the Fund to make such redemption or to liquidate
portfolio securities in order to have available cash for such redemption. The
Fund may voluntarily redeem APS under certain circumstances in order to meet
asset maintenance tests. While a sale of substantially all the assets of the
Fund or the merger of the Fund into another entity would require the approval of
the holders of the APS voting as a separate class as discussed under
"Description of Preferred Shares--
VOTING RIGHTS," a sale of substantially all the assets of the Fund or the merger
of the Fund with or into another entity would not be treated as a liquidation of
the Fund nor require that the Fund redeem the APS, in whole or in part, provided
that the Fund continued to comply with the asset coverage ratios discussed under
"Description of Preferred Shares--RATING AGENCY GUIDELINES AND ASSET COVERAGE."
See "Description of Preferred Shares--RATING AGENCY GUIDELINES AND ASSET
COVERAGE" for a description of the asset maintenance tests the Fund must meet.
SECONDARY MARKET RISK
If you try to sell your APS between auctions you may not be able to sell any or
all of your APS or you may not be able to sell them for $25,000 per share or
$25,000 per share plus accumulated dividends. If the Fund has designated a
Special Dividend Period (a rate period of more than seven days for each series),
changes in interest rates could affect the price you would receive if you sold
your APS in the secondary market. An increase in the level of interest rates
likely will have an adverse effect on the secondary market price of the APS. You
may transfer APS outside of Auctions only to or through a Broker-Dealer that has
entered into an agreement with the Fund's Auction Agent, Deutsche Bank Trust
Company Americas, and the Fund or other person as the Fund permits. The Fund
does not anticipate imposing significant restrictions on transfers to other
persons. However, unless any such other person has entered into a relationship
with a Broker-Dealer that has entered into a Broker-Dealer agreement with the
Auction Agent, that person will not be able to submit Bids at Auctions with
respect to the APS. Broker-Dealers that maintain a secondary trading market for
APS are not required to maintain this market, and the Fund is not required to
redeem APS either if an Auction or an attempted secondary market sale fails
because of a lack of buyers. The APS will not be listed on any stock exchange or
the Nasdaq national market. If you sell your APS to a Broker-Dealer between
Auctions, you may receive less than the price you paid for them, especially if
market interest rates have risen since the last Auction.
INTEREST RATE RISK
The APS pay dividends based on short-term interest rates. The Fund invests the
proceeds from the issuance of the APS principally in preferred stocks and other
preferred securities, which bear dividends or interest rates reflecting
intermediate- and long-term interest rates. The interest or dividend rates on
preferred stocks and other preferred securities are typically, although not
always, higher than shorter-term interest rates. Both shorter-term and
intermediate- to longer-term interest rates may fluctuate. If shorter-term
interest rates rise, dividend rates on the APS may rise so that the amount of
dividends to be paid to holders of APS exceeds the income from the preferred
stocks and other preferred securities and other investments purchased by the
Fund with the proceeds from the sale of APS. Because income from the Fund's
entire investment portfolio (not just the portion of the portfolio purchased
with the proceeds of the APS offering) is available to pay dividends on the APS,
however, dividend rates on the APS would need to exceed the rate of return on
the Fund's investment portfolio by a wide margin before the Fund's ability to
pay dividends on the APS would be jeopardized. If intermediate- to longer-term
interest rates rise, this could negatively impact the value of the Fund's
investment portfolio, reducing the amount of assets serving as asset coverage
for the APS.
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RISK FACTORS
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LEVERAGE RISK
The Fund expects to use financial leverage on an ongoing basis for investment
purposes. Leverage risk includes the risk associated with the issuance of APS to
leverage the Common Shares. If the dividend rate on the APS exceeds the net rate
of return on the Fund's portfolio, the leverage will result in a lower net asset
value than if the Fund were not leveraged, and the Fund's ability to pay
dividends and meet its asset coverage requirements on the APS would be reduced.
Similarly, any decline in the net asset value of the Fund's investments could
result in the Fund being in danger of failing to meet its asset coverage
requirements or of losing its expected "Aaa" rating on the APS or, in an extreme
case, the Fund's current investment income might not be sufficient to meet the
dividend requirements on the APS. To counteract such an event, the Fund might
need to liquidate investments in order to fund a redemption of some or all of
the APS.
It is currently anticipated that, taking into account the APS being offered in
this Prospectus, the initial amount of leverage will represent up to 33 1/3% of
the Fund's total assets.
The Fund's leveraged capital structure creates special risks not associated with
unleveraged funds having similar investment objectives and policies. These
include the possibility of higher volatility of the net asset value of the Fund
and the APS' asset coverage.
While the Fund may from time to time consider reducing leverage in response to
actual or anticipated changes in interest rates in an effort to mitigate the
increased volatility of current income and net asset value associated with
leverage, there can be no assurance that the Fund will actually reduce leverage
in the future or that any reduction, if undertaken, will be effective. Changes
in the future direction of interest rates are very difficult to predict
accurately. If the Fund were to reduce leverage based on a prediction about
future changes to interest rates and that prediction turned out to be incorrect,
the reduction in leverage would likely operate to reduce the Fund's net asset
value relative to the circumstance where the Fund had not reduced leverage. The
Fund may decide that this risk outweighs the likelihood of achieving the desired
reduction to volatility in income and net asset value if the prediction were to
turn out to be correct, and determine not to reduce leverage as described above.
Because the fee paid to the Adviser will be calculated on the basis of the
Fund's managed assets (which equals the aggregate net asset value of the Common
Shares plus the liquidation preference of the APS), the fee will be higher when
leverage is utilized, giving the Adviser an incentive to utilize leverage.
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 APS, both by the
1940 Act and by requirements imposed by Moody's or a successor rating agency,
might impair the Fund's ability to satisfy minimum distribution requirements
that it must satisfy to be treated as a regulated investment company for federal
income tax purposes. While the Fund intends to redeem APS 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
"U.S. federal income tax matters."
GENERAL RISKS OF INVESTING IN THE FUND
GENERAL
The Fund is a diversified, closed-end management investment company designed
primarily as a long-term investment and not as a trading tool. An investment in
the Fund's APS may be speculative in that it involves risk. The Fund should not
constitute a complete investment program and should only be considered as an
addition to an investor's existing diversified portfolio of investments. Due to
the uncertainty in all investments, there can be no assurance that the Fund will
achieve its investment objectives.
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RISK FACTORS
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LIMITED OPERATING HISTORY
The Fund is a recently organized closed-end management investment company which
has been operational for less than two months.
INTEREST RATE RISK
Fixed income securities are subject to certain common risks, including:
+ if interest rates go up, the value of debt securities in the Fund's portfolio
generally will decline
+ during periods of declining interest rates, the issuer of a security may
exercise its option to prepay principal earlier than scheduled, forcing the
Fund to reinvest in lower yielding securities. This is known as call or
prepayment risk. Preferred securities and other fixed income securities
frequently have call features that allow the issuer to repurchase the
security prior to its stated maturity. An issuer may redeem an obligation if
the issuer can refinance the debt at a lower cost due to declining interest
rates or an improvement in the credit standing of the issuer
+ during periods of rising interest rates, the average life of certain types of
securities may be extended because of the right of the issuer to defer
payments or slower than expected principal payments. This may lock in a below
market interest rate, increase the security's duration (the estimated period
until the security is paid in full) and reduce the value of the security.
This is known as extension risk
CREDIT RISK
Credit risk is the risk that preferred securities or debt securities in the
Fund's portfolio will decline in price or fail to make dividend payments when
due because the issuer of the security experiences a decline in its financial
status. Although the Fund will primarily invest in investment grade securities,
the Fund is authorized to invest up to 20% of its total assets in preferred
securities and other fixed income securities that are rated below investment
grade at the time of acquisition. These securities may be rated as low as "B" by
S&P and "Ba" by Moody's. Securities rated "Baa" by Moody's are considered by
Moody's as medium to lower medium grade securities; they are neither highly
protected nor poorly secured; dividend or interest payments and capital or
principal security, as the case may be, appear to Moody's to be adequate for the
present but certain protective elements may be lacking or may be
characteristically unreliable over time; and in the opinion of Moody's,
securities in this rating category lack outstanding investment characteristics
and in fact have speculative characteristics as well. Securities rated "BBB" by
S&P are regarded by S&P as having an adequate capacity to pay dividends or
interest and repay capital or principal, as the case may be; whereas such
securities normally exhibit adequate protection parameters, adverse economic
conditions or changing circumstances are more likely, in the opinion of S&P, to
lead to a weakened capacity to pay dividends or interest and repay capital or
principal for securities in this category than in higher rating categories.
Below investment grade securities and comparable unrated securities involve
substantial risk of loss, are considered speculative with respect to the
issuer's ability to pay interest and any required redemption or principal
payments and are susceptible to default or decline in market value due to
adverse economic and business developments. The ratings of Moody's and S&P
represent their opinions as to the quality of those securities that they rate;
ratings are relative and subjective and are not absolute standards of quality.
SECTOR RISK
Under normal market conditions, the Fund will emphasize investments in preferred
securities issued or guaranteed by U.S. corporations in the utilities sector.
The Fund will not invest 25% or more of its total assets in any one industry,
except that the Fund will invest 25% or more of its total assets in the
industries comprising the utilities sector.
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RISK FACTORS
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The utilities industries in which the Fund may invest include companies engaged
in:
+ the generation, transmission, sale or distribution of electric energy,
+ the distribution, purification and treatment of water,
+ the provision of sewage management, treatment or other sanitary services,
+ the production, transmission or distribution of natural gas,
+ the provision of pollution control or abatement services, and
+ telecommunications, including telephone, telegraph, satellite, microwave and
other communications media (but not companies engaged primarily in public
broadcasting industry)
The Fund's emphasis on securities of utilities issuers makes it more susceptible
to adverse conditions affecting such industries than a fund that does not have
its assets invested to a similar degree in such issuers. Issuers in the
utilities sector are subject to a variety of factors that may adversely affect
their business or operations, including:
+ high interest costs in connection with capital construction programs
+ governmental regulation of rates charged to customers
+ costs associated with environmental and other regulations
+ the effects of economic slowdowns and surplus capacity
+ increased competition from other providers of utility services
+ technological innovations that may render existing plants, equipment or
products obsolete
+ increased costs and reduced availability of certain types of fuel,
occasionally reduced availability and high costs of natural gas for resale,
the effects of energy conservation, and the potential that costs incurred by
the utility, such as the cost of fuel, change more rapidly than the rate the
utility is permitted to charge its customers
+ the effects of a national energy policy and lengthy delays and greatly
increased costs and other problems associated with the design, construction,
licensing, regulation and operation of nuclear facilities for electric
generation, including, among other considerations
+ the problems associated with the use of radioactive materials and the
disposal of radioactive wastes
There are substantial differences between the regulatory practices and policies
of various jurisdictions, and any given regulatory agency may make major shifts
in policy from time to time. There is no assurance that regulatory authorities
will, in the future, grant rate increases or that such increases will be
adequate to permit the payment of dividends on common stocks. Additionally,
existing and possible future regulatory legislation may make it even more
difficult for these utilities to obtain adequate relief. Certain of the issuers
of securities held in the Fund's portfolio may own or operate nuclear generating
facilities. Governmental authorities may from time to time review existing
policies and impose additional requirements governing the licensing,
construction and operation of nuclear power plants. Prolonged changes in
climatic conditions can also have a significant impact on both the revenues of
an electric and gas utility as well as the expenses of a utility, particularly a
hydro-based electric utility.
The nature of regulation of the utility industries is evolving both in the
United States and in foreign countries. In recent years, changes in regulation
in the United States increasingly have allowed utility companies to provide
services and products outside their traditional geographic areas and lines of
business, creating new areas of competition within these industries. In some
instances, utility companies are operating on an unregulated basis. Because of
trends toward deregulation and the evolution of independent power producers as
well as new entrants to the field of telecommunications, non-regulated providers
of utility services have become a significant part of their respective
industries. The emergence of competition and deregulation may result in certain
utility companies being able to
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27
RISK FACTORS
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earn more than their traditional regulated rates of return, while others may be
forced to defend their core business from increased competition and may be less
profitable. Reduced profitability, as well as new uses of funds (such as for
expansion, operations or stock buybacks) could result in cuts in dividend payout
rates.
While the Fund will not invest 25% or more of its total assets in any one of the
industries comprising the financial services sector, from time to time the Fund
may have significant exposure to issuers in such sector. These industries
include bank holding companies, banks, securities brokers and dealers and life,
property, casualty and multi-line insurance companies. These industries are
subject to extensive regulation at the federal and/or state level and, to the
extent that they operate internationally, in other countries. Each of these
industries may also be significantly affected by changes in prevailing interest
rates, general economic conditions and industry specific risks. The enactment of
new legislation and regulation, as well as changes in the interpretation and
enforcement of existing laws and regulations, may directly affect the manner of
operations and profitability of participants in the financial services sector.
From time to time, changes in law and regulation have permitted greater
diversification of their financial products, but their ability to expand by
acquisition or branching across state lines and to engage in non-banking
activities continues to be limited. Federal or state law and regulations require
banks, bank holding companies, broker-dealers and insurance companies to
maintain minimum levels of capital and liquidity. Bank regulators have broad
authority and can impose sanctions, including conservatorship or receivership,
on non-complying banks even when these banks continue to be solvent, thereby
possibly resulting in the elimination of stockholders' equity.
SPECIAL RISKS RELATED TO PREFERRED SECURITIES
There are special risks associated with investing in preferred securities:
+ LIMITED VOTING RIGHTS. Generally, holders of preferred security (such as the
Fund) have no voting rights with respect to the issuing company unless
preferred dividends have been in arrears for a specified number of periods at
which time the preferred security holders may elect a number of directors to
the issuer's board. Generally, once the issuer pays all the arrearages, the
preferred security holders no longer have voting rights.
+ SPECIAL REDEMPTION RIGHTS. In certain varying circumstances, an issuer of
preferred securities may redeem the securities prior to a specified date. For
instance, for certain types of preferred securities, a redemption may be
triggered by a change in federal income tax or securities laws. As with call
provisions, a special redemption by the issuer may negatively impact the
return of the security held by the Fund.
+ DEFERRAL. Preferred securities may include provisions that permit the
issuer, at its discretion, to defer distributions for a stated period. If the
Fund owns a preferred security that is deferring its distributions, the Fund
may be required to report income for federal income tax purposes although it
has not yet received such income in cash.
+ LIQUIDITY. Preferred securities may be substantially less liquid than many
other securities, such as common stocks or U.S. government securities.
+ SUPPLY OF TAXABLE PREFERRED SECURITIES. The Financial Accounting Standards
Board is reviewing accounting guidelines relating to taxable preferred
securities. To the extent that a change in the guidelines could adversely
affect the market for, and availability of, these securities, the Fund may be
adversely affected.
+ NEW TYPES OF SECURITIES. From time to time, preferred securities, including
taxable preferred securities have been, and may in the future be, offered
having features other than those described herein. 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 objectives and policies. Since
the market for these
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28
RISK FACTORS
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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 volatility.
CONVERTIBLE SECURITIES
The Fund may invest in convertible securities. Convertible fixed income
securities generally offer lower interest or dividend yields than
non-convertible securities of similar quality. As with all fixed income
securities, the market values of convertible securities tend to decline as
interest rates increase and, conversely, to increase as interest rates decline.
However, when the market price of the common stock underlying a convertible
security exceeds the conversion price, the convertible security tends to reflect
the market price of the underlying common stock. As the market price of the
underlying common stock declines, the convertible security tends to trade
increasingly on a yield basis and thus may not decline in price to the same
extent as the underlying common stock. Convertible securities rank senior to
common stocks in an issuer's capital structure and consequently entail less risk
than the issuer's common stock. The Fund may invest in convertible securities of
any maturity and will determine whether to hold, sell or convert any security in
which it has invested depending upon the Advisers' outlook for the market value
for such security and the security into which it converts.
COMMON STOCKS
The common stocks and other non-preferred equity securities in which the Fund
invests may experience substantially more volatility in their market value than
the Fund's investments in preferred securities. Such securities may also be more
susceptible to adverse changes in market value due to issuer specific events,
such as unfavorable earnings reports. The market values of common stocks are
also generally sensitive to general movements in the equities markets.
ILLIQUID INVESTMENTS
The Fund may invest up to 20% of its total assets in illiquid securities.
Illiquid securities may be difficult to dispose of at a fair price at the times
when the Adviser believes it is desirable to do so. The market price of illiquid
securities generally is more volatile than that of more liquid securities, which
may adversely affect the price that the Fund pays for or recovers upon the sale
of illiquid securities. Illiquid securities are also more difficult to value and
the Adviser's judgment may play a greater role in the valuation process.
Investment of the Fund's assets in illiquid securities may restrict the Fund's
ability to take advantage of market opportunities. The risks associated with
illiquid securities may be particularly acute in situations in which the Fund's
operations require cash and could result in the Fund borrowing to meet its
short-term needs or incurring losses on the sale of illiquid securities.
FOREIGN SECURITIES
Although the Fund only invests in securities of non-U.S. issuers that are traded
or denominated in U.S. dollars, the Fund's investments in non-U.S. issuers may
involve unique risks compared to investing in securities of U.S. issuers. These
risks are more pronounced to the extent that the Fund invests a significant
portion of its non-U.S. investments in one region or in the securities of
emerging market issuers. These risks may include:
+ less information about non-U.S. issuers or markets may be available due to
less rigorous disclosure or accounting standards or regulatory practices
+ many non-U.S. markets are smaller, less liquid and more volatile. In a
changing market, the Adviser may not be able to sell the Fund's portfolio
securities at times, in amounts and at prices it considers reasonable
+ adverse effect of currency exchange rates or controls on the value of the
Fund's investments
+ the economies of non-U.S. countries may grow at slower rates than expected or
may experience a downturn or recession
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29
RISK FACTORS
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+ economic, political and social developments may adversely affect the
securities markets
+ withholding and other non-U.S. taxes may decrease the Fund's return
There may be less publicly available information about non-U.S. markets and
issuers than is available with respect to U.S. securities and issuers. Non-U.S.
companies generally are not subject to accounting, auditing and financial
reporting standards, practices and requirements comparable to those applicable
to U.S. companies. The trading markets for most non-U.S. securities are
generally less liquid and subject to greater price volatility than the markets
for comparable securities in the U.S. The markets for securities in certain
emerging markets are in the earliest stages of their development. Even the
markets for relatively widely traded securities in certain non-U.S. markets,
including emerging market countries, may not be able to absorb, without price
disruptions, a significant increase in trading volume or trades of a size
customarily undertaken by institutional investors by the U.S. Additionally,
market making and arbitrage activities are generally less extensive in such
markets, which may contribute to increased volatility and reduced liquidity.
Economies and social and political climate in individual countries may differ
unfavorably from the U.S. Non-U.S. economies may have less favorable rates of
growth of gross domestic product, rates of inflation, currency valuation,
capital reinvestment, resource self-sufficiency and balance of payments
positions. Many countries have experienced substantial, and in some cases
extremely high, rates of inflation for many years. Inflation and rapid
fluctuations in inflation rates have had, and may continue to have, very
negative effects on the economies and securities markets of certain emerging
countries. Unanticipated political or social developments may also affect the
values of the Fund's investments and the availability to the Fund of additional
investments in such countries.
DERIVATIVES
Strategic Transactions have risks, including the imperfect correlation between
the value of such instruments and the underlying assets, the possible default of
the other party to the transaction or illiquidity of the derivative instruments.
Furthermore, the ability to successfully use Strategic Transactions depends on
the Adviser's ability to predict pertinent market movements, which cannot be
assured. Thus, the use of Strategic Transactions may result in losses greater
than if they had not been used, may require the Fund to sell or purchase
portfolio securities at inopportune times or for prices other than current
market values, may limit the amount of appreciation the Fund can realize on an
investment, or may cause the Fund to hold a security that it might otherwise
sell. Additionally, amounts paid by the Fund as premiums and cash or other
assets held in margin accounts with respect to Strategic Transactions are not
otherwise available to the Fund for investment purposes.
There are several risks associated with the use of futures contracts and futures
options. A purchase or sale of a futures contract may result in losses in excess
of the amount invested in the futures contract. 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. There may be an imperfect correlation between the Fund's portfolio
holdings and futures contracts or options on futures contracts entered into by
the Fund, which may prevent the Fund from achieving the intended hedge or expose
the Fund to risk of loss. The degree of imperfection of correlation depends on
circumstances such as variations in market demand for futures, futures options
and the related securities, including technical influences in futures and
futures options trading, and differences between the securities markets and the
securities underlying the standard contracts available for trading. 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.
Depending on whether the Fund would be entitled to receive net payments from the
counterparty on the swap or cap, which in turn would depend on the general state
of short-term interest rates at that
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RISK FACTORS
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point in time, a default by a counterparty could negatively impact the Fund's
overall performance. In addition, at the time an interest rate swap or cap
transaction reaches its scheduled termination date, there is a risk that the
Fund would not be able to obtain a replacement transaction or that the terms of
the replacement would not be as favorable as on the expiring transaction. If
this occurs, it could have a negative impact on the Fund's performance. If the
Fund fails to maintain a required 200% asset coverage of the liquidation value
of the outstanding preferred shares or if the Fund loses its expected rating on
the preferred shares or fails to maintain other covenants, the Fund may be
required to redeem some or all of the preferred shares. Similarly, the Fund
could be required to prepay the principal amount of any borrowings. Such
redemption or prepayment would likely result in the Fund seeking to terminate
early all or a portion of any swap or cap transaction. Early termination of a
swap could result in a termination payment by or to the Fund. Early termination
of a cap could result in a termination payment to the Fund. The Fund intends to
maintain in a segregated account cash or liquid securities having a value at
least equal to the Fund's net payment obligations under any swap transaction,
marked to market daily. The Fund will not enter into interest rate swap or cap
transactions having a notional amount that exceeds the outstanding amount of the
Fund's leverage.
The use of interest rate swaps and caps is a highly specialized activity that
involves investment techniques and risks different from those associated with
ordinary portfolio security transactions. Depending on the state of interest
rates in general, the Fund's use of interest rate swaps or caps could enhance or
harm the Fund's overall performance. To the extent there is a decline in
interest rates, the value of the interest rate swap or cap could decline, and
could result in a decline in the Fund's net asset value. In addition, if
short-term interest rates are lower than the Fund's fixed rate of payment on the
interest rate swap, the swap will reduce the Fund's net earnings. If, on the
other hand, short-term interest rates are higher than the fixed rate of payment
on the interest rate swap, the swap will enhance the Fund's net earnings. Buying
interest rate caps could enhance the Fund's performance by providing a maximum
leverage expense. Buying interest rate caps could also decrease Fund's the net
earnings in the event that the premium paid by the Fund to the counterparty
exceeds the additional amount the Fund would have been required to pay had it
not entered into the cap agreement. The Fund has no current intention of selling
an interest rate swap or cap.
Interest rate swaps and caps do not involve the delivery of securities or other
underlying assets or principal. Accordingly, the risk of loss with respect to
interest rate swaps is limited to the net amount of interest payments that the
Fund is contractually obligated to make. If the counterparty defaults, the Fund
would not be able to use the anticipated net receipts under the swap or cap to
offset the dividend payments on the Fund's preferred shares or interest payments
on borrowings. Depending on whether the Fund would be entitled to receive net
payments from the counterparty on the swap or cap, which in turn would depend on
the general state of short-term interest rates at that point in time, such a
default could negatively impact the Fund's performance.
RECENT EVENTS
The terrorist attacks in the United States on September 11, 2001 had a
disruptive effect on the securities markets. The Fund does not know how long the
securities markets will continue to be affected by these events and cannot
predict the effects of similar events that may occur in the future on the U.S.
economy.
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31
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Description of Preferred Shares
The following is a brief description of the material terms of the APS. This
description does not purport to be complete and is subject to, and qualified in
its entirety by reference to, the By-laws, including the provisions thereof
establishing the APS. The By-laws establishing the terms of the APS have been
filed as an exhibit to the Registration Statement of which this Prospectus is a
part.
The APS are preferred shares that entitle their holders to receive dividends
when, as and if declared by the Fund's Board of Trustees, out of funds legally
available therefore, at a rate per annum that may vary for successive Dividend
Periods for each such series of APS. The Applicable Rate for a particular
Dividend Period for the APS will be determined by an Auction conducted on the
Business Day before the start of such Dividend Period. Beneficial Owners and
Potential Beneficial Owners of APS may participate in Auctions, although, except
in the case of Special Dividend Periods of longer than 91 days, Beneficial
Owners desiring to continue to hold all of their APS regardless of the
Applicable Rate resulting from Auctions need not participate in order to
continue to hold their APS. For an explanation of Auctions and the method of
determining the Applicable Rate, see "The Auction" and "--DIVIDENDS AND DIVIDEND
PERIODS."
The nominee of the Securities Depository is expected to be the sole holder of
record of the APS. Accordingly, each purchaser of APS must rely on (i) the
procedures of the Securities Depository and, if such purchaser is not a member
of the Securities Depository, such purchaser's Agent Member, to receive
dividends, distributions and notices and to exercise voting rights (if and when
applicable) and (ii) the records of the Securities Depository and, if such
purchaser is not a member of the Securities Depository, such purchaser's Agent
Member, to evidence its beneficial ownership of the APS.
The APS will rank on parity with each other and any other series of preferred
shares of the Fund as to the payment of dividends and the distribution of assets
upon liquidation. Each share of APS carries one vote on matters on which APS can
be voted. When issued and sold, the APS 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) and will be fully paid and, except as
discussed under "Certain provisions of the Agreement and Declaration of Trust
and By-laws," non-assessable. See "--LIQUIDATION." The APS will not be
convertible into Common Shares or other shares of beneficial interest of the
Fund, and the holders thereof will have no preemptive rights. The APS will not
be subject to any sinking fund but will be subject to redemption at the option
of the Fund on any Dividend Payment Date for the APS (except during the Initial
Dividend Period and during a Non-Call Period) of such series at a redemption
price of $25,000 per share plus accumulated and unpaid dividends. In certain
circumstances, the APS will be subject to mandatory redemption by the Fund at a
redemption price of $25,000 per share plus accumulated and unpaid dividends. See
"--REDEMPTION."
DIVIDENDS AND DIVIDEND PERIODS
The holders of APS will be entitled to receive, when, as and if declared by the
Board of Trustees, out of funds legally available therefore, cumulative cash
dividends on their shares, at the Applicable Rate determined as set forth below
under "--Calculation of dividend payment," payable on the dates set forth below.
Dividends on the APS so declared and payable will be paid in preference to and
in priority over any dividends so declared and payable on the Common Shares. The
following is a general description of dividends for the APS.
DIVIDEND PERIODS
The Initial Dividend Payment Date for each series of APS is set forth below. Any
subsequent Dividend Period will generally be seven (7) days for each series of
the APS; provided, however, that prior to any Auction, the Fund may elect,
subject to certain limitations described herein and upon giving notice to
Existing Holders, a Special Dividend Period. See "--Designation of Special
Dividend Periods."
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DESCRIPTION OF PREFERRED SHARES
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DIVIDEND PAYMENT DATES
Dividends on the APS will be payable, when as and if declared by the Fund's
Board of Trustees, out of legally available funds in accordance with the
Agreement and Declaration of Trust, the By-laws and applicable law. Initial
Dividend Payment Dates are scheduled as follows:
INITIAL DIVIDEND
PAYMENT DATE
------------------------------------------------------------------------------
Series M.................................................... November 5, 2002
Series T.................................................... November 6, 2002
Series W.................................................... Monthly
Series TH................................................... November 8, 2002
Series F.................................................... November 4, 2002
Following the Initial Dividend Payment Date, dividends on each series of APS
will be payable, at the option of the Fund, either (i) with respect to any seven
day Dividend Period or any Short Term Dividend Period of 35 or fewer days, on
the Business Day next succeeding the last day thereof or (ii) with respect to
any Short Term Dividend Period of more than 35 days and with respect to any Long
Term Dividend Period, monthly on the first Business Day of each calendar month
during such Short Term Dividend Period or Long Term Dividend Period and on the
Business Day next succeeding the last day thereof. If dividends are payable on a
day that is not a Business Day, then dividends will generally be payable on the
next day if that is a Business Day or as otherwise specified in the By-laws.
Dividends will be paid through the Securities Depository on each Dividend
Payment Date. The Securities Depository, in accordance with its current
procedures, is expected to distribute dividends received from the Fund in
next-day funds on each Dividend Payment Date to Agent Members. These Agent
Members are in turn expected to distribute such dividends to the persons for
whom they are acting as agents. However, each of the current Broker-Dealers has
indicated to the Fund that dividend payments will be available in same-day funds
on each Dividend Payment Date to customers that use such Broker-Dealer or that
Broker-Dealer's designee as Agent Member.
CALCULATION OF DIVIDEND PAYMENT
The amount of cash dividends per share of APS of each series payable (if
declared) on the Initial Dividend Payment Date, the Dividend Payment Date of
each seven day Dividend Period and each Dividend Payment Date of each Short Term
Dividend Period will be computed by multiplying the Applicable Rate for such
Dividend Period by a fraction, the numerator of which will be the number of days
in such Dividend Period or part thereof that such share was outstanding and for
which dividends are payable on such Dividend Payment Date and the denominator of
which will be 365, multiplying the amount so obtained by $25,000, and rounding
the amount so obtained to the nearest cent. During any Long Term Dividend
Period, the amount of cash dividends per share of APS payable (if declared) on
any Dividend Payment Date will be computed by multiplying the Applicable Rate
for such Dividend Period by a fraction, the numerator of which will be such
number of days in such part of such Dividend Period that such share was
outstanding and for which dividends are payable on such Dividend Payment Date
and the denominator of which will be 360, multiplying the amount so obtained by
$25,000, and rounding the amount so obtained to the nearest cent.
Dividends on APS will accumulate from the date of their original issue, which is
October 23, 2002. The initial dividend rate is 1.85% for Series M APS, 1.85% for
Series T APS, 1.95% for Series W APS, 1.85% for Series TH APS, and 1.85% for
Series F APS. For each Dividend Period after the Initial Dividend Period, the
dividend rate will be the dividend rate for a series determined at Auction for
such series, except that the dividend rate that results from an Auction will not
be greater than the Maximum Applicable Rate described below.
Except during a Non-Payment Period, the Applicable Rate for any Dividend Period
for APS will not be more than the Maximum Applicable Rate applicable to such
shares. The Maximum Applicable Rate
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33
DESCRIPTION OF PREFERRED SHARES
--------------------------------------------------------------------------------
for each series of APS will depend on the credit rating assigned to such series
and on the duration of the Dividend Period. The Maximum Applicable Rate will be
the Applicable Percentage of the Reference Rate. The Reference Rate is (i) with
respect to any seven day Dividend Period or any Short Term Dividend Period
having 182 or fewer days, the applicable "AA" Financial Composite Commercial
Paper Rate, (ii) with respect to any Short Term Dividend period having 183 or
more but fewer than 364 days, the applicable U.S. Treasury Bill Rate and (iii)
with respect to any Long Term Dividend Period, the applicable U.S. Treasury Note
Rate. The Applicable Percentage will be determined based on the credit rating
assigned on such date to the APS by Moody's (or, if Moody's shall not make such
rating available, the equivalent of such rating by a Substitute Rating Agency).
APPLICABLE PERCENTAGE PAYMENT TABLE
MOODY'S CREDIT RATINGS APPLICABLE PERCENTAGE
-----------------------------------------------------------------------------------
Aa3 or higher................................................................ 150%
A3 to A1..................................................................... 200%
Baa3 to Baa1................................................................. 225%
Below Baa3................................................................... 275%
Prior to each Dividend Payment Date, the Fund is required to deposit with the
Auction Agent sufficient funds for the payment of declared dividends. The
failure to make such deposit will not result in the cancellation of any Auction.
The Fund does not intend to establish any reserves for the payment of dividends.
RESTRICTIONS ON DIVIDENDS AND OTHER DISTRIBUTIONS
While any of the APS are outstanding, the Fund, except as provided below, may
not declare, pay or set apart for payment, any dividend or other distribution in
respect of its Common Shares. In addition, the Fund may not call for redemption
or redeem any of its Common Shares. However, the Fund is not confined by the
above restrictions if:
+ immediately after such transaction, the Discounted Value of the Fund's
portfolio would be equal to or greater than the Preferred Shares Basic
Maintenance Amount and the value of the Fund's portfolio would be equal to or
greater than the 1940 Act Preferred Shares Asset Coverage (see "RATING AGENCY
GUIDELINES AND ASSET COVERAGE" below)
+ full cumulative dividends on each series of APS due on or prior to the date
of the transaction have been declared and paid or shall have been declared
and sufficient funds for the payment thereof deposited with the Auction Agent
+ the Fund has redeemed the full number of APS required to be redeemed by any
provision for mandatory redemption contained in the By-laws
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 APS unless the Fund has declared and paid or
contemporaneously declares and pays full cumulative dividends on the APS through
its most recent dividend payment date. However, when the Fund has not paid
dividends in full upon the APS through the most recent dividend payment date or
upon any other class or series of shares of the Fund ranking, as to the payment
of dividends, on a parity with APS through their most recent respective dividend
payment dates, the amount of dividends declared per share on APS 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 APS and such other class or series
of shares bear to each other.
--------------------------------------------------------------------------------
34
DESCRIPTION OF PREFERRED SHARES
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DESIGNATION OF SPECIAL DIVIDEND PERIODS
The Fund, at its option and to the extent permitted by law, by telephonic and
written notice (a "Request for Special Dividend Period") to the Auction Agent
and to each Broker-Dealer, may request that the next succeeding Dividend Period
for the APS of a series will be a number of days (other than seven days) evenly
divisible by seven, and not fewer than fourteen nor more than 364 in the case of
a Short Term Dividend Period or one whole year or more but not greater than five
years in the case of a Long Term Dividend Period, specified in such notice,
provided that the Fund may not give a Request for Special Dividend Period (and
any such request will be null and void) unless, for any Auction occurring after
the initial Auction, Sufficient Clearing Bids were made in the last occurring
Auction and unless full cumulative dividends and any amounts due with respect to
redemptions have been paid in full. Such Request for Special Dividend Period, in
the case of a Short Term Dividend Period, shall be given on or prior to the
second Business Day but not more than seven Business Days prior to an Auction
date for the APS of that series and, in the case of a Long Term Dividend Period,
shall be given on or prior to the second Business Day but not more than 28 days
prior to an Auction Date for the APS of that series. Upon receiving such Request
for Special Dividend Period, the Broker-Dealers jointly shall determine the
Optional Redemption Price of the APS of that series during such Special Dividend
Period and the Specific Redemption Provisions and shall give the Fund and the
Auction Agent written notice (a "Response") of such determination by no later
than the second Business Day prior to such Auction Date. In making such
determination, the Broker-Dealers will consider (i) existing short-term and
long-term market rates and indices of such short-term and long-term rates, (ii)
existing market supply and demand for short-term and long-term securities, (iii)
existing yield curves for short-term and long-term securities comparable to the
APS, (iv) industry and financial conditions which may affect the APS of that
series, (v) the investment objective of the Fund and (vi) the Dividend Periods
and dividend rates at which current and potential beneficial holders of the APS
would remain or become beneficial holders.
After providing the Request for Special Dividend Period to the Auction Agent and
each Broker-Dealer as set forth above, the Fund, by no later than the second
Business Day prior to such Auction Date, may give a notice (a "Notice of Special
Dividend Period") to the Auction Agent, the Securities Depository and each
Broker-Dealer, which notice will specify the duration of the Special Dividend
Period. The Fund has agreed to provide a copy of such Notice of Special Dividend
Period to Moody's. The Fund will not give a Notice of Special Dividend Period
and, if such Notice of Special Dividend Period was given already, will give
telephonic and written notice of its revocation (a "Notice of Revocation") to
the Auction Agent, each Broker-Dealer and the Securities Depository on or prior
to the Business Day prior to the relevant Auction Date if (x) either the 1940
Act Preferred Shares Asset Coverage or the Preferred Shares Basic Maintenance
Amount is not satisfied, on each of the two Business Days immediately preceding
the Business Day prior to the relevant Auction Date or (y) sufficient funds for
the payment of dividends payable on the immediately succeeding Dividend Payment
Date have not been irrevocably deposited with the Auction Agent by the close of
business on the third Business Day preceding the Auction Date immediately
preceding such Dividend Payment Date. The Fund also shall provide a copy of such
Notice of Special Dividend Period to Moody's. If the Fund is prohibited from
giving a Notice of Special Dividend Period as a result of the factors enumerated
in clause (x) or (y) above or if the Fund gives a Notice of Revocation with
respect to a Notice of Special Dividend Period, the next succeeding Dividend
Period for that series will be a seven day Dividend Period. In addition, in the
event Sufficient Clearing Bids are not made in an Auction, or if an Auction is
not held for any reason, the next succeeding Dividend Period will be a seven day
Dividend Period, and the Fund may not again give a Notice of Special Dividend
Period (and any such attempted notice will be null and void) until Sufficient
Clearing Bids have been made in an Auction with respect to a seven day Dividend
Period.
--------------------------------------------------------------------------------
35
DESCRIPTION OF PREFERRED SHARES
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NON-PAYMENT PERIOD AND LATE CHARGE
A "Failure to Deposit," with respect to shares of a series of APS, means a
failure by the Fund to pay to the Auction Agent, not later than 12:00 noon, New
York City time, (A) on the Business Day next preceding any Dividend Payment Date
for shares of such series, in funds available on such Dividend Payment Date in
the City of New York, New York, the full amount of any dividend (whether or not
earned or declared) to be paid on such Dividend Payment Date on any share of
such series or (B) on the Business Day next preceding any redemption date in
funds available on such redemption date for shares of such series in the City of
New York, New York, the redemption price to be paid on such redemption date for
any share of such series after notice of redemption is mailed; provided,
however, that the foregoing clause (B) shall not apply to the Fund's failure to
pay the redemption price in respect of APS when the related notice of redemption
provides that redemption of such shares is subject to one or more conditions
precedent and any such condition precedent shall not have been satisfied at the
time or times and in the manner specified in such notice of redemption. If a
Failure to Deposit occurs with respect to a series of APS but, prior to 12:00
noon, New York City time, on the third Business Day next succeeding the date on
which such Failure to Deposit occurred, such Failure to Deposit shall have been
cured, the Fund shall have paid to the Auction Agent a late charge ("Late
Charge") equal to the sum of (1) if such Failure to Deposit consisted of the
failure timely to pay to the Auction Agent the full amount of dividends with
respect to any Dividend Period of the shares of such series, an amount computed
by multiplying (x) 300% of the "AA" Financial Composite Commercial Paper Rate
for the period during which such Failure to Deposit occurs on the Dividend
Payment Date for such Dividend Period by (y) a fraction, the numerator of which
shall be the number of days for which such Failure to Deposit has not been cured
(including the day such Failure to Deposit occurs and excluding the day such
Failure to Deposit is cured) and the denominator of which shall be 360, and
applying the rate obtained against the aggregate liquidation preference of the
outstanding shares of such series and (2) if such Failure to Deposit consisted
of the failure timely to pay to the Auction Agent the redemption price of the
shares, if any, of such series for which notice of redemption has been mailed by
the Fund, an amount computed by multiplying (x) 300% of the "AA" Financial
Composite Commercial Paper Rate for the Rate Period during which such Failure to
Deposit occurs on the redemption date by (y) a fraction, the numerator of which
shall be the number of days for which such Failure to Deposit is not cured
(including the day such Failure to Deposit occurs and excluding the day such
Failure to Deposit is cured) and the denominator of which shall be 360, and
applying the rate obtained against the aggregate liquidation preference of the
outstanding shares of such series to be redeemed, no Auction will be held in
respect of shares of such series for the subsequent rate period thereof and the
dividend rate for shares of such series for such subsequent rate period will be
the Maximum Rate for shares of such series on the Auction Date for such
subsequent rate period. If any Failure to Deposit shall have occurred with
respect to shares of such series during any Rate Period thereof, and, prior to
12:00 noon, New York City time, on the third Business Day next succeeding the
date on which such Failure to Deposit occurred, such Failure to Deposit shall
not have been cured or the Fund shall not have paid the applicable Late Charge
to the Auction Agent, no Auction will be held in respect of shares of such
series for the first subsequent rate period thereafter (or for any Rate Period
thereafter to and including the Rate Period during which (1) such Failure to
Deposit is cured and (2) the Fund pays the applicable Late Charge to the Auction
Agent (the condition set forth in this clause (2) to apply only in the event
Moody's is rating such shares at the time the Fund cures such Failure to
Deposit), in each case no later than 12:00 noon, New York City time, on the
fourth Business Day prior to the end of such Rate Period) (a "Non-Payment
Period") and the dividend rate for shares of such series for each such
subsequent rate period shall be a rate per annum (the "Non-Payment Period Rate")
equal to 300% of the applicable "AA" Financial Composite Commercial Paper Rate,
provided that the Board of Trustees shall have the authority to adjust, modify,
alter or change from time to time such rate if the Board of Trustees determines
and Moody's (or any Substitute Rating Agency in lieu of Moody's in the event
Moody's shall not rate the APS) advises the Fund in writing
--------------------------------------------------------------------------------
36
DESCRIPTION OF PREFERRED SHARES
--------------------------------------------------------------------------------
that such adjustment, modification, alteration or change will not adversely
affect its then current ratings on the APS.
RATING AGENCY GUIDELINES AND ASSET COVERAGE
The Fund is required under Moody's guidelines to maintain assets having in the
aggregate a Discounted Value at least equal to the Preferred Shares Basic
Maintenance Amount. The Preferred Shares Basic Maintenance Amount is the sum of
(a) the aggregate liquidation preference of the APS then outstanding, together
with the aggregate liquidation preference on any other series of APS, and (b)
certain accrued and projected dividend and other payment obligations of the
Fund. Moody's has established guidelines for determining Discounted Value which
are described in the Statement of Additional Information. The amount of discount
from market value varies depending upon functions such as the type of security,
the maturity of the instrument and the issuer's credit rating. The Moody's
guidelines also impose certain diversification requirements on the Fund's
portfolio and other limitations on the Fund's investments. To the extent any
particular portfolio holding does not satisfy Moody's guidelines, all or a
portion of the holding's value will not be included in the calculation of
Discounted Value (as defined by Moody's). The Moody's guidelines do not impose
any limitations on the percentage of the Fund's assets that may be invested in
holdings not eligible for inclusion in the calculation of the Discounted Value
of the Fund's portfolio. 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.
The Fund will be required under the By-laws to maintain, with respect to the
APS, as of the last Business Day of each month in which any APS are outstanding,
asset coverage of at least 200% with respect to senior securities which are
shares of beneficial interest in the Fund, including the APS (or such other
asset coverage as in the future may be specified in or under the 1940 Act as the
minimum asset coverage for senior securities which are shares of beneficial
interest of a closed-end investment company as a condition of paying dividends
on its common stock) ("1940 Act Preferred Shares Asset Coverage"). If the Fund
fails to maintain the 1940 Act Preferred Shares Asset Coverage and such failure
is not cured as of the last Business Day of the following month (the "1940 Act
Cure Date"), the Fund will be required under certain circumstances to redeem
certain of the APS. See "--REDEMPTION" below.
The 1940 Act Preferred Shares Asset Coverage immediately following the issuance
of APS offered hereby (after giving effect to the deduction of the sales load
and offering expenses for the APS), computed using the Fund's net assets as of
September 30, 2002, adjusted for the exercise of the over-allotment option on
October 4, 2002, and assuming the APS with an aggregate liquidation preference
of $280 million had been issued as of such date, will be as follows:
Value of Fund assets less liabilities not
constituting senior securities 884,191,705
------------------------------------------------ = --------------- = 316%
Senior securities representing indebtedness plus 280,000,000
liquidation value of the shares of APS
In the event the Fund does not timely cure a failure to maintain (a) a
Discounted Value of 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 Moody's or a Substitute Rating
Agency, the Fund will be required by the By-laws to redeem shares of APS as
described under "--REDEMPTION--Mandatory redemption" below.
The Moody's guidelines restrict the Fund's use of some types of investment
strategies. For example, the guidelines, among other restrictions, limit the
Fund's use of futures, options and other derivative transactions and limit the
percentage of the Fund's assets that may be invested in any one issuer or type
or class of issuer.
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37
DESCRIPTION OF PREFERRED SHARES
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The Moody's guidelines also prohibit the Fund from taking certain types of
actions unless it has received written confirmation from Moody's that such
actions would not impair the ratings then assigned to the APS. These include
restrictions on borrowing money, engaging in short sales, lending portfolio
securities, issuing any class or series of shares ranking prior to or on a
parity with the APS with respect to the payment of dividends or the distribution
of assets upon dissolution, liquidation or winding up of the Fund or merging or
consolidating into or with any other entity.
The restrictions in the Moody's guidelines may limit the Fund's ability to make
investments that the Adviser believes would benefit the Fund. The descriptions
of the Moody's guidelines in this section are summaries only and are not
complete. The Moody's guidelines are described in greater detail in the
Statement of Additional Information and are set forth in their entirety in the
By-laws, which have been filed as an exhibit to the Registration Statement of
which this Prospectus is a part.
The Fund may, but is not required to, adopt any modifications to Moody's
guidelines that may hereafter be established by Moody's. Failure to adopt any
such modifications, however, may result in a change in the ratings assigned to
the APS or a withdrawal of ratings altogether. In addition, any rating agency
providing a rating for the APS may, at any time, change or withdraw any such
rating. The Board of Trustees may, without shareholder approval, amend, alter or
repeal any or all of the definitions and related provisions which have been
adopted by the Fund pursuant to Moody's guidelines in the event Moody's is no
longer rating the APS or the Fund receives written confirmation from Moody's or
a Substitute Rating Agency that any such amendment, alteration or repeal would
not impair the rating then assigned to the APS.
As described by Moody's, a preferred stock rating is an assessment of the
capacity and willingness of an issuer to pay preferred stock obligations. The
rating on the APS 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 Moody's guidelines described above
also do not address the likelihood that an owner of APS will be able to sell
such shares in an auction or otherwise. The rating is based on current
information furnished to Moody's by the Fund and/or the Adviser and information
obtained from other sources. The rating may be changed, suspended or withdrawn
as a result of changes in, or the unavailability of, such information. The
Common Shares have not been rated by Moody's.
The Moody's guidelines will apply to the APS only so long as Moody's is rating
APS. The Fund will pay certain fees to Moody's for rating the APS. The Fund may
at some future time seek to have the APS rated by an additional or Substitute
Rating Agency.
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) asset
coverage of at least 200% of the value of senior securities of the Fund which
are equity shares, including the APS (1940 Act Preferred Shares Asset Coverage).
Eligible portfolio securities for purposes of the Preferred Shares Basic
Maintenance Amount and their Discounted Value will be determined from time to
time by the rating agency then rating the APS. The guidelines currently in
effect are described under "Rating agency guidelines and asset coverage" and in
the Statement of Additional Information. If the Fund fails to maintain such
asset coverage amounts and does not timely cure such failure in accordance with
the requirements of the rating agency that rates the APS, the Fund must redeem
all or a portion of the APS. This mandatory redemption will take place on a date
that the Fund's Board of Trustees specifies out of legally available funds, in
accordance with the Agreement and Declaration of Trust, the By-laws and
applicable law, at the redemption price of $25,000 per share plus accumulated
but unpaid dividends (whether or not earned or declared) to (but not including)
the date fixed for redemption. The mandatory redemption will be limited to the
number of APS necessary, after giving effect to such
--------------------------------------------------------------------------------
38
DESCRIPTION OF PREFERRED SHARES
--------------------------------------------------------------------------------
redemption, to cause the Discounted Value of the Fund's portfolio to equal or
exceed the Preferred Shares Basic Maintenance Amount, and the value of the
Fund's portfolio to equal or exceed the 1940 Act Preferred Shares Asset
Coverage. In determining the number of APS required to be redeemed in accordance
with the foregoing, the Fund will allocate the number of APS 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
series of APS and any other preferred shares of the Fund subject to redemption
or retirement. The Fund shall effect such redemption on the date fixed by the
Fund, which date shall not be earlier than 20 days nor later than 40 days after
the applicable cure date, except if the Fund does not have funds legally
available therefor. If fewer than all outstanding Series of shares of any series
are, as a result, to be redeemed, the Fund may redeem such shares by lot or
other method that it deems fair and equitable.
OPTIONAL REDEMPTION
To the extent permitted under the 1940 Act and Massachusetts law, the Fund at
its option may, without the consent of the holders of APS, redeem APS, in whole
or in part, on the Business Day after the last day of such Dividend Period upon
not less than 15 calendar days' and not more than 40 calendar days' prior notice
at the optional redemption price per share; provided that no APS may be redeemed
at the option of the Fund during (a) the Initial Dividend Period or (b) a
Non-Call Period to which such share is subject. The optional redemption price
per share will be $25,000 per share, plus an amount equal to accumulated but
unpaid dividends thereon (whether or not earned or declared) to the date fixed
for redemption plus any applicable redemption premium attributable to the
designation of a Premium Call Period. The Fund will not make any optional
redemption unless, after giving effect thereto, (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 APS of such
series by reason of the redemption of the APS 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.
Notwithstanding the foregoing APS, may not be redeemed at the option of the Fund
unless all dividends in arrears on the outstanding preferred shares, including
all outstanding APS, have been or are being contemporaneously paid or set aside
for payment. This would not prevent the lawful purchase or exchange offer for
APS made on the same terms to holders of all outstanding preferred shares.
LIQUIDATION
If the Fund is liquidated, the holders of any series of outstanding APS will
receive the liquidation preference on such series, plus all accumulated but
unpaid dividends, before any payment is made to the holders of common shares.
The holders of APS will be entitled to receive these amounts from the assets of
the Fund available for distribution to its shareholders. In addition, the rights
of holders of APS to receive these amounts are subject to the rights of holders
of any series or class of shares, including other series of preferred shares,
ranking on a parity with the APS with respect to the distribution of assets upon
liquidation of the Fund. After the payment to the holders of APS of the full
preferential amounts as described, the holders of APS will have no right or
claim to any of the remaining assets of the Fund.
For purpose of the foregoing paragraph, a voluntary or involuntary liquidation
of the Fund does not include:
+ the sale, lease or exchange of all or substantially all the property or
assets of the Fund;
+ the merger or consolidation of the Fund into or with any other business
trust, corporation, or other organization; or
+ the merger or consolidation of any other business trust or corporation into
or with the Fund
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39
DESCRIPTION OF PREFERRED SHARES
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In addition, none of the foregoing would result in the Fund being required to
redeem any APS if after such transaction the Fund continued to comply with the
rating agency guidelines and asset coverage ratios.
VOTING RIGHTS
Except as otherwise provided in this Prospectus or as otherwise required by law,
holders of APS will have equal voting rights with holders of common shares and
any other preferred shares (one vote per share) and will vote together with
holders of common shares and any preferred shares as a single class.
Holders of outstanding preferred shares, including APS, voting as a separate
class, are entitled to elect two of the Fund's Trustees. The remaining Trustees
are elected by holders of Common Shares. In addition, if at any time dividends
(whether or not earned or declared) on outstanding preferred shares, including
APS, 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, then, the sole remedy of holders of
outstanding preferred shares, including APS, is that the number of Trustees
constituting the Board will be automatically increased by the smallest number
that, when added to the two Trustees elected exclusively by the holders of
preferred shares, including APS, as described above, would constitute a majority
of the Board. The holders of preferred shares, including APS, will be entitled
to elect that smallest number of additional Trustees at a special meeting of
shareholders as soon as possible and at all subsequent meetings at which
Trustees are to be elected. The terms of office of the persons who are Trustees
at the time of that election will continue. If the Fund thereafter shall pay, or
declare and set apart for payment, in full, all dividends payable on all
outstanding preferred shares, including APS, the special voting rights stated
above will cease, and the terms of office of the additional Trustees elected by
the holders of preferred shares, including APS, will automatically terminate.
As long as any APS are outstanding, the Fund will not, without the affirmative
vote or consent of the holders of at least a majority of the APS outstanding at
the time (voting together as a separate class):
(a) authorize, create or issue any class or series of shares ranking prior to or
on a parity with the APS with respect to payment of dividends or the
distribution of assets on dissolution, liquidation or winding up the affairs of
the Fund, or authorize, create or issue additional shares of any series of APS
or any other preferred shares, unless, in the case of preferred shares on a
parity with the APS, the Fund obtains written confirmation from Moody's (if
Moody's is then rating preferred shares) or any Substitute Rating Agency (if any
such Substitute Rating Agency is then rating the APS) that the issuance of a
class or series would not impair the rating then assigned by such rating agency
to the APS and the Fund continues to comply with Section 13 of the 1940 Act, the
1940 Act Preferred Shares Asset Coverage requirements and the Preferred Shares
Basic Maintenance Amount requirements, in which case the vote or consent of the
holders of the APS is not required;
(b) amend, alter or repeal the provisions of the Agreement and Declaration of
Trust or the By-laws, whether by merger, consolidation or otherwise, so as to
adversely affect any preference, right or power of the APS or holders of APS;
provided, however, that (i) none of the actions permitted by the exception to
(a) above will be deemed to affect such preferences, rights or powers, (ii) a
division of APS will be deemed to affect such preferences, rights or powers only
if the terms of such division adversely affect the holders of APS and (iii) the
authorization, creation and issuance of classes or series of shares ranking
junior to the APS with respect to the payment of dividends and the distribution
of assets upon dissolution, liquidation or winding up of the affairs of the Fund
will be deemed to affect such preferences, rights or powers only if Moody's is
then rating the APS and such issuance would, at the time thereof, cause the Fund
not to satisfy the 1940 Act Preferred Shares Asset Coverage or the Preferred
Shares Basic Maintenance Amount;
(c) authorize the Fund's conversion from a closed-end to an open-end investment
company;
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40
DESCRIPTION OF PREFERRED SHARES
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(d) amend the provisions of the Agreement and Declaration of Trust, which
provide for the classification of the Board of Trustees of the Fund into three
classes, each with a term of office of three years with only one class of
Trustees standing for election in any year; or
(e) approve any reorganization (as such term is used in the 1940 Act) adversely
affecting the APS
So long as any shares of the APS are outstanding, the Fund shall not, without
the affirmative vote or consent of the holders of at least 66 2/3% of the APS
outstanding at the time, in person or by proxy, either in writing or at a
meeting, voting as a separate class, file a voluntary application for relief
under federal bankruptcy law or any similar application under state law for so
long as the Fund is solvent and does not foresee becoming insolvent.
To the extent permitted under the 1940 Act, the Fund will not approve any of the
actions set forth in (a) or (b) above which adversely affects the rights
expressly set forth in the Agreement and Declaration of Trust, or the By-laws,
of a holder of shares of a series of preferred shares differently than those of
a holder of shares of any other series of preferred shares without the
affirmative vote or consent of the holders of at least a majority of the shares
of each series adversely affected. Unless a higher percentage is provided for
under the Agreement and Declaration of Trust, or the By-laws, the affirmative
vote of the holders of a majority of the outstanding APS, voting together as a
single class, will be required to approve any plan of reorganization (including
bankruptcy proceedings) adversely affecting such shares or any action requiring
a vote of security holders under Section 13(a) of the 1940 Act.
The foregoing voting provisions will not apply with respect to APS 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.
The Auction
GENERAL
Holders of the APS will be entitled to receive cumulative cash dividends on
their APS when, as and if declared by the Fund's Board of Trustees, out of the
funds legally available therefore, on the Initial Dividend Payment Date with
respect to the Initial Dividend Period for each series and, thereafter, on each
Dividend Payment Date with respect to a Subsequent Dividend Period (generally a
period of seven days, subject to certain exceptions set forth under "Description
of the Preferred Shares--DIVIDENDS AND DIVIDEND PERIODS"), at the rate per annum
equal to the Applicable Rate for each such Dividend Period.
The provisions of the By-laws establishing the terms of the APS offered hereby
will provide that the Applicable Rate for each Dividend Period after the Initial
Dividend Period for each series will be equal to the rate per annum that the
Auction Agent advises has resulted on the Business Day preceding the first day
of such Dividend Period due to implementation of the Auction Procedures set
forth in the By-laws in which persons determine to hold or offer to purchase or
sell the APS. The Auction Procedures are attached as Appendix C to the Statement
of Additional Information. Each periodic operation of such procedures with
respect to the APS is referred to herein as an "Auction." If, however, the Fund
should fail to pay or duly provide for the full amount of any dividend on or the
redemption price of the APS called for redemption, the Applicable Rate for the
APS will be determined as set forth under "Description of Preferred
Shares--DIVIDENDS AND DIVIDEND PERIODS--Non-Payment Period and Late Charge."
AUCTION AGENCY AGREEMENT
The Fund will enter into the Auction Agency Agreement with the Auction Agent
(currently, Deutsche Bank Trust Company Americas) which provides, among other
things, that the Auction Agent will
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THE AUCTION
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follow the Auction Procedures to determine the Applicable Rate for the APS. The
Fund will pay the Auction Agent compensation for its services under the Auction
Agency Agreement.
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 and will not be liable for any error of judgment made in good faith
unless the Auction Agent shall have been negligent in ascertaining the pertinent
facts. Pursuant to the Auction Agency Agreement, the Fund is required to
indemnify the Auction Agent for certain losses and liabilities incurred by the
Auction Agent without negligence or bad faith on its part in connection with the
performance of its duties under such agreement.
The Auction Agent may terminate the Auction Agency Agreement upon notice to the
Fund no earlier than 60 days after delivery of said notice. If the Auction Agent
should resign, the Fund will use its best efforts to enter into an agreement
with a successor Auction Agent containing substantially the same terms and
conditions as the Auction Agency Agreement. The Fund may remove the Auction
Agent provided that, prior to removal, the Fund has entered into a replacement
agreement with a successor Auction Agent.
BROKER-DEALER AGREEMENTS
Each Auction requires the participation of one or more Broker-Dealers. The
Auction Agent will enter into agreements with several Broker-Dealers, or other
entities permitted by law to perform the functions required of a Broker-Dealer
in the Auction Procedures, selected by the Fund, which provide for the
participation of those Broker-Dealers in Auctions for APS. The Auction Agent
will pay to each Broker-Dealer after each Auction, from funds provided by the
Fund, a service charge at the annual rate (i) for any seven day Dividend Period
at the annual rate of 0.25% of the liquidation preference ($25,000 per share) of
the APS held by a Broker-Dealer's customer upon settlement in an Auction and
(ii) for any Special Dividend Period as determined by mutual consent of the Fund
and any such Broker-Dealer or Broker-Dealers and which shall be based upon a
selling concession that would be applicable to an underwriting of fixed or
variable rate preferred shares with a similar fixed maturity or variable rate
dividend period, respectively, at the commencement of the Dividend Period with
respect to such Auction.
The Fund may request that the Auction Agent 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 termination of the agreement,
provided that neither the Broker-Dealer Agreement with UBS Warburg LLC nor the
Broker-Dealer Agreement with Merrill Lynch, Pierce, Fenner & Smith Incorporated
may be terminated without the prior written consent of the Fund, which consent
may not be unreasonably withheld.
SECURITIES DEPOSITORY
The Depository Trust Company initially will act as the Securities Depository for
the Agent Members with respect to the APS. All of the shares of APS initially
will be registered in the name of Cede & Co., as nominee of the Securities
Depository. Such APS will be subject to the provisions restricting transfers of
APS, and Beneficial Owners will not be entitled to receive certificates
representing their ownership interest in such APS. See Appendix C (Auction
Procedures) to the Statement of Additional Information. The Securities
Depository will maintain lists of its participants and will maintain the
positions (ownership interests) of the APS held by each Agent Member, whether as
the Beneficial Owner thereof for its own account or as nominee for the
Beneficial Owner thereof. Payments made by the Fund to holders of APS will be
duly made by making payments to the nominee of the Securities Depository.
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THE AUCTION
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AUCTION PROCEDURES
The following is a brief summary of the procedures to be used in conducting
Auctions. This summary is qualified by reference to the Auction Procedures set
forth in Appendix C to the Statement of Additional Information. The Settlement
Procedures to be used with respect to Auctions are set forth in Appendix D to
the Statement of Additional Information.
ORDERS BY BENEFICIAL OWNERS, POTENTIAL BENEFICIAL OWNERS, EXISTING HOLDERS AND
POTENTIAL HOLDERS
Prior to the submission deadline on each Auction Date for the APS, 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 APS may submit the
following types of orders with respect to that Broker-Dealer:
1. Hold Order--indicating its desire to hold APS without regard to the
Applicable Rate for the next Dividend Period
2. Bid--indicating its desire to sell APS at $25,000 per share if the
Applicable Rate for the next Dividend Period is less than the rate or spread
specified in the bid
3. Sell Order--indicating its desire to sell APS at $25,000 per share without
regard to the Applicable Rate for the next Dividend Period
A Beneficial Owner may submit different types of orders to its Broker-Dealer
with respect to different shares of APS then held by the Beneficial Owner. A
Beneficial Owner that submits its bid to its Broker-Dealer having a rate higher
than the Maximum Applicable 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 to its Broker-Dealer for an Auction relating to a Dividend
Period of more than 91 days such Beneficial Owner will be deemed to have
submitted a sell order to its Broker-Dealer. A sell order constitutes an
irrevocable offer to sell the APS subject to the sell order. A Beneficial Owner
that offers to become the Beneficial Owner of additional APS is, for 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 a series of APS but that wishes to purchase APS or that is a
Beneficial Owner that wishes to purchase additional APS. A Potential Holder may
submit Bids to its Broker-Dealer in which it offers to purchase APS at $25,000
per share if the Applicable Rate for APS for the next Dividend Period is not
less than the specified rate in such Bid. A Bid placed by a Potential Holder of
APS specifying a rate higher than the Maximum Rate for APS 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. They will
designate themselves (unless otherwise permitted by the Fund) as Existing
Holders of APS subject to orders submitted or deemed submitted to them by
Beneficial Owners. They will designate themselves as Potential Holders of APS
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 APS 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 APS 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 it is not an affiliate of the Fund.
There are Sufficient Clearing Bids in an Auction if the number of APS subject to
bids submitted or deemed submitted to the Auction Agent by Broker-Dealers for
Potential Holders with rates or spreads
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43
THE AUCTION
--------------------------------------------------------------------------------
equal to or lower than the Maximum Applicable Rate is at least equal to or
exceeds the sum of the number of APS subject to sell orders and the number of
shares subject to bids specifying rates or spreads higher than the Maximum
Applicable 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 next succeeding Dividend Period thereof will be the
lowest rate specified in the submitted bids which, 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 Existing Holders and Potential Holders
owning the APS available for purchase in the Auction.
If there are not Sufficient Clearing Bids, the Applicable Rate for the next
Dividend Period will be the Maximum Rate on the Auction Date. However, if the
Fund has declared a Special Dividend Period and there are not Sufficient
Clearing Bids, the election of a Special Dividend Period will not be effective
and the Applicable Rate for the next Dividend Period will be the Applicable Rate
determined on the previous Auction date same as during the Dividend Period. If
there are not Sufficient Clearing Bids, Beneficial Owners of APS that have
submitted or are deemed to have submitted sell orders may not be able to sell in
the Auction all APS subject to such sell orders. If all of the applicable
outstanding APS are the subject of submitted hold orders (or hold orders deemed
to have been submitted), then the Dividend Period will be a seven day Dividend
Period and the Applicable Rate for the next Dividend Period will be the "AA"
Financial Composite Commercial Paper Rate for a seven day Dividend Period.
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 APS that is different than the number
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.
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, act of war, civil or
military disturbance, act of terrorism, sabotage, riots or a loss or malfunction
of utilities or communications services, or the Auction Agent is not able to
conduct an Auction in accordance with the Auction Procedures for any such
reason, then the Applicable Rate for the next Dividend Period will be the
Applicable 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, act of
war, civil or military disturbance, act of terrorism, sabotage, riots or a loss
or malfunction of utilities or communications services, or the dividend payable
on such date can not 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 its paying agent, if any, are able to
cause the dividend to be paid using their reasonable best efforts
+ the affected Dividend Period will end on the day it otherwise would have
ended
+ the next Dividend Period will begin and end on the dates on which it
otherwise would have begun and ended
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THE AUCTION
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The following is a simplified example of how a typical Auction works. Assume
that the Fund has 1,000 outstanding APS and three Existing Holders. The three
Existing Holders and three Potential Holders submit orders through
Broker-Dealers at the Auction:
Existing Holder A............ Owns 500 shares, wants to Bid order of 2.1% rate for
sell all 500 shares if all 500 shares
Auction Rate is less than
2.1%
Existing Holder B............ Owns 300 shares, wants to Hold order--will take the
hold Auction Rate
Existing Holder C............ Owns 200 shares, wants to Bid order of 1.9% rate for
sell all 200 shares if all 200 shares
Auction Rate is less than
1.9%
Potential Holder D........... Wants to buy 200 shares Place order to buy at or
above 2.0%
Potential Holder E........... Wants to buy 300 shares Place order to buy at or
above 1.9%
Potential Holder F........... Wants to buy 200 shares Place order to buy at or
above 2.1%
The lowest dividend rate that will result in all 1,000 APS continuing to be held
is 2.0% (the offer by D). For the purposes of the example, the lowest dividend
rate is 2.0% at which there is Sufficient Clearing Bids and, therefore, the
dividend rate will be 2.0%. Existing Holders B and C will continue to own their
shares. Existing Holder A will sell its shares because A's Auction Rate bid was
higher than the Applicable Rate. Potential Holder D will buy 200 shares and
Potential Holder E will buy 300 shares because their bid rates were at or below
the Applicable Rate. Potential Holder F will not buy any shares because its bid
rate was above the dividend rate.
SUBMISSION OF ORDERS BY BROKER-DEALERS TO AUCTION AGENT
Prior to 1:30 p.m., New York City time, on each Auction Date, or such other time
on the Auction Date as may be specified by the Auction Agent (the "Submission
Deadline"), each Broker-Dealer will submit to the Auction Agent in writing or
through the Auction Agent's auction processing system all Orders obtained by it
for the Auction for a series of APS to be conducted on such Auction Date,
designating itself (unless otherwise permitted by the Fund) as the Existing
Holder or Potential Holder in respect of the APS subject to such Orders. Any
Order submitted by a Beneficial Owner or a Potential Beneficial Owner to its
Broker-Dealer, or by a Broker-Dealer to the Auction Agent, prior to the
Submission Deadline for any Auction Date, shall be irrevocable.
If the rate per annum specified in any Bid contains more than three figures to
the right of the decimal point, the Auction Agent will round such rate per annum
up to the next highest one-thousandth (.001) of one-percent. If one or more
Orders of an Existing Holder are submitted to the Auction Agent and such Orders
cover in the aggregate more than the number of outstanding shares of APS held by
such Existing Holder, such Orders will be considered valid in the following
order of priority:
(i) any Hold Order will be considered valid up to and including the number of
outstanding APS held by such Existing Holder, provided that if more than
one Hold Order is submitted by such Existing Holder and the number of APS
subject to such Hold Orders exceeds the number of outstanding APS held by
such Existing Holder, the number of APS subject to each of such Hold
Orders will be reduced pro rata so that such Hold Orders, in the
aggregate, will cover exactly the number of outstanding APS held by such
Existing Holder;
(ii) any Bids will be considered valid, in the ascending order of their
respective rates per annum if more than one Bid is submitted by such
Existing Holder, up to and including the excess of the number of
outstanding APS held by such Existing Holder over the number of
outstanding APS
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THE AUCTION
--------------------------------------------------------------------------------
subject to any Hold Order referred to in clause (i) above (and if more
than one Bid submitted by such Existing Holder specifies the same rate
per annum and together they cover more than the remaining number of
shares that can be the subject of valid Bids after application of clause
(i) above and of the foregoing portion of this clause (ii) to any Bid or
Bids specifying a lower rate or rates per annum, the number of shares
subject to each of such Bids will be reduced pro rata so that such Bids,
in the aggregate, cover exactly such remaining number of outstanding
shares); and the number of outstanding shares, if any, subject to Bids
not valid under this clause (ii) shall be treated as the subject of a Bid
by a Potential Holder; and
(iii) any Sell Order will be considered valid up to and including the excess of
the number of outstanding APS held by such Existing Holder over the sum
of the number of APS subject to Hold Orders referred to in clause (i)
above and the number of APS subject to valid Bids by such Existing Holder
referred to in clause (ii) above; provided that, if more than one Sell
Order is submitted by any Existing Holder and the number of APS subject
to such Sell Orders is greater than such excess, the number of APS
subject to each of such Sell Orders will be reduced pro rata so that such
Sell Orders, in the aggregate, will cover exactly the number of APS equal
to such excess
If more than one Bid of any Potential Holder is submitted in any Auction, each
Bid submitted in such Auction will be considered a separate Bid with the rate
per annum and number of APS therein specified.
NOTIFICATION OF RESULTS AND SETTLEMENT
The Auction Agent will advise each Broker-Dealer who submitted a Bid or Sell
Order in an Auction whether such Bid or Sell Order was accepted or rejected in
whole or in part and of the Applicable Rate for the next Dividend Period for the
related APS by telephone or through the Auction Agent's auction processing
system at approximately 3:00 p.m., New York City time, on the Auction Date for
such Auction. Each such Broker-Dealer that submitted an Order for the account of
a customer then will advise such customer whether such Bid or Sell Order was
accepted or rejected, will confirm purchases and sales with each customer
purchasing or selling APS as a result of the Auction and will advise each
customer purchasing or selling APS to give instructions to its Agent Member of
the Securities Depository to pay the purchase price against delivery of such
shares or to deliver such shares against payment therefor as appropriate. If a
customer selling APS as a result of an Auction fails to instruct its Agent
Member to deliver such shares, the Broker-Dealer that submitted such customer's
Bid or Sell Order will instruct such Agent Member to deliver such shares against
payment therefor. Each Broker-Dealer that submitted a Hold Order in an Auction
on behalf of a customer also will advise such customer of the Applicable Rate
for the next Dividend Period for the APS. The Auction Agent will record each
transfer of APS on the record book of Existing Holders to be maintained by the
Auction Agent.
In accordance with the Securities Depository's normal procedures, on the day
after each Auction Date, the transactions described above will be executed
through the Securities Depository, and the accounts of the respective Agent
Members at the Securities Depository will be debited and credited as necessary
to effect the purchases and sales of APS as determined in such Auction.
Purchasers will make payment through their Agent Members in same-day funds to
the Securities Depository against delivery through their Agent Members; the
Securities Depository will make payment in accordance with its normal
procedures, which now provide for payment in same-day funds. If the procedures
of the Securities Depository applicable to APS shall be changed to provide for
payment in next-day funds, then purchasers may be required to make payment in
next-day funds. If the certificates for the APS are not held by the Securities
Depository or its nominee, payment will be made in same-day funds to the Auction
Agent against delivery of such certificates.
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THE AUCTION
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If any Existing Holder selling APS in an Auction fails to deliver such APS, the
Broker-Dealer of any person that was to have purchased APS in such Auction may
deliver to such person a number of whole APS that is less than the number of APS
that otherwise was to be purchased by such person. In such event, the number of
APS to be so delivered will be determined by such Broker-Dealer. Delivery of
such lesser number of APS will constitute good delivery. Each Broker-Dealer
Agreement also will provide that neither the Fund nor the Auction Agent will
have responsibility or liability with respect to the failure of a Potential
Beneficial Owner, Potential Beneficial Owner or their respective Agent Members
to deliver APS or to pay for APS purchased or sold pursuant to an Auction or
otherwise.
BROKER-DEALERS
The Auction Agent after each Auction will pay a service charge from funds
provided by the Fund to each Broker-Dealer on the basis of the purchase price of
APS placed by such Broker-Dealer at such Auction. The service charge (i) for any
seven day Dividend Period shall be payable at the annual rate of 0.25% of the
purchase price of the APS placed by such Broker-Dealer in any such Auction and
(ii) for any Special Dividend Period shall be determined by mutual consent of
the Fund and any such Broker-Dealer or Broker-Dealers and shall be based upon a
selling concession that would be applicable to an underwriting of fixed or
variable rate preferred shares with a similar final maturity or variable rate
dividend period, respectively, at the commencement of the Dividend Period with
respect to such Auction. For the purposes of the preceding sentence, the APS
will be placed by a Broker-Dealer if such shares were (i) the subject of Hold
Orders deemed to have been made by Beneficial Owners that were acquired by such
Beneficial Owners through such Broker-Dealer or (ii) the subject of the
following Orders submitted by such Broker-Dealer: (A) a submitted Bid of a
Beneficial Owner that resulted in such Beneficial Owner continuing to hold such
APS as a result of the Auction, (B) a Submitted Bid of a Potential Beneficial
Owner that resulted in such Potential Beneficial Owner purchasing such APS as a
result of the Auction or (C) a Submitted Hold Order.
The Broker-Dealer Agreements provide that a Broker-Dealer may submit Orders in
Auctions for its own account, unless the Fund notifies all Broker-Dealers that
they no longer may do so; provided that Broker-Dealers may continue to submit
Hold Orders and Sell Orders. If a Broker-Dealer submits an Order for its own
account in any Auction of APS, it may have knowledge of Orders placed through it
in that Auction and therefore have an advantage over other Bidders, but such
Broker-Dealer would not have knowledge of Orders submitted by other
Broker-Dealers in that Auction.
SECONDARY MARKET TRADING AND TRANSFERS OF PREFERRED SHARES
The Broker-Dealers are expected to maintain a secondary trading market in APS
outside of auctions, but are not obligated to do so, and may discontinue such
activity at any time. There can be no assurance that any secondary trading
market in APS will provide owners with liquidity of investment. The APS will not
be registered on any stock exchange or on the Nasdaq National Market.
Investors who purchase APS in an Auction (particularly if the Fund has declared
a Special Dividend 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.
A Beneficial Owner or an Existing Holder may sell, transfer or otherwise dispose
of APS 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
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THE AUCTION
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+ to such other persons as may be permitted by the Fund; provided, however,
that a sale, transfer or other disposition of APS from a customer of a
Broker-Dealer who is listed on the records of that Broker-Dealer as the
holder of such shares to that Broker-Dealer or another customer of that
Broker-Dealer shall not be deemed to be a sale, transfer or other disposition
if such Broker-Dealer remains the Existing Holder of the shares; and in the
case of all transfers other than pursuant to auctions, the Broker-Dealer (or
other person, if permitted by the Fund) to whom such transfer is made will
advise the Auction Agent of such transfer
Management of the Fund
TRUSTEES AND OFFICERS
The Fund's Board of Trustees provides broad supervision over the affairs of the
Fund. The officers of the Fund are responsible for the Fund's operations. The
Trustees and officers of the Fund, together with their principal occupations
during the past five years, are listed in the Statement of Additional
Information. Each of the Trustees serves as a Trustee of each of the other
leveraged closed-end investment companies for which the Adviser acts as
investment adviser.
INVESTMENT ADVISER
The Fund has contracted with John Hancock Advisers, LLC to act as its investment
adviser. The Adviser serves as the investment adviser to the Patriot Group of
Trusts, consisting of Patriot Premium Dividend Fund I, Patriot Premium Dividend
Fund II, Patriot Select Dividend Trust, Patriot Preferred Dividend Fund and
Patriot Global Dividend Fund, all leveraged dual-class, closed-end investment
companies. The Adviser was organized in 1968 and had, as of June 30, 2002
approximately $26 billion in assets under management, of which $2.3 billion was
in closed-end investment companies. The Adviser is an indirect wholly-owned
subsidiary of John Hancock Financial Services, Inc., a financial services
company.
The Adviser has been managing closed-end funds since it was first established in
1968 and has a long history of delivering strong performance through several
market cycles. The Adviser uses a total team approach in which portfolio
managers and analysts work together to research and identify investment
opportunities resulting in a free-flowing exchange of ideas. Although each of
the funds in the Patriot Group of Funds has different investment policies, the
Adviser employs its strategic investment analysis for the funds in a manner
similar to that which the Adviser utilizes for the Fund.
The Adviser is an industry leader in preferred stock fund management and is the
only firm to actively manage six closed-end preferred stock funds. The Adviser
employs a team of seasoned investment professionals to manage the Fund. This
experienced team has been successful in managing preferred assets through John
Hancock's similarly structured Patriot group of funds as well as open-end funds
and institutional portfolios. The team consists of 59 professionals with an
average of 16 years of investment experience. In addition to developing a
structured process to manage interest-rate risk, the management team has
produced a proven track record in using various techniques to maintain level
dividends.
Under the terms of an investment advisory agreement between the Fund and the
Adviser (the "Advisory Agreement"), the Fund has retained the Adviser to provide
overall investment advice and to manage the investment of the Fund's assets and
to place orders for the purchase and sale of its portfolio securities. The
Adviser is responsible for obtaining and evaluating research, economic and
statistical data and, subject to the supervision of the Board of Trustees, for
formulating and implementing investment programs in furtherance of the Fund's
investment objective. The Adviser furnishes to the Fund the services of such
members of its organization as may be duly elected officers
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48
MANAGEMENT OF THE FUND
--------------------------------------------------------------------------------
of the Fund. The Adviser will not be liable to the Fund except for willful
malfeasance, bad faith, gross negligence or reckless disregard of its duties and
obligations.
The Adviser also provides administrative services to the Fund (to the extent
such services are not provided to the Fund pursuant to other agreements)
including (a) providing supervision of the Fund's non-investment operations, (b)
providing the Fund with personnel to perform such executive, administrative and
clerical services as are reasonably necessary to provide effective
administration of the Fund, (c) arranging for the preparation, at the Fund's
expense, of the Fund's tax returns, reports to shareholders and reports filed
with the Securities and Exchange Commission and other regulatory authorities,
(d) providing the Fund with adequate office space and certain related office
equipment and services, and (e) maintaining all of the Fund's records other than
those maintained pursuant to such other agreements.
COMPENSATION AND EXPENSES
For its advisory and administrative services, the Fund accrues and pays to the
Adviser daily, as compensation for the services rendered and expenses paid by
it, a fee on an annual basis equal to 0.75% of the Fund's average daily managed
assets. Because the fee paid to the Adviser is determined on the basis of the
Fund's managed assets, the Adviser's interest in determining whether to leverage
the Fund may differ from the interests of the Fund. "Managed assets" means the
total assets of the Fund (including any assets attributable to any leverage that
may be outstanding) minus the sum of accrued liabilities (other than debt
representing financial leverage). The liquidation preference of the APS is not a
liability. Pursuant to a separate Accounting and Legal Services Agreement, the
Adviser is reimbursed for certain tax, accounting and legal services.
The Adviser has contractually agreed to waive a portion of its advisory fees.
The Adviser has agreed that, until the fifth anniversary of investment advisory
agreement, the Adviser will limit its advisory fee to 0.55% of average daily
managed assets, in the sixth year the Adviser will limit its advisory fee to
0.60% of average daily managed assets, in the seventh year the Adviser will
limit its advisory fee to 0.65% of average daily managed assets, and in the
eighth year the Adviser will limit its advisory fee to 0.70% of average daily
managed assets.
PORTFOLIO MANAGERS
Day-to-day management of the Fund's portfolio is the responsibility of a team of
portfolio managers led by Gregory K. Phelps, Mark T. Maloney and Barry H. Evans.
Gregory K. Phelps is Vice President and Portfolio Manager with over 21 years of
experience. He has extensive expertise in managing preferred securities within
closed-end funds and in researching securities in the utility, bank, and oil and
gas industries.
Mark T. Maloney is a Senior Equity Research Officer and Assistant Portfolio
Manager with over 20 years of experience focusing on electric utilities, gas
distribution and local distribution companies.
Barry H. Evans, CFA, is Senior Vice President and Chief Fixed Income Officer at
John Hancock Advisers, LLC. He oversees fixed-income strategies, which include
both corporate high-grade and high-yield mandates. He has 16 years of investment
experience.
SHAREHOLDER SERVICING AGENT
The Adviser has retained UBS Warburg LLC to act as shareholder servicing agent
for the Fund. Pursuant to an agreement between the Adviser and UBS Warburg LLC,
UBS Warburg LLC will perform certain shareholder relations services for the Fund
and the Adviser, including making available public information pertaining to the
Fund and communicating to investors the Fund's features and benefits, making
available to investors market price, net asset value, yield and other
information regarding the Fund, and providing certain economic research and
statistical information and reports. In consideration of these services, the
Adviser will pay UBS Warburg LLC a fee equal on an annual basis
--------------------------------------------------------------------------------
49
MANAGEMENT OF THE FUND
--------------------------------------------------------------------------------
to 0.10% of the Fund's average daily managed assets. This fee will be an expense
of the Adviser and not the Fund.
Net asset value
The Fund calculates a net asset value for its common shares every day the New
York Stock Exchange is open when regular trading closes (normally 4:00 p.m. New
York City time). For purposes of determining the net asset value of a common
share, the value of the securities held by the Fund plus any cash or other
assets (including interest accrued but not yet received) minus all liabilities
(including accrued expenses and indebtedness) and the aggregate liquidation
value of any outstanding preferred shares is divided by the total number of
common shares outstanding at such time. Currently, the net asset values of
shares of publicly traded closed-end investment companies investing in debt
securities are published in Barron's, the Monday edition of The Wall Street
Journal and the Monday and Saturday editions of The New York Times.
The Fund generally values its portfolio securities using closing market prices
or readily available market quotations. When closing market prices or market
quotations are not available or, in the opinion of the Adviser, are not
representative of the true market value, the fair value of a security may be
determined in accordance with procedures approved by the Trustees. Debt
investment securities are valued on the basis of valuations furnished by a
principal market maker or a pricing service, both of which generally utilize
electronic data processing techniques to determine valuations for normal
institutional size trading units of debt securities without exclusive reliance
upon quoted prices. Short-term debt investments which have a remaining maturity
of 60 days or less are generally valued at amortized cost which approximates
market value. If market quotations are not readily available or if, in the
opinion of the Adviser, any quotation or price is not representative of true
market value, the fair value of the security may be determined in good faith in
accordance with procedures approved by the Trustees. Foreign securities are
valued on the basis of quotations from the primary market in which they are
traded. Any assets or liabilities expressed in terms of foreign currencies are
translated into U.S. dollars by the custodian bank based on London currency
exchange quotations as of 5:00 p.m., London time (12:00 noon, New York City
time) on the date of any determination of the Fund's net asset value. If
quotations are not readily available, or the value has been materially affected
by the events occurring after closing of a foreign market, assets are valued by
a method that Trustees believe accurately reflects fair value. The value of
interest rate swaps, caps and floors is determined in accordance with a formula
and then confirmed periodically by obtaining a bank quotation. Positions in
options are valued at the last sale price on the market where any such option is
principally traded. Positions in futures contracts are valued at closing prices
for such contracts established by the exchange on which they are traded.
Repurchase agreements are valued at cost plus accrued interest.
U.S. federal income tax matters
The following is a summary discussion of certain U.S. federal income tax
consequences that may be relevant to a shareholder of acquiring, holding and
disposing of APS. This discussion only addresses U.S. federal income tax
consequences to U.S. shareholders who hold their shares as capital assets and
does not address all of the U.S. federal income tax consequences that may be
relevant to particular shareholders in light of their individual circumstances.
This discussion also does not address the tax consequences to shareholders who
are subject to special rules, including, without limitation, financial
institutions, insurance companies, dealers in securities or foreign currencies,
foreign shareholders, shareholders who hold their shares as or in a hedge
against currency risk, a constructive sale, or conversion transaction,
shareholders who are subject to the alternative minimum tax, or tax-exempt or
tax-deferred plans, accounts, or entities. In addition, the discussion does not
address any state, local, or foreign tax consequences, and it does not address
any federal tax consequences other than U.S.
--------------------------------------------------------------------------------
50
U.S. FEDERAL INCOME TAX MATTERS
--------------------------------------------------------------------------------
federal income tax consequences. The discussion reflects applicable tax laws of
the United States as of the date of this Prospectus, which tax laws may be
changed or subject to new interpretations by the courts or the Internal Revenue
Service ("IRS") retroactively or prospectively. No attempt is made to present a
detailed explanation of all U.S. federal income tax concerns affecting the Fund
and its shareholders, and the discussion set forth herein does not constitute
tax advice. Investors are urged to consult their own tax advisers to determine
the specific tax consequences to them of investing in the Fund, including the
applicable federal, state, local and foreign tax consequences to them and the
effect of possible changes in tax laws.
The Fund intends to elect to be treated and to qualify each year as a "regulated
investment company" under Subchapter M of the Code and to comply with applicable
distribution requirements so that it generally will not pay U.S. federal income
tax on income and capital gains distributed to shareholders. In order to qualify
as a regulated investment company, which qualification the following discussion
assumes, the Fund must satisfy certain tests regarding the sources of its income
and the diversification of its assets. If the Fund qualifies as a regulated
investment company and, for each taxable year, it distributes to its
shareholders an amount equal to or exceeding the sum of (i) 90% of its
"investment company taxable income" as that term is defined in the Code (which
includes, among other things, dividends, taxable interest, and the excess of any
net short-term capital gains over net long-term capital losses, as reduced by
certain deductible expenses) without regard to the deduction for dividends paid
and (ii) 90% of the excess of its gross tax-exempt interest, if any, over
certain disallowed deductions, the Fund generally will not be subject to U.S.
federal income tax on any income of the Fund, including "net capital gain" (the
excess of net long-term capital gain over net short-term capital loss),
distributed to shareholders. However, if the Fund retains any investment company
taxable income or net capital gain, it generally will be subject to U.S. federal
income tax at regular corporate rates on the amount retained. The Fund intends
to distribute at least annually all or substantially all of its investment
company taxable income, net tax-exempt interest, and net capital gain. If for
any taxable year the Fund did not qualify as a regulated investment company, it
would be treated as a corporation subject to U.S. federal income tax.
Under the Code, the Fund will be subject to a nondeductible 4% federal excise
tax on a portion of its undistributed ordinary income and capital gains if it
fails to meet certain distribution requirements with respect to each calendar
year. The Fund intends to make distributions in a timely manner and accordingly
does not expect to be subject to the excise tax, but there can be no assurance
that the Fund's distributions will be sufficient to avoid this tax entirely.
Based in part on the lack of any present intention on the part of the Fund to
redeem or purchase the APS at any time in the future, the Fund intends to take
the position that under present law the APS will constitute stock of the Fund
and distributions with respect to the APS (other than distributions in
redemption of the APS that are treated as exchanges of stock under Section
302(b) of the Code) will constitute dividends to the extent of the Fund's
current or accumulated earnings and profits as calculated for U.S. federal
income tax purposes. Such dividends generally will be taxable as ordinary income
to holders (other than capital gain dividends, as described below). This view
relies in part on a published ruling of the IRS stating that certain preferred
stock similar in many material respects to the APS represents equity. It is
possible, however, that the IRS might take a contrary position asserting, for
example that the APS constitute debt of the Fund. If this position were upheld,
the discussion of the treatment of distributions above would not apply. Instead
distributions by the Fund to holders of APS would constitute interest, whether
or not such distributions exceeded the earnings and profits of the Fund, would
be included in full in the income of the recipient and would be taxed as
ordinary income.
Dividends paid out of the Fund's current or accumulated earnings and profits
generally will be taxable as ordinary income except as described below.
Distributions of net capital gain (if any) that are designated by the Fund as
capital gain dividends will be treated as long-term capital gains without
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51
U.S. FEDERAL INCOME TAX MATTERS
--------------------------------------------------------------------------------
regard to the length of time the shareholder has held shares of the Fund.
Distributions, if any, in excess of the Fund's current and accumulated earnings
and profits will first reduce the adjusted tax basis of a shareholder's shares
and, after that basis has been reduced to zero, will constitute a capital gain
to the shareholder. The U.S. federal income tax status of all distributions will
be reported to shareholders annually.
The IRS has taken the position that if a regulated investment company has two
classes of shares, it must designate distributions made to each class in any
year as consisting of no more than such class's proportionate share of
particular types of income (including ordinary income and capital gains). A
class's proportionate share of a particular type of income is determined
according to the percentage of total dividends paid by the regulated investment
company during the year to such class. Consequently, the Fund intends to
designate distributions made to the common shareholders and the preferred
shareholders of particular types of income in accordance with each such class's
proportionate shares of such income.
If the Fund retains any net capital gain for a taxable year, the Fund may
designate the retained amount as undistributed capital gains in a notice to
shareholders who, if subject to U.S. federal income tax on long-term capital
gains, (i) will be required to include in income for U.S. federal income tax
purposes, as long-term capital gain, their proportionate shares of such
undistributed amount, and (ii) will be entitled to credit their proportionate
shares of the tax paid by the Fund on the undistributed amount against their
U.S. federal income tax liabilities, if any, and to claim refunds to the extent
the credit exceeds such liabilities.
Distributions from the Fund to its corporate shareholders are not expected to
qualify for the 70% corporate Dividends Received Deduction to the extent of the
income received by the Fund from its investment in taxable preferred securities.
See "Investment objectives and principal investment strategies--PORTFOLIO
CONTENTS AND PRINCIPAL INVESTMENT STRATEGIES--Taxable preferred securities."
Sales, redemptions, and other dispositions of APS generally are taxable events
for shareholders that are subject to tax. Shareholders should consult their own
tax advisers with reference to their individual circumstances to determine
whether any particular transaction in the Fund's shares (including a redemption
of APS) is properly treated as a sale for tax purposes, as the following
discussion assumes, and the tax treatment of any gains or losses recognized in
such transactions. In general, if APS are sold, the shareholder will recognize
gain or loss equal to the difference between the amount realized on the sale and
the shareholder's adjusted basis in the shares. Such gain or loss generally will
be treated as long-term gain or loss if the shares were held for more than one
year and otherwise generally will be treated as short-term gain or loss. If
there is a sale as a result of a redemption of APS, any declared but unpaid
dividends distributed to shareholders in connection with the redemption will be
taxable to shareholders as dividends as described above.
If, in connection with the selection of a Long Term Dividend Period, (i) the
Fund provides that a Premium Call Period will follow a Non-Call Period, (ii)
based on all the facts and circumstances at the time of the designation of the
Long Term Dividend Period the Fund is more likely than not to redeem the
Preferred Shares during the Premium Call Period, and (iii) the premium to be
paid upon redemption during the Premium Call Period exceeds a reasonable penalty
for early redemption, it is possible that the holders of APS will be required to
accrue such premium as a dividend (to the extent of the Fund's earnings and
profits) over the term of the Non-Call Period.
Any loss recognized by a shareholder upon the sale or other disposition of
shares with a tax holding period of six months or less generally will be treated
as a long-term capital loss to the extent of any amounts treated as
distributions of long-term capital gain with respect to such shares. Losses on
sales or other dispositions of shares may be disallowed under "wash sale" rules
in the event a shareholder acquires other shares in the Fund (including those
acquired pursuant to reinvestment of dividends
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52
U.S. FEDERAL INCOME TAX MATTERS
--------------------------------------------------------------------------------
and/or capital gains distributions) within a period of 61 days beginning 30 days
before and ending 30 days after a sale or other disposition of shares.
The Fund is required in certain circumstances to backup withhold on reportable
payments, including dividends, capital gains distributions, and proceeds of
sales or other dispositions of the Fund's shares paid to certain holders of the
Fund's shares who do not furnish the Fund with their correct social security
number or other taxpayer identification number and certain other certifications,
or who are otherwise subject to backup withholding. Backup withholding is not an
additional tax. Any amounts withheld from payments made to a shareholder may be
refunded or credited against such shareholder's U.S. federal income tax
liability, if any, provided that the required information is furnished to the
IRS.
The foregoing is a general and abbreviated summary of the provisions of the Code
and the Treasury regulations in effect as they generally affect the taxation of
the Fund and its shareholders. As noted above, these provisions are subject to
change by legislative, judicial or administrative action, and any such change
may be retroactive. A further discussion of the U.S. federal income tax rules
applicable to the Fund can be found in the Statement of Additional Information,
which is incorporated by reference into this Prospectus. Shareholders are urged
to consult their tax advisers regarding specific questions as to U.S. federal,
foreign, state, and local income or other taxes.
Description of shares
The Fund is authorized to issue an unlimited number of Common Shares. The Fund
is also authorized to issue an unlimited number of preferred shares. The Board
of Trustees is authorized to classify and reclassify any unissued shares into
one or more additional classes or series of shares. The Board of Trustees may
establish such series or class, including preferred shares, from time to time by
setting or changing in any one or more respects the designations, preferences,
conversion or other rights, voting powers, restrictions, limitations as to
dividends, qualifications or terms or conditions of redemption of such shares
and pursuant to such classification or reclassification to increase or decrease
the number of authorized shares of any existing class or series. The Board of
Trustees, without shareholder approval, is authorized to amend the Agreement and
Declaration of Trust and By-laws to reflect the terms of any such class or
series, including any class of preferred shares. The Fund is also authorized to
issue other securities, including debt securities.
Under Massachusetts law, shareholders of the Fund, including holders of the
Common Shares and any preferred shares, could, in certain circumstances, be held
personally liable for the obligations of the Fund. However, the Agreement and
Declaration of Trust disclaims shareholder liability for acts or obligations of
the Fund. Notice of such disclaimer may be given in any agreement, obligation or
instrument entered into or executed by the Fund or the Trustees on behalf of the
Fund. The Agreement and Declaration of Trust provides for indemnification out of
Fund property for all loss and expense of any shareholder held personally liable
for the obligations of the Fund. Thus, the risk of a shareholder incurring
financial loss on account of shareholder liability is limited to circumstances
in which the Fund would be unable to meet its obligations.
The Agreement and Declaration of Trust further provides that obligations of the
Fund are not binding upon the Trustees individually but only upon the property
of the Fund and that the Trustees will not be liable for actions or failures to
act. Nothing in the Agreement and Declaration of Trust, however, protects a
Trustee against any liability to which such Trustee may be subject by reason of
willful misfeasance, bad faith, gross negligence or reckless disregard of the
duties involved in the conduct of such Trustee's office.
COMMON SHARES
Common Shares, when issued and outstanding, will be fully paid and
non-assessable. Shareholders are entitled to share pro rata in the net assets of
the Fund available for distribution to Common
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53
DESCRIPTION OF SHARES
--------------------------------------------------------------------------------
Shareholders upon liquidation of the Fund. Common Shareholders are entitled to
one vote for each share held.
So long as any shares of the Fund's preferred shares are outstanding, including
the APS, holders of Common Shares will not be entitled to receive any net income
of or other distributions from the Fund unless all accumulated dividends on
preferred shares have been paid, and unless asset coverage (as defined in the
1940 Act) with respect to preferred shares would be at least 200% after giving
effect to such distributions.
The Fund will send unaudited reports at least semiannually and audited annual
financial statements to all of its shareholders.
Certain provisions of the Agreement and Declaration of Trust and By-laws
The Agreement and Declaration of Trust includes provisions that could limit the
ability of other entities or persons to acquire control of the Fund or to
convert the Fund to open-end status. Specifically, the Agreement and Declaration
of Trust requires a vote by holders of at least 75% of the outstanding common
and preferred shares, voting together as a single class, to authorize:
+ a conversion of the Fund from a closed-end to an open-end investment company
+ a merger or consolidation of the Fund, or a series or class of the Fund, with
any corporation, association, trust or other organization or a reorganization
of the Fund, or a series or class of the Fund
+ a sale, lease or transfer of all or substantially all of the Fund's assets
(other than in the regular course of the Fund's investment activities)
+ in certain circumstances, a termination of the Fund, or a series or class of
the Fund
+ a removal of Trustees by shareholders, and then only for cause
unless, with respect to the forgoing (other than the removal of Trustees), such
transaction has already been authorized by the affirmative vote of 75% of the
total number of Trustees fixed in accordance with the Agreement and Declaration
of Trust or the By-laws, in which case the affirmative vote of the holders of at
least a majority of the Fund's common and preferred shares outstanding at the
time, voting together as a single class, is required, provided, however, that
where only a particular class or series is affected (or, in the case of removing
a Trustee, when the Trustee has been elected by only one class), only the
required vote by the applicable class or series will be required. Approval of
shareholders is not required, however, for any transaction, whether deemed a
merger, consolidation, reorganization or otherwise whereby the Fund issues
shares in connection with the acquisition of assets (including those subject to
liabilities) from any other investment company or similar entity. None of the
foregoing provisions may be amended except by the vote of at least 75% of the
outstanding common shares and preferred shares, voting together as a single
class. In the case of the conversion of the Fund to an open-end investment
company, or in the case of any of the foregoing transactions constituting a plan
of reorganization which adversely affects the holders of the Fund's preferred
shares, the action in question will also require the affirmative vote of the
holders of at least 75% of the outstanding preferred shares, voting as a
separate class, or, if such action has been authorized by the affirmative vote
of 75% of the total number of Trustees fixed in accordance with the Agreement
and Declaration of Trust or the By-laws, the affirmative vote of the holders of
at least a majority of the Fund's outstanding preferred shares, voting as a
separate class.
The votes required to approve the conversion of the Fund from a closed-end to an
open-end investment company or to approve transactions constituting a plan of
reorganization which adversely affects the holders of the Fund's preferred
shares are higher than those required by the 1940 Act. The
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54
CERTAIN PROVISIONS OF THE AGREEMENT AND DECLARATION OF TRUST AND BY-LAWS
--------------------------------------------------------------------------------
Board of Trustees believes that the provisions of the Agreement and Declaration
of Trust relating to such higher votes are in the best interest of the Fund and
its shareholders.
The Board of Trustees is divided into three classes of approximately equal size.
The terms of the Trustees of the different classes are staggered so that
approximately one third of the Board of Trustees is elected by shareholders each
year.
The provisions of the Agreement and Declaration of Trust described above could
have the effect of depriving the common shareholders of opportunities to sell
their Common Shares at a premium over the then current market price of the
Common Shares by discouraging a third party from seeking to obtain control of
the Fund in a tender offer or similar transaction. The overall effect of these
provisions is to render more difficult the accomplishment of a merger or the
assumption of control by a third party. They provide, however, the advantage of
potentially requiring persons seeking control of the Fund to negotiate with its
management regarding the price to be paid and facilitating the continuity of the
Fund's investment objectives and policies. The Board of Trustees of the Fund has
considered the foregoing anti-takeover provisions and concluded that they are in
the best interests of the Fund and its common shareholders.
The Fund's By-laws generally require that advance notice be given to the Fund in
the event a shareholder desires to nominate a person for election to the Board
of Trustees or to transact any other business at an annual meeting of
shareholders. With respect to an annual meeting following the first annual
meeting of shareholders, notice of any such nomination or business must be
delivered to or received at the principal executive offices of the Fund not less
than 90 calendar days nor more than 120 calendar days prior to the anniversary
date of the prior year's annual meeting (subject to certain exceptions). In the
case of the first annual meeting of shareholders, the notice must be given no
later than the tenth calendar day following public disclosure as specified in
the By-laws of the date of the meeting. Any notice by a shareholder must be
accompanied by certain information as provided in the By-laws.
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55
--------------------------------------------------------------------------------
Underwriting
The underwriters named below (the "Underwriters"), acting through UBS Warburg
LLC, 299 Park Avenue, New York, New York and Merrill Lynch, Pierce, Fenner &
Smith Incorporated, 4 World Financial Center, New York, New York, as lead
managers, and Prudential Securities Incorporated as their representative
(together with the lead managers, the "Representatives") have severally agreed,
subject to the terms and conditions of the Underwriting Agreement with the Fund
and the Adviser, to purchase from the Fund the number of APS set forth opposite
their respective names. The Underwriters are committed to purchase and pay for
all of such APS if any are purchased.
NUMBER
UNDERWRITER OF APS
---------------------------------------------------------------------
UBS Warburg LLC............................................. 5,152
Merrill Lynch, Pierce, Fenner & Smith
Incorporated................................... 4,368
Prudential Securities Incorporated.......................... 1,680
------
Total.................................................. 11,200
======
The Underwriters have advised the Fund that they propose initially to offer the
APS directly to the public at the public offering price set forth on the cover
page of this Prospectus, and to certain dealers at such price less a concession
not in excess of $137.50 per share. The Underwriters may allow, and such dealers
may reallow, a concession not in excess of $100.00 per share to other dealers.
After the initial public offering, the public offering price, concession and
discount may be changed. Investors must pay for any APS purchased in the initial
public offering on or before October 23, 2002.
The Underwriters will act in auctions as Broker-Dealers and receive fees as set
forth under "The Auction" and in the Statement of Additional Information. The
Underwriters also may provide information to be used in determining the
Reference Rate.
The Fund anticipates that the Representatives may from time to time act as
brokers and dealers in connection with the execution of the Fund's portfolio
transactions after they have ceased to be principal underwriters of the Fund
under the 1940 Act and, subject to certain conditions, may act as such brokers
while they are principal underwriters.
The Fund and the Adviser have agreed to indemnify the Underwriters against
certain liabilities including liabilities under the Securities Act of 1933, as
amended.
As described above under "Management of the Fund," UBS Warburg LLC will provide
shareholder services to the Fund pursuant to a shareholder servicing agreement
with the Adviser.
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56
--------------------------------------------------------------------------------
Legal matters
Certain legal matters in connection with the shares offered hereby are passed on
for the Fund by Hale and Dorr LLP, Boston, Massachusetts. Certain matters have
been passed upon for the Underwriters by Skadden, Arps, Slate, Meagher & Flom
(Illinois), Chicago, Illinois and its affiliates.
Table of contents for
Statement of Additional Information
PAGE
------------------------------------------------------------------
Organization of the Fund.................................... 2
Investment Objectives and Policies.......................... 2
Investment Restrictions..................................... 15
Those Responsible for Management............................ 16
Investment Advisory and Other Services...................... 23
Additional Information Concerning the Auctions for the
Preferred Shares.......................................... 25
Rating Agency Guidelines.................................... 26
Net Asset Value............................................. 35
Brokerage Allocation........................................ 35
U.S. Federal Income Tax Matters............................. 37
Performance................................................. 42
Custody of Portfolio........................................ 42
Independent Auditors........................................ 42
Additional Information...................................... 42
Financial Statements........................................ 43
Appendix A--More About Risk................................. A-1
Appendix B--Description of Ratings.......................... B-1
Appendix C--Auction Procedures.............................. C-1
Appendix D--Settlement Procedures........................... D-1
PRIVACY PRINCIPLES OF THE FUND
The Fund is committed to maintaining the privacy of its shareholders and to
safeguarding their non-public personal information. The following information is
provided to help you understand what personal information the Fund collects, how
the Fund protects that information and why, in certain cases, the Fund may share
information with select other parties.
Generally, the Fund does not receive any non-public personal information
relating to its shareholders, although certain non-public personal information
of its shareholders may become available to the Fund. The Fund does not disclose
any non-public personal information about its shareholders or former
shareholders to anyone, except as permitted by law or as is necessary in order
to service shareholder accounts (for example, to a transfer agent or third-party
administrator).
The Fund restricts access to non-public personal information about its
shareholders to employees of the Fund's investment adviser and its affiliates
with a legitimate business need for the information. The Fund maintains
physical, electronic and procedural safeguards designed to protect the
non-public personal information of its shareholders.
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57
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Glossary
" 'AA' Financial Composite Commercial Paper Rate" on any valuation date, means
(i) (A) the Interest Equivalent of the 30-day rate (for Dividend Periods fewer
than or equal to 31 days), the 60-day rate (for Dividend Periods greater than 31
days but fewer than or equal to 61 days) and the 90-day rate (for Dividend
Periods greater than 61 days but fewer than or equal to 91 days) on commercial
paper on behalf of issuers whose corporate bonds are rated "AA" by S&P, or the
equivalent of such rating by another rating agency, as announced by the Federal
Reserve Bank of New York for the close of business on the Business Day
immediately preceding such date; and (B) for Dividend Periods greater than 91
days but fewer than 184 days, the rate described in clause (ii) below; or (ii)
if the Federal Reserve Bank of New York does not make available such a rate, or
with respect to Dividend Periods greater than 91 days but fewer than 184 days,
then the arithmetic average of the Interest Equivalent of such rates on
commercial paper placed on behalf of such issuers, as quoted on a discount basis
or otherwise by the Commercial Paper Dealers to the Auction Agent for the close
of business on the Business Day immediately preceding such date (rounded to the
next highest one-thousandth (0.001) of 1%). If any Commercial Paper Dealer does
not quote a rate required to determine the "AA" Financial Composite Commercial
Paper Rate, such rate shall be determined on the basis of the quotations (or
quotation) furnished by the remaining Commercial Paper Dealers (or Dealer), if
any, or, if there are no such Commercial Paper Dealers, by the Auction Agent.
For purposes of this definition, (A) "Commercial Paper Dealers" shall mean (1)
UBS Warburg LLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated and
Prudential Securities Incorporated; (2) in lieu of any thereof, its respective
affiliate or successor; and (3) in the event that any of the foregoing shall
cease to quote rates for commercial paper of issuers of the sort described
above, in substitution therefor, a nationally recognized dealer in commercial
paper of such issuers then making such quotations selected by the Fund, and (B)
"Interest Equivalent" of a rate stated on a discount basis for commercial paper
of a given number of days' maturity shall mean a number equal to the quotient
(rounded upward to the next higher one-thousandth (0.001) of 1%) of (1) such
rate expressed as a decimal, divided by (2) the difference between (x) 1.00 and
(y) a fraction, the numerator of which shall be the product of such rate
expressed as a decimal, multiplied by the number of days in which such
commercial paper shall mature and the denominator of which shall be 360.
"Agent Member" means a member, or participant in, of the Securities Depository
that will act on behalf of a Beneficial Owner of one or more Preferred Shares or
on behalf of a Potential Beneficial Owner.
"Applicable Percentage" has the meaning specified under "Description of
Preferred Shares--
DIVIDENDS AND DIVIDEND PERIODS" in this Prospectus.
"Applicable Rate" means the rate per annum at which cash dividends are payable
on the APS for any Dividend Period.
"Auction" means a periodic operation of the Auction Procedures.
"Auction Agency Agreement" means the agreement entered into between the Fund and
the Auction Agent which provides, among other things, that the Auction Agent
will follow the Auction Procedures for the purpose of determining the Applicable
Rate.
"Auction Agent" means Deutsche Bank Trust Company Americas unless and until
another commercial bank, trust company or other financial institution appointed
by a resolution of the Board of Trustees of the Fund or a duly authorized
committee thereof enters into an agreement with the Fund to follow the Auction
Procedures for the purpose of determining the Applicable Rate and to act as
transfer agent, registrar, dividend disbursing agent and redemption agent for
the APS.
"Auction Date" has the meaning specified under "The Auction" in this Prospectus.
--------------------------------------------------------------------------------
58
GLOSSARY
--------------------------------------------------------------------------------
"Auction Procedures" means the procedures for conducting Auctions set forth in
Appendix C to the Statement of Additional Information.
"Beneficial Owner" means a customer of a Broker-Dealer who is listed on the
records of that Broker-Dealer (or if applicable, the Auction Agent) as a holder
of Preferred Shares or a Broker-Dealer that holds Preferred Shares for its own
account.
"Bid" has the meaning specified under "The Auction--AUCTION PROCEDURES--Orders
by Beneficial Owners, Potential Beneficial Owners, Existing Holders and
Potential Holders" in this Prospectus.
"Broker-Dealer" has the meaning specified under "The Auction--BROKER-DEALER
AGREEMENTS" in this Prospectus.
"Broker-Dealer Agreement" has the meaning specified under "The
Auction--BROKER-DEALERS" in this Prospectus.
"Business Day" means a day on which the New York Stock Exchange is open for
trading and which is not a Saturday, Sunday or other day on which banks in New
York City are authorized or obligated by law to close.
"By-laws" means the By-laws of the Fund as amended, specifying, in part, the
powers, preferences and rights of the Preferred Shares.
"Common Shares" means the common shares of beneficial interest, no par value, of
the Fund.
"Date of Original Issue" means, with respect to any share of Preferred Shares,
the date on which such share first is issued by the Fund.
"Discounted Value" of any asset of the Fund means the quotient of the market
value of an asset eligible to be held by the Fund under the Moody's guidelines
divided by the applicable discount factor assigned to such assets under the
Moody's guidelines.
"Dividend Payment Date" has the meaning specified under "Description of
Preferred Shares--DIVIDENDS AND DIVIDEND PERIODS--Divided Payment Dates" in this
Prospectus.
"Dividend Period" has the meaning specified under "Description of Preferred
Shares--DIVIDENDS AND DIVIDEND PERIODS--Divided Periods" in this Prospectus.
"Existing Holder" means a Broker-Dealer or any such other person as may be
permitted by the Fund that is listed as the holder of record of Preferred Shares
in the records of the Auction Agent.
"Hold Order" has the meaning specified under "Description of Preferred
Shares--AUCTION PROCEDURES--Orders by Beneficial Owners, Potential Beneficial
Owners, Existing Holders and Potential Holders" in this Prospectus.
"Initial Dividend Payment Date" means, with respect to a series of Preferred
Shares, the Initial Dividend Payment Date specified under "Description of
Preferred Shares--DIVIDENDS AND DIVIDEND PERIODS--Divided payment dates" in this
Prospectus.
"Initial Dividend Period" means, for each series of Preferred Shares, the period
from and including the Date of Original Issue but excluding the Initial Dividend
Payment Date.
"Maximum Applicable Rate" has the meaning specified under "Description of
Preferred Shares--DIVIDENDS AND DIVIDEND PERIODS--Calculation of dividend
payment" in this Prospectus.
"Moody's" means Moody's Investors Service, Inc. or its successors.
"1940 Act Preferred Shares Asset Coverage" has the meaning specified under
"Description of Preferred Shares--RATING AGENCY GUIDELINES AND ASSET COVERAGE"
in this Prospectus.
--------------------------------------------------------------------------------
59
GLOSSARY
--------------------------------------------------------------------------------
"1940 Act Cure Date" has the meaning specified under "Description of Preferred
Shares--RATING AGENCY GUIDELINES AND ASSET COVERAGE" in this Prospectus.
"Non-Call Period" has the meaning set forth in the definition of "Specific
Redemption Provisions" below.
"Non-Payment Period Rate" has the meaning specified under "Description of
Preferred Shares--DIVIDENDS AND DIVIDEND PERIODS--Non-Payment Period and Late
Charge" in this Prospectus.
"Notice of Special Dividend Period" has the meaning specified under "Description
of Preferred Shares--DIVIDENDS AND DIVIDEND PERIODS--Designation of Special
Dividend Periods" in this Prospectus.
"Order" has the meaning specified under "Description of Preferred
Shares--AUCTION PROCEDURES--Orders by Beneficial Owners, Potential Beneficial
Owners, Existing Holders and Potential Holders" in this Prospectus.
"Potential Beneficial Owner" means a customer of a Broker-Dealer or a
Broker-Dealer that is not a Beneficial Owner of Preferred Shares but that wishes
to purchase such shares, or that is a Beneficial Owner that wishes to purchase
additional Preferred Shares.
"Potential Holder" means any Broker-Dealer or any such other person as may be
permitted by the Fund, including any Existing Holder, who may be interested in
acquiring Preferred Shares (or, in the case of an Existing Holder, additional
Preferred Shares).
"Preferred Shares" means the Auction Preferred Shares, no par value per share
and a liquidation preference of $25,000 per share plus an amount equal to
accumulated but unpaid dividends thereon (whether or not earned or declared) of
the Fund.
"Preferred Shares Basic Maintenance Amount" has the meaning specified under
"Description of Preferred Shares--RATING AGENCY GUIDELINES AND ASSET COVERAGE"
in this Prospectus.
"Preferred Shares Basic Maintenance Cure Date" has the meaning specified under
"Description of Preferred Shares--RATING AGENCY GUIDELINES AND ASSET COVERAGE"
in this Prospectus.
Premium Call Period" has the meaning set forth in the definition of "Specific
Redemption Provisions" below.
"Rate Period" means the Initial Dividend Period and any subsequent Dividend
Period, including a Special Dividend Period.
"Redemption Price" means the redemption price for the APS specified under
"Description of Preferred Shares--REDEMPTION" in the Prospectus.
"Request for Special Dividend Period" has the meaning specified under
"Description of Preferred Shares--DIVIDENDS AND DIVIDEND PERIODS--Designation of
Special Dividend Periods" in this Prospectus.
"Securities Depository" means The Depository Trust Company and its successors
and assigns or any successor securities depository selected by the Fund that
agrees to follow the procedures required to be followed by such securities
depository in connection with the Preferred Shares.
"Sell Order" has the meaning specified under "Description of Preferred
Shares--AUCTION PROCEDURES--Orders by Beneficial Owners, Potential Beneficial
Owners, Existing Holders and Potential Holders" in this Prospectus.
"Special Dividend Period" has the meaning specified under "Description of
Preferred Shares--DIVIDENDS AND DIVIDEND PERIODS--Description of Special
Dividend Periods" in this Prospectus.
--------------------------------------------------------------------------------
60
GLOSSARY
--------------------------------------------------------------------------------
Specific Redemption Provisions" means, with respect to a Special Dividend
Period, either, or both of, (i) a period (a "Non-Call Period") determined by the
Fund, after consultation with the Auction Agent and the Broker-Dealers, during
which the APS subject to such Dividend Period shall not be subject to redemption
at the option of the Fund and (ii) a period (a "Premium Call Period"),
consisting of a number of whole years and determined by the Fund, after
consultation with the Auction Agent and the Broker-Dealers, during each year of
which the APS subject to such Dividend Period shall be redeemable at the Fund's
option at a price per share equal to $25,000 plus accumulated but unpaid
dividends plus a premium expressed as a percentage of $25,000, as determined by
the Fund after consultation with the Auction Agent and the Broker-Dealers.
"Subsequent Dividend Period" means each Dividend Period after the Initial
Dividend Period.
"Substitute Rating Agency" shall mean a nationally recognized statistical rating
organization selected by the Fund to act as a substitute rating agency to
determine the credit ratings of the Preferred Shares.
"Sufficient Clearing Bids" has the meaning specified in the Auction Procedures.
--------------------------------------------------------------------------------
61
[JHF LOGO]
P80PN 10/02
JOHN HANCOCK PREFERRED INCOME FUND
Statement of Additional Information
October 18, 2002
John Hancock Preferred Income Fund (the "Fund") is a newly organized,
diversified, closed-end management investment company. This Statement of
Additional Information provides information about the Fund in addition to the
information that is contained in the Fund's current Prospectus, dated October
18, 2002 (the "Prospectus"). This Statement of Additional Information does not
include all information that a prospective investor should consider before
purchasing the Fund's Series M auction preferred shares, Series T auction
preferred shares, Series W auction preferred shares, Series TH auction preferred
shares or Series F auction preferred shares (collectively, the "Preferred
Shares" or "APS"), is not a prospectus and investors should obtain and read the
Prospectus prior to purchasing the Preferred Shares. A copy of the Prospectus
can be obtained free of charge by writing or telephoning:
John Hancock Advisers, LLC
Closed-End Fund Product Management
101 Huntington Avenue, 12th Floor
Boston, MA 02199
1-800-225-6020
You may also obtain a copy of the Prospectus on the Securities and
Exchange Commission's web site (http://www.sec.gov).
TABLE OF CONTENTS
Organization Of The Fund.....................................................2
------------------------
Investment Objectives And Policies...........................................2
----------------------------------
Investment Restrictions.....................................................15
-----------------------
Those Responsible For Management............................................16
--------------------------------
Investment Advisory And Other Services......................................23
--------------------------------------
Additional Information Concerning The Auctions For The Preferred Shares.....26
-----------------------------------------------------------------------
Rating Agency Guidelines....................................................27
------------------------
Net Asset Value.............................................................35
---------------
Brokerage Allocation........................................................36
--------------------
U.S. Federal Income Tax Matters.............................................38
-------------------------------
Performance.................................................................42
-----------
Custody Of Portfolio........................................................42
--------------------
Independent Auditors........................................................43
--------------------
Additional Information......................................................43
----------------------
Financial Statements........................................................44
--------------------
Appendix A - More About Risk...............................................A-1
----------------------------
Appendix B - Description Of Ratings........................................B-1
-----------------------------------
Appendix C - Auction Procedures............................................C-1
-------------------------------
Appendix D - Settlement Procedures.........................................D-1
----------------------------------
1
ORGANIZATION OF THE FUND
The Fund is a diversified, closed-end investment management company
organized as a Massachusetts business trust on June 27, 2002 under the laws of
The Commonwealth of Massachusetts as John Hancock Preferred Equity Income Fund.
On August 22, 2002, the Fund changed its name to John Hancock Preferred Income
Fund.
John Hancock Advisers, LLC (prior to February 1, 2002, John Hancock
Advisers, Inc.) (the "Adviser") is the Fund's investment adviser. The Adviser is
an indirect, wholly-owned subsidiary of John Hancock Life Insurance Company
(formerly John Hancock Mutual Life Insurance Company) (the "Life Company"), a
Massachusetts life insurance company chartered in 1862, with national
headquarters at John Hancock Place, Boston, Massachusetts. The Life Company is
wholly owned by John Hancock Financial Services, Inc., a Delaware corporation
organized in February, 2000.
INVESTMENT OBJECTIVES AND POLICIES
The following information supplements the discussion of the Fund's
investment objectives and policies discussed in the Prospectus. Appendix A
contains further information describing investment risks. The investment
objectives are non-fundamental and may be changed by the Trustees without
shareholder approval. There is no assurance that the Fund will achieve its
investment objectives.
The Fund's primary investment objective is to provide a high level of
current income, consistent with preservation of capital. The Fund's secondary
investment objective is to provide growth of capital to the extent consistent
with its primary objective. The Fund seeks to achieve its objectives by
investing in securities that, in the opinion of the Adviser, may be undervalued
relative to similar securities in the marketplace.
Portfolio contents. Under normal market conditions, the Fund invests at
least 80% of its assets (net assets plus borrowing for investment purposes) in
preferred stocks and other preferred securities, including convertible preferred
securities. The Fund will invest at least 80% of its total assets in preferred
securities and other fixed income securities which are rated investment grade
(i.e., at least "Baa" by Moody's Investors Service, Inc. ("Moody's") or "BBB" by
Standard & Poor's Rating Group ("S&P")) or in unrated securities determined by
the Adviser to be of comparable quality. The Fund may invest up to 20% of its
total assets in (i) preferred securities or other fixed income securities rated
below investment grade (B or higher) or unrated preferred securities or unrated
fixed income securities determined by the Adviser to be of comparable quality,
and (ii) common stocks or other equity securities that are not considered
preferred securities. The weighted average credit rating of the Fund's portfolio
of preferred securities and other fixed income securities will be at least
investment grade. The Fund intends to invest primarily in fully taxable
preferred securities. The Fund's portfolio may include both fixed rate and
adjustable rate securities. The allocation of the Fund's assets in various types
of preferred, debt and equity securities may vary from time to time depending on
the Adviser's assessment of market conditions.
The Adviser will perform its own investment analysis when making
investment decisions for the Fund and will not rely solely on the ratings
assigned to rated securities. Securities ratings are based largely on an
issuer's historical financial information and each rating agency's investment
analysis at the time of rating. Consequently, the rating assigned to any
particular security is not necessarily a reflection of the issuer's current
financial condition, which may be better or worse than the rating indicates. The
Adviser's analysis may include consideration of the issuer's experience and
managerial strength, changing financial condition, borrowing requirements or
debt maturity schedules, and its responsiveness to changes in business
conditions and interest or dividend rates. The Adviser will also consider
relative values based on anticipated cash flow, interest or dividend coverage,
asset coverage, earnings prospects, current yield and price stability.
Industry and issuer concentration. The Fund expects to emphasize
investments in preferred securities issued or guaranteed by U.S. corporations in
the utilities sector and will be subject to certain risks due to such emphasis.
The Fund will not invest 25% or more of its total assets in any one industry,
except that the Fund will invest 25% or more of its total assets in the
industries comprising the utilities sector. The Fund will allocate its
investments among industry sectors and among issuers in such sectors, based on
the Adviser's evaluation of market and economic conditions.
2
Foreign securities. Although the Fund will invest primarily in the
securities of U.S. issuers, the Fund may invest up to 20% of its total assets in
securities of corporate and governmental issuers located outside the United
States that are traded or denominated in U.S. dollars.
Illiquid securities. The Fund may invest up to 20% of its total assets
in illiquid securities, which are securities that can not be disposed of by the
Fund within seven days in the ordinary course of business at approximately the
amount at which the Fund values the securities. The Fund may invest in
securities that are sold in direct private placement transactions and are
neither listed on an exchange nor traded in the over-the-counter market.
Other securities. Normally, the Fund will invest substantially all of
its assets to meet its investment objectives. The Fund may invest the remainder
of its assets in securities with remaining maturities of less than one year,
cash equivalents or may hold cash. For temporary defensive purposes, the Fund
may depart from its principal investment strategies and invest part or all of
its assets in securities with remaining maturities of less than one year or cash
equivalents or may hold cash. During such periods, the Fund may not be able to
achieve its investment objectives.
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 dividends received deduction. These
securities can be perpetual with no maturity date or subject to mandatory
redemptions such as through a sinking fund. 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 common shares at the holder's option at
any time prior to some specified date.
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. The adjustable dividend rate feature is intended to
make the market value of these securities less sensitive to changes in interest
rates than similar securities with fixed dividend rates. Nonetheless, adjustable
rate preferred stocks have fluctuated in market value and are expected to do so
in the future.
The dividend rate on an adjustable rate preferred stock is determined
typically each quarter by applying an adjustment formula established at the time
of issuance of the stock. Although adjustment formulas vary among issues, they
typically involve a fixed relationship either to (1) rates on specific classes
of debt securities issued by the U.S. Treasury or (2) LIBOR, with limits (known
as "collars") on the minimum and maximum dividend rates that may be paid. As the
maximum dividend rate is approached, any further increase in interest rates may
adversely affect the market value of the stock. Conversely, as the minimum
dividend rate is approached, any further decrease in interest rates may
positively affect the market value of the stock. The adjustment formula is fixed
at the time of issuance of the adjustable rate preferred stock and cannot be
changed without the approval of the holders thereof.
The market values of outstanding issues of adjustable rate preferred
stock may fluctuate in response to changing market conditions. In the event that
market participants in a particular issue demand a different dividend yield than
the adjustment formula produces, the market price will change to produce the
desired yield. The dividend yield demanded by market participants may vary with
changing perceptions of credit quality and the relative levels of short-term and
long-term interest rates, as well as other factors.
Preferred securities. Generally, preferred stocks receive dividends
prior to distributions on common stock and usually have 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 and common stocks is typically eligible
for the dividends received deduction. Preferred stocks do not usually have
voting rights equivalent to common stock of the same issue but may be
convertible into common stock. Perpetual preferred stocks are issued with no
mandatory retirement provisions, but typically are callable after a period of
time at the option of the issuer. Generally, 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 stocks provide for the redemption of a portion of the
3
issue on a regularly scheduled basis with, in most cases, the entire issue being
retired at a future date. Preferred securities other than preferred stock have
certain characteristics of both debt and equity securities. Like debt
securities, preferred securities' rate of income is contractually fixed. Like
equity securities, preferred securities do not have rights to precipitate
bankruptcy filings or collection activities in the event of missed payments.
Furthermore, preferred securities are in a subordinated position in an issuer's
capital structure and their value are heavily dependent on the profitability of
the issuer rather than on any legal claims to specific assets or cash flows.
Taxable preferred securities, are a comparatively new asset class, having first
been introduced late in 1993. Income paid on these securities is not eligible
for the dividends received deduction, but does constitute deductible interest
expense for issuers thereof. The universe of issuers of taxable preferred
securities 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 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.
Dividends consisting of income from taxable preferred securities are
not eligible for the dividends received deduction and are not considered equity
of an issuer for certain purposes. 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, taxable preferred securities typically permit an issuer to defer the
payment of income for specified periods triggering an event of default. 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), taxable preferred securities may
also be treated in a similar fashion to traditional preferred 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. Taxable
preferred securities may be convertible into underlying common stock of the
issuer or associated grantor.
Taxable preferred securities 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.
In order to be payable, dividends on preferred stock must be declared
by the issuer's board of directors. In addition, distributions on taxable
preferred 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.
Because the claim on an issuer's earnings represented by preferred
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 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 in the
Prospectus or this Statement of Additional Information 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 objectives 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
volatility.
4
Risks of concentration in utility industries.
Risks that are intrinsic to the utility industries include:
o difficulty in obtaining an adequate return on invested capital,
o difficulty in financing large construction programs during an
inflationary period,
o restrictions on operations and increased cost and delays attributable
to environmental considerations and regulation,
o difficulty in raising capital in adequate amounts on reasonable terms
in periods of high inflation and unsettled capital markets,
o technological innovations that may render existing plants, equipment or
products obsolete,
o the potential impact of natural or man-made disasters, increased costs
and reduced availability of certain types of fuel,
o occasionally reduced availability and high costs of natural gas for
resale,
o the effects of energy conservation,
o the effects of a national energy policy, and
o lengthy delays and greatly increased costs and other problems
associated with the design, construction, licensing, regulation
and operation of nuclear facilities for electric generation,
including, among other considerations, the problems associated
with the use of radioactive materials and the disposal of
radioactive wastes.
There are substantial differences between the regulatory practices and policies
of various jurisdictions, and any given regulatory agency may make major shifts
in policy from time to time. There is no assurance that regulatory authorities
will, in the future, grant rate increases or that such increases will be
adequate to permit the payment of dividends on common stocks. Additionally,
existing and possible future regulatory legislation may make it even more
difficult for these utilities to obtain adequate relief. Certain of the issuers
of securities held in the Fund's portfolio may own or operate nuclear generating
facilities. Governmental authorities may from time to time review existing
policies and impose additional requirements governing the licensing,
construction and operation of nuclear power plants. Prolonged changes in
climatic conditions can also have a significant impact on both the revenues of
an electric and gas utility as well as the expenses of a utility, particularly a
hydro-based electric utility.
Utility companies in the United States and in foreign countries are
generally subject to regulation. In the United States, most utility companies
are regulated by state and/or federal authorities. Such regulation is intended
to ensure appropriate standards of service and adequate capacity to meet public
demand. Generally, prices are also regulated in the United States and in foreign
countries with the intention of protecting the public while ensuring that the
rate of return earned by utility companies is sufficient to allow them to
attract capital in order to grow and continue to provide appropriate services.
There can be no assurance that such pricing policies or rates of return will
continue in the future.
The nature of regulation of the utility industries is evolving both in
the United States and in foreign countries. In recent years, changes in
regulation in the United States increasingly have allowed utility companies to
provide services and products outside their traditional geographic areas and
lines of business, creating new areas of competition within the industries. In
some instances, utility companies are operating on an unregulated basis. Because
of trends toward deregulation and the evolution of independent power producers
as well as new entrants to the field of telecommunications, non-regulated
providers of utility services have become a significant part of their respective
industries.
5
Foreign utility companies are also subject to regulation, although such
regulations may or may not be comparable to those in the United States. Foreign
utility companies may be more heavily regulated by their respective governments
than utilities in the United States and, as in the U.S., generally are required
to seek government approval for rate increases. In addition, many foreign
utilities use fuels that may cause more pollution than those used in the United
States, which may require such utilities to invest in pollution control
equipment to meet any proposed pollution restrictions. Foreign regulatory
systems vary from country to country and may evolve in ways different from
regulation in the United States.
The revenues of domestic and foreign utility companies generally
reflect the economic growth and development in the geographic areas in which
they do business. The Adviser will take into account anticipated economic growth
rates and other economic developments when selecting securities of utility
companies.
Electric. The electric utility industry consists of companies that are
engaged principally in the generation, transmission and sale of electric energy,
although many also provide other energy-related services. In the past, electric
utility companies, in general, have been favorably affected by lower fuel and
financing costs and the full or near completion of major construction programs.
In addition, many of these companies have generated cash flows in excess of
current operating expenses and construction expenditures, permitting some degree
of diversification into unregulated businesses. Some electric utilities have
also taken advantage of the right to sell power outside of their traditional
geographic areas. Electric utility companies have historically been subject to
the risks associated with increases in fuel and other operating costs, high
interest costs on borrowings needed for capital construction programs, costs
associated with compliance with environmental and safety regulations and changes
in the regulatory climate. As interest rates declined, many utilities refinanced
high cost debt and in doing so improved their fixed charges coverage.
Regulators, however, lowered allowed rates of return as interest rates declined
and thereby caused the benefits of the rate declines to be shared wholly or in
part with customers.
The construction and operation of nuclear power facilities are subject
to increased scrutiny by, and evolving regulations of, the Nuclear Regulatory
Commission and state agencies having comparable jurisdiction. Increased scrutiny
might result in higher operating costs and higher capital expenditures, with the
risk that the regulators may disallow inclusion of these costs in rate
authorizations or the risk that a company may not be permitted to operate or
complete construction of a facility. In addition, operators of nuclear power
plants may be subject to significant costs for disposal of nuclear fuel and for
decommissioning such plants.
The rating agencies are taking a closer look at the business profile of
utilities. Ratings for companies are expected to be impacted to a greater extent
in the future by the division of their asset base. Electric utility companies
that focus more on the generation of electricity may be assigned less favorable
ratings as this business is expected to be competitive and the least regulated.
On the other hand, companies that focus on transmission and distribution which
is expected to be the least competitive and the more regulated part of the
business may see higher ratings given the greater predictability of cash flow.
Currently, several states are considering deregulation proposals. The
introduction of competition into the industry as a result of deregulation may
result in lower revenue, lower credit ratings, increased default risk, and lower
electric utility security prices. Such increased competition may also cause
long-term contracts, which electric utilities previously entered into to buy
power, to become "stranded assets" which have no economic value. Any loss
associated with such contracts must be absorbed by ratepayers and investors. In
addition, in anticipation of increasing competition, some electric utilities
have acquired electric utilities overseas to diversify, enhance earnings and
gain experience in operating in a deregulated environment. In some instances,
such acquisitions have involved significant borrowings, which have burdened the
acquirer's balance sheet. There is no assurance that current deregulation
proposals will be adopted. However, deregulation in any form could significantly
impact the electric utilities industry.
Telecommunications. The telecommunications industry today includes both
traditional telephone companies, with a history of broad market coverage and
highly regulated businesses, and cable companies, which began as small, lightly
regulated businesses focused on limited markets. Today these two historically
different businesses are converging in an industry which is trending toward
larger, competitive, national and international markets with an emphasis on
deregulation. Companies that distribute telephone services and provide access to
the telephone networks still comprise the greatest portion of this segment, but
non-regulated activities such as cellular telephone services, paging, data
6
processing, equipment retailing, computer software and hardware services are
becoming increasingly significant components as well. The presence of
unregulated companies in this industry and the entry of traditional telephone
companies into unregulated or less regulated businesses provide significant
investment opportunities with companies which may increase their earnings at
faster rates than had been allowed in traditional regulated businesses. Still,
increasing competition, technological innovations and other structural changes
could adversely affect the profitability of such utilities and the growth rate
of their dividends. Given mergers, certain marketing tests currently underway
and proposed legislation and enforcement changes, it is likely that both
traditional telephone companies and cable companies will soon provide a greatly
expanded range of utility services, including two-way video and informational
services to both residential, corporate and governmental customers.
In February 1996, the Telecommunications Act of 1996 (the "Act") became
law. The Act removed regulatory restrictions on entry that prevented local and
long-distance telephone companies and cable television companies from competing
against one another. The Act also removed most cable rate controls and allows
broadcasters to own more radio and television stations. Litigation concerning
the constitutionality of certain major provisions of the Act has slowed the
implementation of such provisions.
Gas. Gas transmission companies and gas distribution companies are also
undergoing significant changes. In the United States, interstate transmission
companies are regulated by the Federal Energy Regulatory Commission, which is
reducing its regulation of the industry. Many companies have diversified into
oil and gas exploration and development, making returns more sensitive to energy
prices. In the recent decade, gas utility companies have been adversely affected
by disruptions in the oil industry and have also been affected by increased
concentration and competition.
Water. Water supply utilities are companies that collect, purify,
distribute and sell water. In the United States and around the world the
industry is highly fragmented because most of the supplies are owned by local
authorities. Companies in this industry are generally mature and are
experiencing little or no per capita volume growth.
There can be no assurance that the positive developments noted above,
including those relating to privatization and changing regulation, will occur or
that risk factors other than those noted above will not develop in the future.
Risks of investments in the financial services sector. Since a
significant portion of the Fund's investments may be focused in issuers in the
financial services sector, the Fund will be subject to risks or events which
significantly affect the sector as a whole or a particular segment in which the
Fund invests.
Most financial services companies are subject to extensive governmental
regulation which limits their activities and may (as with insurance rate
regulation) affect the ability to earn a profit from a given line of business.
Certain financial services businesses are subject to intense competitive
pressures, including market share and price competition. The removal of
regulatory barriers to participation in certain segments of the financial
services sector may also increase competitive pressures on different types of
firms. For example, recent legislation removing traditional barriers between
banking and investment banking activities will allow large commercial banks to
compete for business that previously was the exclusive domain of securities
firms. Similarly, the removal of regional barriers in the banking industry has
intensified competition within the industry. The availability and cost of funds
to financial services firms is crucial to their profitability. Consequently,
volatile interest rates and general economic conditions can adversely affect
their financial performance.
Financial services companies in foreign countries are subject to
similar regulatory and interest rate concerns. In particular, government
regulation in certain foreign countries may include controls on interest rates,
credit availability, prices and currency movements. In some cases, foreign
governments have taken steps to nationalize the operations of banks and other
financial services companies.
As deregulation of various financial services businesses continues and
new segments of the financial services sector are opened to certain larger
financial services firms formerly prohibited from doing business in these
segments, (such as national and money center banks) certain established
companies in these market segments (such as regional banks or securities firms)
may become attractive acquisition candidates for the larger firm seeking
entrance into the segment.
7
In addition, financial services companies in growth segments (such as
securities firms during times of stock market expansion) or geographically
linked to areas experiencing strong economic growth (such as certain regional
banks) are likely to participate in and benefit from such growth through
increased demand for their products and services. Many financial services
companies which are actively and aggressively managed and are expanding services
as deregulation opens up new opportunities also show potential for capital
appreciation, particularly in expanding into areas where nonregulatory barriers
to entry are low.
Ratings as investment criteria. In general, the ratings of Moody's and
S&P represent the opinions of these agencies as to the quality of the securities
which they rate. It should be emphasized, however, that ratings are relative and
subjective and are not absolute standards of quality. These ratings will be used
by the Fund as initial criteria for the selection of debt securities. Among the
factors which will be considered are the long-term ability of the issuer to pay
principal and interest and general economic trends. Appendix B contains further
information concerning the rating of Moody's and S&P and their significance.
Subsequent to its purchase by the Fund, an issue of securities may cease to be
rated or its rating may be reduced below the minimum required for purchase by
the Fund or the average weighted credit quality of the Fund's portfolio may
cease to be investment grade. None of these events will require the sale of the
securities by the Fund.
Short-term bank and corporate obligations. The Fund may invest in
depository-type obligations of banks and savings and loan associations and other
high quality money market instruments consisting of short-term obligations of
the U.S. Government or its agencies and commercial paper. Commercial paper
represents short-term unsecured promissory notes issued in bearer form by banks
or bank holding companies, corporations and finance companies. Depository-type
obligations in which the Fund may invest include certificates of deposit,
bankers' acceptances and fixed time deposits. Certificates of deposit are
negotiable certificates issued against funds deposited in a commercial bank for
a definite period of time and earning a specified return.
Bankers' acceptances are negotiable drafts or bills of exchange,
normally drawn by an importer or exporter to pay for specific merchandise, which
are "accepted" by a bank, meaning, in effect, that the bank unconditionally
agrees to pay the face value of the instrument at maturity. Fixed time deposits
are bank obligations payable at a stated maturity date and bearing interest at a
fixed rate. Fixed time deposits may be withdrawn on demand by the investor, but
may be subject to early withdrawal penalties which vary depending upon market
conditions and the remaining maturity of the obligation. There are no
contractual restrictions on the right to transfer a beneficial interest in a
fixed time deposit to a third party, although there is no market for such
deposits. Bank notes and bankers' acceptances rank junior to domestic deposit
liabilities of the bank and pari passu with other senior, unsecured obligations
of the bank. Bank notes are not insured by the Federal Deposit Insurance
Corporation or any other insurer. Deposit notes are insured by the Federal
Deposit Insurance Corporation only to the extent of $100,000 per depositor per
bank.
Investments in foreign securities. The Fund may invest directly in the
securities of foreign issuers as well as securities in the form of sponsored or
unsponsored American Depository Receipts ("ADRs"), European Depository Receipts
("EDRs") and Global Depository Receipts (GDRs) or other securities convertible
into foreign securities. ADRs are receipts typically issued by a U.S. bank or
trust company which evidence ownership of underlying securities issued by a
foreign corporation. EDRs are receipts issued in Europe which evidence a similar
ownership arrangement. Issuers of unsponsored ADRs are not contractually
obligated to disclose material information, including financial information, in
the United States. Generally, ADRs are designed for use in the United States
securities markets and EDRs are designed for use in European securities markets.
An investment in foreign securities including ADRs may be affected by
changes in currency rates and in exchange control regulations. Issuers of
unsponsored ADRs are not contractually obligated to disclose material
information including financial information, in the United States and,
therefore, there may not be a correlation between such information and the
market value of the unsponsored ADR. Foreign companies may not be subject to
accounting standards or government supervision comparable to U.S. companies, and
there is often less publicly available information about their operations.
Foreign companies may also be affected by political or financial instability
abroad. These risk considerations may be intensified in the case of investments
in ADRs of foreign companies that are located in emerging market countries. ADRs
of companies located in these countries may have limited marketability and may
be subject to more abrupt or erratic price movements.
Risks of foreign securities. Investments in foreign securities may
involve a greater degree of risk than those in domestic securities. There is
generally less publicly available information about foreign companies in the
form of reports and ratings similar to those that are published about issuers in
the United States. Also, foreign issuers are generally not subject to uniform
accounting, auditing and financial reporting requirements comparable to those
applicable to United States issuers.
8
Foreign securities will be purchased in the best available market,
whether through over-the-counter markets or exchanges located in the countries
where principal offices of the issuers are located. Foreign securities markets
are generally not as developed or efficient as those in the United States. While
growing in volume, they usually have substantially less volume than the New York
Stock Exchange, and securities of some foreign issuers are less liquid and more
volatile than securities of comparable United States issuers. Fixed commissions
on foreign exchanges are generally higher than negotiated commissions on United
States exchanges, although the Fund will endeavor to achieve the most favorable
net results on its portfolio transactions. There is generally less government
supervision and regulation of securities exchanges, brokers and listed issuers
than in the United States.
With respect to certain foreign countries, there is the possibility of
adverse changes in investment or exchange control regulations, expropriation,
nationalization or confiscatory taxation limitations on the removal of funds or
other assets of the Fund, political or social instability, or diplomatic
developments which could affect United States investments in those countries.
Moreover, individual foreign economies may differ favorably or unfavorably from
the United States' economy in terms of growth of gross national product, rate of
inflation, capital reinvestment, resource self-sufficiency and balance of
payments position.
The dividends, in some cases capital gains and interest payable on
certain of the Fund's foreign portfolio securities, may be subject to foreign
withholding or other foreign taxes, thus reducing the net amount of income or
gains available for distribution to the Fund's shareholders.
Repurchase agreements. In a repurchase agreement the Fund buys a
security for a relatively short period (usually not more than 7 days) subject to
the obligation to sell it back to the issuer at a fixed time and price plus
accrued interest. The Fund will enter into repurchase agreements only with
member banks of the Federal Reserve System and with "primary dealers" in U.S.
Government securities. The Adviser will continuously monitor the
creditworthiness of the parties with whom the Fund enters into repurchase
agreements.
The Fund has established a procedure providing that the securities
serving as collateral for each repurchase agreement must be delivered to the
Fund's custodian either physically or in book-entry form and that the collateral
must be marked to market daily to ensure that each repurchase agreement is fully
collateralized at all times. In the event of bankruptcy or other default by a
seller of a repurchase agreement, the Fund could experience delays in
liquidating the underlying securities during the period in which the Fund seeks
to enforce its rights thereto, possible subnormal levels of income decline in
value of the underlying securities or lack of access to income during this
period and the expense of enforcing its rights.
Reverse repurchase agreements. The Fund may also enter into reverse
repurchase agreements, which involve the sale of U.S. Government securities held
in its portfolio to a bank with an agreement that the Fund will buy back the
securities at a fixed future date at a fixed price plus an agreed amount of
"interest" which may be reflected in the repurchase price. Reverse repurchase
agreements are considered to be borrowings by the Fund. Reverse repurchase
agreements involve the risk that the market value of securities purchased by the
Fund with proceeds of the transaction may decline below the repurchase price of
the securities sold by the Fund which it is obligated to repurchase. The Fund
will also continue to be subject to the risk of a decline in the market value of
the securities sold under the agreements because it will reacquire those
securities upon effecting their repurchase. To minimize various risks associated
with reverse repurchase agreements, the Fund will establish and maintain a
separate account consisting of liquid securities, of any type or maturity, in an
amount at least equal to the repurchase prices of the securities (plus any
accrued interest thereon) under such agreements.
Options on securities and securities indices. The Fund may purchase and
write (sell) call and put options on any securities and securities indices.
These options may be listed on national domestic securities exchanges or foreign
securities exchanges or traded in the over-the-counter market. The Fund may
write covered put and call options and purchase put and call options as a
substitute for the purchase or sale of securities or to protect against declines
in the value of portfolio securities and against increases in the cost of
securities to be acquired.
Writing covered options. A call option on securities written by the
Fund obligates the Fund to sell specified securities to the holder of the option
at a specified price if the option is exercised at any time before the
expiration date. A put option on securities written by the Fund obligates the
Fund to purchase specified securities from the option holder at a specified
price if the option is exercised at any time before the expiration date. Options
on securities indices are similar to options on securities, except that the
9
exercise of securities index options requires cash settlement payments and does
not involve the actual purchase or sale of securities. In addition, securities
index options are designed to reflect price fluctuations in a group of
securities or segment of the securities market rather than price fluctuations in
a single security. Writing covered call options may deprive the Fund of the
opportunity to profit from an increase in the market price of the securities in
its portfolio. Writing covered put options may deprive the Fund of the
opportunity to profit from a decrease in the market price of the securities to
be acquired for its portfolio.
All call and put options written by the Fund are covered. A written
call option or put option may be covered by (i) maintaining cash or liquid
securities in a segregated account with a value at least equal to the Fund's
obligation under the option, (ii) entering into an offsetting forward commitment
and/or (iii) purchasing an offsetting option or any other option which, by
virtue of its exercise price or otherwise, reduces the Fund's net exposure on
its written option position. A written call option on securities is typically
covered by maintaining the securities that are subject to the option in a
segregated account. The Fund may cover call options on a securities index by
owning securities whose price changes are expected to be similar to those of the
underlying index.
The Fund may terminate its obligations under an exchange traded call or
put option by purchasing an option identical to the one it has written.
Obligations under over-the-counter options may be terminated only by entering
into an offsetting transaction with the counterparty to such option. Such
purchases are referred to as "closing purchase transactions."
Purchasing options. The Fund would normally purchase call options in
anticipation of an increase, or put options in anticipation of a decrease
("protective puts"), in the market value of securities of the type in which it
may invest. The Fund may also sell call and put options to close out its
purchased options.
The purchase of a call option would entitle the Fund, in return for the
premium paid, to purchase specified securities or currency at a specified price
during the option period. The Fund would ordinarily realize a gain on the
purchase of a call option if, during the option period, the value of such
securities or currency exceeded the sum of the exercise price, the premium paid
and transaction costs; otherwise the Fund would realize either no gain or a loss
on the purchase of the call option.
The purchase of a put option would entitle the Fund, in exchange for
the premium paid, to sell specified securities at a specified price during the
option period. The purchase of protective puts is designed to offset or hedge
against a decline in the market value of the Fund's portfolio securities. Put
options may also be purchased by the Fund for the purpose of affirmatively
benefiting from a decline in the price of securities which it does not own. The
Fund would ordinarily realize a gain if, during the option period, the value of
the underlying securities decreased below the exercise price sufficiently to
cover the premium and transaction costs; otherwise the Fund would realize either
no gain or a loss on the purchase of the put option. Gains and losses on the
purchase of put options may be offset by countervailing changes in the value of
the Fund's portfolio securities.
The Fund's options transactions will be subject to limitations
established by each of the exchanges, boards of trade or other trading
facilities on which such options are traded. These limitations govern the
maximum number of options in each class which may be written or purchased by a
single investor or group of investors acting in concert, regardless of whether
the options are written or purchased on the same or different exchanges, boards
of trade or other trading facilities or are held or written in one or more
accounts or through one or more brokers. Thus, the number of options which the
Fund may write or purchase may be affected by options written or purchased by
other investment advisory clients of the Adviser. An exchange, board of trade or
other trading facility may order the liquidation of positions found to be in
excess of these limits, and it may impose certain other sanctions.
Risks associated with options transactions. There is no assurance that
a liquid secondary market on a domestic or foreign options exchange will exist
for any particular exchange-traded option or at any particular time. If the Fund
is unable to effect a closing purchase transaction with respect to covered
options it has written, the Fund will not be able to sell the underlying
securities or dispose of assets held in a segregated account until the options
expire or are exercised. Similarly, if the Fund is unable to effect a closing
sale transaction with respect to options it has purchased, it would have to
exercise the options in order to realize any profit and will incur transaction
costs upon the purchase or sale of underlying securities or currencies.
10
Reasons for the absence of a liquid secondary market on an exchange
include the following: (i) there may be insufficient trading interest in certain
options; (ii) restrictions may be imposed by an exchange on opening transactions
or closing transactions or both; (iii) trading halts, suspensions or other
restrictions may be imposed with respect to particular classes or series of
options; (iv) unusual or unforeseen circumstances may interrupt normal
operations on an exchange; (v) the facilities of an exchange or the Options
Clearing Corporation may not at all times be adequate to handle current trading
volume; or (vi) one or more exchanges could, for economic or other reasons,
decide or be compelled at some future date to discontinue the trading of options
(or a particular class or series of options). If trading were discontinued, the
secondary market on that exchange (or in that class or series of options) would
cease to exist. However, outstanding options on that exchange that had been
issued by the Options Clearing Corporation as a result of trades on that
exchange would continue to be exercisable in accordance with their terms.
The Fund's ability to terminate over-the-counter options is more
limited than with exchange-traded options and may involve the risk that
broker-dealers participating in such transactions will not fulfill their
obligations. The Adviser will determine the liquidity of each over-the-counter
option in accordance with guidelines adopted by the Board of Trustees (the
"Board").
The writing and purchase of options is a highly specialized activity
which involves investment techniques and risks different from those associated
with ordinary portfolio securities transactions. The successful use of options
depends in part on the Adviser's ability to predict future price fluctuations
and, for hedging transactions, the degree of correlation between the options and
securities or currency markets.
Futures contracts and options on futures contracts. The Fund may
purchase and sell futures contracts based on various securities (such as U.S.
Government securities) and securities indices, and any other financial
instruments and indices and purchase and write call and put options on these
futures contracts. The Fund may also enter into closing purchase and sale
transactions with respect to any of these contracts and options. All futures
contracts entered into by a Fund are traded on U.S. or foreign exchanges or
boards of trade that are licensed, regulated or approved by the Commodity
Futures Trading Commission ("CFTC").
Futures contracts. A futures contract may generally be described as an
agreement between two parties to buy and sell particular financial instruments
or currencies for an agreed price during a designated month (or to deliver the
final cash settlement price, in the case of a contract relating to an index or
otherwise not calling for physical delivery at the end of trading in the
contract).
Positions taken in the futures markets are not normally held to
maturity but are instead liquidated through offsetting transactions which may
result in a profit or a loss. While futures contracts on securities will usually
be liquidated in this manner, the Fund may instead make, or take, delivery of
the underlying securities or currency whenever it appears economically
advantageous to do so. A clearing corporation associated with the exchange on
which futures contracts are traded guarantees that, if still open, the sale or
purchase will be performed on the settlement date.
A Fund may, for example, take a "short" position in the futures market
by selling futures contracts in an attempt to hedge against an anticipated
decline in market prices that would adversely affect the value of the Fund's
portfolio securities. Such futures contracts may include contracts for the
future delivery of securities held by a Fund or securities with characteristics
similar to those of the Fund's portfolio securities.
Hedging and other strategies. Hedging is an attempt to establish with
more certainty than would otherwise be possible the effective price or rate of
return on portfolio securities or securities that the Fund proposes to acquire
or the exchange rate of currencies in which the portfolio securities are quoted
or denominated. When securities prices are falling, the Fund can seek to offset
a decline in the value of its current portfolio securities through the sale of
futures contracts. When securities prices are rising, the Fund, through the
purchase of futures contracts, can attempt to secure better rates or prices than
might later be available in the market when it effects anticipated purchases.
If, in the opinion of the Adviser, there is a sufficient degree of
correlation between price trends for the Fund's portfolio securities and futures
contracts based on other financial instruments, securities indices or other
indices, the Fund may also enter into such futures contracts as part of its
hedging strategy. Although under some circumstances prices of securities in the
Fund's portfolio may be more or less volatile than prices of such futures
contracts, the Adviser will attempt to estimate the extent of this volatility
difference based on historical patterns and compensate for any differential by
having the Fund enter into a greater or lesser number of futures contracts or by
attempting to achieve only a partial hedge against price changes affecting the
Fund's portfolio securities.
11
When a short hedging position is successful, any depreciation in the
value of portfolio securities will be substantially offset by appreciation in
the value of the futures position. On the other hand, any unanticipated
appreciation in the value of the Fund's portfolio securities would be
substantially offset by a decline in the value of the futures position. On other
occasions, the Fund may take a "long" position by purchasing futures contracts.
Options on futures contracts. The purchase of put and call options on
futures contracts will give the Fund the right (but not the obligation) for a
specified price to sell or to purchase, respectively, the underlying futures
contract at any time during the option period. As the purchaser of an option on
a futures contract, the Fund obtains the benefit of the futures position if
prices move in a favorable direction but limits its risk of loss in the event of
an unfavorable price movement to the loss of the premium and transaction costs.
The writing of a call option on a futures contract generates a premium
which may partially offset a decline in the value of the Fund's assets. By
writing a call option, the Fund becomes obligated, in exchange for the premium
(upon exercise of the option) to sell a futures contract if the option is
exercised, which may have a value higher than the exercise price. Conversely,
the writing of a put option on a futures contract generates a premium which may
partially offset an increase in the price of securities that the Fund intends to
purchase. However, a Fund becomes obligated (upon exercise of the option) to
purchase a futures contract if the option is exercised, which may have a value
lower than the exercise price. The loss incurred by each Fund in writing options
on futures is potentially unlimited and may exceed the amount of the premium
received.
The holder or writer of an option on a futures contract may terminate
its position by selling or purchasing an offsetting option of the same series.
There is no guarantee that such closing transactions can be effected. A Fund's
ability to establish and close out positions on such options will be subject to
the development and maintenance of a liquid market.
Other considerations. The Fund will engage in futures and related
options transactions either for bona fide hedging or for other purposes as
permitted by the CFTC. These purposes may include using futures and options on
futures as a substitute for the purchase or sale of securities to increase or
reduce exposure to particular markets. To the extent that the Fund is using
futures and related options for hedging purposes, futures contracts will be sold
to protect against a decline in the price of securities that the Fund owns or
futures contracts will be purchased to protect the Fund against an increase in
the price of securities it intends to purchase. The Fund will determine that the
price fluctuations in the futures contracts and options on futures used for
hedging purposes are substantially related to price fluctuations in securities
held by the Fund or securities or instruments which it expects to purchase. As
evidence of its hedging intent, the Fund expects that on 75% or more of the
occasions on which it takes a long futures or option position (involving the
purchase of futures contracts), the Fund will have purchased, or will be in the
process of purchasing, equivalent amounts of related securities in the cash
market at the time when the futures or option position is closed out. However,
in particular cases, when it is economically advantageous for the Fund to do so,
a long futures position may be terminated or an option may expire without the
corresponding purchase of securities or other assets.
To the extent that the Fund engages in nonhedging transactions in
futures contracts and options on futures, the aggregate initial margin and
premiums required to establish these nonhedging positions will not exceed 5% of
the net asset value of the Fund's portfolio, after taking into account
unrealized profits and losses on any such positions and excluding the amount by
which such options were in-the-money at the time of purchase.
Transactions in futures contracts and options on futures involve
brokerage costs, require margin deposits and, in the case of contracts and
options obligating the Fund to purchase securities, require the Fund to
establish a segregated account consisting of cash or liquid securities in an
amount equal to the underlying value of such contracts and options.
While transactions in futures contracts and options on futures may
reduce certain risks, these transactions themselves entail certain other risks.
For example, unanticipated changes in interest rates or securities prices may
result in a poorer overall performance for the Fund than if it had not entered
into any futures contracts or options transactions.
12
Perfect correlation between the Fund's futures positions and portfolio
positions will be impossible to achieve. In the event of an imperfect
correlation between a futures position and a portfolio position which is
intended to be protected, the desired protection may not be obtained and the
Fund may be exposed to risk of loss.
Some futures contracts or options on futures may become illiquid under
adverse market conditions. In addition, during periods of market volatility, a
commodity exchange may suspend or limit trading in a futures contract or related
option, which may make the instrument temporarily illiquid and difficult to
price. Commodity exchanges may also establish daily limits on the amount that
the price of a futures contract or related option can vary from the previous
day's settlement price. Once the daily limit is reached, no trades may be made
that day at a price beyond the limit. This may prevent the Fund from closing out
positions and limiting its losses.
Interest rate swaps, collars, caps and floors. In order to hedge the
value of the Fund's portfolio against interest rate fluctuations or to enhance
the Fund's income, the Fund may, but is not required to, enter into various
interest rate transactions such as interest rate swaps and the purchase or sale
of interest rate caps and floors. To the extent that the Fund enters into these
transactions, the Fund expects to do so primarily to preserve a return or spread
on a particular investment or portion of its portfolio, to protect against any
increase in the price of securities the Fund anticipates purchasing at a later
date or to manage the Fund's interest rate exposure on any debt securities or
preferred shares issued by the Fund for leverage purposes. The Fund intends to
use these transactions primarily as a hedge. However, the Fund also may invest
in interest rate swaps to enhance income or to increase the Fund's yield, for
example, during periods of steep interest rate yield curves (i.e., wide
differences between short-term and long-term interest rates). The Fund is not
required to hedge its portfolio and may choose not to do so. The Fund cannot
guarantee that any hedging strategies it uses will work.
In an interest rate swap, the Fund exchanges with another party their
respective commitments to pay or receive interest (e.g., an exchange of fixed
rate payments for floating rate payments). For example, if the Fund holds a debt
instrument with an interest rate that is reset only once each year, it may swap
the right to receive interest at this fixed rate for the right to receive
interest at a rate that is reset every week. This would enable the Fund to
offset a decline in the value of the debt instrument due to rising interest
rates but would also limit its ability to benefit from falling interest rates.
Conversely, if the Fund holds a debt instrument with an interest rate that is
reset every week and it would like to lock in what it believes to be a high
interest rate for one year, it may swap the right to receive interest at this
variable weekly rate for the right to receive interest at a rate that is fixed
for one year. Such a swap would protect the Fund from a reduction in yield due
to falling interest rates and may permit the Fund to enhance its income through
the positive differential between one week and one year interest rates, but
would preclude it from taking full advantage of rising interest rates.
The Fund usually will enter into interest rate swaps on a net basis
(i.e., the two payment streams are netted out with the trust receiving or
paying, as the case may be, only the net amount of the two payments). The net
amount of the excess, if any, of the Fund's obligations over its entitlements
with respect to each interest rate swap will be accrued on a daily basis, and an
amount of cash or liquid instruments having an aggregate net asset value at
least equal to the accrued excess will be maintained in a segregated account by
the Fund's custodian. If the interest rate swap transaction is entered into on
other than a net basis, the full amount of the Fund's obligations will be
accrued on a daily basis, and the full amount of the Fund's obligations will be
maintained in a segregated account by the Fund's custodian.
The Fund also may engage in interest rate transactions in the form of
purchasing or selling interest rate caps or floors. The Fund will not sell
interest rate caps or floors that it does not own. The purchase of an interest
rate cap entitles the purchaser, to the extent that a specified index exceeds a
predetermined interest rate, to receive payments of interest equal to the
difference of the index and the predetermined rate on a notional principal
amount (i.e., the reference amount with respect to which interest obligations
are determined although no actual exchange of principal occurs) from the party
selling such interest rate cap. The purchase of an interest rate floor entitles
the purchaser, to the extent that a specified index falls below a predetermined
interest rate, to receive payments of interest at the difference of the index
and the predetermined rate on a notional principal amount from the party selling
such interest rate floor.
Typically, the parties with which the Fund will enter into interest
rate transactions will be broker-dealers and other financial institutions. The
Fund will not enter into any interest rate swap, cap or floor transaction unless
the unsecured senior debt or the claims-paying ability of the other party
thereto is rated investment grade quality by at least one nationally recognized
statistical rating organization at the time of entering into such transaction or
whose creditworthiness is believed by the Adviser to be equivalent to such
rating. If there is a default by the other party to such a transaction, the Fund
13
will have contractual remedies pursuant to the agreements related to the
transaction. The swap market has grown substantially in recent years with a
large number of banks and investment banking firms acting both as principals and
as agents utilizing standardized swap documentation. As a result, the swap
market has become relatively liquid in comparison with other similar instruments
traded in the interbank market. Caps and floors, however, are less liquid than
swaps. Certain federal income tax requirements may limit the Fund's ability to
engage in interest rate swaps.
Credit default swap agreements. The Fund may enter into credit default
swap agreements. The "buyer" in a credit default contract is obligated to pay
the "seller" a periodic stream of payments over the term of the contract
provided that no event of default on an underlying reference obligation has
occurred. If an event of default occurs, the seller must pay the buyer the "par
value" (full notional value) of the reference obligation in exchange for the
reference obligation. The Fund may be either the buyer or seller in the
transaction. If the Fund is a buyer and no event of default occurs, the Fund
loses its investment and recovers nothing. However, if an event of default
occurs, the buyer receives full notional value for a reference obligation that
may have little or no value. As a seller, the Fund receives a fixed rate of
income throughout the term of the contract, which typically is between six
months and three years, provided that there is no default event. If an event of
default occurs, the seller must pay the buyer the full notional value of the
reference obligation.
Credit default swaps involve greater risks than if the Fund had
invested in the reference obligation directly. In addition to general market
risks, credit default swaps are subject to illiquidity risk, counterparty risk
and credit risks. The Fund will enter into swap agreements only with
counterparties who are rated investment grade quality by at least one nationally
recognized statistical rating organization at the time of entering into such
transaction or whose creditworthiness is believed by the Adviser to be
equivalent to such rating. A buyer also will lose its investment and recover
nothing should no event of default occur. If an event of default were to occur,
the value of the reference obligation received by the seller, coupled with the
periodic payments previously received, may be less than the full notional value
it pays to the buyer, resulting in a loss of value to the Fund. When the Fund
acts as a seller of a credit default swap agreement it is exposed to the risks
of leverage since if an event of default occurs the seller must pay the buyer
the full notional value of the reference obligation.
The Fund may in the future employ new or additional investment
strategies and hedging instruments if those strategies and instruments are
consistent with the trust's investment objectives and are permissible under
applicable regulations governing the Fund.
Rights and warrants. The Fund may purchase warrants and rights which
are securities permitting, but not obligating, their holder to purchase the
underlying securities at a predetermined price, subject to the Fund's investment
restrictions. Generally, warrants and stock purchase rights do not carry with
them the right to receive dividends or exercise voting rights with respect to
the underlying securities, and they do not represent any rights in the assets of
the issuer. As a result, an investment in warrants and rights may be considered
to entail greater investment risk than certain other types of investments. In
addition, the value of warrants and rights does not necessarily change with the
value of the underlying securities, and they cease to have value if they are not
exercised on or prior to their expiration date. Investment in warrants and
rights increases the potential profit or loss to be realized from the investment
of a given amount of the Fund's assets as compared with investing the same
amount in the underlying stock.
Forward commitment and when-issued securities. The Fund may purchase
securities on a when-issued or forward commitment basis. "When-issued" refers to
securities whose terms are available and for which a market exists, but which
have not been issued. The Fund will engage in when-issued transactions with
respect to securities purchased for its portfolio in order to obtain what is
considered to be an advantageous price and yield at the time of the transaction.
For when-issued transactions, no payment is made until delivery is due, often a
month or more after the purchase. In a forward commitment transaction, the Fund
contracts to purchase securities for a fixed price at a future date beyond
customary settlement time.
When the Fund engages in forward commitment and when-issued
transactions, it relies on the seller to consummate the transaction. The failure
of the issuer or seller to consummate the transaction may result in the Fund's
losing the opportunity to obtain a price and yield considered to be
advantageous. The purchase of securities on a when-issued or forward commitment
basis also involves a risk of loss if the value of the security to be purchased
declines prior to the settlement date.
14
On the date the Fund enters into an agreement to purchase securities on
a when-issued or forward commitment basis, the Fund will segregate in a separate
account cash or liquid securities equal, of any type or maturity, in value to
the Fund's commitment. These assets will be valued daily at market, and
additional cash or securities will be segregated in a separate account to the
extent that the total value of the assets in the account declines below the
amount of the when-issued commitments. Alternatively, the Fund may enter into
offsetting contracts for the forward sale of other securities that it owns.
INVESTMENT RESTRICTIONS
Fundamental Investment Restrictions. The following investment
restrictions will not be changed without the approval of a majority of the
Fund's outstanding voting securities which, as used in the Prospectus and this
Statement of Additional Information, means the approval by the lesser of (1) the
holders of 67% or more of the Fund's shares represented at a meeting if more
than 50% of the Fund's outstanding shares are present in person or by proxy at
that meeting or (2) more than 50% of the Fund's outstanding shares.
The Fund may not:
1. Issue senior securities, except as permitted by the 1940 Act and the
rules and interpretive positions of the Securities and Exchange
Commission (the "SEC") thereunder. Senior securities that the Fund may
issue in accordance with the 1940 Act include preferred shares,
borrowing, futures, when-issued and delayed delivery securities and
forward foreign currency exchange transactions.
2. Borrow money, except as permitted by the 1940 Act and the rules and
interpretive positions of the SEC thereunder.
3. Act as an underwriter, except to the extent that in connection with the
disposition of portfolio securities, the Fund may be deemed to be an
underwriter for purposes of the Securities Act of 1933.
4. Purchase, sell or invest in real estate, but subject to its other
investment policies and restrictions may invest in securities of
companies that deal in real estate or are engaged in the real estate
business. These companies include real estate investment trusts and
securities secured by real estate or interests in real estate. The Fund
may hold and sell real estate acquired through default, liquidation or
other distributions of an interest in real estate as a result of the
Fund's ownership of securities.
5. Invest in commodities or commodity futures contracts, other than
financial derivative contracts. Financial derivatives include forward
currency contracts; financial futures contracts and options on
financial futures contracts; options and warrants on securities,
currencies and financial indices; swaps, caps, floors, collars and
swaptions; and repurchase agreements entered into in accordance with
the Fund's investment policies.
6. Make loans, except that the Fund may (i) lend portfolio securities in
accordance with the Fund's investment policies, (ii) enter into
repurchase agreements, and (iii) purchase all or a portion of an issue
of publicly distributed debt securities, bank loan participation
interests, bank certificates of deposit, bankers' acceptances,
debentures or other securities, whether or not the purchase is made
upon the original issuance of the securities.
7. Purchase the securities of issuers conducting their principal activity
in the same industry if, immediately after such purchase, the value of
its investments in such industry would exceed 25% of its total assets
taken at market value at the time of such investment, except that the
Fund will invest 25% or more of its total assets in the industries
comprising the utilities sector. This limitation does not apply to
investments in securities issued by the U.S. Government or any of its
agencies, instrumentalities or authorities.
8. With respect to 75% of the fund's total assets, the Fund may not invest
more than 5% of the fund's total assets in the securities of any single
issuer or own more than 10% of the outstanding voting securities of any
one issuer, in each case other than (i) securities issued or guaranteed
by the U.S. Government, its agencies or its instrumentalities or (ii)
securities of other investment companies.
Non-Fundamental Investment Restrictions. The following investment restrictions
are designated as non-fundamental and may be changed by the Trustees without
shareholder approval.
15
1. Purchase a security if, as a result, (i) more than 10% of the Fund's
total assets would be invested in the securities of other investment
companies, (ii) the Fund would hold more than 3% of the total
outstanding voting securities of any one investment company, or (iii)
more than 5% of the Fund's total assets would be invested in the
securities of any one investment company. These limitations do not
apply to (a) the investment of cash collateral, received by the Fund in
connection with lending of the Fund's portfolio securities, in the
securities of open-end investment companies or (b) the purchase of
shares of any investment company in connection with a merger,
consolidation, reorganization or purchase of substantially all of the
assets of another investment company. Subject to the above percentage
limitations, the fund may, in connection with the John Hancock Deferred
Compensation Plan for Independent Trustees/Directors (a means for the
Fund's trustee to deferred receipt of their fees as trustee), purchase
securities of other investment companies within the group of open-end
and closed-end investment companies for which the Adviser acts as
investment adviser (the "John Hancock Fund Complex").
2. Invest more than 20% of its net assets in securities that are illiquid.
If a percentage restriction on investment or utilization of assets as
set forth above is adhered to at the time an investment is made, a later change
in percentage resulting from changes in the value of the Fund's assets will not
be considered a violation of the restriction.
The Fund intends to apply for ratings for its preferred shares from a
nationally recognized statistical rating organization ("NRSRO"). In order to
obtain and maintain the required ratings, the Fund may be required to comply
with investment quality, diversification and other guidelines established by the
NRSRO. Such guidelines will likely be more restrictive than the restrictions set
forth above. The Fund may also be subject to certain restrictions and guidelines
imposed by lenders if the Fund engages in borrowings. The Fund does not
anticipate that such guidelines would have a material adverse effect on its
common shareholders or the Fund's ability to achieve its investment objectives.
The Fund will invest only in countries on the Adviser's Approved
Country Listing. The Approved Country Listing is a list maintained by the
Adviser's investment department that outlines all countries, including the
United States, that have been approved for investment by Funds managed by the
Adviser.
If allowed by the Fund's other investment policies and restrictions,
the Fund may invest up to 5% of its total assets in Russian equity securities
and up to 10% of its total assets in Russian fixed income securities. All
Russian securities must be: (1) denominated in U.S. dollars; (2) traded on a
major exchange; and (3) held physically outside of Russia.
THOSE RESPONSIBLE FOR MANAGEMENT
The business of the Fund is managed by its Trustees, who elect officers
who are responsible for the day-to-day operations of the Fund and who execute
policies formulated by the Trustees. Several of the officers and Trustees of the
Fund are also officers or Directors of the Adviser, or officers and Directors of
the Fund's principal distributor, John Hancock Funds, LLC (prior to February 1,
2002, John Hancock Funds, Inc.) ("John Hancock Funds").
16
John Hancock Fund Complex means the open-end and closed-end investment
companies for which the Adviser acts as investment adviser.
----------------------- ------------- ---------- ------------------------------------- ------------ ----------------
Number of
Funds in
the John
Name, Address (1) Position(s) Trustee/Of Principal Occupation(s) During Past Hancock Other
And Age Held with Since(2) 5 Years Fund Directorships
Fund Complex
Overseen
by Trustee
----------------------- ------------- ---------- ------------------------------------- ------------ ----------------
Interested Trustees
----------------------- ------------- ---------- ------------------------------------- ------------ ----------------
John M. DeCiccio (3) Trustee 2002 Executive Vice President and Chief 60 None
(Age 54) Investment Officer, John Hancock
Financial Services, Inc.;
Director, Executive Vice
President and Chief Investment
Officer, John Hancock Life
Insurance Company; Chairman of
the Committee of Finance of
John Hancock Life Insurance
Company; Director, John Hancock
Subsidiaries, LLC, Hancock
Natural Resource Group, Inc.,
Independence Investment LLC,
Independence Fixed Income LLC,
John Hancock Advisers, LLC (the
"Adviser") and The Berkeley
Financial Group, LLC ("The
Berkeley Group"), John Hancock
Funds, LLC ("John Hancock
Funds"), Massachusetts Business
Development Corporation;
Director, John Hancock
Insurance Agency, Inc.
("Insurance Agency, Inc.)
(until 1999) and John Hancock
Signature Services, Inc.
("Signature Services") (until
1997).
----------------------- ------------- ---------- ------------------------------------- ------------ ----------------
Maureen R. Ford (3) Trustee, 2002 Executive Vice President, John 60 None
(Age 47) Chairman, Hancock Financial Services, Inc.,
President John Hancock Life Insurance
and Chief Company; Chairman, Director,
Executive President and Chief Executive
Officer Officer, the Adviser and The
Berkeley Group; Chairman,
Director and Chief Executive
Officer, John Hancock Funds,
Chairman, Director and
President, Insurance Agency,
Inc; Chairman, Director and
Chief Executive Officer,
Sovereign Asset Management
Corporation ("SAMCorp.");
Director, Independence
Investment LLC, Independence
Fixed Income LLC and Signature
Services; Senior Vice
President, MassMutual Insurance
Co. (until 1999).
----------------------- ------------- ---------- ------------------------------------- ------------ ----------------
Independent Trustees
----------------------- ------------- ---------- ------------------------------------- ------------ ----------------
James F. Carlin Trustee 2002 Chairman and CEO, Alpha Analytical 29 Massachusetts
(Age 62) Laboratories (chemical analysis); Health and
Part Owner and Treasurer, Lawrence Education Tax
Carlin Insurance Agency, Inc. Exempt Trust;
(since 1995); Part owner and Vice Uno Restaurant
President, Mone Lawrence Carlin Corp. (until
Insurance Agency, Inc. (since 2001), Arbella
1996); Director/Treasurer, Rizzo Mutual
Associates (until 2000); Chairman (insurance)
and CEO, Carlin Consolidated, Inc. (until 2000),
(management/investments); HealthPlan
Director/Partner, Proctor Carlin & Services, Inc.
Co., Inc. (until 1999). (until 1999),
Flagship
Healthcare,
Inc. (until
1999), Carlin
Insurance
Agency, Inc.
(until 1999),
Chairman,
Massachusetts
Board of
Higher
Education
(until 1999).
----------------------- ------------- ---------- ------------------------------------- ------------ ----------------
17
----------------------- ------------- ---------- ------------------------------------- ------------ ----------------
William H. Cunningham Trustee 2002 Former Chancellor, University of 29 Hire.com
(Age 58) Texas System and former President (since 2000),
of the University of Texas, Austin, STC
Texas; Chairman, IBT Technologies; Broadcasting,
Director of the following: The Inc. and
University of Texas Investment Sunrise
Management Company (until 2000). Television
Corp. (since
2000), Symtx,
Inc. (since
2001),
Adorno/Rogers
Technology,
Inc. (since
2001),
Pinnacle Foods
Corporation
(since 2000),
rateGenius
(since 2000),
Southwest
Airlines and
Introgen;
Advisory
Director, Q
Investments;
Advisory
Director,
Chase Bank
(formerly
Texas Commerce
Bank - Austin).
----------------------- ------------- ---------- ------------------------------------- ------------ ----------------
Ronald R. Dion Trustee 2002 Chairman and Chief Executive 29 The New
(Age 56) Officer, R.M. Bradley & Co., Inc. England
Council and
Massachusetts
Roundtable;
North Shore
Medical
Center; BJ's
Wholesale
Club, Inc. and
a corporator
of the Eastern
Bank; Emmanuel
College.
----------------------- ------------- ---------- ------------------------------------- ------------ ----------------
18
----------------------- ------------- ---------- ------------------------------------- ------------ ----------------
Charles L. Ladner Trustee 2002 Chairman and Trustee, Dunwoody 29 Parks and
(Age 64) Village, Inc. (continuing care History
retirement community); Senior Vice Association
President and Chief Financial (since 2001).
Officer, UGI Corporation (Public
Utility Holding Company) (retired
1998); Vice President and Director
for AmeriGas, Inc. (retired 1998).
Director of AmeriGas Partners, L.P.
(until 1997) (gas distribution).
----------------------- ------------- ---------- ------------------------------------- ------------ ----------------
John A. Moore Trustee 2002 President and Chief Executive 38 CIIT
(Age 63) Officer, Institute for Evaluating (nonprofit
Health Risks, (nonprofit research)
institution) (until 2001); Senior (since 2002).
Scientist, Sciences
International (health
research)(since 1998);
Principal, Hollyhouse
(consulting)(since 2000).
----------------------- ------------- ---------- ------------------------------------- ------------ ----------------
Patti McGill Peterson Trustee 2002 Executive Director, Council for 38 Niagara Mohawk
(Age 59) International Exchange of Scholars Power
(since 1998); Vice President, Corporation
Institute of International (electric
Education (since 1998); Senior utility).
Fellow, Cornell Institute of Public
Affairs, Cornell University (until
1997); President Emerita of Wells
College and St. Lawrence
University.
----------------------- ------------- ---------- ------------------------------------- ------------ ----------------
Steven R. Pruchansky Trustee 2002 Chairman and Chief Executive 29 None
(Age 58) Officer, Mast Holdings, Inc. (since
2000); Director and President, Mast
Holdings, Inc. (until 2000);
Managing Director, JonJames, LLC
(real estate)(since 2001).
----------------------- ------------- ---------- ------------------------------------- ------------ ----------------
Norman H. Smith Trustee 2002 Lieutenant General, United States 29 None
(Age 69) Marine Corps; Deputy Chief of Staff
for Manpower and Reserve Affairs,
Headquarters Marine Corps;
Commanding General III Marine
Expeditionary Force/3rd Marine
Division (retired 1991).
----------------------- ------------- ---------- ------------------------------------- ------------ ----------------
19
----------------------- ------------- ---------- ------------------------------------- ------------ ----------------
John P. Toolan Trustee 2002 Chairman, Smith Barney Trust 29 The Smith
(Age 72) Company (retired 1991); Director, Barney Muni
Smith Barney, Inc., Mutual Bond Funds,
Management Company and Smith Barney The Smith
Advisers, Inc. (investment Barney
advisers) (retired 1991); Senior Tax-Free Money
Executive Vice President, Director Funds, Inc.,
and member of the Executive Vantage Money
Committee, Smith Barney, Harris Market Funds
Upham & Co., Incorporated (mutual
(investment bankers) (until 1991). funds), The
Inefficient-Market
Fund, Inc.
(closed-end
investment
company) and
Smith Barney
Trust Company
of Florida.
----------------------- ------------- ---------- ------------------------------------- ------------ ----------------
The following persons are the officers of the Fund who are not also members of
the Board of Trustees.
----------------------- ------------- ---------- ------------------------------------- ------------ ----------------
Number of
Funds in
the John
Name, Address (1) Position(s) Trustee/Of Principal Occupation(s) During Past Hancock Other
And Age Held with Since(2) 5 Years Fund Directorships
Fund Complex
Overseen
by Trustee
----------------------- ------------- ---------- ------------------------------------- --------------- ---------------
----------------------- ------------- ---------- ------------------------------------- --------------- ---------------
Principal Officers
who are not Trustees
----------------------- ------------- ---------- ------------------------------------- --------------- ---------------
William L. Braman Executive 2002 Executive Vice President and Chief N/A
(Age 48) Vice Investment Officer, the Adviser and
President the John Hancock Fund Complex;
and Chief Director, SAMCorp., Executive Vice
Investment President and Chief Investment
Officer Officer, Baring Asset Management,
London U.K. (until 2000).
----------------------- ------------- ---------- ------------------------------------- --------------- ---------------
Richard A. Brown Senior Vice 2002 Senior Vice President, Chief N/A
(Age 53) President Financial Officer and Treasurer,
and Chief the Adviser, the John Hancock Fund
Financial Complex, and The Berkeley Group;
Officer Second Vice President and Senior
Associate Controller, Corporate Tax
Department, John Hancock Financial
Services, Inc. (until 2001).
----------------------- ------------- ---------- ------------------------------------- --------------- ---------------
Thomas H. Connors Vice 2002 Vice President and Compliance N/A
(Age 43) President Officer, the Adviser and the John
and Hancock Fund Complex; Vice
Compliance President, John Hancock Funds.
Officer
----------------------- ------------- ---------- ------------------------------------- --------------- ----------------
William H. King Vice 2002 Vice President and Assistant N/A
(Age 50) President Treasurer, the Adviser; Vice
and President and Treasurer of John
Treasurer Hancock Fund Complex; Assistant
Treasurer of each of the John
Hancock Fund Complex (until
2001).
----------------------- ------------- ---------- ------------------------------------- --------------- ----------------
Susan S. Newton Senior Vice 2002 Senior Vice President, Secretary N/A
(Age 52) President, and Chief Legal Officer, SAMCorp.,
Secretary the Adviser and the John Hancock
and Chief Fund Complex, John Hancock Funds
Legal and The Berkeley Group; Vice
Officer President, Signature Services
(until 2000), Director, Senior Vice
President and Secretary, NM Capital.
----------------------- ------------- ---------- ------------------------------------- --------------- ----------------
(1) Business address for independent and interested Trustees and officers is
101 Huntington Avenue, Boston, Massachusetts 02199.
(2) Each Trustee serves until resignation, retirement age or until her or his
successor is elected.
(3) Interested Trustee: holds positions with the Fund's investment adviser,
underwriter, and/or certain other affiliates.
20
The Fund's Board of Trustees currently has five standing Committees:
the Audit Committee, the Administration Committee, the Contracts/Operations
Committee, the Investment Performance Committee and the Coordinating Committee.
Each Committee is comprised of Independent Trustees who are not "interested
persons".
The Audit Committee members are Messrs. Carlin (Chairman), Ladner,
Moore and Toolan. All of the members of the Audit Committee are independent
under the New York Stock Exchange's Revised Listing Rules, and each member is
financially literate with at least one having accounting or financial management
expertise. The Board has adopted a written charter for the Audit Committee. The
Audit Committee recommends to the full board auditors for the Fund, monitors and
oversees the audits of the Fund, communicates with both independent auditors and
internal auditors on a regular basis and provides a forum for the auditors to
report and discuss any matters they deem appropriate at any time.
The Administration Committee's members are Messrs. Smith (Chairman),
Carlin, Cunningham, Dion, Ladner, Moore, Pruchansky, Toolan and Madame Peterson.
The Administration Committee reviews the activities of the other four standing
committees and makes the final selection and nomination of candidates to serve
as Independent Trustees. The Administration Committee will consider nominees
recommended by shareholders to serve as Independent Trustees, provided that
shareholders submit recommendations in compliance with all of the pertinent
provisions of Rule 14a-8 under the Securities Exchange Act of 1934. The
Administration Committee also works with all Trustees on the selection and
election of officers of the Fund.
The Contracts/Operations Committee members are Messrs. Cunningham
(Chairman) and Pruchansky. The Contracts/Operations Committee oversees the
initiation, operation, and renewal of contracts between the Fund and other
entities. These contracts include advisory and subadvisory agreements, custodial
and transfer agency agreements and arrangements with other service providers.
The Investment Performance Committee members are Messrs. Dion
(Chairman), Smith and Madame Peterson. The Investment Performance Committee
monitors and analyzes the performance of the Fund generally, consults with the
adviser as necessary if the Fund requires special attention, and reviews peer
groups and other comparative standards as necessary.
The Coordinating Committee members are the chairpersons of the other
four standing committees. The Coordinating Committee assures consistency of
action among committees, reviews Trustee compensation, evaluates Trustee
performance and considers committee membership rotations as well as relevant
corporate governance issues.
The following table provides a dollar range indicating each Trustee's
ownership of equity securities of the Fund, as well as aggregate holdings of
shares of equity securities of all funds in the John Hancock Fund Complex
overseen by the Trustee, as of December 31, 2001.
21
--------------------------------------------------------------------------------
Aggregate Dollar Range of
Dollar Range of Holdings in funds in John
Fund Shares Hancock Fund Complex
Name of Trustee Owned by Trustee Overseen by Trustee (1)
--------------------------------------------------------------------------------
Independent Trustees
--------------------------------------------------------------------------------
James F. Carlin None $10,001-$50,000
--------------------------------------------------------------------------------
William H. Cunningham None $10,001-$50,000
--------------------------------------------------------------------------------
Ronald R. Dion None Over $100,000
--------------------------------------------------------------------------------
Charles L. Ladner None Over $100,000
--------------------------------------------------------------------------------
John A. Moore None Over $100,000
--------------------------------------------------------------------------------
Patti McGill Peterson None Over $100,000
--------------------------------------------------------------------------------
Steven R. Pruchansky None Over $100,000
--------------------------------------------------------------------------------
Norman H. Smith None Over $100,000
--------------------------------------------------------------------------------
John P. Toolan None Over $100,000
--------------------------------------------------------------------------------
Interested Trustees
--------------------------------------------------------------------------------
John M. DeCiccio None Over $100,000
--------------------------------------------------------------------------------
Maureen R. Ford None Over $100,000
--------------------------------------------------------------------------------
(1) Under the John Hancock Deferred Compensation Plan for Independent
Trustees, an Independent Trustee may elect to earn a return on his or
her deferred fees equal to the amount that he or she would have earned
if the deferred fees amount were invested in one or more funds in the
John Hancock Fund Complex. Under these circumstances, a Trustee is not
the legal owner of the underlying shares, but participates in any
positive or negative return on those shares to the same extent as other
shareholders. If the Trustees were deemed to own the shares used in
computing the value of his deferred compensation, as of December 31,
2001, the respective "Dollar Range of Fund Shares Owned by Trustee" and
the "Aggregate Dollar Range of Holdings in Funds in the John Hancock
Fund Complex Overseen by Trustee" would be none and over $100,000 for
Mr. Cunningham, none and over $100,000 for Mr. Dion, none and
$10,000-$50,000 for Mr. Pruchansky, none and $50,000-$100,000 for Mr.
Smith, none and over $100,000 for Mr. Toolan.
The following table provides information regarding the compensation
paid by the Fund and the other investment companies in the John Hancock Fund
Complex to the Independent Trustees for their services. Ms. Ford and John M.
DeCiccio, interested Trustees, and each of the officers of the Fund who are
interested persons of the Adviser, and/or affiliates are compensated by the
Adviser and receive no compensation from the Fund for their services.
Aggregate Total Compensation from all
Compensation Funds in John Hancock Fund
Trustees From the Fund(1) Complex to Trustees(2)
-------- ---------------- ----------------------
James F. Carlin $50 $75,000
William H. Cunningham* $50 $72,100
Ronald R. Dion* $50 $75,000
Charles L. Ladner $50 $75,100
John A. Moore $50 $75,100
Patti McGill Peterson $50 $72,000
Steven R. Pruchansky* $50 $72,000
Norman H. Smith* $50 $78,000
John P. Toolan* $50 $72,000
--------------------------------------------------------------------------------
Total $450 $666,300
22
(1) Since the Fund is newly organized, this figure is estimated for the
calendar year ending December 31, 2002.
(2) Total compensation paid by the John Hancock Fund Complex to the
Independent Trustees is for the calendar year ended December 31, 2001.
As of that date, there were sixty-six funds in the John Hancock Fund
Complex, with each of these Independent Trustees serving on thirty-six
funds.
(*) As of December 31, 2001 the value of the aggregate accrued deferred
compensation from all Funds in the John Hancock Fund Complex for Mr.
Cunningham was $540,844, for Mr. Dion was $112,044, for Mr. Moore was
$238,982, for Mr. Pruchansky was $117,545, for Mr. Smith was $202,737
and for Mr. Toolan was $621,800 under the John Hancock Deferred
Compensation Plan for Independent Trustees (the "Plan").
All of the officers listed are officers or employees of the Adviser or
affiliated companies. Some of the Trustees and officers may also be officers
and/or Directors and/or Trustees of one or more other funds for which the
Adviser serves as investment adviser.
As of August 30, 2002 officers and Trustees of the Fund as a group
owned less than 1% of the outstanding shares of the Fund. To the knowledge of
the Fund, no persons owned of record or beneficially 5% or more of any class of
the Fund's outstanding shares of the Fund.
INVESTMENT ADVISORY AND OTHER SERVICES
The Adviser, located at 101 Huntington Avenue, Boston, Massachusetts
02199-7603, was organized in 1968 and has approximately $26 billion in assets
under management as of June 30, 2002 in its capacity as investment adviser to
the Fund and other funds in the John Hancock Fund Complex as well as retail and
institutional privately managed accounts. The Adviser is an affiliate of the
Life Company, one of the most recognized and respected financial institutions in
the nation. With total assets under management of approximately $124 billion as
of June 30, 2002, the Life Company is one of the ten largest life insurance
companies in the United States, and carries a high rating with S&P and A. M.
Best. Founded in 1862, the Life Company has been serving clients for over 130
years.
The Fund has entered into an investment management contract (the
"Advisory Agreement") with the Adviser, which was approved by the Fund's sole
shareholder. Pursuant to the Advisory Agreement, the Adviser will: (a) furnish
continuously an investment program for the Fund and determine, subject to the
overall supervision and review of the Trustees, which investments should be
purchased, held, sold or exchanged, and (b) provide supervision over all aspects
of the Fund's operations except those which are delegated to a custodian,
transfer agent or other agent.
The Fund bears all costs of its organization and operation, including
but not limited to expenses of preparing, printing and mailing all shareholders'
reports, notices, prospectuses, proxy statements and reports to regulatory
agencies; expenses relating to the issuance, registration and qualification of
shares; government fees; interest charges; expenses of furnishing to
shareholders their account statements; taxes; expenses of redeeming shares;
brokerage and other expenses connected with the execution of portfolio
securities transactions; expenses pursuant to the Fund's plan of distribution;
fees and expenses of custodians including those for keeping books and accounts,
maintaining a committed line of credit, and calculating the net asset value of
shares; fees and expenses of transfer agents and dividend disbursing agents;
legal, accounting, financial, management, tax and auditing fees and expenses of
the Fund (including an allocable portion of the cost of the Adviser's employees
rendering such services to the Fund); the compensation and expenses of Trustees
who are not otherwise affiliated with the Fund, the Adviser or any of their
affiliates; expenses of Trustees' and shareholders' meetings; trade association
memberships; insurance premiums; and any extraordinary expenses.
For its advisory and administrative services, the Fund will accrue and
pay to the Adviser daily, as compensation for the services rendered and expenses
paid by it, a fee on an annual basis equal to 0.75% of the Fund's average daily
managed assets. Because the fee paid to the Adviser is determined on the basis
of the Fund's managed assets, the Adviser's interest in determining whether to
leverage the Fund may differ from the interests of the Fund. "Managed assets"
means the total assets of the Fund (including any assets attributable to any
leverage that may be outstanding) minus the sum of accrued liabilities (other
than liabilities representing financial leverage). The liquidation preference of
any preferred shares is no a liability.
23
The Adviser has contractually agreed to waive a portion of its advisory
fee. The Adviser has agreed that, until the fifth anniversary of investment
advisory agreement, the Adviser will limit its advisory fee to 0.55% of average
daily managed assets, in the sixth year to 0.60% of average daily managed
assets, in the seventh year to 0.65% of average daily managed assets, and in the
eighth year to 0.70% of average daily managed assets. After the eighth year the
Adviser will no longer waive a portion of its advisory fee.
From time to time, the Adviser may reduce its fee or make other
arrangements to limit the Fund's expenses to a specified percentage of its
average daily net assets. The Adviser retains the right to reimpose a fee and
recover any other payments to the extent that, at the end of any fiscal year,
the Fund's annual expenses fall below this limit.
Securities held by the Fund may also be held by other funds or
investment advisory clients for which the Adviser or its affiliates provide
investment advice. Because of different investment objectives or other factors,
a particular security may be bought for one or more funds or clients when one or
more other funds or clients are selling the same security. If opportunities for
purchase or sale of securities by the Adviser for the Fund or for other funds or
clients for which the Adviser renders investment advice arise for consideration
at or about the same time, transactions in such securities will be made, insofar
as feasible, for the respective funds or clients in a manner deemed equitable to
all of them. To the extent that transactions on behalf of more than one client
of the Adviser or its affiliates may increase the demand for securities being
purchased or the supply of securities being sold, there may be an adverse effect
on price.
Pursuant to its Advisory Agreement, the Adviser is not 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 a
loss resulting from willful misfeasance, bad faith or gross negligence on the
part of the Adviser in the performance of its duties or from reckless disregard
by the Adviser of its obligations and duties under the Advisory Agreement.
Under the Advisory Agreement, the Fund may use the name "John Hancock"
or any name derived from or similar to it only for so long as the Advisory
Agreement or any extension, renewal or amendment thereof remains in effect. If
the Advisory Agreement is no longer in effect, the Fund (to the extent that it
lawfully can) will cease to use such a name or any other name indicating that it
is advised by or otherwise connected with the Adviser. In addition, the Adviser
or the Life Company may grant the nonexclusive right to use the name "John
Hancock" or any similar name to any other corporation or entity, including but
not limited to any investment company of which the Life Company or any
subsidiary or affiliate thereof or any successor to the business of any
subsidiary or affiliate thereof shall be the investment adviser.
The Board is responsible for overseeing the performance of the Adviser
and determining whether to approve and renew the Advisory Agreement. Prior to
the July 17, 2002 meeting, the Board requested and received from the Adviser
certain information the Board deemed important in evaluating the Adviser's
qualifications and the reasonableness of the proposed fee. The Board also met
with the proposed portfolio management team for the Fund. In addition, the Board
drew upon its experience in acting as trustees for other investment companies.
The primary factors that the Board considered to be favorable in approving the
Advisory Agreement were:
o The Adviser's experience in managing other investment companies,
including investment companies that invest in preferred securities
and employ a leverage structure (the "Comparable Funds"). In
considering this factor, the Board considered the experience of
the portfolio management team in managing portfolios of preferred
securities. The members of the Board also considered their
experience, as trustees of the Comparable Funds, with the quality
of the compliance and administrative staff of the Adviser.
o The investment performance of the Comparable Fund, both in
absolute terms and relative to their performance benchmarks.
During the one, three and five year periods ended June 30,
2002, the average annual return of Patriot Select Dividend
Fund was (4.00)%, 2.99% and 5.61% respectively, the average
annual return of Patriot Preferred Dividend Fund was 0.80%,
4.79% and 5.87% respectively, and the average annual return of
Patriot Premium Dividend Fund I was (4.57)%, 2.51% and 6.11%
respectively. During the same one, three and five year period,
the average annual return of the Standard & Poor's 500 was
(20.47)%, (12.88)% and (1.62)% and the average annual return
of the Dow Jones Utilities Average was (25.58)%, (6.93)% and
1.69%.
24
o The reasonableness of the proposed fee. In making that
determination, the Board took into consideration the fees charged
by similar funds managed by other investment advisers and the fees
charged by the Adviser for managing the Comparable Funds. The fee
payable by the Fund is lower than the fee charged to the
Comparable Funds and lower than another closed-end fund focusing
on preferred securities that had recently completed the public
offering of its common shares, before giving effect to fee
waivers.
o The Adviser's commitment to waive a portion of its advisory fee
for a period of eight years. The Adviser has agreed that, until
the fifth anniversary of investment advisory agreement, the
Adviser will limit its advisory fee to 0.55% of average daily
managed assets, in the sixth year to 0.60% of average daily
managed assets, in the seventh year to 0.65% of average daily
managed assets, and in the eighth year to 0.70% of average daily
managed assets. After the eighth year the Adviser will no longer
waive a portion of its advisory fee.
The Advisory Agreement was approved by all Trustees who were serving as
Trustees on July 27, 2002. The Board was subsequently increased from 3 members
to 11 members. The Advisory Agreement will continue in effect from year to year,
provided that its continuance is approved annually after its initial two year
term both (i) by the holders of a majority of the outstanding voting securities
of the Fund or by the Trustees, and (ii) by a majority of the Trustees who are
not parties to the Agreement or "interested persons" of any such parties. The
Advisory Agreement may be terminated on 60 days written notice by any party or
by vote of a majority of the outstanding voting securities of the Fund and will
terminate automatically if assigned.
Accounting and Legal Services Agreement. The Fund is a party to an
Accounting and Legal Services Agreement with the Adviser. Pursuant to this
agreement, the Adviser provides the Fund with certain tax, accounting and legal
services.
Shareholder Servicing Agent. The Adviser has retained UBS Warburg LLC
to act as shareholder servicing agent for the Fund. Pursuant to the Shareholder
Servicing Agreement, UBS Warburg LLC will: (i) undertake to make public
information pertaining to the Fund on an ongoing basis and to communicate to
investors and prospective investors the Fund's features and benefits (including
periodic seminars or conference calls, responses to questions from current or
prospective shareholders and specific shareholder contact where appropriate);
(ii) make available to investors and prospective investors market price, net
asset value, yield and other information regarding the Fund, if reasonably
obtainable, for the purpose of maintaining the visibility of the Fund in the
investor community; (iii) at the request of the Adviser, provide certain
economic research and statistical information and reports, if reasonably
obtainable, on behalf of the Fund, and consult with representatives and Trustees
of the Fund in connection therewith, which information and reports shall
include: (a) statistical and financial market information with respect to the
Fund's market performance and (b) comparative information regarding the Fund and
other closed-end management investment companies with respect to (1) the net
asset value of their respective share, (2) the respective market performance of
the Fund and such other companies, (3) other relevant performance indicators;
and (iv) at the request of the Adviser, provide information to and consult with
the Board with respect to applicable modifications to dividend policies or
capital structure, repositioning or restructuring of the Fund, conversion of the
Fund to an open-end investment company, or a Fund liquidation or merger;
provided, however, that under the terms of the Shareholder Servicing Agreement,
UBS Warburg LLC is not obligated to render any opinions, valuations or
recommendations of any kind or to perform any such similar services. Under the
terms of the Shareholder Servicing Agreement, UBS Warburg LLC is relieved from
liability to the Adviser for any act or omission in the course of its
performances under the Shareholder Servicing Agreement in the absence of gross
negligence or willful misconduct. In consideration of these services, the
Adviser will pay UBS Warburg LLC a fee equal on an annual basis to 0.10% of the
Fund's average daily-managed assets. This fee will be an expense of the Adviser
and not the Fund. The Shareholder Services Agreement has an initial term of two
years and is renewable thereafter with the consent of both parties.
Code of Ethics. Personnel of the Adviser and its affiliates may trade
securities for their personal accounts. The Fund also may hold, or may be buying
or selling, the same securities. To prevent the Fund from being disadvantaged,
the adviser(s), principal underwriter and the Fund have adopted a code of
ethics, which restricts the trading activity of those personnel.
25
ADDITIONAL INFORMATION CONCERNING THE AUCTIONS FOR THE PREFERRED SHARES
General. Depository Trust Company ("DTC") will act as the securities
depository with respect to the Preferred Shares. One certificate for all of the
Preferred Shares of any series will be registered in the name of Cede & Co., as
nominee of the securities depository. Such certificate will bear a legend to the
effect that such certificate is issued subject to the provisions restricting
transfers of the Preferred Shares contained in the By-Laws. Prior to the
commencement of the right of holders of the Preferred Shares to elect a majority
of the Trustees, as described under "Description of Preferred Shares -- Voting
Rights" in the prospectus, Cede & Co. will be the holder of record of the
Preferred Shares and owners of such shares will not be entitled to receive
certificates representing their ownership interest in such 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 in the Preferred Shares,
whether for its own account or as a nominee for another person.
Concerning The Auction Agent. Deutsche Bank Trust Company Americas (the
"Auction Agent") will act as agent for the Fund in connection with the auctions
of the Preferred Shares (the "Auctions"). In the absence of willful misconduct
or gross 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 between the
trust and the Auction Agent and will not be liable for any error of judgment
made in good faith unless the Auction Agent was grossly negligent in
ascertaining the pertinent facts.
The Auction Agent may conclusively rely upon, as evidence of the
identities of the holders of the Preferred Shares, the Auction Agent's registry
of holders, and 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 -- Secondary Market Trading and Transfers of Preferred
Shares" 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 its auction agency agreement with the
Fund 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 use its best efforts
to enter into an agreement with a successor auction agent containing
substantially the same terms and conditions as the auction agency agreement. The
Fund may remove the Auction Agent provided that prior to such removal the Fund
shall have entered into such an agreement with a successor auction agent.
Broker-Dealers. The Auction Agent after each Auction for Preferred
Shares will pay to each Broker-Dealer, from funds provided by the Fund, a
service charge at the annual rate of 0.25% in the case of any Auction
immediately preceding the dividend period of less than one year, or a percentage
agreed to by the Fund and the Broker-Dealer in the case of any auction
immediately preceding a dividend period of one year or longer, of the purchase
price of the Preferred Shares placed by such Broker-Dealer at such auction. For
the purposes of the preceding sentence, the Preferred Shares will be placed by a
Broker-Dealer if such shares were (a) the subject of hold orders deemed to have
been submitted to the Auction Agent by the Broker-Dealer and were acquired by
such Broker-Dealer for its customers who are beneficial owners or (b) the
subject of an order submitted by such Broker-Dealer that is (i) a submitted bid
of an existing holder that resulted in the existing holder continuing to hold
such shares as a result of the Auction or (ii) a submitted bid of a potential
bidder that resulted in the potential holder purchasing such shares as a result
of the Auction or (iii) a valid hold order.
The Fund may request the Auction Agent to terminate one or more
Broker-Dealer agreements at any time, provided that at least one Broker-Dealer
agreement is in effect after such termination.
The Broker-Dealer agreement provides that a Broker-Dealer (other than
an affiliate of the trust) 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.
26
RATING AGENCY GUIDELINES
The description of Moody's rating guidelines contained in this
Statement of Additional Information does not purport to be complete and is
subject to and qualified in its entirety by reference to the By-Laws. A copy of
the By-Laws is filed as an exhibit to the registration statement of which the
Prospectus and this Statement of Additional Information are a part and may be
inspected, and copies thereof may be obtained, as described in the prospectus.
The composition of the Fund's portfolio reflects guidelines (referred
to herein as the "Rating Agency Guidelines") established by Moody's in
connection with the Fund's receipt of a rating of "Aaa" from Moody's for the
Preferred Shares. These Rating Agency Guidelines relate, among other things, to
industry and credit quality characteristics of issuers and diversification
requirements and specify various discount factors for different types of
securities (with the level of discount greater as the rating of a security
becomes lower). Under the Rating Agency Guidelines, certain types of securities
in which the Fund may otherwise invest consistent with its investment strategy
are not eligible for inclusion in the calculation of the discounted value of the
Fund's portfolio. Such instruments include, for example, private placements
(other than Rule 144A Securities) and other securities not within the investment
guidelines. Accordingly, although the Fund reserves the right to invest in such
securities to the extent set forth herein, they have not and it is anticipated
that they will not constitute a significant portion of the Fund's portfolio.
The Rating Agency Guidelines require that the Fund maintain assets
having an aggregate discounted value, determined on the basis of the Rating
Agency Guidelines, greater than the aggregate liquidation preference of the
Preferred Shares plus specified liabilities, payment obligations and other
amounts, as of periodic valuation dates. The Rating Agency Guidelines also
require the Fund to maintain asset coverage for the Preferred Shares on a
non-discounted basis of at least 200% as of the end of each month, and the 1940
Act requires this asset coverage as a condition to paying dividends or other
distributions on the Fund's common shares. The Fund has agreed with Moody's that
the auditors must certify once per quarter the asset coverage test on a date
randomly selected by the auditor. The effect of compliance with the Rating
Agency Guidelines may be to cause the Fund to invest in higher quality assets
and/or to maintain relatively substantial balances of highly liquid assets or to
restrict the Fund's ability to make certain investments than would otherwise be
deemed potentially desirable by the Adviser, including private placements of
other than Rule 144A Securities. The Rating Agency Guidelines are subject to
change from time to time with the consent of Moody's and would not apply if the
Fund in the future elected not to use investment leverage consisting of senior
securities rated by one or more rating agencies, although other similar
arrangements might apply with respect to other senior securities that the Fund
may issue.
The Fund intends to maintain, at specified times, a discounted value
for its portfolio at least equal to the amount specified by Moody's (the
"Preferred Shares Basic Maintenance Amount"). Moody's has established Share
guidelines for determining discounted value. To the extent any particular
portfolio holding does not satisfy the Rating Agency's Guidelines, all or a
portion of such holding's value will not be included in the calculation of
discounted value (as defined by such rating agency).
The Rating Agency Guidelines do not impose any limitations on the
percentage of Fund's assets that may be invested in holdings not eligible for
inclusion in the calculation of the discounted value of the Fund's portfolio.
The amount of such assets included in the portfolio at any time may vary
depending upon the rating, diversification and other characteristics of the
assets included in the portfolio which are eligible for inclusion in the
discounted value of the portfolio under the Rating Agency Guidelines.
A credit rating of preferred stock does not address the likelihood that
a resale mechanism (e.g., the Auction) will be successful. As described by
Moody's, an issue of preferred stock which is rated `aaa' is considered to be
top-quality preferred stock with good asset protection and the least risk of
dividend impairment within the universe of preferred stocks. `aaa' ratings
denote the lowest expectation of credit risk and are assigned only in case of
exceptionally strong capacity for timely payment of financial commitments. This
capacity is highly unlikely to be adversely affected by foreseeable events.
Ratings are not recommendations to purchase, hold or sell Preferred
Shares, inasmuch as the rating does not comment as to market price or
suitability for a particular investor. The rating is based on current
information furnished to Moody's by the Fund and obtained by Moody's from other
sources. The rating may be changed, suspended or withdrawn as a result of
changes in, or unavailability of, such information.
27
For purposes of calculating the discounted value of the Fund's
portfolio under current Moody's guidelines, the fair market value of portfolio
securities eligible for consideration under such guidelines ("Moody's Eligible
Assets") must be discounted by certain discount factors set forth below
("Moody's Discount Factors"). The discounted value of a portfolio security under
Moody's guidelines is the market value thereof, determined as specified by
Moody's, divided by the Moody's Discount Factor. According to Moody's
guidelines, the portfolio coverage ratio of Moody's Eligible Assets to
liabilities should not be less than 130% in order to maintain the rating. The
Moody's Discount Factor with respect to securities other than those described
below will be the percentage provided in writing by Moody's.
Moody's Discount Factor. For the purposes of determining the Discounted
Value of any Moody's Eligible Asset, the percentage is determined as follows.
According to Moody's guidelines, in addition to standard weekly reporting, the
Fund must notify Moody's if the portfolio coverage ratio of the Discounted Value
of Moody's Eligible Assets to liabilities is less than 130%. Computation of
rating agency asset coverage ratio requires use of the Diversification Tables
prior to applying discount factors noted below and after identifying Moody's
Eligible Assets for purposes of completing basic maintenance tests. The Moody's
Discount Factor for any Moody's Eligible Asset other than the securities set
forth below will be the percentage provided in writing by Moody's.
Corporate debt securities. The percentage determined by reference to
the rating on such asset with reference to the remaining term to maturity of
such asset, in accordance with the table set forth below.
Moody's Rating Category(1)
--------------------------
Term to Maturity of Corporate
Debt Security Aaa Aa A Baa Ba Unrated(2)
------------- --- -- - --- -- ----------
1 year or less............................... 109% 112% 115% 118% 119% 225%
2 years or less (but longer than 1 year)..... 115 118 122 125 127 225
3 years or less (but longer than 2 years).... 120 123 127 131 133 225
4 years or less (but longer than 3 years).... 126 129 133 138 140 225
5 years or less (but longer than 4 years).... 132 135 139 144 146 225
7 years or less (but longer than 5 years).... 139 143 147 152 156 225
10 years or less (but longer than 7 years)... 145 150 155 160 164 225
15 years or less (but longer than 10 years).. 150 155 160 165 170 225
20 years or less (but longer than 15 years).. 150 155 160 165 170 225
30 years or less (but longer than 20 years).. 150 155 160 165 170 225
Greater than 30 years........................ 165 173 181 189 205 225
---------------------------------------------
(1) If a corporate debt security is unrated by Moody's but is rated by S&P,
a rating two numeric ratings below the S&P rating will be used (e.g.,
where the S&P rating is AAA, a Moody's rating of Aa2 will be used;
where the S&P rating is AA+, a Moody's rating of Aa3 will be used).
(2) Unrated corporate debt securities, which are corporate debt securities
rated below Ba by Moody's or rated by neither Moody's nor S&P, are
limited to 10% of discounted Moody's Eligible Assets. If a corporate
debt security is unrated by both Moody's and S&P, the Fund will use the
percentage set forth under "Unrated" in this table.
The Moody's Discount Factor presented in the immediately preceding
table will also apply to corporate debt securities that do not pay interest in
U.S. dollars or euros, provided that the Moody's Discount Factor determined from
the table shall be multiplied by a factor of 120% for purposes of calculating
the Discounted Value of such securities.
Preferred stock. The Moody's Discount Factor for preferred stock is (A)
for preferred stocks issued by a utility, 152%; (B) for preferred stocks of
industrial and financial issuers, 197%; (C) for preferred stocks issued by real
estate related issuers, 154%; and (D) for auction rate preferred stocks, 350%.
28
Short-term instruments and cash. The Moody's Discount Factor applied to
short-term portfolio securities, including without limitation corporate debt
securities, short term money market instruments and short-term municipal debt
obligations, is (A) 100%, so long as such portfolio securities mature or have a
demand feature at par exercisable within the Moody's Exposure Period; (B) 115%,
so long as such portfolio securities mature or have a demand feature at par not
exercisable within the Moody's Exposure Period; and (C) 125%, if such securities
are not rated by Moody's, so long as such portfolio securities are rated at
least A-1+/AA or SP-1+/AA by S&P and mature or have a demand feature at par
exercisable within the Moody's Exposure Period. A Moody's Discount Factor of
100% will be applied to cash. Moody's rated 2a-7 money market funds will also
have a discount factor of 100%.
U.S. Government Securities and U.S. Treasury Strips.
---------------------------------------------------
U.S. Government and Agency U.S. Treasury Strips
Remaining Term to Maturity Securities Discount Factor Discount Factor
-------------------------- -------------------------- ---------------
1 year or less......................................... 107% 107%
2 years or less (but longer than 1 year)............... 113 115
3 years or less (but longer than 2 years).............. 118 121
4 years or less (but longer than 3 years).............. 123 128
5 years or less (but longer than 4 years).............. 128 135
7 years or less (but longer than 5 years).............. 135 147
10 years or less (but longer than 7 years)............. 141 163
15 years or less (but longer than 10 years)............ 146 191
20 years or less (but longer than 15 years)............ 154 218
30 years or less (but longer than 20 years)............ 154 244
Rule 144A securities: The Moody's Discount Factor applied to Rule 144A
Securities for Rule 144A Securities, which lack registration rights, will be
130% of the Moody's Discount Factor which would apply were the securities
registered under the Securities Act.
Convertible securities:
----------------------
--------------------------------------------------------------------------------
Moody's Rating (1) Utility Industrial Financial Transportation
------------------ ------- ---------- --------- --------------
--------------------------------------------------------------------------------
Aaa 162% 256% 233% 332%
--------------------------------------------------------------------------------
Aa 167% 261% 238% 337%
--------------------------------------------------------------------------------
A 172% 266% 243% 342%
--------------------------------------------------------------------------------
Baa 188% 282% 259% 358%
--------------------------------------------------------------------------------
Ba 195% 290% 265% 365%
--------------------------------------------------------------------------------
B 199% 293% 270% 369%
--------------------------------------------------------------------------------
Unrated(2) 300% 300% 300% 300%
--------------------------------------------------------------------------------
(1) If a corporate debt security is unrated by Moody's but is rated by S&P,
a rating two numeric ratings below the S&P rating will be used (e.g.,
where the S&P rating is AAA, a Moody's rating of Aa2 will be used;
where the S&P rating is AA+, a Moody's rating of Aa3 will be used).
(3) Unrated corporate debt securities including corporate debt, convertible
bonds and common stocks, which are corporate debt securities rated
below Ba by Moody's or rated by neither Moody's nor S&P, are limited to
an aggregate of 10% of discounted Moody's Eligible Assets.
29
Common Stock*, the following Discount Factors will be applied to the
Common Stock holdings:
--------------------------------------------------------------------------------
Common Stocks Utility Industrial Financial
--------------------------------------------------------------------------------
241% 170% 264% 241%
--------------------------------------------------------------------------------
In all cases, if a security is not rated by Moody's but rated by S&P, a
rating two numeric ratings below the factual S&P rating should be used as an
equivalent Moody's rating (e.g., where the S&P rating is AAA, a Moody's rating
of Aa2 will be used; where the S&P rating is AA+, a Moody's rating of Aa3 will
be used).
Moody's Eligible Assets. Under current Moody's guidelines, the
following are considered to be Moody's Eligible Assets:
Cash. (including interest and dividends due on assets rated (A) Baa3 or
higher by Moody's if the payment date is within five Business Days of the
Valuation Date, (B) A2 or higher if the payment date is within thirty days of
the Valuation Date, and (C) A1 or higher if the payment date is within the
Moody's Exposure Period) and receivables for Moody's Eligible Assets sold if the
receivable is due within five Business Days of the Valuation Date, and if the
trades which generated such receivables are (A) settled through clearing house
firms with respect to which the Fund has received prior written authorization
from Moody's or (B) (1) with counterparties having a Moody's long-term debt
rating of at least Baa3 or (2) with counterparties having a Moody's short term
money market instrument rating of at least P-1.
Short term money market instruments, so long as (A) such securities are
rated at least P-1, (B) in the case of demand deposits, time deposits and
overnight funds, the supporting entity is rated at least A2, or (C) in all other
cases, the supporting entity (1) is rated A2 and the security matures within one
month, (2) is rated A1 and the security matures within three months or (3) is
rated at least Aa3 and the security matures within six months. In addition,
Moody's rated 2a-7 money market funds are also eligible investments.
U.S. Government Securities and U.S. Treasury Strips.
---------------------------------------------------
Rule 144A Securities.
--------------------
Corporate debt securities if (A) such securities are rated B3 or higher
by Moody's; (B) such securities provide for the periodic payment of interest in
cash in U.S. dollars or euros, except that such securities that do not pay
interest in U.S. dollars or euros shall be considered Moody's Eligible Assets if
they are rated by Moody's or S&P (C) for securities which provide for
conversion or exchange at the option of the issuer into equity capital at some
time over their lives, the issuer must be rated at least B3 by Moody's; (D) for
debt securities rated Ba1 and below, no more than 10% of the original amount of
such issue may constitute Moody's Eligible Assets; (E) such securities have been
registered under the Securities Act or are restricted as to resale under federal
securities laws but are eligible for resale pursuant to Rule 144A under the
Securities Act as determined by the Fund's investment adviser or portfolio
manager acting pursuant to procedures approved by the Board of Trustees, except
that such securities that are not subject to U.S. federal securities laws shall
be considered Moody's Eligible Assets if they are publicly traded; and (F) such
securities are not subject to extended settlement. In order to merit
consideration as Moody's Eligible Asset, debt securities are issued by entities
which:
- have not filed for bankruptcy within the past three years
- are current on all principle and interest in their fixed income obligations
- are current on all preferred stock dividends
- possess a current, unqualified auditor's report without qualified, explanatory
language
Convertible bonds and convertible preferred stocks, excluding synthetic
convertible securities shall be diversified as set forth in the table below:
----------------------------------------------------------------------------------------------
Type Maximum Single Issuer (%) Maximum Single Industry Maximum Single State (%)
---- -------------------------- ------------------------ -------------------------
(1) (%) (1) (1)
--- ------- ---
----------------------------------------------------------------------------------------------
Utility 4 50 7 (2)
----------------------------------------------------------------------------------------------
Other 6 20 n/a
----------------------------------------------------------------------------------------------
30
(1) Percentage represents a portion of the aggregate market value of the
portfolio.
(4) Utility companies operating in more than one state should be
diversified according to the state in which they generate the largest
part of their revenues. Publicly available information on utility
company revenues by state is available from the Uniform Statistical
Report (USR) or the Federal Energy Regulation Commission (FERC).
Preferred stocks if (A) dividends on such preferred stock are
cumulative, (B) such securities provide for the periodic payment of dividends
thereon in cash in U.S. dollars or euros, (C) the issuer of such a preferred
stock has common stock listed on either the NYSE, AMEX or NASDAQ, (D) the issuer
of such a preferred stock has a senior debt rating from Moody's of Baa3 or
higher or a preferred stock rating from Moody's of Baa3 or higher or S&P rating
of BBB+ or higher and (E) such preferred stock has paid consistent cash
dividends in U.S. dollars or euros over the last three years or has a minimum
Moody's rating of A1 or S&P rating of AA (if the issuer of such preferred stock
has other preferred issues outstanding that have been paying dividends
consistently for the last three years, then a preferred stock without such a
dividend history would also be eligible). (F) Investment in a single issue may
not be less than $500,000 or greater than 2.5% of the portfolio aggregate market
value. (G) The preferred stocks portfolio must be diversified as set forth in
the table below. (H) The preferred stock must be from an issue with a minimum
size of $50 million.
Common stocks if (A) the issuer of common stock have Moody's senior
unsecured debt rating of Baa3 or better, or an S&P rating of BBB+ or better, (B)
the common stocks are traded on the NYSE, AMEX or NASDAQ, (C) market
capitalization of the issuer is greater than $500 million, (D) the issuer has
paid consistent dividends for the past thirty six months or has not terminated
dividend payments within the last twelve months. Where there is less than three
years history, the company must have a minimum Moody's senior debt rating of A3
or S&P rating of A+. (E) Dividends must be paid in U.S. dollars or euros. (F)
The Fund shall not hold shares exceeding the average weekly trading volume
during the preceding month. (G) The portfolio of common holdings must be
diversified as set forth in the following table.
Diversification. In addition, portfolio holdings as described below
must be within the following diversification and issue size requirements in
order to be included in Moody's Eligible Assets. The table below establishes
maximum limits for inclusion of corporate bonds and preferred stocks except
convertibles and common stocks as eligible assets prior to applying Moody's
Discount Factors to eligible securities:
Maximum Single Maximum Single Minimum Issue Size ($
Ratings (1) Issuer (2),(3) Industry(3),(4) in millions) (5)
----------- -------------- --------------- ----------------
Aaa.................... 100% 100% $100
Aa..................... 20 60 100
A...................... 10 40 100
Baa, Com. St. ......... 6 20 100
Ba..................... 4 12 50(6)
B1-B2.................. 3 8 50(6)
B3..................... 2 5 50(6)
----------------------------------
(1) Refers to the preferred stock and senior debt rating of the portfolio
holding.
(3) Companies subject to common ownership of 25% or more are considered as
one issuer.
(4) Percentages represent a portion of the aggregate Market Value of the
portfolio.
(5) Industries are determined according to Moody's Industry
Classifications, as defined herein.
31
(6) Except for preferred stock, which has a minimum issue size of $50
million.
(7) Portfolio holdings from issues ranging from $50 million to $100 million
are limited to 20% of the Fund's total assets.
Financial contracts, as such term is defined in Section 3(c)(2)(B)(ii)
of the 1940 Act, not otherwise provided for in this definition but only upon
receipt by the Fund of a letter from Moody's specifying any conditions on
including such financial contract in Moody's Eligible Assets and assuring the
Fund that including such financial contract in the manner so specified would not
affect the credit rating assigned by Moody's to the Preferred Stocks.
Where the Fund sells an asset and agrees to repurchase such asset in
the future, the Discounted Value of such asset will constitute a Moody's
Eligible Asset and the amount the Fund is required to pay upon repurchase of
such asset will count as a liability for the purposes of the Preferred Stock's
Basic Maintenance Amount. Where the Fund purchases an asset and agrees to sell
it to a third party in the future, cash receivable by the Fund thereby will
constitute a Moody's Eligible Asset if the long-term debt of such other party is
rated at least A2 by Moody's and such agreement has a term of 30 days or less;
otherwise, the Discounted Value of such purchased asset will constitute a
Moody's Eligible Asset. For the purposes of calculation of Moody's Eligible
Assets, portfolio securities which have been called for redemption by the issuer
thereof shall be valued at the lower of Market Value or the call price of such
portfolio securities.
Notwithstanding the foregoing, an asset will not be considered a
Moody's Eligible Asset to the extent that it has been irrevocably deposited for
the payment of (i)(A) through (i)(E) under the definition of Preferred Shares
Basic Maintenance Amount or to the extent it is subject to any Liens, including
assets segregated under margin account requirements in connection with Fund
engagement in hedging transactions, except for (A) Liens which are being
contested in good faith by appropriate proceedings and which Moody's has
indicated to the Fund will not affect the status of such assets as a Moody's
Eligible Asset, (B) Liens for taxes that are not then due and payable or that
can be paid thereafter without penalty, (C) Liens to secure payment for services
rendered or cash advanced to the Fund by its investment manager or portfolio
manager, the Fund's custodian, transfer agent or registrar or the Auction Agent
and (D) Liens arising by virtue of any repurchase agreement.
The following are Moody's industry classifications for the purpose of
the foregoing diversified requirements:
Aerospace and Defense: Major Contractor, Subsystems, Research, Aircraft
Manufacturing, Arms, Ammunition
Automobile: Automobile Equipment, Auto-Manufacturing, Auto Parts Manufacturing,
Personal Use Trailers, Motor Homes, Dealers
Banking: Bank Holding, Savings and Loans, Consumer Credit, Small Loan, Agency,
Factoring, Receivables
Beverage, Food and Tobacco: Beer and Ale, Distillers, Wines and Liquors,
Distributors, Soft Drink Syrup, Bottlers, Bakery, Mill Sugar, Canned Foods, Corn
Refiners, Dairy Products, Meat Products, Poultry Products, Snacks, Packaged
Foods, Distributors, Candy, Gum, Seafood, Frozen Food, Cigarettes, Cigars,
Leaf/Snuff, Vegetable Oil
Buildings and Real Estate: Brick, Cement, Climate Controls, Contracting,
Engineering, Construction, Hardware, Forest Products (building-related only),
Plumbing, Roofing, Wallboard, Real Estate, Real Estate Development, REITs, Land
Development
Chemicals, Plastics and Rubber: Chemicals (non-agricultural), Industrial Gases,
Sulphur, Plastics, Plastic Products, Abrasives, Coatings, Paints, Varnish,
Fabricating, Containers
Packaging and Glass: Glass, Fiberglass, Containers made of: Glass, Metal, Paper,
Plastic, Wood or Fiberglass
Personal and Non-Durable Consumer Products (Manufacturing Only): Soaps,
Perfumes, Cosmetics, Toiletries, Cleaning Supplies, School Supplies
Diversified/Conglomerate Manufacturing
32
Diversified/Conglomerate Service
Diversified Natural Resources, Precious Metals and Minerals: Fabricating,
Distribution
Ecological: Pollution Control, Waste Removal, Waste Treatment and Waste Disposal
Electronics: Computer Hardware, Electric Equipment, Components, Controllers,
Motors, Household Appliances, Information Service Communication Systems, Radios,
TVs, Tape Machines, Speakers, Printers, Drivers, Technology
Finance: Investment Brokerage, Leasing, Syndication, Securities
Farming and Agriculture: Livestock, Grains, Produce, Agriculture Chemicals,
Agricultural Equipment, Fertilizers
Grocery: Grocery Stores, Convenience Food Stores
Healthcare, Education and Childcare: Ethical Drugs, Proprietary Drugs, Research,
Health Care Centers, Nursing Homes, HMOs, Hospitals, Hospital Supplies, Medical
Equipment
Home and Office Furnishings, Housewares, and Durable Consumer Products: Carpets,
Floor Coverings, Furniture, Cooking, Ranges
Hotels, Motels, Inns and Gaming
Insurance: Life, Property and Casualty, Broker, Agent, Surety
Leisure, Amusement, Motion Pictures, Entertainment: Boating, Bowling, Billiards,
Musical Instruments, Fishing, Photo Equipment, Records, Tapes, Sports, Outdoor
Equipment (Camping), Tourism, Resorts, Games, Toy Manufacturing, Motion Picture
Production Theaters, Motion Picture Distribution
Machinery (Non-Agricultural, Non-Construction, Non-Electronic): Industrial,
Machine Tools, Steam Generators
Mining, Steel, Iron and Non-Precious Metals: Coal, Copper, Lead, Uranium, Zinc,
Aluminum, Stainless Steel, Integrated Steel, Ore Production, Refractories, Steel
Mill Machinery, Mini-Mills, Fabricating, Distribution and Sales of the foregoing
Oil and Gas: Crude Producer, Retailer, Well Supply, Service and Drilling
Printing, Publishing, and Broadcasting: Graphic Arts, Paper, Paper Products,
Business Forms, Magazines, Books, Periodicals, Newspapers, Textbooks, Radio,
T.V., Cable Broadcasting Equipment
Cargo Transport: Rail, Shipping, Railroads, Rail-car Builders, Ship Builders,
Containers, Container Builders, Parts, Overnight Mail, Trucking, Truck
Manufacturing, Trailer Manufacturing, Air Cargo, Transport
Retail Stores: Apparel, Toy, Variety, Drugs, Department, Mail Order Catalog,
Showroom
Telecommunications: Local, Long Distance, Independent, Telephone, Telegraph,
Satellite, Equipment, Research, Cellular
Textiles and Leather: Producer, Synthetic Fiber, Apparel Manufacturer, Leather
Shoes
Personal Transportation: Air, Bus, Rail, Car Rental
Utilities: Electric, Water, Hydro Power, Gas
Diversified Sovereigns: Semi-sovereigns, Canadian Provinces, Supranational
Agencies
33
The Fund will use its discretion in determining which industry
classification is applicable to a particular investment in consultation with its
independent auditors and Moody's, to the extent the trust considers necessary.
Moody's Exposure Period means the period commencing on a given
Valuation Date and ending 42 days thereafter.
Hedging. The Fund may enter into, sell, purchase or exchange-traded
financial futures contracts based on any index approved by Moody's or Treasury
bonds, and purchase, write or sell, exchange-traded put options on such
financial futures contracts, any index approved by Moody's or Treasury bonds,
and purchase, exchange-traded call options on such financial futures contracts,
any index approved by Moody's or Treasury bonds, "Moody's Hedging Transactions"
subject to the following limitations:
o The Fund may not engage in any Moody's Hedging Transaction based on
any index approved by Moody's (other than closing transactions) that
would cause the Fund at the time of such transaction to own or have
sold: (A) outstanding financial futures contracts based on such index
exceeding in number 10% of the average number of daily traded financial
futures contracts based on such index in the 30 days preceding the time
of effecting such transaction as reported by The Wall Street Journal;
or (B) outstanding financial futures contracts based on any index
approved by Moody's having a market value exceeding 50% of the market
value of all portfolio securities of the trust constituting Moody's
Eligible Assets owned by the trust (other than Moody's Eligible Assets
already subject to a Moody's Hedging Transaction).
o The Fund may not engage in any Moody's Hedging Transaction based on
Treasury bonds (other than closing transactions) that would cause the
Fund at the time of such transaction to own or have sold: (A)
outstanding financial futures contracts based on Treasury bonds with
such contracts having an aggregate market value exceeding 20% of the
aggregate market value of Moody's Eligible Assets owned by the trust
and rated Aa by Moody's (or, if not rated by Moody's but rated by S&P,
rated AAA by S&P) or (B) outstanding financial futures contracts based
on Treasury bonds with such contracts having an aggregate market value
exceeding 80% of the aggregate market value of all portfolio securities
of the Fund constituting Moody's Eligible Assets owned by the trust
(other than Moody's Eligible Assets already subject to a Moody's
Hedging Transaction) and rated Baa or A by Moody's (or, if not rated by
Moody's but rated by S&P, rated A or AA by S&P).
o For purposes of the foregoing, the Fund is deemed to own the number
of financial futures contracts that underlie any outstanding options
written by the trust).
o The Fund may engage in closing transactions to close out any
outstanding financial futures contract based on any index approved by
Moody's if the amount of open interest in such index as reported by The
Wall Street Journal is less than an amount to be mutually determined by
Moody's and the trust.
o The Fund may engage in a closing transaction to close out any
outstanding financial futures contract by no later than the fifth
Business Day of the month in which such contract expires and will
engage in a Closing Transaction to close out any outstanding option on
a financial futures contract by no later than the first Business Day of
the month in which such option expires.
o The Fund may engage in Moody's Hedging Transactions only with respect
to financial futures contracts or options thereon having the next
settlement date or the settlement date immediately thereafter;
o The Fund (A) may not engage in options and futures transactions for
leveraging or speculative purposes, except that an option or futures
transaction shall not for these purposes be considered a leveraged
position or speculative so long as the combination of the trust's
non-derivative positions, together with the relevant option or futures
transaction, produces a synthetic investment position, or the same
economic result, that could be achieved by an investment, consistent
with the trust's investment objectives and policies, in a security that
is not an option or futures transaction, and (B) will not write any
call options or sell any financial futures contracts for the purpose of
hedging the anticipated purchase of an asset prior to completion of
such purchase.
34
o The Fund may not enter into an option or futures transaction unless,
after giving effect thereto, the Fund would continue to have Moody's
Eligible Assets with an aggregate Discounted Value equal to or greater
than the Preferred Shares Basic Maintenance Amount.
Other. Where the Fund sells an asset and agrees to repurchase such
asset in the future, the Discounted Value of such asset will constitute a
Moody's Eligible Asset and the amount the trust is required to pay upon
repurchase of such asset will count as a liability for the purposes of the
Preferred Shares Basic Maintenance Amount. Where the trust purchases an asset
and agrees to sell it to a third party in the future, cash receivable by the
trust thereby will constitute a Moody's Eligible Asset if the long-term debt of
such other party is rated at least A2 by Moody's and such agreement has a term
of 30 days or less; otherwise the Discounted Value of such purchased asset will
constitute a Moody's Eligible Asset. For the purposes of calculation of Moody's
Eligible Assets, portfolio securities which have been called for redemption by
the issuer thereof shall be valued at the lower of market value or the call
price of such portfolio securities.
Notwithstanding the foregoing, an asset will not be considered a Moody's
Eligible Asset to the extent that it has been irrevocably deposited for the
payment of (i)(A) through (i)(E) under the definition of Preferred Shares Basic
Maintenance Amount or it is subject to any liens, except for (A) liens which are
being contested in good faith by appropriate proceedings and which Moody's has
indicated to the trust will not affect the status of such asset as a Moody's
Eligible Asset, (B) liens for taxes that are not then due and payable or that
can be paid thereafter without penalty, (C) liens to secure payment for services
rendered or cash advanced to the trust by its investment manager or portfolio
manager, the trust's custodian, transfer agent or registrar or the Auction Agent
and (D) liens arising by virtue of any repurchase agreement.
NET ASSET VALUE
For purposes of calculating the net asset value ("NAV") of the Fund's
common shares, the following procedures are utilized wherever applicable.
Debt investment securities are valued on the basis of valuations
furnished by a principal market-maker or a pricing service, both of which
generally utilize electronic data processing techniques to determine valuations
for normal institutional size trading units of debt securities without exclusive
reliance upon quoted prices.
Equity securities traded on a principal exchange or NASDAQ National
Market Issues are generally valued at last sale price on the day of valuation.
Securities in the aforementioned category for which no sales are reported and
other securities traded over-the-counter are generally valued at the last
available bid price.
Short-term debt investments which have a remaining maturity of 60 days
or less are generally valued at amortized cost which approximates market value.
If market quotations are not readily available or if in the opinion of the
Adviser any quotation or price is not representative of true market value, the
fair value of the security may be determined in good faith in accordance with
procedures approved by the Board of Trustees.
Foreign securities are valued on the basis of quotations from the
primary market in which they are traded. Any assets or liabilities expressed in
terms of foreign currencies are translated into U.S. dollars by the custodian
bank based on London currency exchange quotations as of 5:00 p.m., London time
(12:00 noon, New York time) on the date of a determination of the Fund's NAV. If
quotations are not readily available, or the value has been materially affected
by the events occurring after the closing of a foreign market, assets are valued
by a method that the Board of Trustees believes accurately reflects fair value.
The NAV of the Fund's common shares is determined each business day at
the close of regular trading on the New York Stock Exchange (typically 4:00 p.m.
Eastern Time) by dividing the net assets by the number of its common shares
outstanding. On any day an international market is closed and the New York Stock
Exchange is open, any foreign securities will be valued at the prior day's close
with the current day's exchange rate. Trading of foreign securities may take
place on Saturdays and U.S. business holidays on which the Fund's NAV is not
calculated. Consequently, the Fund's portfolio securities may trade and the NAV
of the Fund's common shares may be significantly affected on days when a
shareholder has no access to the New York Stock Exchange.
35
BROKERAGE ALLOCATION
Decisions concerning the purchase and sale of portfolio securities and
the allocation of brokerage commissions are made by the Adviser pursuant to
recommendations made by an investment committee of the Adviser, which consists
of officers and directors of the Adviser and affiliates and officers and
Trustees who are interested persons of the Fund. Orders for purchases and sales
of securities are placed in a manner which, in the opinion of the Adviser, will
offer the best price and market for the execution of each such transaction.
Purchases from underwriters of portfolio securities may include a commission or
commissions paid by the issuer, and transactions with dealers serving as market
makers reflect a "spread". Debt securities are generally traded on a net basis
through dealers acting for their own account as principals and not as brokers;
no brokerage commissions are payable on these transactions.
In the U.S. Government securities market, securities are generally
traded on a "net" basis with dealers acting as principal for their own account
without a stated commission, although the price of the security usually includes
a profit to the dealer. On occasion, certain money market instruments and agency
securities may be purchased directly from the issuer, in which case no
commissions or premiums are paid. In other countries, both debt and equity
securities are traded on exchanges at fixed commission rates. Commissions on
foreign transactions are generally higher than the negotiated commission rates
available in the U.S. There is generally less government supervision and
regulation of foreign stock exchanges and broker-dealers than in the U.S.
The Fund's primary policy is to execute all purchases and sales of
portfolio instruments at the most favorable prices consistent with best
execution, considering all of the costs of the transaction including brokerage
commissions. This policy governs the selection of brokers and dealers and the
market in which a transaction is executed.
To the extent consistent with the foregoing, the Fund will be governed
in the selection of brokers and dealers, and the negotiation of brokerage
commission rates and dealer spreads, by the reliability and quality of the
services, including primarily the availability and value of research information
and, to a lesser extent, statistical assistance furnished to the Adviser and
their value and expected contribution to the performance of the Fund.
As permitted by Section 28(e) of the Securities Exchange Act of 1934,
the Fund may pay a broker which provides brokerage and research services to the
Fund an amount of disclosed commission in excess of the commission which another
broker would have charged for effecting that transaction. This practice is
subject to a good faith determination by the Board of Trustees that such
commission is reasonable in light of the services provided and to such policies
as the Board of Trustees may adopt from time to time.
Research services received from broker-dealers supplement the Adviser's
own research (and the research of its affiliates), and may include the following
types of information: statistical and background information on the U.S. and
foreign economies, industry groups and individual companies; forecasts and
interpretations with respect to the U.S. and foreign economies, securities,
markets, specific industry groups and individual companies; information on
federal, state, local and foreign political developments; portfolio management
strategies; performance information on securities, indexes and investment
accounts; and information concerning prices of securities. Broker-dealers may
communicate such information electronically, orally, in written form or on
computer software. Research services may also include the providing of
electronic communication of trade information and the providing of custody
services, as well as the providing of equipment used to communicate research
information, the providing of specialized consultations with the Adviser's
personnel with respect to computerized systems and data furnished to the Adviser
as a component of other research services, the arranging of meetings with
management of companies, and the providing of access to consultants who supply
research information.
The outside research assistance is useful to the Adviser since the
broker-dealers used by the Adviser tend to follow a broader universe of
securities and other matters than the Adviser's staff can follow. In addition,
the research provides the Adviser with a diverse perspective on financial
markets. Research services provided to the Adviser by broker-dealers are
available for the benefit of all accounts managed or advised by the Adviser or
by its affiliates. Some broker-dealers may indicate that the provision of
research services is dependent upon the generation of certain specified levels
of commissions and underwriting concessions by the Adviser's clients, including
the Fund. However, the Fund is not under any obligation to deal with any
broker-dealer in the execution of transactions in portfolio securities. In some
cases, the research services are available only from the broker-dealer providing
them. In other cases, the research services may be obtainable from alternative
sources in return for cash payments.
36
The Adviser believes that the research services are beneficial in
supplementing the Adviser's research and analysis and that they improve the
quality of the Adviser's investment advice. It is not possible to place a dollar
value on information and services to be received from brokers and dealers, since
it is only supplementary to the research efforts of the Adviser. The advisory
fee paid by the Fund is not reduced because the Adviser receives such services.
However, to the extent that the Adviser would have purchased research services
had they not been provided by broker-dealers, the expenses to the Adviser could
be considered to have been reduced accordingly. The research information and
statistical assistance furnished by brokers and dealers may benefit the Life
Company or other advisory clients of the Adviser, and conversely, brokerage
commissions and spreads paid by other advisory clients of the Adviser may result
in research information and statistical assistance beneficial to the Fund. The
Fund will make no commitment to allocate portfolio transactions upon any
prescribed basis.
While the Adviser's officers, will be primarily responsible for the
allocation of the Fund's brokerage business, the policies and practices of the
Adviser in this regard must be consistent with the foregoing and at all times be
subject to review by the Trustees.
The Adviser may determine target levels of commission business with
various brokers on behalf of its clients (including the Fund) over a certain
time period. The target levels will be based upon the following factors, among
others: (1) the execution services provided by the broker; (2) the research
services provided by the broker; and (3) the broker's interest in mutual funds
in general and in the Fund and other mutual funds advised by the Adviser in
particular, including sales of the Fund. In connection with (3) above, the
Fund's trades may be executed directly by dealers that sell shares of the John
Hancock funds or by other broker-dealers with which such dealers have clearing
arrangements, consistent with obtaining best execution and the Conduct Rules of
the National Association of Securities Dealers, Inc. The Adviser will not use a
specific formula in connection with any of these considerations to determine the
target levels.
The Adviser's indirect parent, the Life Company, is the indirect sole
shareholder of Signator Investors, Inc., a broker-dealer (until January 1, 1999,
John Hancock Distributors, Inc.) ("Signator" or "Affiliated Broker"). Pursuant
to procedures determined by the Trustees and consistent with the above policy of
obtaining best net results, the Fund may execute portfolio transactions with or
through the Affiliated Broker.
Signator may act as broker for the Fund on exchange transactions,
subject, however, to the general policy of the Fund set forth above and the
procedures adopted by the Trustees pursuant to the 1940 Act. Commissions paid to
an Affiliated Broker must be at least as favorable as those which the Trustees
believe to be contemporaneously charged by other brokers in connection with
comparable transactions involving similar securities being purchased or sold. A
transaction would not be placed with an Affiliated Broker if the Fund would have
to pay a commission rate less favorable than the Affiliated Broker's
contemporaneous charges for comparable transactions for its other most favored,
but unaffiliated, customers, except for accounts for which the Affiliated Broker
acts as clearing broker for another brokerage firm, and any customers of the
Affiliated Broker not comparable to the Fund as determined by a majority of the
Trustees who are not "interested persons" (as defined in the 1940 Act) of the
Fund, the Adviser or the Affiliated Broker. Because the Adviser, which is
affiliated with the Affiliated Broker, has, as an investment adviser to the
Fund, the obligation to provide investment management services, which include
elements of research and related investment skills, such research and related
skills will not be used by the Affiliated Broker as a basis for negotiating
commissions at a rate higher than that determined in accordance with the above
criteria.
Other investment advisory clients advised by the Adviser may also
invest in the same securities as the Fund. When these clients buy or sell the
same securities at substantially the same time, the Adviser may average the
transactions as to price and allocate the amount of available investments in a
manner which the Adviser believes to be equitable to each client, including the
Fund. Because of this, client accounts in a particular style may sometimes not
sell or acquire securities as quickly or at the same prices as they might if
each were managed and traded individually.
For purchases of equity securities, when a complete order is not
filled, a partial allocation will be made to each account pro rata based on the
order size. For high demand issues (for example, initial public offerings),
shares will be allocated pro rata by account size as well as on the basis of
account objective, account size ( a small account's allocation may be increased
to provide it with a meaningful position), and the account's other holdings. In
addition, an account's allocation may be increased if that account's portfolio
manager was responsible for generating the investment idea or the portfolio
manager intends to buy more shares in the secondary market. For fixed income
accounts, generally securities will be allocated when appropriate among accounts
37
based on account size, except if the accounts have different objectives or if an
account is too small to get a meaningful allocation. For new issues, when a
complete order is not filled, a partial allocation will be made to each account
pro rata based on the order size. However, if a partial allocation is too small
to be meaningful, it may be reallocated based on such factors as account
objectives, strategies, duration benchmarks and credit and sector exposure. For
example, value funds will likely not participate in initial public offerings as
frequently as growth funds. In some instances, this investment procedure may
adversely affect the price paid or received by the Fund or the size of the
position obtainable for it. On the other hand, to the extent permitted by law,
the Adviser may aggregate securities to be sold or purchased for the Fund with
those to be sold or purchased for other clients managed by it in order to obtain
best execution.
U.S. FEDERAL INCOME TAX MATTERS
The following is a summary discussion of certain U.S. federal income
tax consequences that may be relevant to a shareholder of acquiring, holding and
disposing of the Preferred Shares. This discussion only addresses U.S. federal
income tax consequences to U.S. shareholders who hold their shares as capital
assets and does not address all of the U.S. federal income tax consequences that
may be relevant to particular shareholders in light of their individual
circumstances. This discussion also does not address the tax consequences to
shareholders who are subject to special rules, including, without limitation,
financial institutions, insurance companies, dealers in securities or foreign
currencies, foreign shareholders, shareholders who hold their shares as or in a
hedge against currency risk, a constructive sale, or conversion transaction,
shareholders who are subject to the alternative minimum tax, or tax-exempt or
tax-deferred plans, accounts, or entities. In addition, the discussion does not
address any state, local, or foreign tax consequences, and it does not address
any federal tax consequences other than U.S. federal income tax consequences.
The discussion reflects applicable tax laws of the United States as of the date
of this statement of additional information, which tax laws may be changed or
subject to new interpretations by the courts or the Internal Revenue Service
("IRS") retroactively or prospectively. No attempt is made to present a detailed
explanation of all U.S. federal income tax concerns affecting the Fund and its
shareholders, and the discussion set forth herein does not constitute tax
advice. Investors are urged to consult their own tax advisers to determine the
tax consequences to them of investing in the Fund, including the applicable
federal, state, local and foreign tax consequences to them and the effect of
possible changes in tax laws.
The Fund intends to elect to be treated and to qualify each year as a
"regulated investment company" under Subchapter M of the Code and to comply with
applicable distribution requirements so that it generally will not pay U.S.
federal income tax on income and capital gains distributed to shareholders. In
order to qualify as a regulated investment company under Subchapter M of the
Code, which qualification this discussion assumes, the Fund must, among other
things, derive at least 90% of its gross income for each taxable year from
dividends, interest, payments with respect to securities loans, gains from the
sale or other disposition of stock, securities or foreign currencies, or other
income (including gains from options, futures and forward contracts) derived
with respect to its business of investing in such stock, securities or
currencies (the "90% income test") and satisfy certain quarterly asset
diversification requirements. In order to meeting these requirements of
Subchapter M of the Code, the Fund may not be able to utilize certain investment
techniques described above and in the Prospectus. For purposes of the 90% income
test, the character of income earned by certain entities in which the Fund
invests that are not treated as corporations for U.S. federal income tax
purposes (e.g., partnerships or trusts) will generally pass through to the Fund.
Consequently, the Fund may be required to limit its equity investments in such
entities that earn fee income, rental income or other nonqualifying income.
If the Fund qualifies as a regulated investment company and, for each
taxable year, it distributes to its shareholders an amount equal to or exceeding
the sum of (i) 90% of its "investment company taxable income" as that term is
defined in the Code (which includes, among other items, dividends, taxable
interest, and the excess of any net short-term capital gains over net long-term
capital losses, as reduced by certain deductible expenses) determined without
regard to the deduction for dividends paid and (ii) 90% of the excess of its
gross tax-exempt interest, if any, over certain disallowed deductions, the Fund
will generally be relieved of U.S. federal income tax on any income of the Fund,
including "net capital gains" (the excess of net long-term capital gain over net
short-term capital loss), distributed to shareholders. However, if the Fund
retains any investment company taxable income or net capital gain, it generally
will be subject to U.S. federal income tax at regular corporate rates on the
amount retained. The Fund intends to distribute at least annually all or
substantially all of its investment company taxable income, net tax-exempt
interest (if any), and net capital gain. If for any taxable year the Fund did
not qualify as a regulated investment company, it would be treated as a
corporation subject to U.S. federal income tax (even if it distributed all of
its income to its shareholders) and all distributions out of earnings and
profits would be taxed to shareholders as ordinary income. In addition, the Fund
could be required to recognize unrealized gains, pay taxes and make
distributions (which could be subject to interest charges) before requalifying
as a regulated investment company.
38
Under the Code, the Fund will be subject to a nondeductible 4% federal
excise tax on a portion of its undistributed ordinary income and capital gain
net income if it fails to meet certain distribution requirements with respect to
each calendar year. For purposes of the excise tax, any ordinary income or
capital gain net income retained by, and subject to federal income tax in the
hands of, the Fund will be treated as having been distributed. The Fund intends
to make distributions in a timely manner and accordingly does not expect to be
subject to the excise tax, but, as described below, there can be no assurance
that the Fund's distributions will be sufficient to avoid entirely this tax.
Based in part on the lack of any present intention on the part of the
Fund to redeem or purchase the Preferred Shares at any time in the future, the
Fund believes that under present law the Preferred Shares will constitute stock
of the Fund and distributions with respect to the Preferred Shares (other than
distributions in redemption of the Preferred Shares that are treated as
exchanges of stock under Section 302(b) of the Code) will constitute dividends
to the extent of the Fund's current or accumulated earnings and profits as
calculated for U.S. federal income tax purposes. Such dividends generally will
be taxable as ordinary income to holders (other than capital gain dividends, as
described below). This view relies in part on a published ruling of the IRS
stating that certain preferred stock similar in many material respects to the
Preferred Shares represents equity. It is possible, however, that the IRS might
take a contrary position asserting, for example that the Preferred Shares
constitute debt of the Fund. If this position were upheld, the discussion of the
treatment of distributions above would not apply. Instead distributions by the
Fund to holders of Preferred Shares would constitute interest, whether or not
such distributions exceeded the earnings and profits of the Fund, would be
included in full in the income of the recipient and would be taxed as ordinary
income.
In general, to the extent the Fund has sufficient current or
accumulated earnings and profits, dividends from investment company taxable
income will be taxable as ordinary income and distributions from net capital
gain designated as capital gain dividends, if any, will be taxable as long-term
capital gains for U.S. federal income tax purposes without regard to the length
of time the shareholder has held shares of the Fund. Distributions by the Fund
in excess of the Fund's current and accumulated earnings and profits will be
treated as a return of capital to the extent of (and in reduction of) the
shareholder's tax basis in its shares and any such amount in excess of that
basis will be treated as gain from the sale of the shares, as discussed below.
The U.S. federal income tax status of all distributions will be reported to
shareholders annually.
If the Fund retains any net capital gain for a taxable year, the Fund
may designate the retained amount as undistributed capital gains in a notice to
shareholders who, if subject to U.S. federal income tax on long-term capital
gains, (i) will be required to include in income for U.S. federal income tax
purposes, as long-term capital gain, their proportionate shares of such
undistributed amount, and (ii) will be entitled to credit their proportionate
shares of the tax paid by the Fund on the undistributed amount against their
U.S. 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 the
amount of undistributed capital gain included in the gross income of such
shareholder less the tax deemed paid by such shareholder under clause (ii) of
the preceding sentence. The Fund intends to distribute at least annually to its
shareholders all or substantially all of its investment company taxable income,
net tax-exempt interest (if any) and net capital gain.
Although dividends generally will be treated as distributed when paid,
any dividend declared by the Fund as of a record date in October, November or
December and paid during the following January will be treated for U.S. federal
income tax purposes as received by shareholders on December 31 of the calendar
year in which it is declared. In addition, certain other distributions made
after the close of a taxable year of the Fund may be "spilled back" and treated
as paid by the Fund (except for purposes of the 4% excise tax) during such
taxable year. In such case, shareholders will be treated as having received such
dividends in the taxable year in which the distributions were actually made.
If the Fund acquires any equity interest (under Treasury regulations
that may be promulgated in the future, generally including not only stock but
also an option to acquire stock such as is inherent in a convertible bond) in
certain foreign corporations that receive at least 75% of their annual gross
income from passive sources (such as interest, dividends, certain rents and
royalties, or capital gains) or that hold at least 50% of their assets in
investments producing such passive income ("passive foreign investment
companies"), the Fund could be subject to U.S. federal income tax and additional
interest charges on "excess distributions" received from such companies or on
gain from the disposition of stock in such companies, even if all income or gain
actually received by the Fund is timely distributed to its shareholders. The
Fund would not be able to pass through to its shareholders any credit or
39
deduction for such a tax. An election may generally be available that would
ameliorate these adverse tax consequences, but any such election could require
the Fund to recognize taxable income or gain (subject to tax distribution
requirements) without the concurrent receipt of cash. These investments could
also result in the treatment of capital gains from the sale of stock of passive
foreign investment companies as ordinary income. The Fund will monitor may limit
and/or manage its holdings in passive foreign investment companies to limit its
tax liability or maximize its return from these investments.
The Fund may invest to a limited extent in debt obligations that are in
the lowest rating categories or are unrated, including debt obligations of
issuers not currently paying interest or who are in default. Investments in debt
obligations that are at risk of or in default present special tax issues for the
Fund. Tax rules are not entirely clear about issues such as when and to what
extent deductions may be taken for bad debts or worthless securities and how
payments received on obligations in default should be allocated between
principal and income. These and other issues will be addressed by the Fund, in
the event it invests in such securities, in order to seek to ensure that it
distributes sufficient income to preserve its status as a regulated investment
company and does not become subject to U.S. federal income or excise tax.
If at any time when the Preferred Shares are outstanding the Fund fails
to meet the Discounted Value of eligible portfolio securities equal to the
Preferred Shares Basic Maintenance Amount or the value of the Fund's portfolio
fails to equal or exceed the 1940 Preferred Shares Asset Coverage, the Fund will
be required to suspend distributions to holders of its common shares until such
maintenance or asset coverage, as the case may be, is restored. This could
prevent the Fund from distributing at least an amount equal to 90% of its
investment company taxable income (determined without regard to the deduction
for dividends paid) and 90% of its net tax-exempt income (if any), and may
therefore jeopardize the Fund's qualification for taxation as a regulated
investment company or cause the Fund to incur a tax liability or a
non-deductible 4% excise tax on the undistributed taxable income (including net
capital gain), or both. Upon any failure to meet such maintenance or asset
coverage requirements, the Fund will be required to purchase or redeem shares of
preferred stock, including the Preferred Shares, in order to maintain or restore
the requisite maintenance or asset coverage and avoid the adverse consequences
to the Fund and its shareholders of failing to qualify as a regulated investment
company. There can be no assurance, however, that any such action would achieve
these objectives. The Fund will endeavor to avoid restrictions on its ability to
distribute dividends.
If the Fund invests in certain pay-in-kind securities, zero coupon
securities, deferred interest securities or, in general, any other securities
with original issue discount (or with market discount if the Fund elects to
include market discount in income currently), the Fund generally must accrue
income on such investments for each taxable year, which generally will be prior
to the receipt of the corresponding cash payments. However, the Fund must
distribute, at least annually, all or substantially all of its investment
company taxable income, including such accrued income, and its net tax-exempt
income (if any) to shareholders to qualify as a regulated investment company
under the Code and avoid U.S. federal income and excise taxes. Therefore, the
Fund may have to dispose of its portfolio securities under disadvantageous
circumstances to generate cash, or may have to borrow the cash, to satisfy
distribution requirements.
Sales and other dispositions of the Fund's shares generally are taxable
events for shareholders that are subject to tax. Shareholders should consult
their own tax advisers with reference to their individual circumstances to
determine whether any particular transaction in the Fund's shares (including a
redemption of the Preferred Shares) is properly treated as a sale for tax
purposes, as the following discussion assumes, and the tax treatment of any
gains or losses recognized in such transactions. In general, if Fund shares are
sold, the shareholder will recognize gain or loss equal to the difference
between the amount realized on the sale and the shareholder's adjusted basis in
the shares. Such gain or loss generally will be treated as long-term gain or
loss if the shares were held for more than one year and otherwise generally will
be treated as short-term gain or loss.
The Fund may, at its option, redeem preferred shares (including the
Preferred Shares) in whole or in part subject to certain limitations and to the
extent permitted under applicable law, and is required to redeem all or a
portion of the Preferred Shares to the extent required to maintain the Preferred
Shares Basic Maintenance Amount and the 1940 Act Preferred Shares Asset
Coverage. Gain or loss, if any, resulting from a redemption of the Preferred
Shares generally will be taxed as gain or loss from the sale of the Preferred
Shares under Section 302 of the Code rather than as a dividend, but only if the
redemption distribution (a) is deemed not to be essentially equivalent to a
40
dividend, (b) is in complete redemption of a shareholder's interest in the Fund,
(c) is substantially disproportionate with respect to the shareholder, or (d)
with respect to a non-corporate shareholder, is in partial liquidation of the
shareholder's interest in the Fund. For purposes of clauses (a), (b), and (c)
above, a shareholder's ownership of common shares will be taken into account and
the Preferred Shares and common shares held by persons who are related to the
redeemed shareholder may also have to be taken into account. If none of the
conditions (a) through (d) above are met, the redemption proceeds may be
considered a dividend distribution taxable as ordinary income as discussed
above. In addition, any declared but unpaid dividends distributed to
shareholders in connection with a redemption will be taxable to shareholders as
dividends as described above.
Any loss recognized by a shareholder upon the sale or other disposition
of shares with a tax holding period of six months or less generally will be
treated as a long-term capital loss to the extent of any amounts treated as
distributions of long-term capital gain with respect to such shares. Losses on
sales or other dispositions of shares may be disallowed under "wash sale" rules
in the event a shareholder acquires other shares in the Fund (including those
acquired pursuant to reinvestment of dividends and/or capital gain
distributions) within a period of 61 days beginning 30 days before and ending 30
days after a sale or other disposition of shares. In that event, the basis of
the replacement shares of the Fund will be adjusted to reflect the disallowed
loss.
Options written or purchased and futures contracts entered into by the
Fund on certain securities, indices and foreign currencies, as well as certain
forward foreign currency contracts, may cause the Fund to recognize gains or
losses from marking-to-market even though such options may not have lapsed, been
closed out, or exercised, or such futures or forward contracts may not have been
performed or closed out. The tax rules applicable to these contracts may affect
the characterization of some capital gains and losses recognized by the Fund as
long-term or short-term. Certain options, futures and forward contracts relating
to foreign currency may be subject to Section 988 of the Code, and accordingly
may produce ordinary income or loss. Additionally, the Fund may be required to
recognize gain if an option, futures contract, forward contract, short sale or
other transaction that is not subject to the mark-to-market rules is treated as
a "constructive sale" of an "appreciated financial position" held by the Fund
under Section 1259 of the Code. Any net mark-to-market gains and/or gains from
constructive sales may also have to be distributed to satisfy the distribution
requirements referred to above even though the Fund may receive no corresponding
cash amounts, possibly requiring the Fund to dispose of portfolio securities or
borrow to obtain the necessary cash. Losses on certain options, futures or
forward contracts and/or offsetting positions (portfolio securities or other
positions with respect to which the Fund's risk of loss is substantially
diminished by one or more options, futures or forward contracts) may also be
deferred under the tax straddle rules of the Code, which may also affect the
characterization of capital gains or losses from straddle positions and certain
successor positions as long-term or short-term. Certain tax elections may be
available that would enable the Fund to ameliorate some adverse effects of the
tax rules described in this paragraph. The tax rules applicable to options,
futures, forward contracts and straddles may affect the amount, timing and
character of the Fund's income and gains or losses and hence of its
distributions to shareholders.
The income to be received by the Fund from its investment in taxable
preferred securities is not expected to qualify for the dividends received
deduction under the Code. As a result, the Fund does not expect that its
distributions to its corporate shareholders will qualify for such deduction.
The federal income tax treatment of the Fund's investment in preferred
securities or other securities and its participation in transactions involving
interest rate swaps, caps, floors or collars or credit transactions and credit
default swaps is uncertain and may be subject to recharacterization by the IRS.
To the extent that the tax treatment of such securities or transactions differs
from the tax treatment expected by the Fund, the timing or character of income
recognized by the Fund could be affected, the Fund may be required to purchase
or sell securities, or otherwise change its portfolio, in order to comply with
the tax rules applicable to regulated investment companies under the Code.
The IRS has taken the position that if a regulated investment company
has two classes of shares, it must designate distributions made to each class in
any year as consisting of no more than such class's proportionate share of
particular types of income, including net capital gains. A class's proportionate
share of a particular type of income is determined according to the percentage
of total dividends paid by the regulated investment company during the year to
such class. Consequently, the Fund intends to designate distributions of
particular types of income made to common shareholders and preferred
shareholders in accordance with each such class's proportionate shares of such
income. Thus, the Fund will designate distributions comprised of particular
41
types of income, including net capital gains, in a manner that allocates such
income between the holder of common shares and preferred shares, including the
Preferred Shares, in proportion to the total dividends paid to each class during
or for the taxable year, or otherwise required by applicable law. Distributions
in excess of the Fund's current and accumulated earnings and profits (if any),
however, will not be allocated proportionately among the Preferred Shares and
the common shares. Since the Fund's current and accumulated earnings 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 holders of
common shares.
The Fund may be subject to withholding and other taxes imposed by
foreign countries, including taxes on interest, dividends and capital gains with
respect to its investments in those countries, which would, if imposed, reduce
the yield on or return from those investments. Tax conventions between certain
countries and the U.S. may reduce or eliminate such taxes in some cases. The
Fund does not expect to satisfy the requirements for passing through to its
shareholders their pro rata shares of qualified foreign taxes paid by the Fund,
with the general result that shareholders would not include such taxes in their
gross incomes and would not be entitled to any deduction or credit for such
taxes on their own tax returns.
The Fund is required to withhold (as "backup withholding") on
reportable payments, including dividends, capital gain distributions and the
proceeds of sales or other dispositions of the Fund's shares paid to certain
shareholders who have not complied with IRS regulations. In order to avoid this
withholding requirement, shareholders must certify on their Account
Applications, or on separate IRS Forms W-9, that the Social Security number or
other taxpayer identification number they provide is their correct number and
that they are not currently subject to backup withholding, or that they are
exempt from backup withholding. The Fund may nevertheless be required to backup
withhold if it receives notice from the IRS or a broker that the taxpayer
identification number provided is incorrect or backup withholding is applicable
as a result of previous underreporting of income.
The description of certain federal tax provisions above related only to
U.S. federal income tax consequences for shareholders who are U.S. persons
(i.e., U.S. citizens or residents or U.S. corporations, partnerships, trusts or
estates, all as determined for U.S. federal income tax purposes) and who are
subject to U.S. federal income Tax. Investors other than U.S. persons may be
subject to different U.S. federal income tax treatment, including a non-resident
alien U.S. withholding tax on amounts treated as ordinary income dividends from
the Fund and, unless an effective IRS Form W-8Ben or other authorized
withholding certificate of documentation is on file, to backup withholding on
certain other payments from the Fund. Shareholder should consult their own tax
advisers on these matters and on any specific questions as to U.S. federal,
state, local, foreign and other applicable tax laws.
PERFORMANCE
From time to time, in reports and promotional literature, the Fund's
total return will be compared to indices of mutual funds such as Lipper
Analytical Services, Inc.'s "Lipper - Mutual Fund Performance Analysis," a
monthly publication which tracks net assets, total return and yield on mutual
funds in the United States. Ibottson and Associates, CDA Weisenberger and F.C.
Towers are also used for comparison purposes, as well as the Russell and
Wilshire Indices.
Performance rankings and ratings reported periodically in, and excerpts
from, national financial publications such as MONEY Magazine, FORBES, BUSINESS
WEEK, THE WALL STREET JOURNAL, MICROPAL, INC., MORNINGSTAR, STANGER'S and
BARRON'S may also be utilized. The Fund's promotional and sales literature may
make reference to the Fund's "beta". Beta is a reflection of the market related
risk of the Fund by showing how responsive the Fund is to the market.
CUSTODY OF PORTFOLIO
Portfolio securities of the Fund are held pursuant to a custodian
agreement between the Fund and The Bank of New York, One Wall Street, New York,
New York 10286. Under the custodian agreement, The Bank of New York is
performing custody, portfolio, foreign custody manager and fund accounting
services.
42
INDEPENDENT AUDITORS
The independent auditors of the Fund are Deloitte & Touche LLP, 200
Berkeley Street, Boston, MA 02116, audits and renders an opinion on the Fund's
annual financial statements, and reviews the Fund's annual federal income tax
return.
ADDITIONAL INFORMATION
A Registration Statement on Form N-2, relating to the shares offered
hereby, has been filed by the Fund with the Securities and Exchange Commission
(the "Commission"), Washington, D.C. The Prospectus and this Statement of
Additional Information do not contain all of 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. A copy of the Registration
Statement may be inspected without charge at the Commission's principal office
in Washington, D.C., and copies of all or any part thereof may be obtained from
the Commission upon the payment of certain fees prescribed by the Commission.
43
FINANCIAL STATEMENTS
Following are the audited financial statements for the initial capitalization of
the John Hancock Preferred Income Fund dated August 9, 2002 and the report of
Deloitte and Touche LLP.
John Hancock Preferred Income Fund
Statement of assets and liabilities
August 9, 2002
Assets:
Cash $153,015
----------
$153,015
Total assets ==========
Liabilities:
Payable for organization expenses $53,000
----------
$53,000
Total liabilities ==========
Net Assets: $153,015
Capital paid-in
Accumulated net investment loss (53,000)
----------
$100,015
Net assets ==========
Net assets value per share:
(Based on net assets and 6,409 shares of
beneficial interest outstanding -
22 million shares authorized
with no par value) $15.61
==========
-----------------------------------------------------------------------------------------
1. STATEMENT OF OPERATIONS
For the period from June 27, 2002 (date of inception) to August 9, 2002
-----------------------------------------------------------------------------------------
Organization expenses $53,000
----------
Net investment loss ($53,000)
==========
-----------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------
2. STATEMENT OF CHANGES IN NET ASSETS
For the period from June 27, 2002 (date of inception) to August 9, 2002
Increase (decrease) in net assets From operations:
Net investment loss ($53,000)
--------
Decrease in net assets resulting from operations (53,000)
========
From Fund share transactions:
Net proceeds from the issuance of common shares 153,015
========
Net assets
Beginning of period
End of Period $100,015
========
See notes to financial statements.
44
NOTES TO FINANCIAL STATEMENTS
Note 1. Organization
John Hancock Preferred Income Funds was organized on June 27, 2002 as a
diversified closed-end management investment company registered under the
Investment Company Act of 1940. The Fund's primary investment objective is to
provide a high level of current income, consistent with preservation of capital.
The Fund's secondary investment objective is to provide growth of capital. The
Fund will invest at least 80% of its managed assets (net assets plus borrowing
for investment purposes) in preferred stocks and other preferred securities,
including convertible preferred securities, in various industry sectors.
At August 9, 2002, the Fund is inactive except for matters relating to its
organization, registration and the sale of 6,409 shares for $153,015 ($23.875
per share) to John Hancock Advisers, LLC (the "Adviser"), an indirect,
wholly-owned subsidiary of John Hancock Life Insurance Company.
Note 2. Agreements
The Fund has entered into an investment management contract with the Adviser.
The Fund also has an administrative agreement with the Adviser under which the
Adviser will oversee the custodial, auditing, valuation, accounting, legal,
stock transfer and dividend disbursing services and will maintain the Fund's
communications with shareholders. Upon commencement of the Fund's operations,
the Adviser will receive a daily management fee from the Fund at an annual rate
of 0.75% of the Fund's average daily managed assets. The Adviser has agreed to
limit the Fund's management fee to the following: 0.55% of the Fund's average
daily managed assets until the fifth anniversary of the commencement of the
Fund's operations, 0.60% of such assets in the sixth year, 0.65% of such assets
in the seventh year, and 0.70% of average daily managed assets in the eighth
year. After the eighth year the Adviser will no longer waive a portion of the
management fee.
Note 3. Organization Expenses and Offering Costs
Organization expenses, which amount to $53,000, have been expensed by the Fund.
Offering costs, estimated to be approximately $401,000, will be charged to the
Fund's capital paid-in at the time shares of beneficial interest are sold.
45
INDEPENDENT AUDITORS' REPORT
The Board of Trustees and Shareholder of
John Hancock Preferred Income Fund
We have audited the accompanying statement of assets and liabilities of John
Hancock Preferred Income Fund (the "Fund") as of August 9, 2002 and the related
statements of operations and changes in net assets for the period from June 27,
2002 (date of inception) to August 9, 2002. These financial statements are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of the Fund at August 9, 2002 and the results
of its operations and changes in its net assets for the period then ended, in
conformity with accounting principles generally accepted in the United States of
America.
Deloitte & Touche LLP
Boston, Massachusetts
August 12, 2002
46
APPENDIX A - MORE ABOUT RISK
A fund's risk profile is largely defined by the fund's primary
securities and investment practices. You may find the most concise description
of the fund's risk profile in the Prospectus.
A fund is permitted to utilize -- within limits established by the
Trustees -- certain other securities and investment practices that have higher
risks and opportunities associated with them. To the extent that the Fund
utilizes these securities or practices, its overall performance may be affected,
either positively or negatively. On the following pages are brief definitions of
certain associated risks with them with examples of related securities and
investment practices included in brackets. See the "Investment Objective and
Policies" and "Investment Restrictions" sections of this Statement of Additional
Information for a description of this Fund's investment policies. The Fund
follows certain policies that may reduce these risks.
As with any mutual fund, there is no guarantee that the Fund will earn
income or show a positive return over any period of time -- days, months or
years.
TYPES OF INVESTMENT RISK
Correlation Risk The risk that changes in the value of a hedging
instrument will not match those of the asset being hedged (hedging is the use of
one investment to offset the effects of another investment). Incomplete
correlation can result in unanticipated risks (e.g., short sales, financial
futures and options; securities and index options, currency contracts).
Credit Risk The risk that the issuer of a security, or the counterparty
to a contract, will default or otherwise become unable to honor a financial
obligation (e.g., borrowing; reverse repurchase agreements, repurchase
agreements, securities lending, non-investment-grade securities, financial
futures and options; securities and index options).
Information Risk The risk that key information about a security or
market is inaccurate or unavailable (e.g., non-investment-grade securities,
foreign equities).
Interest Rate Risk The risk of market losses attributable to changes in
interest rates. With fixed-rate securities, a rise in interest rates typically
causes a fall in values, while a fall in rates typically causes a rise in values
(e.g., non-investment-grade securities, financial futures and options;
securities and index options).
- Leverage Risk Associated with securities or practices (such as
borrowing) that multiply small index or market movements into large
changes in value (e.g., borrowing; reverse repurchase agreements,
when-issued securities and forward commitments).
- Hedged When a derivative (a security whose value is based on another
security or index) is used as a hedge against an opposite position that
the fund also holds, any loss generated by the derivative should be
substantially offset by gains on the hedged investment, and vice versa.
While hedging can reduce or eliminate losses, it can also reduce or
eliminate gains. (e.g., short sales, financial futures and options
securities and index options; currency contracts).
- Speculative To the extent that a derivative is not used as a hedge, the
fund is directly exposed to the risks of that derivative. Gains or
losses from speculative positions in a derivative may be substantially
greater than the derivative's original cost. (e.g., short sales,
financial futures and options securities and index options; currency
contracts).
- Liquidity Risk The risk that certain securities may be difficult or
impossible to sell at the time and the price that the seller would
like. The seller may have to lower the price, sell other securities
instead or forego an investment opportunity, any of which could have a
negative effect on fund management or performance (e.g.,
non-investment-grand securities, short sales, restricted and illiquid
securities, financial futures and options securities and index options;
currency contracts).
A-1
Management Risk The risk that a strategy used by a fund's management
may fail to produce the intended result. Common to all mutual funds.
Market Risk The risk that the market value of a security may move up
and down, sometimes rapidly and unpredictably. These fluctuations may cause a
security to be worth less than the price originally paid for it, or less than it
was worth at an earlier time. Market risk may affect a single issuer, industry,
sector of the economy or the market as a whole. Common to all stocks and bonds
and the mutual funds that invest in them (e.g., short sales, short-term trading,
when-issued securities and forward commitments, non-investment-grade securities,
foreign equities, financial futures and options; securities and index options
restricted and illiquid securities).
Natural Event Risk The risk of losses attributable to natural
disasters, crop failures and similar events (e.g., foreign equities).
Opportunity Risk The risk of missing out on an investment opportunity
because the assets necessary to take advantage of it are tied up in less
advantageous investments (e.g., short sales, when-issued securities and forward
commitments; financial futures and options; securities and index options,
currency contracts).
Political Risk The risk of losses attributable to government or
political actions, from changes in tax or trade statutes to governmental
collapse and war (e.g., foreign equities).
Valuation Risk The risk that a fund has valued certain of its
securities at a higher price than it can sell them for (e.g.,
non-investment-grade securities, restricted and illiquid securities).
A-2
APPENDIX B - DESCRIPTION OF RATINGS
The ratings of Moody's Investors Service, Inc. and Standard & Poor's
Ratings Group represent their opinions as to the quality of various debt
instruments they undertake to rate. It should be emphasized that ratings are not
absolute standards of quality. Consequently, debt instruments with the same
maturity, coupon and rating may have different yields while debt instruments of
the same maturity and coupon with different ratings may have the same yield.
MOODY'S INVESTORS SERVICE, INC. - PREFERRED SECURITIES RATINGS
aaa: Preferred stocks which are rated "aaa" are considered to be top 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 considered to be high grade. 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" are considered to be 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 judged lower-medium grade,
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 considered to have speculative
elements and their future cannot be considered well assured. Earnings and asset
protection may be very moderate and not well safeguarded during adverse periods.
Uncertainty of position characterizes preferred stocks in this class.
MOODY'S INVESTORS SERVICE, INC.- BOND RATINGS
Aaa: Bonds which are rated Aaa are judged to be of the best quality. They carry
the smallest degree of investment risk and are generally referred to as "gilt
edge." Interest payments are protected by a large or by an exceptionally stable
margin and principal is secure. While the various protective elements are likely
to change, such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
Aa: Bonds which are rated Aa are judged to be of high quality by all standards.
Together with the Aaa group they comprise what are generally known as high grade
bonds. They are rated lower than the best bonds because margins of protection
may not be as large as in Aaa securities or fluctuations of protective elements
may be of greater amplitude or there may be other elements present which make
the long-term risks appear somewhat larger than in Aaa securities.
A: Bonds which are rated A possess many favorable investment attributes and are
to be considered as upper medium grade obligations. Factors giving security to
principal and interest are considered adequate but elements may be present which
suggest a susceptibility to impairment at some time in the future.
Baa: Bonds which are rated Baa are considered as medium grade obligations, i.e.,
they are neither highly protected nor poorly secured. Interest payments and
principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba: Bonds 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 bonds in this class.
B-1
B: Bonds which are rated B generally lack the characteristics of desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Caa: Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal or
interest.
Ca: Bonds which are rated Ca represented obligations which are speculative in a
high degree. Such issues are often in default or have other marked shortcomings.
STANDARD & POOR'S RATINGS GROUP - PREFERRED SECURITIES 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 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 pay the preferred stock obligation. While
such issues will likely have some quality and protective characteristics, there
are outweighed by large uncertainties or major risk exposures to adverse
conditions.
STANDARD & POOR'S RATINGS GROUP - BOND RATINGS
AAA: Debt rated AAA has the highest rating assigned by Standard & Poor's.
Capacity to pay interest and repay principal is extremely strong.
AA: Debt rated AA has a very strong capacity to pay interest and repay principal
and differs from the highest rated issues only in small degree.
A: Debt rated A has a strong capacity to pay interest and repay principal,
although it is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher rated categories.
BBB: Debt rated BBB is regarded as having an adequate capacity to pay interest
and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
BB, B: Debt rated BB, and B is regarded, on balance, as predominantly
speculative with respect to capacity to pay interest and repay principal in
accordance with the terms of the obligation. BB indicates the lowest degree of
speculation and CC the highest degree of speculation. While such debt will
likely have some quality and protective characteristics, these are outweighed by
large uncertainties or major risk exposures to adverse conditions.
CCC: Debt rated 'CCC' has a currently identifiable vulnerability to default, and
is dependent upon favorable business, financial, and economic conditions to meet
timely payment of interest and repayment of principal. In the event of adverse
business, financial or economic conditions, it is not likely to have the
capacity to pay interest and repay principal. The 'CCC' rating category is also
used for debt subordinated to senior debt that is assigned an actual or implied
'B' or 'B-' rating.
B-2
CC: The rating 'CC' is typically applied to debt subordinated to senior debt
that is assigned an actual or implied 'CCC' rating.
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APPENDIX C - AUCTION PROCEDURES
The following procedures will be set forth in provisions of the By-Laws
relating to the Preferred Shares and will be incorporated by reference in the
Auction Agency Agreement and each Broker-Dealer Agreement. Capitalized terms
used herein are defined in the By-Laws or the Prospectus, except that the term
"Trust" means the Fund. Nothing contained in this Appendix C constitutes a
representation by the Fund that in each Auction each party referred to herein
actually will perform the procedures described herein to be performed by such
party.
Section 8.9. Auction Procedures
(a) Orders.
(i) Prior to the Submission Deadline on each Auction Date for
shares of a series of APS:
(A) each Beneficial Owner of shares of such series may submit
to its Broker-Dealer by telephone or otherwise information as to:
(1) the number of Outstanding shares, if any, of such series held by
such Beneficial Owner which such Beneficial Owner desires to continue to hold
without regard to the Applicable Rate for shares of such series for the next
succeeding Rate Period of such shares;
(2) the number of Outstanding shares, if any, of such series held by
such Beneficial Owner which such Beneficial Owner offers to sell if the
Applicable Rate for shares of such series for the next succeeding Rate Period of
shares of such series shall be less than the rate per annum specified by such
Beneficial Owner; and/or
(3) the number of Outstanding shares, if any, of such series held by
such Beneficial Owner which such Beneficial Owner offers to sell without regard
to the Applicable Rate for shares of such series for the next succeeding Rate
Period of shares of such series; and
(B) One or more Broker-Dealers, using lists of Potential Beneficial
Owners, shall in good faith for the purpose of conducting a competitive Auction
in a commercially reasonable manner, contact Potential Beneficial Owners (by
telephone or otherwise), including Persons that are not Beneficial Owners, on
such lists to determine the number of shares, if any, of such series which each
such Potential Beneficial Owner offers to purchase if the Applicable Rate for
shares of such series for the next succeeding Rate Period of shares of such
series shall not be less than the rate per annum specified by such Potential
Beneficial Owner.
(C) For the purposes hereof, the communication by a Beneficial Owner or
Potential Beneficial Owner to a Broker-Dealer, or by a Broker-Dealer to the
Auction Agent, of information referred to in clause (A)(1), (A)(2), (A)(3) or
(B) of this Section 8.9(a)(i) is hereinafter referred to as an "Order" and
collectively as "Orders" and each Beneficial Owner and each Potential Beneficial
Owner placing an Order with a Broker-Dealer, and such Broker-Dealer placing an
order with the Auction Agent, is hereinafter referred to as a "Bidder" and
collectively as "Bidders"; an Order containing the information referred to in
clause (A)(1) of this Section 8.9(a)(i) is hereinafter referred to as a "Hold
Order" and collectively as "Hold Orders"; an Order containing the information
referred to in clause (A)(2) or (B) of this Section 8.9(a)(i) is hereinafter
referred to as a "Bid" and collectively as "Bids"; and an Order containing the
information referred to in clause (A)(3) of this Section 8.9(a)(i) is
hereinafter referred to as a "Sell Order" and collectively as "Sell Orders."
(D) A Bid by a Beneficial Owner or an Existing Holder of shares of a
series of APS subject to an Auction on any Auction Date shall constitute an
irrevocable offer to sell:
(1) the number of Outstanding shares of such series specified in such
Bid if the Applicable Rate for shares of such series determined on such Auction
Date shall be less than the rate specified therein;
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(2) such number or a lesser number of Outstanding shares of such series
to be determined as set forth in Section 8.9(d)(i)(A)(4) if the Applicable Rate
for shares of such series determined on such Auction Date shall be equal to the
rate specified therein; or
(3) the number of Outstanding shares of such series specified in such
Bid if the rate specified therein shall be higher than the Maximum Rate for
shares of such series, or such number or a lesser number of Outstanding shares
of such series to be determined as set forth in Section 8.9(d)(i)(A)(4) if the
rate specified therein shall be higher than the Maximum Rate for shares of such
series and Sufficient Clearing Bids for shares of such series do not exist.
(E) A Sell Order by a Beneficial Owner or an Existing Holder
of shares of a series of APS subject to an Auction on any Auction Date shall
constitute an irrevocable offer to sell:
(1) the number of Outstanding shares of such series specified in such
Sell Order; or
(2) such number or a lesser number of Outstanding shares of such series
as set forth in Section 8.9(d)(i)(B)(3) if Sufficient Clearing Bids for shares
of such series do not exist; provided, however, that a Broker-Dealer that is an
Existing Holder with respect to shares of a series of APS shall not be liable to
any Person for failing to sell such shares pursuant to a Sell Order described in
the proviso to paragraph (iii) of Section 8.9(b) if (X) such shares were
transferred by the Beneficial Owner thereof without compliance by such
Beneficial Owner or its transferee Broker-Dealer (or other transferee person, if
permitted by the Fund) with the provisions of Section 8.9(f) or (Y) such
Broker-Dealer has informed the Auction Agent pursuant to the terms of its
Broker-Dealer Agreement that, according to such Broker-Dealer's records, such
Broker Dealer believes it is not the Existing Holder of such shares.
(F) A Bid by a Potential Beneficial Holder or a Potential Holder of
shares of a series of APS subject to an Auction on any Auction Date shall
constitute an irrevocable offer to purchase:
(1) the number of Outstanding shares of such series specified in such
Bid if the Applicable Rate for shares of such series determined on such Auction
Date shall be higher than the rate specified therein; or
(2) such number or a lesser number of Outstanding shares of such series
as set forth in Section 8.9(d)(i)(A)(5) if the Applicable Rate for shares of
such series determined on such Auction Date shall be equal to the rate specified
therein.
(ii) No Order for any number of APS other than whole shares shall be
valid.
(b) Submission of Orders by Broker-Dealers to Auction Agent.
(i) Each Broker-Dealer shall submit in writing to the Auction Agent
prior to the Submission Deadline on each Auction Date all Orders for APS of a
series subject to an Auction on such Auction Date obtained by such
Broker-Dealer, designating itself (unless otherwise permitted by the Fund) as an
Existing Holder in respect of shares subject to Orders submitted or deemed
submitted to it by Beneficial Owners and as a Potential Holder in respect of
shares subject to Orders submitted to it by Potential Beneficial Owners, and
shall specify with respect to each Order for such shares:
(A) the name of the Bidder placing such Order (which shall be the
Broker-Dealer unless otherwise permitted by the Fund);
(B) the aggregate number of shares of such series that are the subject
of such Order;
(C) to the extent that such Bidder is an Existing Holder of shares of
such series:
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(1) the number of shares, if any, of such series subject to any Hold
Order of such Existing Holder;
(2) the number of shares, if any, of such series subject to any Bid of
such Existing Holder and the rate specified in such Bid; and
(3) the number of shares, if any, of such series subject to any Sell
Order of such Existing Holder; and
(D) to the extent such Bidder is a Potential Holder of shares of such
series, the rate and number of shares of such series specified in such Potential
Holder's Bid.
(ii) If any rate specified in any Bid contains more than three figures
to the right of the decimal point, the Auction Agent shall round such rate up to
the next highest one thousandth (.001) of 1%.
(iii) If an Order or Orders covering all of the outstanding APS of a
series held by any Existing Holder is not submitted to the Auction Agent prior
to the Submission Deadline, the Auction Agent shall deem a Hold Order to have
been submitted by or on behalf of such Existing Holder covering the number of
Outstanding shares of such series held by such Existing Holder and not subject
to Orders submitted to the Auction Agent; provided, however, that if an Order or
Orders covering all of the Outstanding shares of such series held by any
Existing Holder is not submitted to the Auction Agent prior to the Submission
Deadline for an Auction relating to a Special Rate Period consisting of more
than 91 days, the Auction Agent shall deem a Sell order to have been submitted
by or on behalf of such Existing Holder covering the number of outstanding
shares of such series held by such Existing Holder and not subject to Orders
submitted to the Auction Agent.
(iv) If one or more Orders of an Existing Holder is submitted to the
Auction Agent covering in the aggregate more than the number of Outstanding APS
of a series subject to an Auction held by such Existing Holder, such Orders
shall be considered valid in the following order of priority:
(A) all Hold Orders for shares of such series shall be
considered valid, but only up to and including in the aggregate the number of
Outstanding shares of such series held by such Existing Holder, and if the
number of shares of such series subject to such Hold Orders exceeds the number
of Outstanding shares of such series held by such Existing Holder, the number of
shares subject to each such Hold Order shall be reduced pro rata to cover the
number of Outstanding shares of such series held by such Existing Holder;
(B)
(1) any Bid for shares of such series shall be considered valid up to
and including the excess of the number of Outstanding shares of such series held
by such Existing Holder over the number of shares of such series subject to any
Hold Orders referred to in clause (A) above;
(2) subject to subclause (1), if more than one Bid of an Existing
Holder for shares of such series is submitted to the Auction Agent with the same
rate and the number of Outstanding shares of such series subject to such Bids is
greater than such excess, such Bids shall be considered valid up to and
including the amount of such excess, and the number of shares of such series
subject to each Bid with the same rate shall be reduced pro rata to cover the
number of shares of such series equal to such excess;
(3) subject to subclauses (1) and (2), if more than one Bid of an
Existing Holder for shares of such series is submitted to the Auction Agent with
different rates, such Bids shall be considered valid in the ascending order of
their respective rates up to and including the amount of such excess;
(4) in any such event, the number, if any, of such Outstanding shares
of such series subject to any portion of Bids considered not valid in whole or
in part under this clause (B) shall be treated as the subject of a Bid for
shares of such series by or on behalf of a Potential Holder at the rate therein
specified; and
C-3
(C) all Sell Orders for shares of such series shall be considered valid
up to and including the excess of the number of Outstanding shares of such
series held by such Existing Holder over the sum of shares of such series
subject to valid Hold Orders referred to in clause (A) above and valid Bids
referred to in clause (B) above.
(v) If more than one Bid for one or more shares of a series of APS is
submitted to the Auction Agent by or on behalf of any Potential Holder, each
such Bid submitted shall be a separate Bid with the rate and number of shares
therein specified.
(vi) Any Order submitted by a Beneficial Owner or a Potential
Beneficial Owner to its Broker-Dealer, or by a Broker-Dealer to the Auction
Agent, prior to the Submission Deadline on any Auction Date, shall be
irrevocable.
(c) Determination of Sufficient Clearing Bids, Winning Bids Rate and Applicable
Rate.
(i) Not earlier than the Submission Deadline on each Auction Date for
shares of a series of APS, the Auction Agent shall assemble all valid Orders
submitted or deemed submitted to it by the Broker-Dealers in respect of shares
of such series (each such Order as submitted or deemed submitted by a
Broker-Dealer being hereinafter referred to individually as a "Submitted Hold
Order," a "Submitted Bid" or a "Submitted Sell Order," as the case may be, or as
a "Submitted Order" and collectively as "Submitted Hold Orders," "Submitted
Bids" or "Submitted Sell Orders," as the case may be, or as "Submitted Orders")
and shall determine for such series:
(A) the excess of the number of Outstanding shares of such series over
the number of Outstanding shares of such series subject to Submitted Hold Orders
(such excess being hereinafter referred to as the "Available APS" of such
series);
(B) from the Submitted Orders for shares of such series whether:
(1) the number of Outstanding shares of such series subject to
Submitted Bids of Potential Holders specifying one or more rates equal to or
lower than the Maximum Rate for shares of such series exceeds or is equal to the
sum of:
(2) the number of Outstanding shares of such series subject to
Submitted Bids of Existing Holders specifying one or more rates higher than the
Maximum Rate for shares of such series; and
(3) the number of Outstanding shares of such series subject to
Submitted Sell Orders
(in the event such excess or such equality exists (other than because
the number of shares of such series in subclauses (2) and (3) above is zero
because all of the Outstanding shares of such series are subject to Submitted
Hold Orders), such Submitted Bids in subclause (1) above being hereinafter
referred to collectively as "Sufficient Clearing Bids" for shares of such
series); and
(C) if Sufficient Clearing Bids for shares of such series exist, the
lowest rate specified in such Submitted Bids (the "Winning Bid Rate" for shares
of such series) which if:
(1) (X) each such Submitted Bid of Existing Holders specifying such
lowest rate and (Y) all other such Submitted Bids of Existing Holders specifying
lower rates were rejected, thus entitling such Existing Holders to continue to
hold the shares of such series that are subject to such Submitted Bids; and
(2) (X) each such Submitted Bid of Potential Holders specifying such
lowest rate and (Y) all other such Submitted Bids of Potential Holders
specifying lower rates were accepted would result in such Existing Holders
described in Section 8.9(c(i)(B)(2) (1) above continuing to hold an aggregate
number of Outstanding shares of such series which, when added to the number of
Outstanding shares of such series to be purchased by such Potential Holders
described in Section 8.9(c(i)(B)(2), would equal not less than the Available APS
of such series.
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(ii) Promptly after the Auction Agent has made the determinations
pursuant to paragraph (i) of this Section 8.9(c), the Auction Agent shall advise
the Fund of the Maximum Rate for shares of the series of APS for which an
Auction is being held on the Auction Date and, based on such determination the
Applicable Rate for shares of such series for the next succeeding Rate Period
thereof as follows:
(A) if Sufficient Clearing Bids for shares of such series
exist, that the Applicable Rate for all shares of such series for the next
succeeding Rate Period thereof shall be equal to the Winning Bid Rate for shares
of such series so determined;
(B) if Sufficient Clearing Bids for shares of such series do
not exist (other than because all of the Outstanding shares of such series are
subject to Submitted Hold Orders), that the Applicable Rate for all shares of
such series for the next succeeding Rate Period thereof shall be equal to the
Maximum Rate for shares of such series; or
(C) if all of the Outstanding shares of such series are
subject to Submitted Hold Orders, that the Applicable Rate for all shares of
such series for the next succeeding Rate Period thereof shall be the applicable
"AA" Financial Composite Commercial Paper Rate on such Auction Date.
(d) Acceptance and Rejection of Submitted Bids and Submitted Sell Orders and
Allocation of Shares.
(i) Existing Holders shall continue to hold the APS that are subject to
Submitted Hold Orders, and, based on the determinations made pursuant to Section
8.9(c)(i)(A), the Submitted Bids and Submitted Sell Orders shall be accepted or
rejected by the Auction Agent and the Auction Agent shall take such other action
as set forth below:
(A) If Sufficient Clearing Bids for shares of a series of APS have been
made, all Submitted Sell Orders with respect to shares of such series shall be
accepted and, subject to the provisions of paragraphs (iv) and (v) of Section
8.9(d), Submitted Bids with respect to shares of such series shall be accepted
or rejected as follows in the following order of priority and all other
Submitted Bids with respect to shares of such series shall be rejected:
(1) Existing Holders' Submitted Bids for shares of such series
specifying any rate that is higher than the Winning Bid Rate for shares of such
series shall be accepted, thus requiring each such Existing Holder to sell the
APS subject to such Submitted Bids;
(2) Existing Holders' Submitted Bids for shares of such series
specifying any rate that is lower than the Winning Bid Rate for shares of such
series shall be rejected, thus entitling each such Existing Holder to continue
to hold the APS subject to such Submitted Bids;
(3) Potential Holders' Submitted Bids for shares of such series
specifying any rate that is lower than the Winning Bid Rate for shares of such
series shall be accepted;
(4) each Existing Holder's Submitted Bid for shares of such series
specifying a rate that is equal to the Winning Bid Rate for shares of such
series shall be rejected, thus entitling such Existing Holder to continue to
hold the APS subject to such Submitted Bid, unless the number of Outstanding APS
subject to all such Submitted Bids shall be greater than the number of APS
("remaining shares") in the excess of the Available APS of such series over the
number of APS subject to Submitted Bids described in Sections 8.9(d)(i)(A) and
(C), in which event such Submitted Bid of such Existing Holder shall be rejected
in part, and such Existing Holder shall be entitled to continue to hold APS
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subject to such Submitted Bid, but only in an amount equal to the number of APS
of such series obtained by multiplying the number of remaining shares by a
fraction, the numerator of which shall be the number of Outstanding APS held by
such Existing Holder subject to such Submitted Bid and the denominator of which
shall be the aggregate number of Outstanding APS subject to such Submitted Bids
made by all such Existing Holders that specified a rate equal to the Winning Bid
Rate for shares of such series; and
(5) each Potential Holder's Submitted Bid for shares of such series
specifying a rate that is equal to the Winning Bid Rate for shares of such
series shall be accepted but only in an amount equal to the number of shares of
such series obtained by multiplying the number of shares in the excess of the
Available APS of such series over the number of APS subject to Submitted Bids
described in clauses (2) through (4) of this Section 8.9(i)(A) by a fraction,
the numerator of which shall be the number of Outstanding APS subject to such
Submitted Bid and the denominator of which shall be the aggregate number of
Outstanding APS subject to such Submitted Bids made by all such Potential
Holders that specified a rate equal to the Winning Bid Rate for shares of such
series.
(B) If Sufficient Clearing Bids for shares of a series of APS
have not been made (other than because all of the Outstanding shares of such
series are subject to Submitted Hold Orders), subject to the provisions of
Section 8.9(d)(4), Submitted Orders for shares of such series shall be accepted
or rejected as follows in the following order of priority and all other
Submitted Bids for shares of such series shall be rejected:
(1) Existing Holders' Submitted Bids for shares of such series
specifying any rate that is equal to or lower than the Maximum Rate for shares
of such series shall be rejected, thus entitling such Existing Holders to
continue to hold the APS subject to such Submitted Bids;
(2) Potential Holders' Submitted Bids for shares of such series
specifying any rate that is equal to or lower than the Maximum Rate for shares
of such series shall be accepted; and
(3) Each Existing Holder's Submitted Bid for shares of such series
specifying any rate that is higher than the Maximum Rate for shares of such
series and the Submitted Sell Orders for shares of such series of each Existing
Holder shall be accepted, thus entitling each Existing Holder that submitted or
on whose behalf was submitted any such Submitted Bid or Submitted Sell Order to
sell the shares of such series subject to such Submitted Bid or Submitted Sell
Order, but in both cases only in an amount equal to the number of shares of such
series obtained by multiplying the number of shares of such series subject to
Submitted Bids described in clause (2) of this paragraph (B) by a fraction, the
numerator of which shall be the number of Outstanding shares of such series held
by such Existing Holder subject to such Submitted Bid or Submitted Sell Order
and the denominator of which shall be the aggregate number of Outstanding shares
of such series subject to all such Submitted Bids and Submitted Sell Orders.
(C) If all of the Outstanding shares of a series of APS are
subject to Submitted Hold Orders, all Submitted Bids for shares of such series
shall be rejected.
(D) If, as a result of the procedures described in clause (4)
or (5) of paragraph (A) or clause (3) of paragraph (B) of this Section
8.9(d)(i), any Existing Holder would be entitled or required to sell, or any
Potential Holder would be entitled or required to purchase, a fraction of a
share of a series of APS on any Auction Date, the Auction Agent shall, in such
manner as it shall determine in its sole discretion, round up or down the number
of APS of such series to be purchased or sold by any Existing Holder or
Potential Holder on such Auction Date as a result of such procedures so that the
number of shares so purchased or sold by each Existing Holder or Potential
Holder on such Auction Date shall be whole APS.
(E) If, as a result of the procedures described in clause (5)
of Section 8.9(d)(i)(A), any Potential Holder would be entitled or required to
purchase less than a whole share of a series of APS on any Auction Date, the
Auction Agent shall, in such manner as it shall determine in its sole
discretion, allocate APS of such series for purchase among Potential Holders so
that only whole shares of APS of such series are purchased on such Auction Date
as a result of such procedures by any Potential Holder, even if such allocation
results in one or more Potential Holders not purchasing APS of such series on
such Auction Date.
(F) Based on the results of each Auction for shares of a
series of APS, the Auction Agent shall determine the aggregate number of shares
of such series to be purchased and the aggregate number of shares of such series
to be sold by Potential Holders and Existing Holders and, with respect to each
Potential Holder and Existing Holder, to the extent that such aggregate number
of shares to be purchased and such aggregate number of shares to be sold differ,
determine to which other Potential Holder(s) or Existing Holder(s) they shall
deliver, or from which other Potential Holder(s) or Existing Holder(s) they
shall receive, as the case may be, APS of such series. Notwithstanding any
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provision of the Auction Procedures to the contrary, in the event an Existing
Holder or Beneficial Owner of a series of APS with respect to whom a
Broker-Dealer submitted a Bid to the Auction Agent for such shares that was
accepted in whole or in part, or submitted or is deemed to have submitted a Sell
Order for such shares that was accepted in whole or in part, fails to instruct
its Agent Member to deliver such shares against payment therefor, partial
deliveries of APS that have been made in respect of Potential Holders' or
Potential Beneficial Owners' submitted Bids for shares of such series that have
been accepted in whole or in part shall constitute good delivery to such
Potential Holders and Potential Beneficial Owners.
(G) None of the Fund, the Adviser, nor the Auction Agent nor any
affiliate of either shall have any responsibility or liability with respect to
the failure of an Existing Holder, a Potential Holder, a Beneficial Owner, a
Potential Beneficial Owner or its respective Agent Member to deliver APS of any
series or to pay for APS of any series sold or purchased pursuant to the Auction
Procedures or otherwise.
(e) Auction Agent.
For so long as any APS are outstanding, the Auction Agent, duly
appointed by the Fund to so act, shall be in each case a commercial bank, trust
company or other financial institution independent of the Fund and its
Affiliates (which however may engage or have engaged in business transactions
with the Fund or its Affiliates) and at no time shall the Fund or any of its
affiliates act as the Auction Agent in connection with the Auction Procedures.
If the Auction Agent resigns or for any reason its appointment is terminated
during any period that any APS are outstanding, the Board of Trustees shall use
its best efforts promptly thereafter to appoint another qualified commercial
bank, trust company or financial institution to act as the Auction Agent. The
Auction Agent's registry of Existing Holders of a series of APS shall be
conclusive and binding on the Broker-Dealers. A Broker-Dealer may inquire of the
Auction Agent between 3:00 p.m. on the Business Day preceding an Auction for a
series of APS and 9:30 a.m. on the Auction Date for such Auction to ascertain
the number of shares of such series in respect of which the Auction Agent has
determined such Broker-Dealer to be an Existing Holder. If such Broker-Dealer
believes it is the Existing Holder of fewer shares of such series than specified
by the Auction Agent in response to such Broker-Dealer's inquiry, such
Broker-Dealer may so inform the Auction Agent of that belief. Such Broker-Dealer
shall not, in its capacity as Existing Holder of shares of such series, submit
Orders in such Auction in respect of shares of such series covering in the
aggregate more than the number of shares of such series specified by the Auction
Agent in response to such Broker-Dealer's inquiry.
(f) Transfer of APS.
Unless otherwise permitted by the Fund, a Beneficial Owner or an
Existing Holder may sell, transfer or otherwise dispose of APS only in whole
shares and only pursuant to a Bid or Sell Order placed with the Auction Agent in
accordance with the procedures described in this Section 8.9 or to a
Broker-Dealer; provided, however, that (a) a sale, transfer or other disposition
of APS from a customer of a Broker-Dealer who is listed on the records of that
Broker-Dealer as the holder of such shares to that Broker-Dealer or another
customer of that Broker-Dealer shall not be deemed to be a sale, transfer or
other disposition for purposes of this Section 8.9 if such Broker-Dealer remains
the Existing Holder of the shares so sold, transferred or disposed of
immediately after such sale, transfer or disposition and (b) in the case of all
transfers other than pursuant to Auctions, the Broker-Dealer (or other Person,
if permitted by the Fund) to whom such transfer is made shall advise the Auction
Agent of such transfer.
(g) Global Certificate.
Prior to the commencement of a any period in which the holders of
Preferred Shares are entitled to elect a majority of the Board of Trustees, (i)
all of the shares of a series of APS outstanding from time to time shall be
represented by one global certificate registered in the name of the Securities
Depository or its nominee and (ii) no registration of transfer of shares of a
series of APS shall be made on the books of the Fund to any Person other than
the Securities Depository or its nominee.
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(h) Force Majeure.
(i) Notwithstanding anything else set forth herein, if an Auction Date
is not a Business Day because the New York Stock Exchange is closed for business
due to an act of God, natural disaster, act of war, civil or military
disturbance, act of terrorism, sabotage, riots or a loss or malfunction of
utilities or communications services or the Auction Agent is not able to conduct
an Auction in accordance with the Auction Procedures for any such reason, then
the Auction Rate for the next Dividend Period shall be the Auction Rate
determined on the previous Auction Date.
(ii) Notwithstanding anything else set forth herein, if a Dividend
Payment Date is not a Business Day because the New York Stock Exchange is closed
for business due to an act of God, natural disaster, act of war civil or
military disturbance, act of terrorism, sabotage, riots or a loss or malfunction
of utilities or communications services or the dividend payable on such date can
not be paid for any such reason, then:
(A) the Dividend Payment Date for the affected Dividend Period
shall be the next Business Day on which the Fund and its paying agent, if any,
are able to cause the dividend to be paid using their reasonable best efforts;
(B) the affected Dividend Period shall end on the day it would
have ended had such event not occurred and the Dividend Payment Date had
remained the scheduled date; and
(C) the next Dividend Period will begin and end on the dates
on which it would have begun and ended had such event not occurred and the
Dividend Payment Date remained the scheduled date.
(i) Miscellaneous.
The Board of Trustees may interpret the provisions of this Section 8.9
to resolve any inconsistency or ambiguity, remedy any formal defect or make any
other change or modification that does not materially adversely affect the
rights of Existing Holders of the Preferred Shares, and if such inconsistency,
ambiguity or formal defect reflects an inaccurate provision hereof, the Board of
Trustees may, in appropriate circumstances, amend this Section 8.9. An Existing
Holder (A) may sell, transfer or otherwise dispose of Preferred Shares only
pursuant to a Bid or Sell Order in accordance with the procedures described in
this Section 8.9 or to or through a Broker-Dealer, provided that in the case of
all transfers other than pursuant to Auctions such Existing Holder or its
Broker-Dealer or its Agent Member advises the Auction Agent of such transfer,
and (B) shall have the ownership of the Preferred Shares held by it maintained
in book-entry form by the Securities Depository in the account of its Agent
Member, which in turn will maintain records of such Existing Holder's beneficial
ownership. Neither the Fund nor any affiliated person of the Fund (as defined
under the Investment Company Act) shall submit any Order in any Auction. All of
the Outstanding Preferred Shares shall be represented by one certificate
registered in the name of the nominee of the Securities Depository. Each such
certificate shall bear a legend substantially to the effect that transfer of the
Shares represented by such certificate is subject to the restrictions specified
in Section 8.9(f). Neither the Fund nor any of its agents, including, without
limitation, the Auction Agent, shall have any liability with respect to the
failure of a Potential Holder, Existing Holder or Agent Member to deliver, or to
pay for, Preferred Shares sold or purchased in an Auction or otherwise.
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APPENDIX D - SETTLEMENT PROCEDURES
The following summary of Settlement Procedures sets forth the
procedures expected to be followed in connection with the settlement of each
Auction and will be incorporated by reference in the Auction Agency Agreement
and each Broker-Dealer Agreement. Nothing contained in this Appendix D
constitutes a representation by the Fund that in each Auction each party
referred to herein actually will perform the procedures described herein to be
performed by such party. Capitalized terms used herein shall have the respective
meanings specified in the glossary of the Prospectus or Appendix C hereto, as
the case may be.
(a) On each Auction Date, the Auction Agent shall notify by telephone
or through the Auction Agent's auction processing system the Broker-Dealers that
participated in the Auction held on such Auction Date and submitted an Order on
behalf of any Beneficial Owner or Potential Beneficial Owner of:
(i) the Applicable Rate fixed for the next succeeding Dividend Period;
(ii) whether Sufficient Clearing Bids existed for the determination of
the Applicable Rate;
(iii) if such Broker-Dealer (a "Seller's Broker-Dealer") submitted a
Bid or a Sell Order on behalf of a Beneficial Owner, the number of Preferred
Shares, if any, to be sold by such Beneficial Owner;
(iv) if such Broker-Dealer (a "Buyer's Broker-Dealer") submitted a Bid
on behalf of a Potential Beneficial Owner, the number of Preferred Shares, if
any, to be purchased by such Potential Beneficial Owner;
(v) if the aggregate number of Preferred Shares to be sold by all
Beneficial Owners on whose behalf such Broker-Dealer submitted a Bid or a Sell
Order exceeds the aggregate number of Preferred Shares to be purchased by all
Potential Beneficial Owners on whose behalf such Broker-Dealer submitted a Bid,
the name or names of one or more Buyer's Broker-Dealers (and the name of the
Agent Member, if any, of each such Buyer's Broker-Dealer) acting for one or more
purchasers of such excess number of Preferred Shares and the number of such
shares to be purchased from one or more Beneficial Owners on whose behalf such
Broker-Dealer acted by one or more Potential Beneficial Owners on whose behalf
each of such Buyer's Broker-Dealers acted;
(vi) if the aggregate number of Preferred Shares to be purchased by all
Potential Beneficial Owners on whose behalf such Broker-Dealer submitted a Bid
exceeds the aggregate number of Preferred Shares to be sold by all Beneficial
Owners on whose behalf such Broker-Dealer submitted a Bid or a Sell Order, the
name or names of one or more Seller's Broker-Dealers (and the name of the Agent
Member, if any, of each such Seller's Broker-Dealer) acting for one or more
sellers of such excess number of Preferred Shares and the number of such shares
to be sold to one or more Potential Beneficial Owners on whose behalf such
Broker-Dealer acted by one or more Beneficial Owners on whose behalf each of
such Seller's Broker-Dealers acted; and
(vii) the Auction Date of the next succeeding Auction with respect to
the Preferred Shares.
(b) On each Auction Date, each Broker-Dealer that submitted an Order on
behalf of any Beneficial Owner or Potential Beneficial Owner shall:
(i) in the case of a Broker-Dealer that is a Buyer's Broker-Dealer,
instruct each Potential Beneficial Owner on whose behalf such Broker-Dealer
submitted a Bid that was accepted, in whole or in part, to instruct such
Potential Beneficial Owner's Agent Member to pay to such Broker-Dealer (or its
Agent Member) through the Securities Depository the amount necessary to purchase
the number of Preferred Shares to be purchased pursuant to such Bid against
receipt of such shares and advise such Potential Beneficial Owner of the
Applicable Rate for the next succeeding Dividend Period;
(ii) in the case of a Broker-Dealer that is a Seller's Broker-Dealer,
instruct each Beneficial Owner on whose behalf such Broker-Dealer submitted a
Sell Order that was accepted, in whole or in part, to instruct such Beneficial
Owner's Agent Member to deliver to such Broker-Dealer (or its Agent Member)
through the Securities Depository the number of Preferred Shares to be sold
pursuant to such Order against payment therefor and advise any such Beneficial
Owner that will continue to hold Preferred Shares of the Applicable Rate for the
next succeeding Dividend Period;
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(iii) advise each Beneficial Owner on whose behalf such
Broker-Dealer submitted a Hold Order of the Applicable Rate for the next
succeeding Dividend Period;
(iv) advise each Beneficial Owner on whose behalf such Broker-Dealer
submitted an Order of the Auction Date for the next succeeding Auction; and
(v) advise each Potential Beneficial Owner on whose behalf
such Broker-Dealer submitted a Bid that was accepted, in whole or in part, of
the Auction Date for the next succeeding Auction.
(c) On the basis of the information provided to it pursuant to (a)
above, each Broker-Dealer that submitted a Bid or a Sell Order on behalf of a
Potential Beneficial Owner or a Beneficial Owner shall, in such manner and at
such time or times as in its sole discretion it may determine, allocate any
funds received by it pursuant to (b)(i) above and any AMPS received by it
pursuant to (b)(ii) above among the Potential Beneficial Owners, if any, on
whose behalf such Broker-Dealer submitted Bids, the Beneficial Owners, if any,
on whose behalf such Broker-Dealer submitted Bids that were accepted or Sell
Orders, and any Broker-Dealer or Broker-Dealers identified to it by the Auction
Agent pursuant to (a)(v) or (a)(vi) above.
(d) On each Auction Date:
(i) each Potential Beneficial Owner and Beneficial Owner shall instruct
its Agent Member as provided in (b)(i) or (ii) above, as the case may be;
(ii) each Seller's Broker-Dealer which is not an Agent Member
of the Securities Depository shall instruct its Agent Member to (A) pay through
the Securities Depository to the Agent Member of the Beneficial Owner delivering
shares to such Broker-Dealer pursuant to (b)(ii) above the amount necessary to
purchase such shares against receipt of such shares, and (B) deliver such shares
through the Securities Depository to a Buyer's Broker-Dealer (or its Agent
Member) identified to such Seller's Broker-Dealer pursuant to (a)(v) above
against payment therefor; and
(iii) each Buyer's Broker-Dealer which is not an Agent Member
of the Securities Depository shall instruct its Agent Member to (A) pay through
the Securities Depository to a Seller's Broker-Dealer (or its Agent Member)
identified pursuant to (a)(vi) above the amount necessary to purchase the shares
to be purchased pursuant to (b)(i) above against receipt of such shares, and (B)
deliver such shares through the Securities Depository to the Agent Member of the
purchaser thereof against payment therefor.
(e) On the day after the Auction Date:
(i) each Bidder's Agent Member referred to in (d)(i) above
shall instruct the Securities Depository to execute the transactions described
in (b)(i) or (ii) above, and the Securities Depository shall execute such
transactions;
(ii) each Seller's Broker-Dealer or its Agent Member shall
instruct the Securities Depository to execute the transactions described in
(d)(ii) above, and the Securities Depository shall execute such transactions;
and
(iii) each Buyer's Broker-Dealer or its Agent Member shall
instruct the Securities Depository to execute the transactions described in
(d)(iii) above, and the Securities Depository shall execute such transactions.
(f) If a Beneficial Owner selling Preferred Shares in an Auction fails
to deliver such shares (by authorized book-entry), a Broker-Dealer may deliver
to the Potential Beneficial Owner on behalf of which it submitted a Bid that was
accepted a number of whole Preferred Shares that is less than the number of
shares that otherwise was to be purchased by such Potential Beneficial Owner. In
such event, the number of Preferred Shares to be so delivered shall be
D-2
determined solely by such Broker-Dealer. Delivery of such lesser number of
shares shall constitute good delivery. Notwithstanding the foregoing terms of
this paragraph (f), any delivery or non-delivery of shares which shall represent
any departure from the results of an Auction, as determined by the Auction
Agent, shall be of no effect unless and until the Auction Agent shall have been
notified of such delivery or non-delivery in accordance with the provisions of
the Auction Agency Agreement and the Broker-Dealer Agreements.
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