PROSPECTUS October 30, 2003
--------------------------------------------------------------------------------
1,780 SHARES SERIES A
1,780 SHARES SERIES B
[JHF LOGO]
JOHN HANCOCK INCOME SECURITIES TRUST
AUCTION PREFERRED SHARES
--------------------------------------------------------------------------------
John Hancock Income Securities Trust (the "Fund") is a diversified, closed-end
management investment company organized in 1972. The Fund is offering 1,780
shares of its Series A Auction Preferred Shares and 1,780 shares of its Series B
Auction Preferred Shares (collectively, the "Preferred Shares" or "APS").
INVESTMENT OBJECTIVE. The Fund's investment objective is to generate a high
level of current income consistent with prudent investment risk.
PORTFOLIO CONTENTS. The Fund seeks to achieve its objective by investing
primarily in a diversified portfolio of freely marketable debt securities issued
by U.S. and foreign corporations and governments. Under normal circumstances the
Fund invests at least 80% of its assets (net assets plus borrowing for
investment purposes) in income securities, consisting of the following: (i)
marketable corporate debt securities, (ii) governmental obligations and (iii)
cash and commercial paper. The Fund may also invest up to 20% of its total
assets in income-producing preferred and common stocks. At least 75% of Fund's
total assets will be represented by debt securities which are rated, at the time
of acquisition, 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 Fund's investment adviser to be of
comparable credit quality. While the Fund focuses on intermediate and
longer-term debt securities, the Fund may acquire securities of any maturity and
is not subject to any limits as to the average maturity of its overall
portfolio. There can be no assurance that the Fund will achieve its investment
objective.
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 25.
CERTAIN OF THESE RISKS ARE SUMMARIZED IN "PROSPECTUS SUMMARY--SPECIAL RISK
CONSIDERATIONS" BEGINNING ON PAGE 3.
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)
------------------------------------------------------------------------------------------------------------------
Per share $ 25,000 $ 250 $ 24,750
------------------------------------------------------------------------------------------------------------------
Total $89,000,000 $890,000 $88,110,000
------------------------------------------------------------------------------------------------------------------
(1) Plus accumulated dividends, if any, from the date the APS are issued, but
before offering expenses payable by the Fund estimated to be $208,900.
The APS are being offered by the underwriter subject to certain conditions. The
underwriter reserves 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 November 4, 2003.
UBS Investment Bank
--------------------------------------------------------------------------------
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 A APS for the initial period from and including the date of issue
to, but excluding, November 20, 2003 will be 1.15% per year. The dividend rate
on the Series B APS for the initial period from and including the date of issue
to, but excluding, November 21, 2003 will be 1.15% 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 D 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 ("Common Shares"). The Fund's Common Shares are traded
on the New York Stock Exchange under the symbol "JHS." 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 30, 2003, 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 58 of this Prospectus. You may request a free copy of the Statement of
Additional Information by calling (800) 225-6020 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 underwriter has 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 underwriter is 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.
TABLE OF CONTENTS
--------------------------------------------------------------------------------
Prospectus summary........................... 1
Financial highlights......................... 13
The Fund..................................... 15
Use of proceeds.............................. 15
Capitalization (unaudited)................... 16
Portfolio composition........................ 16
Investment objective and principal investment
strategies................................. 17
Risk factors................................. 25
Description of Preferred Shares.............. 33
The Auction.................................. 43
Management of the Fund....................... 49
Net asset value.............................. 51
U.S. federal income tax matters.............. 52
Description of shares........................ 55
Certain provisions of the Declaration of
Trust and By-laws.......................... 56
Underwriting................................. 57
Custodian, transfer agent, registrar and
dividend disbursing agent.................. 57
Legal matters................................ 57
Table of contents for Statement of Additional
Information................................ 58
Glossary..................................... 59
--------------------------------------------------------------------------------
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 Income Securities Trust (the "Fund") is a diversified, closed-end
management investment company registered under the Investment Company Act of
1940, as amended (the "1940 Act"). The Fund was organized in 1972 and commenced
operations in 1973. See "The Fund." John Hancock Advisers, LLC (the "Adviser")
acts as the Fund's investment adviser and administrator. The Fund's common
shares of beneficial interest ("Common Shares") are traded on the New York Stock
Exchange under the symbol "JHS." As of September 30, 2003, the Fund had
11,002,049 Common Shares outstanding and net assets of $185.6 million.
THE OFFERING
The Fund is offering an aggregate of 1,780 Series A APS and 1,780 Series B 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 by UBS
Securities LLC (the "Underwriter"). 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 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 A APS will be November 19, 2003, and for Series B APS will be
November 20, 2003, each being the Business Day before the Initial Dividend
Payment Date for the Initial Dividend Period for the relevant series of APS,
November 20, 2003 for Series A APS, and November 21, 2003 for Series B APS.
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, the Auction Date for Series A APS
generally will be Wednesday and for Series B APS generally will be Thursday.
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.
INVESTMENT OBJECTIVE AND POLICIES
INVESTMENT OBJECTIVE
The Fund's investment objective is to generate a high level of current income
consistent with prudent investment risk.
1
PORTFOLIO CONTENTS
The Fund seeks to achieve its objective by investing primarily in a diversified
portfolio of freely marketable debt securities issued by U.S. and foreign
corporations and governments. Under normal circumstances the Fund will invest at
least 80% of its assets (net assets plus borrowing for investment purposes) in
income securities, consisting of: (i) marketable corporate debt securities, (ii)
governmental obligations and (iii) cash and commercial paper. The Fund may also
invest up to 20% of its total assets in income-producing preferred and common
stocks. While the Fund focuses on intermediate and longer-term debt securities,
the Fund may acquire securities of any maturity and is not subject to any limits
as to the average maturity of its overall portfolio.
At least 75% of the Fund's total assets will be represented by debt securities
which are rated, at the time of acquisition, 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 25% of its total
assets in debt securities rated below investment grade or in unrated debt
securities determined by the Adviser to be of comparable quality.
In managing the Fund's portfolio, the Adviser concentrates first on sector
selection by deciding which types of debt securities and industries to emphasize
at a given time, and then which individual debt securities to buy. When making
sector and industry allocations, the Adviser tries to anticipate shifts in the
business cycle, using top-down analysis to determine which sectors and
industries may benefit over the next 12 months. In choosing individual
securities, the Adviser uses bottom-up research to find securities that appear
comparatively undervalued. The Adviser looks at bonds of all quality levels and
maturities from many different issuers, potentially including U.S.
dollar-denominated securities of foreign corporations and governments. The
Adviser may use short-term trading as a means of managing the Fund's portfolio
to achieve its investment objective. There can be no assurance that the Fund
will achieve its investment objective.
FOREIGN SECURITIES
Although the Fund will focus on securities of U.S. issuers, the Fund may invest
in securities of corporate and governmental issuers located outside the United
States that are payable in U.S. dollars, including emerging market issuers.
ILLIQUID SECURITIES
The Fund may invest up to 20% of its total assets in illiquid securities, which
are securities that cannot 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 objective. The Fund may invest the remainder of its assets in
securities with remaining maturities of less than one year or cash equivalents,
or it 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 it may hold cash. During such periods, the Fund may not be able to achieve
its investment objective.
HEDGING AND INTEREST RATE TRANSACTIONS
The Fund may, but is not required to, use various hedging and interest rate
transactions to mitigate risks and to facilitate portfolio management. The Fund
may purchase and sell derivative instruments such as exchange-listed and
over-the-counter put and call options on securities, fixed income, interest rate
and equity indices, and other financial instruments and purchase and sell
financial futures contracts and options thereon, and 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
2
instruments that combine features of these instruments. The Fund generally seeks
to use these instruments and transactions as a hedging or portfolio management
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 does not engage in these transactions
for speculation, but only for hedging or other permissible risk management
purposes and to facilitate portfolio management.
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 objective 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 the preparation of reports.
The Adviser serves as the investment adviser to several closed-end and open-end
investment companies which focus on investing in fixed income securities. The
Adviser also serves as the investment adviser to several leveraged dual-class,
closed-end investment companies. The Adviser was organized in 1968 and had, as
of June 30, 2003, approximately $27.5 billion in assets under management, of
which approximately $12.6 billion was invested in fixed income securities. The
Adviser manages approximately $3.4 billion in leveraged dual-class funds. The
Adviser is an indirect wholly-owned subsidiary of John Hancock Financial
Services, Inc., a financial services company. On September 28, 2003, Manulife
Financial Corporation and John Hancock Financial Services, Inc. announced plans
to merge, which transaction is expected to occur in the first half of 2004.
LEVERAGE
The Fund expects to utilize financial leverage on an ongoing basis for
investment purposes. After completion of the offering of the APS, the Fund
anticipates its total leverage from the issuance of APS will be approximately
33 1/3% of the Fund's total capital. This amount may change, but total leverage
will not exceed 50% of the Fund's total capital. 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). 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 "Risk factors--RISKS OF
INVESTMENT IN PREFERRED SHARES--Leverage risk."
SPECIAL RISK CONSIDERATIONS
Risks of investing in the Preferred Shares include:
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 APS if you sell them outside of the Auction,
especially when market interest rates are rising
3
+ 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 a similar investment objective and similar policies.
These include the possibility of higher volatility of the net asset value of the
Fund and the Preferred Shares' asset coverage.
INTEREST RATE RISK
The APS pay dividends based on shorter-term interest rates. The Fund will invest
the proceeds from the issuance of the APS primarily in debt securities issued by
corporate and governmental issuers, which bear intermediate to longer-term
interest rates. The yields on intermediate to longer-term debt 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 debt 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. Given the historically low level of
interest rates during 2003 and the likelihood that interest rates will increase
when the national economy strengthens, the risk of the potentially negative
impact of rising interest rates on the value of the Fund's portfolio may be
significant and may adversely affect the Preferred Shares' asset coverage.
Increasing short-term interest rates may also adversely affect the benefits of a
leverage structure to the holders of the Common Shares, increasing the potential
for the Fund to voluntarily redeem the APS. In addition, the longer the average
maturity of the Fund's portfolio of debt securities, the greater the potential
impact of rising interest rates on the value of the Fund's portfolio and the
less flexibility the Fund may have to respond to the decreasing spread between
the yield on its portfolio securities and the yield on the APS.
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 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 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
4
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 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:
INTEREST RATE RISK
Interest rate risk is the risk that fixed income securities such as debt
securities and preferred 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 investments in debt securities and
preferred securities means that the Fund's net asset value will tend to decline
if market interest rates rise. Given the historically low level of interest
rates during 2003 and the likelihood that interest rates will increase when the
national economy strengthens, the risk of the potentially negative impact of
rising interest rates on the value of the Fund's portfolio may be significant
and may adversely affect the Preferred Shares' asset coverage. Increasing
short-term interest rates may also adversely affect the benefits of a leverage
structure to the holders of the Common Shares, increasing the potential for the
Fund to voluntarily redeem the APS. In addition, the longer the average maturity
of the Fund's portfolio of debt securities, the greater the potential impact of
rising interest rates on the value of the Fund's portfolio and the less
flexibility the Fund may have to respond to the decreasing spread between the
yield on its portfolio securities and the yield on the APS.
During periods of declining interest rates, an issuer may exercise its option to
prepay principal of debt securities or to redeem preferred 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.
CORPORATE DEBT SECURITIES
Corporate debt obligations are subject to the risk of an issuer's inability to
meet principal and interest payments on the obligations and may also be subject
to price volatility due to such factors as market interest rates, market
perception of the creditworthiness of the issuer and general market liquidity.
CREDIT RISK
Credit risk is the risk that debt securities in the Fund's portfolio will
decline in price or fail to make interest or dividend payments when due because
the issuer of the security experiences a decline in its financial status. At
least 75% of the Fund's total assets will be represented by debt securities
which are rated, at the time of acquisition, investment grade or in unrated
securities determined by the Adviser to be of comparable credit quality.
Although the Fund will primarily invest in investment grade securities, the Fund
is authorized to invest up to 25% of its total assets in debt securities rated
below investment grade at the time of acquisition.
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;
interest or dividend payments and
5
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 interest or
dividends 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 interest or dividends and to 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 highly 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. Below investment grade securities
are commonly referred to as "junk bonds" or "high yield securities." Securities
rated Ba or BB may face significant ongoing uncertainties or exposure to adverse
business, financial or economic conditions that could lead to the issuer being
unable to meet its financial commitments. The protection of interest and
principal may be moderate and not well safeguarded during both good and bad
times. Securities rated B generally lack the characteristics of a desirable
investment. Assurance of interest and principal payments over the long term may
be low, and such securities are more vulnerable to nonpayment than obligations
rated BB or Ba. Adverse business, financial or economic conditions will likely
impair the issuer's capacity or willingness to meet its financial commitments.
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.
MORTGAGE-BACKED SECURITIES
Mortgage-backed securities represent participation interests in pools of
adjustable and fixed rate mortgage loans which are guaranteed by agencies or
instrumentalities of the U.S. government. Unlike conventional debt obligations,
mortgage-backed securities provide monthly payments derived from the monthly
interest and principal payments (including any prepayments) made by the
individual borrowers on the pooled mortgage loans. The mortgage loans underlying
mortgage-backed securities are generally subject to a greater rate of principal
prepayments in a declining interest rate environment and to a lesser rate of
principal prepayments in an increasing interest rate environment. Under certain
interest and prepayment scenarios, the Fund may fail to recover the full amount
of its investment in mortgage-backed securities notwithstanding any direct or
indirect governmental or agency guarantee. Since faster than expected
prepayments must usually be invested in lower yielding securities, mortgage-
backed securities are less effective than conventional bonds in "locking in" a
specified interest rate. In a rising interest rate environment, a declining
prepayment rate may extend the average life of many mortgage-backed securities.
Extending the average life of a mortgage-backed security increases the risk of
depreciation due to future increases in market interest rates. Government
sponsored entities such as the Federal Home Loan Mortgage Corporation, the
Federal National Mortgage Association and the Federal Home Loan Banks, although
chartered or sponsored by Congress, are not funded by congressional
appropriations and the debt and mortgage-backed securities issued by them are
neither guaranteed nor issued by the U.S. government.
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. 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 government. Others
are supported by: (i) the right of the issuer to borrow from the U.S. Treasury;
(ii) the discretionary authority of the U.S. government to purchase the agency's
obligations; 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
6
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.
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.
PREFERRED SECURITIES
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. Preferred securities may be substantially less liquid
than many other securities, such as common stocks or U.S. government securities.
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. An issuer of preferred securities may also redeem the securities prior to
a specified date. A special redemption by the issuer may negatively impact the
return of the security held by the Fund. 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.
COMMON STOCKS
The common stocks and other non-preferred equity securities in which the Fund
may invest may experience substantially more volatility in their market value
than the Fund's investments in debt 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.
FOREIGN SECURITIES
Although the Fund will only invest in securities of non-U.S. issuers that are
payable 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, accounting standards or regulatory practices
+ many non-U.S. markets are smaller, less liquid and more volatile; therefore,
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
+ currency exchange rates or controls may adversely affect the value of the
Fund's investments
7
+ 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
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
hedging and interest rate transactions successfully 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.
SHORT-TERM TRADING AND PORTFOLIO TURNOVER
The Fund may engage in short-term trading in response to changes in interest
rates, stock market conditions, or other economic trends and developments, or to
take advantage of yield disparities between various fixed income securities in
order to improve income. Short-term trading may have the effect of increasing
portfolio turnover rate. A high rate of portfolio turnover (100% or greater)
involves correspondingly greater brokerage expenses. For the fiscal year ended
December 31, 2002, the Fund's portfolio turnover rate was 371%. The success of
short-term trading will depend upon the ability of the Adviser to evaluate
particular securities, to anticipate relevant market factors, including trends
of interest rates and earnings and variations from such trends, to obtain
relevant information, to evaluate it promptly, and to take advantage of its
evaluations by completing transactions on a favorable basis. There can be no
assurance that the Adviser will be successful in that evaluation.
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. Most of such dividends will be taxable as ordinary
income to shareholders that, in the case of corporate shareholders, will not
qualify for the dividends received deduction and, in the case of individual
shareholders, will not be treated as "qualified dividend income" and thus will
not be eligible for taxation at the new favorable tax rates applicable to
long-term capital gains. Distributions of net capital gain that are designated
by the Fund as capital gain dividends (if any) 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, 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.
8
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 Initial 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.
ENDING DATE OF NUMBER OF DAYS OF
INITIAL DIVIDEND INITIAL DIVIDEND INITIAL DIVIDEND SUBSEQUENT DIVIDEND INITIAL DIVIDEND
RATE PERIOD PAYMENT DATE PAYMENT DATES PERIOD
--------------------------------------------------------------------------------------------------------------------------
Series A............. 1.15% November 19, 2003 November 20, 2003 Normally every 7 days 16
Series B............. 1.15% November 20, 2003 November 21, 2003 Normally every 7 days 17
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).
9
APPLICABLE PERCENTAGE PAYMENT TABLE
MOODY'S CREDIT RATINGS APPLICABLE PERCENTAGE
-----------------------------------------------------------------------------------
Aaa......................................................... 125%
Aa3 to Aa1.................................................. 150%
A3 to A1.................................................... 200%
Baa3 to Baa1................................................ 250%
Below Baa3.................................................. 300%
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 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."
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
+ asset coverage of at least 200% with respect to senior securities of the Fund
that are shares of beneficial interest, 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, 2003, the asset coverage of the APS as measured pursuant to
the 1940 Act would be approximately 307% if the Fund were to issue the 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
10
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
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.
+ 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 who 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
11
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
Information contained in the table below shows the audited operating performance
of the Fund for the last ten fiscal years. The information was audited by Ernst
& Young LLP, independent auditors, whose reports, along with the Fund's
financial statements, are included in the Fund's annual reports. The information
for the semi-annual period ended June 30, 2003 is unaudited.
SEMI-ANNUAL
PERIOD ENDED FISCAL YEARS ENDED DECEMBER 31,
JUNE 30, ---------------------------------------------
2003(1) 2002(2) 2001(2) 2000 1999 1998
-----------------------------------------------------------------------------------------------
Per Common Share operating
performance:
Net asset value, beginning of
period........................ $16.31 $16.06 $15.89 $15.37 $ 16.64 $16.55
Increase/(decrease) from
investment operations:
Net investment income(3)...... 0.44 0.89 1.00 1.07 1.10 1.14
Net realized and unrealized
gain/(loss) on
investments................ 0.78 0.28 0.19 0.52 (1.27) 0.09
Total from investment
operations.................... 1.22 1.17 1.19 1.59 (0.17) 1.23
Less distributions:
Distributions (from net
investment income) to
shareholders............... (0.46) (0.92) (1.02) (1.07) (1.10) (1.14)
Distributions (from net
realized gain on
investments sold) to
shareholders............... -- -- -- -- -- --
Total distributions............. (0.46) (0.92) (1.02) (1.07) (1.10) (1.14)
Net asset value, end of
period........................ $17.07 $16.31 $16.06 $15.89 $ 15.37 $16.64
Per share market value, end of
period........................ $15.70 $14.66 $14.65 $14.44 $ 12.69 $15.88
Total Return at Market
Value(4)(%)................... 10.26(5) 6.42 8.69 23.06 (13.42) 1.75
Ratios and supplemental data:
Net assets, end of period (in
millions)..................... $188 $ 179 $ 175 $ 172 $ 165 $ 177
Ratio of expenses to average net
assets (%).................... 0.81(6) 0.84 0.80 0.84 0.80 0.81
Ratio of net investment income
to average net assets
applicable to shareholders
(%)........................... 5.31(6) 5.56 6.17 6.89 6.88 6.79
Portfolio turnover rate (%)..... 151 371 299 248 184 240
--------------------------------------------------------------------------------
13
FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------
FISCAL YEARS ENDED DECEMBER 31,
---------------------------------------------
1997 1996 1995 1994 1993
------------------------------------------------------------------------------------------------
Per Common Share operating performance:
Net asset value, beginning of period........... $16.20 $16.74 $15.10 $16.97 $16.31
Increase/(decrease) from investment operations:
Net investment income........................ 1.20 1.22 1.26 1.28 1.31
Net realized and unrealized gain/(loss) on
investments and financial futures
contracts................................. 0.35 (0.54) 1.64 (1.79) 0.80
Total from investment operations............... 1.55 0.68 2.90 (0.51) 2.11
Less distributions:
Distributions (from net investment income) to
shareholders.............................. (1.20) (1.22) (1.26) (1.28) (1.32)
Distributions (from net realized gain on
investments sold and financial futures
contracts) to common shareholders......... -- -- -- (0.08) (0.13)
Total distributions............................ (1.20) (1.22) (1.26) (1.36) (1.45)
Net asset value, end of period................. $16.55 $16.20 $16.74 $15.10 $16.97
Per share market value, end of period.......... $16.75 $14.88 $15.75 $13.75 $16.50
Total Return at Market Value(4)(%)............. 21.57 2.34 24.11 (8.70) 7.22
Ratios and supplemental data:
Net assets, end of period (in millions)........ $ 174 $ 169 $ 173 $ 154 $ 171
Ratio of expenses to average net assets (%).... 0.84 0.84 0.84 0.87 0.84
Ratio of net investment income to average net
assets (%)................................... 7.34 7.50 7.77 8.03 7.67
Portfolio turnover rate (%).................... 143 117 105 82 95
(1) Semiannual period from January 1, 2003 to June 30, 2003 is unaudited
(2) As required, effective January 1, 2001, the Fund has adopted the
provisions of the AICPA Audit and Accounting Guide for Investment
Companies, as revised, relating to the amortization of premiums and
accretion of discounts on debt securities. The effect of this change for
the year ended December 31, 2001, was to decrease net investment income
per share by $0.02, increase net realized and unrealized gain per share by
$0.02, and, had the Fund not made these changes to amortization, the ratio
of net investment income to average net assets would have been 6.30%. Per
share ratios and supplemental data for the periods prior to January 1,
2001 have not been restated to reflect this change in presentation
(3) Based on average shares outstanding
(4) Assumes dividend reinvestment
(5) Not annualized
(6) Annualized
--------------------------------------------------------------------------------
14
--------------------------------------------------------------------------------
The Fund
John Hancock Income Securities Trust (the "Fund") is a diversified, closed-end
management investment company registered under the 1940 Act. The Fund was
organized as a corporation under the laws of the State of Maryland on October
20, 1972 and converted to a Massachusetts business trust under the laws of the
Commonwealth of Massachusetts on October 5, 1984. The Fund commenced operations
on February 22, 1973. The Fund's principal office is located at 101 Huntington
Avenue, Boston, Massachusetts 02199, and its telephone number is (800) 255-6020.
The Fund's Common Shares are traded on the NYSE under the symbol "JHS."
The following provides information about the Fund's outstanding shares as of
September 30, 2003.
AMOUNT HELD
AMOUNT BY THE FUND OR AMOUNT
TITLE OF CLASS AUTHORIZED FOR ITS ACCOUNT OUTSTANDING
--------------------------------------------------------------------------------------------------
Common Shares......................................... Unlimited 0 11,002,049
Unlimited
for each
Auction Preferred Shares.............................. series 0 0
Series A
Series B
Use of proceeds
The net proceeds of this offering of APS will be approximately $87,901,100 after
payment of offering costs (including sales load) estimated to be approximately
$1,098,900. The Fund will invest the net proceeds of the offering in accordance
with its investment objective and policies as stated below under "Investment
objective 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 objective 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 objective and principal investment strategies."
--------------------------------------------------------------------------------
15
--------------------------------------------------------------------------------
Capitalization (unaudited)
The following table sets forth the capitalization of the Fund as of September
30, 2003, 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 outstanding Common Shares.
ACTUAL AS ADJUSTED
------------------------------------------------------------------------------------------
Auction Preferred Shares, no par value per share (no shares
issued;
3,560 shares issued, as adjusted at $25,000 per share
liquidation preference)................................ $ -- $ 89,000,000
============ ============
SHAREHOLDER'S EQUITY:
Common Shares, no par value per share (11,002,049 shares
outstanding)(1)........................................ 176,275,780 175,176,880
------------ ------------
PAID-IN SURPLUS
Balance of undistributed net investment income............ 50,603 50,603
------------ ------------
Accumulated net realized gain/(loss) from investment
transactions........................................... 2,839,412 2,839,412
------------ ------------
Net unrealized appreciation/(depreciation) of
investments............................................ 6,397,370 6,397,370
------------ ------------
Net assets attributable to Common Shares.................. 185,563,165 184,464,265
============ ============
(1) None of these outstanding shares are held by or for the account of the Fund
Portfolio composition
As of September 30, 2003, approximately 88% of the market value of the Fund's
portfolio was invested in debt securities, approximately 11% in preferred
securities and approximately 1% of the market value of the Fund's portfolio was
invested in 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, 2003, based on the highest rating assigned each investment.
VALUE
CREDIT RATING (MOODY'S/S&P) NUMBER OF ISSUES (000) PERCENT
--------------------------------------------------------------------------------------------------
Aaa/AAA.................................................. 10 $ 56,305 30%
Aa/AA.................................................... 6 2,410 1
A/A...................................................... 27 26,721 14
Baa/BBB.................................................. 62 70,707 38
Ba/BB.................................................... 16 16,143 9
B/B...................................................... 16 9,759 5
Caa/CCC.................................................. 2 1,433 1
Unrated+................................................. 4 1,498 1
Short-term............................................... 1 1,051 1
--- ---------- ---
Total.................................................. 144 186,027 100
=== ========== ===
+ Refers to securities that have not been rated by Moody's or S&P. See
"Investment objective and principal investment strategies--PORTFOLIO CONTENTS
AND PRINCIPAL INVESTMENT STRATEGIES"
--------------------------------------------------------------------------------
16
--------------------------------------------------------------------------------
Investment objective and principal investment strategies
INVESTMENT OBJECTIVE
The Fund's investment objective is to generate a high level of current income
consistent with prudent investment risk. The Fund's investment objective is not
a fundamental policy 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 objective.
PRINCIPAL INVESTMENT FOCUS AND PHILOSOPHY
The Fund seeks to achieve its objective by investing primarily in a diversified
portfolio of freely marketable debt securities issued by U.S. and foreign
corporations and governments. Under normal circumstances the Fund will invest at
least 80% of its assets (net assets plus borrowing for investment purposes) in
income securities, consisting of: (i) marketable corporate debt securities, (ii)
governmental obligations and (iii) cash and commercial paper. This is a
non-fundamental policy and may be changed by the Board of Trustees of the Fund
as long as 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 may also
invest up to 20% of its total assets in income-producing preferred and common
stocks. While the Fund focuses on intermediate and longer-term debt securities,
the Fund may acquire securities of any maturity and is not subject to any limits
as to the average maturity of its overall portfolio.
At least 75% of the Fund's total assets will be represented by debt securities
which are rated, at the time of acquisition, 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 Fund's
investment adviser to be of comparable credit quality. The Fund may invest up to
25% of its total assets in debt securities rated below investment grade or in
unrated debt securities determined by the Adviser to be of comparable quality.
Securities rated "BBB" by S&P are regarded by S&P as having an adequate capacity
to pay interest or dividends 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 interest or dividends 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; interest or dividend 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 highly
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.
Securities rated Ba or BB may face significant ongoing uncertainties or exposure
to adverse business, financial or economic conditions that could lead to the
issuer being unable to meet its financial commitments. The protection of
interest and principal may be moderate and not well safeguarded during both good
and bad times. Securities rated B generally lack the characteristics of a
desirable investment. Assurance of interest and principal payments over the long
term may be low, and such securities are more vulnerable to nonpayment than
obligations rated BB or Ba. Adverse business, financial or economic conditions
will likely impair the issuer's capacity or willingness to meet its financial
commitments. 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
--------------------------------------------------------------------------------
17
INVESTMENT OBJECTIVE AND PRINCIPAL INVESTMENT STRATEGIES
--------------------------------------------------------------------------------
securities ratings by Moody's and S&P in this Prospectus shall, unless otherwise
indicated, include all securities within each such rating category (e.g.,
"Baa1", "Baa2" and "Baa3" in the case of Moody's and "BBB+", "BBB" and "BBB-" in
the case of S&P). All percentage and ratings limitations on securities in which
the Fund may invest apply 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.
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.
In managing the Fund's portfolio, the Adviser concentrates first on sector
selection by deciding which types of bonds and industries to emphasize at a
given time, and then which individual bonds to buy. When making sector and
industry allocations, the Adviser tries to anticipate shifts in the business
cycle, using top-down analysis to determine which sectors and industries may
benefit over the next 12 months. In choosing individual securities, the Adviser
uses bottom-up research to find securities that appear comparatively
undervalued. The Adviser looks at bonds of all quality levels and maturities
from many different issuers, potentially including U.S. dollar-denominated
securities of foreign corporations and governments. The Adviser may use
short-term trading as a means of managing the Fund's portfolio to achieve its
investment objective. There can be no assurance that the Fund will achieve its
investment objective.
PORTFOLIO CONTENTS AND PRINCIPAL INVESTMENT STRATEGIES
CORPORATE DEBT SECURITIES
Corporate debt obligations are subject to the risk of an issuer's inability to
meet principal and interest payments on the obligations and may also be subject
to price volatility due to such factors as market interest rates, market
perception of the creditworthiness of the issuer and general market liquidity.
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 Cooperatives, Federal Farm Credit Banks,
Federal Home Loan Banks (FHLB), 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 government. 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
--------------------------------------------------------------------------------
18
INVESTMENT OBJECTIVE AND PRINCIPAL INVESTMENT STRATEGIES
--------------------------------------------------------------------------------
(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.
MORTGAGE-BACKED SECURITIES
The Fund may invest in mortgage-backed securities which represent participation
interests in pools of adjustable and fixed rate mortgage loans which are
guaranteed by agencies or instrumentalities of the U.S. government. Unlike
conventional debt obligations, mortgage-backed securities provide monthly
payments derived from the monthly interest and principal payments (including any
prepayments) made by the individual borrowers on the pooled mortgage loans. The
mortgage loans underlying mortgage-backed securities are generally subject to a
greater rate of principal prepayments in a declining interest rate environment
and to a lesser rate of principal prepayments in an increasing interest rate
environment. Under certain interest and prepayment scenarios, the Fund may fail
to recover the full amount of its investment in mortgage-backed securities
notwithstanding any direct or indirect governmental or agency guarantee. Since
faster than expected prepayments must usually be invested in lower yielding
securities, mortgage-backed securities are less effective than conventional
bonds in "locking in" a specified interest rate. In a rising interest rate
environment, a declining prepayment rate may extend the average life of many
mortgage-backed securities. Extending the average life of a mortgage-backed
security increases the risk of depreciation due to future increases in market
interest rates. Government sponsored entities such as the FHLMC, FNMA, and FHLB,
although chartered or sponsored by Congress, are not funded by congressional
appropriations and the debt and mortgage-backed securities issued by them are
neither guaranteed nor issued by the U.S. government.
The Fund's investments in mortgage-backed securities may include conventional
mortgage pass through securities and certain classes of multiple class
collateralized mortgage obligations ("CMOs"). In order to reduce the risk of
prepayment for investors, CMOs are issued in multiple classes, each having
different maturities, interest rates, payment schedules and allocations of
principal and interest on the underlying mortgages. Senior CMO classes will
typically have priority over residual CMO classes as to the receipt of principal
and/or interest payments on the underlying mortgages. The CMO classes in which
the Fund may invest include but are not limited to sequential and parallel pay
CMOs, including planned amortization class ("PAC") and target amortization class
("TAC") securities.
Different types of mortgage-backed securities are subject to different
combinations of prepayment, extension, interest rate and/or other market risks.
Conventional mortgage pass through securities and sequential pay CMOs are
subject to all of these risks, but are typically not leveraged. PACs, TACs and
other senior classes of sequential and parallel pay CMOs involve less exposure
to prepayment, extension and interest rate risk than other mortgage-backed
securities, provided that prepayment rates remain within expected prepayment
ranges or "collars."
FOREIGN SECURITIES
While the Fund primarily invests in the securities of U.S. issuers, the Fund may
invest in securities of corporate and governmental issuers located outside the
United States, including emerging market issuers. The Fund only invests in
securities of foreign issuers that are payable in U.S. dollars.
PREFERRED AND COMMON STOCKS
The Fund may invest up to 20% of its assets in income producing preferred
securities and common stocks. The Fund normally will invest in such securities
when the Adviser believes that they will provide a sufficiently high yield to
attain the Fund's investment objective. The Fund may also purchase income
producing securities which are convertible into or come with rights to purchase
preferred and 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
--------------------------------------------------------------------------------
19
INVESTMENT OBJECTIVE AND PRINCIPAL INVESTMENT STRATEGIES
--------------------------------------------------------------------------------
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 capital appreciation.
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 as of 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 its liquidation value 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.
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.
SHORT-TERM TRADING
The Fund may engage in short-term trading in response to stock market
conditions, changes in interest rates or other economic trends and developments,
or to take advantage of yield disparities between various fixed income
securities in order to realize capital gains or improve income. Short term
trading may have the effect of increasing portfolio turnover rate. A high rate
of portfolio turnover (100% or greater) involves correspondingly greater
brokerage expenses. For the fiscal year ended December 31, 2002, the Fund's
portfolio turnover rate was 371%. The success of short-term trading will depend
upon the ability of the Adviser to evaluate particular securities, to anticipate
relevant market factors, including trends of interest rates and earnings and
variations from such trends, to obtain relevant information, to evaluate it
promptly, and to take advantage of its evaluations by completing
--------------------------------------------------------------------------------
20
INVESTMENT OBJECTIVE AND PRINCIPAL INVESTMENT STRATEGIES
--------------------------------------------------------------------------------
transactions on a favorable basis. There can be no assurance that the Adviser
will be successful in that evaluation.
HEDGING AND INTEREST RATE TRANSACTIONS
The Fund may, but is not required to, use various hedging and interest rate
transactions described below to mitigate risks or facilitate portfolio
management. Such transactions are generally accepted under modern portfolio
management and are regularly used by many mutual funds and other institutional
investors. Although the Adviser seeks to use these practices to further the
Fund's investment objective, 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,
fixed income, interest rate and equity indices, and other financial instruments,
purchase and sell financial futures contracts and options thereon, and 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 does not engage in these transactions
for speculative 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 objective. 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.
--------------------------------------------------------------------------------
21
INVESTMENT OBJECTIVE AND PRINCIPAL INVESTMENT STRATEGIES
--------------------------------------------------------------------------------
OTHER INVESTMENT POLICIES
STRUCTURED SECURITIES
The Fund may invest in structured securities including notes, bonds or
debentures, the value of the principal of and/or interest on which is to be
determined by reference to changes in the value of specific currencies, interest
rates, commodities, indices or other financial indicators (the "Reference") or
the relative change in two or more References. The interest rate or the
principal amount payable upon maturity or redemption may be increased or
decreased depending upon changes in the applicable Reference. The terms of the
structured securities may provide that in certain circumstances no principal is
due at maturity and, therefore, may result in the loss of the Fund's investment.
Structured securities may be positively or negatively indexed, so that
appreciation of the Reference may produce an increase or decrease in the
interest rate or value of the security at maturity. In addition, the change in
interest rate or the value of the security at maturity may be a multiple of the
change in the value of the Reference. Consequently, structured securities entail
a greater degree of market risk than other types of debt obligations. Structured
securities may also be more volatile, less liquid and more difficult to price
accurately than less complex fixed income investments.
FORWARD COMMITMENT AND WHEN-ISSUED SECURITIES
The Fund may purchase securities on a when-issued or forward commitment basis.
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. 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, of any
type or maturity, equal in value to the Fund's commitment. Alternatively, the
Fund may enter into offsetting contracts for the forward sale of other
securities that it owns.
REPURCHASE AGREEMENTS
In a repurchase agreement the Fund would buy 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. In the event of bankruptcy or other default
by a seller of a repurchase agreement, the Fund could experience delays and
additional expense in liquidating the underlying securities, declines in value
of the underlying securities and a loss of income.
REVERSE REPURCHASE AGREEMENTS
The Fund may also enter into reverse repurchase agreements but has no current
intention to do so. Reverse repurchase agreements 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
--------------------------------------------------------------------------------
22
INVESTMENT OBJECTIVE AND PRINCIPAL INVESTMENT STRATEGIES
--------------------------------------------------------------------------------
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. In addition, the Fund will not enter into reverse repurchase
agreements, except from banks as a temporary measure for extraordinary emergency
purposes in amounts not to exceed 33 1/3% of the Fund's total assets (including
the amount borrowed) taken at market value. The Fund will enter into reverse
repurchase agreements only with federally insured banks which are approved in
advance as being creditworthy by the Trustees. Under the procedures established
by the Trustees, the Adviser will monitor the creditworthiness of the banks
involved. The Fund's ability to enter into reverse repurchase agreements may be
limited by the issuance of the Preferred Shares, including the guidelines
established by Moody's.
MORTGAGE "DOLLAR ROLL" TRANSACTIONS
The Fund may enter into mortgage "dollar roll" transactions with selected banks
and broker-dealers pursuant to which the Fund sells mortgage-backed securities
and simultaneously contracts to repurchase substantially similar (same type,
coupon and maturity) securities on a specified future date. The Fund will only
enter into covered rolls. A "covered roll" is a specific type of dollar roll for
which there is an offsetting cash position or a cash equivalent security
position which matures on or before the forward settlement date of the dollar
roll transaction. Covered rolls are not treated as a borrowing or other senior
security and will be excluded from the calculation of the Fund's borrowings and
other senior securities. For financial reporting and tax purposes, the Fund
treats mortgage dollar rolls as two separate transactions; one involving the
purchase of a security and a separate transaction involving a sale.
ASSET-BACKED SECURITIES
The Fund may invest in asset-backed securities. Asset-backed securities are
often subject to more rapid repayment than their stated maturity date would
indicate as a result of the pass-through of prepayments of principal on the
underlying loans. During periods of declining interest rates, prepayment of
loans underlying asset-backed securities can be expected to accelerate.
Accordingly, the Fund's ability to maintain positions in these securities will
be affected by reductions in the principal amount of such securities resulting
from prepayments, and its ability to reinvest the returns of principal at
comparable yields is subject to generally prevailing interest rates at that
time.
BRADY BONDS
The Fund may invest in Brady Bonds and other sovereign debt securities of
countries that have restructured or are in the process of restructuring
sovereign debt pursuant to the Brady Plan. Brady Bonds are debt securities
described as part of a restructuring plan created by U.S. Treasury Secretary
Nicholas F. Brady in 1989 as a mechanism for debtor nations to restructure their
outstanding external indebtedness (generally, commercial bank debt). In
restructuring its external debt under the Brady Plan framework, a debtor nation
negotiates with its existing bank lenders as well as multilateral institutions
such as the World Bank and the International Monetary Fund (the "IMF"). The
Brady Plan facilitates the exchange of commercial bank debt for newly issued
bonds (known as Brady Bonds). The World Bank and the IMF provide funds pursuant
to loan agreements or other arrangements which enable the debtor nation to
collateralize the new Brady Bonds or to repurchase outstanding bank debt at a
discount. Under these arrangements the IMF debtor nations are required to
implement domestic monetary and fiscal reforms. These reforms have included the
liberalization of trade and foreign investment, the privatization of state-owned
enterprises and the setting of targets for public spending and borrowing. These
policies and programs seek to promote the debtor country's ability to service
its external obligations and promote its economic growth and development. The
Brady Plan only sets forth general guiding principles for economic reform and
debt reduction, emphasizing that solutions must be negotiated on a case-by-case
basis between debtor nations and their creditors.
--------------------------------------------------------------------------------
23
INVESTMENT OBJECTIVE AND PRINCIPAL INVESTMENT STRATEGIES
--------------------------------------------------------------------------------
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.
ILLIQUID SECURITIES
The Fund may purchase securities that are not registered ("restricted
securities") under the 1933 Act, including commercial paper issued in reliance
on Section 4(2) of the 1933 Act. The Fund will not invest more than 20% of its
total assets in illiquid investments. If the Trustees determine, based upon a
continuing review of the trading markets for specific Section 4(2) commercial
paper or Rule 144A securities, that they are liquid, they will not be subject to
the 20% limit on illiquid investments. The Trustees have adopted guidelines and
delegated to the Adviser the daily function of determining the monitoring and
liquidity of restricted investments. The Trustees, however, will retain
sufficient oversight and be ultimately responsible for the determinations.
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.
LENDING OF SECURITIES
The Fund may lend portfolio securities to brokers, dealers and financial
institutions if the loan is collateralized by cash or U.S. government securities
according to applicable regulatory requirements. The Fund may reinvest any cash
collateral in short-term securities and money market funds. When the
--------------------------------------------------------------------------------
24
INVESTMENT OBJECTIVE AND PRINCIPAL INVESTMENT STRATEGIES
--------------------------------------------------------------------------------
Fund lends portfolio securities, there is a risk that the borrower may fail to
return the securities involved in the transaction. As a result, the Fund may
incur a loss or, in the event of the borrower's bankruptcy, the Fund may be
delayed in or prevented from liquidating the collateral. The Fund may not lend
portfolio securities having a total value exceeding 33 1/3% of its total assets.
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 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
--------------------------------------------------------------------------------
25
RISK FACTORS
--------------------------------------------------------------------------------
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 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 debt securities and
preferred securities, which bear interest or dividends rates reflecting
intermediate and long-term interest rates. The interest or dividend rates on
debt securities and preferred stocks 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 debt securities, preferred stocks 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. Given the historically low level of
interest rates during 2003 and the likelihood that interest rates will increase
when the national economy strengthens, the risk of the potentially negative
impact of rising interest rates on the value of the Fund's portfolio may be
significant and may adversely affect the Preferred Shares' asset coverage.
Increasing short-term interest rates may also adversely affect the benefits of a
leverage structure to the holders of the Common Shares, increasing the potential
for the Fund to voluntarily redeem the APS. In addition, the longer the average
maturity of the Fund's portfolio of debt securities, the greater the potential
impact of rising interest rates on the value of the Fund's portfolio and the
less flexibility the Fund may have to respond to the decreasing spread between
the yield on its portfolio securities and the yield on the APS.
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
--------------------------------------------------------------------------------
26
RISK FACTORS
--------------------------------------------------------------------------------
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 approximately
33 1/3% of the Fund's total capital.
The Fund's leveraged capital structure creates special risks not associated with
unleveraged funds having a similar investment objective and similar policies.
These include the possibility of higher volatility of the net asset value of the
Fund and the Preferred Shares' 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 in
reducing the volatility of the Fund's net asset value. Changes in the future
direction of interest rates are 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 Substitute 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 favorable tax treatment 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 objective.
--------------------------------------------------------------------------------
27
RISK FACTORS
--------------------------------------------------------------------------------
INTEREST RATE RISK
Debt 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. Given the historical low level of interest rates
during 2003 and the likelihood that interest rates will increase when the
national economy strengthens, the risk of the potentially negative impact of
rising interest rates on the value of the Fund's portfolio may be significant
and may adversely affect the Preferred Shares' asset coverage. Increasing
short-term interest rates may also adversely affect the benefits of a
leverage structure to the holders of the Common Shares, increasing the
potential for the Fund to voluntarily redeem the APS. In addition, the longer
the average maturity of the Fund's portfolio of debt securities, the greater
the potential impact of rising interest rates on the value of the Fund's
portfolio and the less flexibility the Fund may have to respond to the
decreasing spread between the yield on its portfolio securities and the yield
on the APS
+ 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. Certain types of 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
+ The Adviser's judgment about the attractiveness, relative value or potential
appreciation of a particular sector, security or investment strategy may
prove to be incorrect
CREDIT RISK
Credit risk is the risk that debt securities or preferred securities in the
Fund's portfolio will decline in price or fail to make interest or dividend
payments when due because the issuer of the security experiences a decline in
its financial status. Although the Fund primarily invests in investment grade
securities, the Fund is authorized to invest up to 25% of its total assets in
debt securities rated below investment grade at the time of acquisition.
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;
interest or dividend 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 interest or dividends and repay capital or principal, as the case may be;
and 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 interest or dividends 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 highly speculative with respect
to the issuer's ability to pay interest or dividends and any required redemption
or principal payments and are susceptible to default or decline in market value
due to adverse economic and business developments. Securities rated Ba or BB may
face significant ongoing uncertainties or exposure to adverse business,
financial or economic conditions that could lead to the issuer being unable to
meet its financial commitments. The protection of interest and principal may be
moderate and not well safeguarded during both good and bad times. Securities
rated B
--------------------------------------------------------------------------------
28
RISK FACTORS
--------------------------------------------------------------------------------
generally lack the characteristics of a desirable investment. Assurance of
interest and principal payments over the long term may be low, and such
securities are more vulnerable to nonpayment than obligations rated BB or Ba.
Adverse business, financial or economic conditions will likely impair the
issuer's capacity or willingness to meet its financial commitments. 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.
MORTGAGE-BACKED AND ASSET-BACKED SECURITIES
To the extent the Fund invests significantly in mortgage-backed and asset-backed
securities, its exposure to prepayment and extension risks may be greater than
if it invested in other fixed income securities. Certain debt instruments may
only pay principal at maturity or may only represent the right to receive
payments of principal or payments of interest on underlying pools of mortgage or
government securities, but not both. The value of these types of instruments may
change more drastically than debt securities that pay both principal and
interest during periods of changing interest rates. Principal only
mortgage-backed securities generally increase in value if interest rates
decline, but are also subject to the risk of prepayment. Interest only
instruments generally increase in value in a rising interest rate environment
when fewer of the underlying mortgages are prepaid. The value of interest only
instruments may decline significantly or these instruments may become worthless
in the event that the underlying mortgage pool experiences substantial and
unanticipated payments. The Fund may invest in mortgage derivatives and
structured securities. Because these securities have imbedded leverage features,
small changes in interest or prepayment rates may cause large and sudden price
movements. Mortgage derivatives can also become illiquid and hard to value in
declining markets. Government sponsored entities such as the FHLMC, FNMA and
FHLB, although chartered or sponsored by Congress, are not funded by
congressional appropriations and the debt and mortgage-backed securities issued
by them are neither guaranteed nor issued by the U.S. government.
CORPORATE DEBT SECURITIES
Corporate debt obligations are subject to the risk of an issuer's inability to
meet principal and interest payments on the obligations and may also be subject
to price volatility due to such factors as market interest rates, market
perception of the creditworthiness of the issuer and general market liquidity.
PREFERRED SECURITIES
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. Preferred securities may be substantially less liquid
than many other securities, such as common stocks or U.S. government securities.
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. An issuer of preferred securities may also redeem the securities prior to
a specified date. As with call provisions, a special redemption by the issuer
may negatively impact the return of the security held by the Fund. 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.
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 debt securities or preferred securities. Such
securities may also be more susceptible to adverse changes in
--------------------------------------------------------------------------------
29
RISK FACTORS
--------------------------------------------------------------------------------
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.
FOREIGN SECURITIES
Although the Fund only invests in securities of non-U.S. issuers that are
payable 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, accounting standards or regulatory practices
+ many non-U.S. markets are smaller, less liquid and more volatile; therefore,
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
+ currency exchange rates or controls may adversely affect 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
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 in 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 climates 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, 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.
SOVEREIGN DEBT OBLIGATIONS AND BRADY BONDS
An investment in debt obligations of non-U.S. governments and their political
subdivisions (sovereign debt), involves special risks that are not present in
corporate debt obligations. The non-U.S. issuer of the sovereign debt or the
non-U.S. governmental authorities that control the repayment of the debt may be
unable or unwilling to repay principal or pay interest when due, and the Fund
may have limited recourse in the event of a default. During periods of economic
uncertainty, the market prices of sovereign debt may be more volatile than
prices of debt obligations of U.S. issuers. In the past, certain non-U.S.
countries have encountered difficulties in servicing their debt obligations,
withheld payments of principal and interest and declared moratoria on the
payment of principal and interest on their
--------------------------------------------------------------------------------
30
RISK FACTORS
--------------------------------------------------------------------------------
sovereign debt. A sovereign debtor's willingness or ability to repay principal
and pay interest in a timely manner may be affected by, among other factors, its
cash flow situation, the extent of its foreign currency reserves, the
availability of sufficient foreign exchange, the relative size of the debt
service burden, the sovereign debtor's policy toward its principal international
lenders and local political constraints. Sovereign debtors may also be dependent
on expected disbursements from non-U.S. governments, multilateral agencies and
other entities to reduce principal and interest arrearages on their debt. The
failure of a sovereign debtor to implement economic reforms, achieve specified
levels of economic performance or repay principal or interest when due may
result in the cancellation of third-party commitments to lend funds to the
sovereign debtor, which may further impair such debtor's ability or willingness
to service its debts.
Brady Bonds may involve a high degree of risk, may be in default or present the
risk of default. Agreements implemented under the Brady Plan to date are
designed to achieve debt and debt-service reduction through specific options
negotiated by a debtor nation with its creditors. As a result, the financial
packages offered by each country differ. The types of options have included the
exchange of outstanding commercial bank debt for bonds issued at 100% of face
value of such debt, bonds issued at a discount of face value of such debt, bonds
bearing an interest rate which increases over time and bonds issued in exchange
for the advancement of new money by existing lenders. Certain Brady Bonds have
been collateralized as to principal due at maturity by U.S. Treasury zero coupon
bonds with a maturity equal to the final maturity of such Brady Bonds, although
the collateral is not available to investors until the final maturity of the
Brady Bonds. Collateral purchases are financed by the IMF, the World Bank and
the debtor nations' reserves. In addition, the first two or three interest
payments on certain types of Brady Bonds may be collateralized by cash or
securities agreed upon by creditors. Although Brady Bonds may be collateralized
by U.S. Government securities, repayment of principal and interest is not
guaranteed by the U.S. Government.
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.
--------------------------------------------------------------------------------
31
RISK 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 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 change 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 the Fund's 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.
ILLIQUID INVESTMENTS
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.
--------------------------------------------------------------------------------
32
RISK FACTORS
--------------------------------------------------------------------------------
LENDING OF SECURITIES
When the Fund lends portfolio securities, there is a risk that the borrower may
fail to return the securities involved in the transaction. As a result, the Fund
may incur a loss or, in the event of the borrower's bankruptcy, the Fund may be
delayed in or prevented from liquidating the collateral. The Fund would not have
the right to vote any securities having voting rights during the existence of
the loan, but would have the ability to call the loan in anticipation of an
important vote to be taken among holders of the securities or of the giving or
withholding of its consent on a material matter affecting the investment. If
there is a delay in the recall of a particular security out on loan, the Fund
may not be able to exercise its voting rights with respect to that security.
SHORT-TERM TRADING
Short-term trading may have the effect of increasing portfolio turnover rate,
which the Fund anticipates will be greater than 100% annually. For the fiscal
year ended December 31, 2002, the Fund's annual portfolio turnover rate was
371%. A high rate of portfolio turnover (100% or greater) involves
correspondingly greater brokerage expenses and other transactional expenses that
are borne by the Fund. High portfolio turnover may also result in the
realization of net short-term capital gains by the Fund which, when distributed
to shareholders, will be taxable as ordinary income. See "U.S. federal income
tax matters."
MARKET DISRUPTION AND GEOPOLITICAL RISK
The war with, and the continuing occupation of, Iraq may have a substantial
impact on the U.S. and world economies and securities markets. The nature, scope
and duration of such impact cannot be predicted with any certainty. Terrorist
attacks on the World Trade Center and the Pentagon on September 11, 2001 closed
some of the U.S. securities markets for a four-day period. Similar events and
market disruptions may occur in the future. Geopolitical risks have, and may in
the future, contribute to increased short-term market volatility and may have
adverse long-term effects on U.S. and world economies and markets generally.
Those events could also have an acute effect on individual issuers or related
groups of issuers.
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 therefor, 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 "--DIVIDENDS AND DIVIDEND PERIODS" below
and "The Auction."
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
--------------------------------------------------------------------------------
33
DESCRIPTION OF PREFERRED SHARES
--------------------------------------------------------------------------------
(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 declared) and will be fully paid and, except as discussed under
"Certain provisions of the 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 therefor, 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."
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
Declaration of Trust, the By-laws and applicable law. Initial Dividend Payment
Dates are scheduled as follows:
INITIAL DIVIDEND
PAYMENT DATE
---------------------------------------------------------------------------------
Series A.................................................... November 20, 2003
Series B.................................................... November 21, 2003
Following the Initial Dividend Payment Date, dividends on each series of APS
will be payable (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
--------------------------------------------------------------------------------
34
DESCRIPTION OF PREFERRED SHARES
--------------------------------------------------------------------------------
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 of APS 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
of APS 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
November 4, 2003. The initial dividend rate is 1.15% for Series A APS. The
initial dividend rate is 1.15% for Series B 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 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
-----------------------------------------------------------------------------------
Aaa......................................................... 125%
Aa3 to Aa1.................................................. 150%
A3 to A1.................................................... 200%
Baa3 to Baa1................................................ 250%
Below Baa3.................................................. 300%
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.
--------------------------------------------------------------------------------
35
DESCRIPTION OF PREFERRED SHARES
--------------------------------------------------------------------------------
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.
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 and provided further that the Fund may not
request a Special Dividend Period that is a Long-Term Dividend Period unless the
Fund has received written confirmation from Moody's (or any Substitute Rating
Agency) that the Fund's election of a proposed Long-Term Dividend Period will
not impair the ratings then assigned by Moody's (or any Substitute Rating
Agency) of the applicable series of APS. 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
--------------------------------------------------------------------------------
36
DESCRIPTION OF PREFERRED SHARES
--------------------------------------------------------------------------------
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. 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.
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,
--------------------------------------------------------------------------------
37
DESCRIPTION OF PREFERRED SHARES
--------------------------------------------------------------------------------
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, and 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 Applicable 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) advises the Fund in writing 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 equal to
130% of 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
--------------------------------------------------------------------------------
38
DESCRIPTION OF PREFERRED SHARES
--------------------------------------------------------------------------------
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, 2003, and assuming the APS with an aggregate liquidation
preference of $89 million had been issued as of such date, will be as follows:
Value of Fund assets less liabilities not
constituting senior securities 273,464,265
------------------------------ = -------- = 307%
Senior securities representing indebtedness plus 89,000,000
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.
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, 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
--------------------------------------------------------------------------------
39
DESCRIPTION OF PREFERRED SHARES
--------------------------------------------------------------------------------
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 at least equal to the Preferred Shares Basic Maintenance Amount and
(b) asset coverage of at least equal to the 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" above
and in the Statement of Additional Information. If the Fund fails to maintain
the 1940 Act Preferred Shares Asset Coverage and eligible portfolio securities
with a Discounted Value equal to the Preferred Shares Basic Maintenance Amount
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
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 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 APS 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 APS are 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 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
--------------------------------------------------------------------------------
40
DESCRIPTION OF PREFERRED SHARES
--------------------------------------------------------------------------------
(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.
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
--------------------------------------------------------------------------------
41
DESCRIPTION OF PREFERRED SHARES
--------------------------------------------------------------------------------
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 the APS) 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 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;
(d) 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 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
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.
--------------------------------------------------------------------------------
42
--------------------------------------------------------------------------------
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 therefor, 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 D 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 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
--------------------------------------------------------------------------------
43
THE AUCTION
--------------------------------------------------------------------------------
rate: (i) for any seven day Dividend Period, 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, and
provided that the Broker-Dealer Agreement with UBS Securities LLC may not 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 D (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.
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 D to the Statement of Additional Information. The Settlement
Procedures to be used with respect to Auctions are set forth in Appendix E 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:
+ 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.
+ 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 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
--------------------------------------------------------------------------------
44
THE AUCTION
--------------------------------------------------------------------------------
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 Applicable 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 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 Applicable 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 APS 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
--------------------------------------------------------------------------------
45
THE AUCTION
--------------------------------------------------------------------------------
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, a natural disaster, an act of war, a
civil or military disturbance, an 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, a natural disaster, an act
of war, a civil or military disturbance, an 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.
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 of 2.1% rate for all
sell all 500 shares if 500 shares
Applicable Rate is less
than 2.1%
Existing Holder B.......... Owns 300 shares, wants to Hold Order--will take the
hold Applicable Rate
Existing Holder C.......... Owns 200 shares, wants to Bid of 1.9% rate for all
sell all 200 shares if 200 shares
Applicable 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 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
--------------------------------------------------------------------------------
46
THE AUCTION
--------------------------------------------------------------------------------
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 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
--------------------------------------------------------------------------------
47
THE AUCTION
--------------------------------------------------------------------------------
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.
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 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.
--------------------------------------------------------------------------------
48
THE 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
+ 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.
INVESTMENT ADVISER
John Hancock Advisers, LLC, located at 101 Huntington Avenue, Boston,
Massachusetts 02199, has served as the Fund's investment adviser since the
commencement of the Fund's operations in 1973. The Adviser also serves as the
investment adviser to several other closed-end investment companies and open-end
investment companies which focus on investing in intermediate and long-term
fixed income securities. These funds include John Hancock Investors Trust, John
Hancock Bond Fund, John Hancock Government Income Fund, John Hancock High Income
Fund, John Hancock High Yield Bond Fund, John Hancock Investment Grade Bond
Fund, and John Hancock Strategic Income Fund. The Adviser also serves as the
investment adviser to several leveraged dual-class, closed-end investment
companies which focus on investing in preferred stocks and other securities.
These leveraged dual-class funds include John Hancock Preferred Income Fund,
John Hancock Preferred Income Fund II, John Hancock Preferred Income Fund III,
John Hancock Patriot Premium Dividend Fund I, John Hancock Patriot Premium
Dividend Fund II, John Hancock Patriot Select Dividend Trust, John Hancock
Patriot Preferred Dividend Fund and John Hancock Patriot Global Dividend Fund.
The Adviser was organized in 1968 and had, as of June 30, 2003, approximately
$27.5 billion in assets under management, of which approximately $12.6 billion
was invested in fixed income securities. The Adviser manages approximately $3.4
billion in leveraged dual-class funds. The Adviser is an indirect wholly-owned
--------------------------------------------------------------------------------
49
MANAGEMENT OF THE FUND
--------------------------------------------------------------------------------
subsidiary of John Hancock Financial Services, Inc., a financial services
company. On September 28, 2003, Manulife Financial Corporation and John Hancock
Financial Services, Inc. announced plans to merge, which transaction is expected
to occur in the first half of 2004.
The Adviser has been managing closed-end funds since 1971 and has a long history
of delivering regular dividends through several market cycles. The Adviser is an
industry leader in managing dual-class closed-end funds.
The Adviser employs a team of seasoned investment professionals to manage the
Fund. This experienced team has been successful in managing fixed income assets
through John Hancock's similarly structured dual-class, closed-end funds, as
well as open-end funds and institutional portfolios. The team consists of 60
professionals with an average of 18 years of investment experience. In addition
to developing a structured process to manage interest-rate risk, the management
team has produced a track record of maintaining regular dividends 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. The Adviser's goal
is to deliver consistent investment results, where its investment philosophy can
be maintained through teamwork rather than individual efforts.
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 of the Fund. The
Adviser will not be liable to the Fund except for willful misfeasance, 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 (i) providing supervision of the Fund's non-investment operations,
(ii) providing the Fund with personnel to perform such executive, administrative
and clerical services as are reasonably necessary to provide effective
administration of the Fund, (iii) 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,
(iv) providing the Fund with adequate office space and certain related office
equipment and services, and (v) 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 quarterly, as compensation for the services rendered and expenses paid
by it, a fee equivalent on an annual basis to a stated percentage of the average
weekly managed assets of the Fund as set forth below:
MANAGED ASSET VALUE ANNUAL RATE
-------------------------------------------------------------------------
First $150 million.......................................... 0.650%
Next $50 million............................................ 0.375%
Next $100 million........................................... 0.350%
Amount over $300 million.................................... 0.300%
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
--------------------------------------------------------------------------------
50
MANAGEMENT OF THE FUND
--------------------------------------------------------------------------------
leverage that may be outstanding) minus the sum of accrued liabilities (other
than liabilities representing financial leverage). The liquidation preference of
the APS is not a liability. Consequently, if the Fund issues preferred shares
and does not borrow, managed assets will generally be approximately equal to the
Fund's net assets attributable to common shares plus the liquidation preference
of any outstanding preferred shares.
Pursuant to a separate Accounting and Legal Services Agreement, the Adviser is
reimbursed for certain tax, accounting and legal services.
PORTFOLIO MANAGERS
Day-to-day management of the Fund's portfolio is the responsibility of a team of
portfolio managers led by Barry H. Evans and Jeffrey N. Given.
Barry H. Evans, CFA, is a Senior Vice President and Chief Fixed Income Officer
at the Adviser. He oversees fixed income strategies, which include both
corporate high grade and high yield mandates. He has 17 years of investment
experience and has managed the Fund since 2000. In 1998 and 1999, he was a
Senior Vice President at the Adviser and has been a Chief Fixed Income Officer
at the Adviser since 2000.
Jeffrey N. Given is a Senior Portfolio Officer and Portfolio Manager at the
Adviser. He has 10 years of investment experience. He has been a Senior
Portfolio Officer at the Adviser since 2002 and has been managing the Fund since
1999. From 1998 to 2002, he was an analyst with the Adviser.
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 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. 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 the 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.
--------------------------------------------------------------------------------
51
NET ASSET VALUE
--------------------------------------------------------------------------------
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 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 a 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 U.S. 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 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 has elected to be treated, has qualified and intends to continue 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, 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, thereby subjecting any income earned by the
Fund to tax at the corporate level at a 35% federal income tax rate and, when
such income is distributed, to a further tax at the shareholder level.
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
--------------------------------------------------------------------------------
52
U.S. FEDERAL INCOME TAX MATTERS
--------------------------------------------------------------------------------
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 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. 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 designated by the Fund as "qualified dividend income" (if any) may
be taxable to individual shareholders at a maximum 15% federal income tax rate.
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 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.
Most of the dividends distributed to shareholders will be attributable to income
from the Fund's investments in debt securities or other investments that do not
produce qualified dividend income as that term is defined in Section 1(h)(11) of
the Code, and thus will not qualify for the maximum 15% federal income tax rate
on qualified dividend income. A portion of the dividend distributions to
individual shareholders may qualify for such maximum 15% federal income tax rate
to the extent that such dividends are attributable to qualified dividend income
from the Fund's investments in common and preferred stock of U.S. companies and
stock of certain foreign corporations, provided that certain holding period and
other requirements are met. Capital gain dividends distributed by the Fund (if
any) to individual shareholders generally will qualify for the maximum 15%
federal income tax rate on long-term capital gains to the extent that such
dividends relate to capital gains recognized by the Fund on or after May 6,
2003. Under current law, the maximum 15% federal income tax rate on qualified
dividend income and long-term capital gains will cease to apply to taxable years
beginning after December 31, 2008. Distributions from the Fund to its corporate
shareholders also 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 debt securities.
The IRS has taken the position that if a regulated investment company has two or
more 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 (including ordinary income, qualified
dividend income and capital gains) in accordance with each such class's
proportionate share 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
--------------------------------------------------------------------------------
53
U.S. FEDERAL INCOME TAX MATTERS
--------------------------------------------------------------------------------
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.
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 or exchange 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 sold. 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. Even if a redemption of APS were treated as a sale or
exchange, any declared but unpaid dividends distributed to shareholders in
connection with the redeemed shares would 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 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 currently 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.
--------------------------------------------------------------------------------
54
--------------------------------------------------------------------------------
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 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, including the APS, could, in certain
circumstances, be held personally liable for the obligations of the Fund.
However, the 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 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 Declaration of Trust further provides that obligations of the Fund are not
binding upon the Trustees or officers individually but only upon the property of
the Fund and that the Trustees or officers will not be liable for actions or
failures to act. Nothing in the Declaration of Trust, however, protects a
Trustee or officer against any liability to which such Trustee or officer 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 or
officer'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 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.
--------------------------------------------------------------------------------
55
--------------------------------------------------------------------------------
Certain provisions of the Declaration of Trust and By-laws
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 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 first anniversary of the date of mailing of the
notice for the prior year's annual meeting (subject to certain exceptions). In
the case of a special meeting of shareholders, the notice must be given as
described above or no later than the tenth calendar day following public
disclosure, as specified in the By-laws, of the date of the special meeting. Any
notice by a shareholder must be accompanied by certain information as provided
in the By-laws.
--------------------------------------------------------------------------------
56
--------------------------------------------------------------------------------
Underwriting
UBS Securities LLC, 299 Park Avenue, New York, New York, acting as underwriter
(the "Underwriter") has 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 below. The Underwriter is committed to purchase and
pay for all of such APS if any are purchased.
NUMBER OF NUMBER OF
SERIES A APS SERIES B APS
-----------------------------------------------------------------------------------------
UBS Securities LLC.......................................... 1,780 1,780
The Underwriter has advised the Fund that it proposes 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 Underwriter 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 November 4, 2003.
The Underwriter will act in Auctions as a Broker-Dealer and receive fees as set
forth under "The Auction" and in the Statement of Additional Information. The
Underwriter also may provide information to be used in determining the Reference
Rate.
The Fund anticipates that the Underwriter may from time to time act as a broker
or dealer in connection with the execution of the Fund's portfolio transactions
after it has ceased to be a principal underwriter of the Fund under the 1940 Act
and, subject to certain conditions, may act as such a broker or dealer while it
is a principal underwriter.
In connection with this offering, the Underwriter or selected dealers may
distribute prospectuses electronically.
The Fund and the Adviser have agreed to indemnify the Underwriter against
certain liabilities including liabilities under the Securities Act.
Custodian, transfer agent, registrar and dividend disbursing agent
The Fund's securities and cash are held under a custodian agreement with The
Bank of New York, located at One Wall Street, New York, New York 10286. Deutsche
Bank Trust Company Americas, located at 60 Wall Street, New York, New York 10005
is the Fund's transfer agent, registrar and dividend disbursing agent in its
capacity as Auction Agent for the APS.
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 Underwriter by Skadden, Arps, Slate, Meagher & Flom
(Illinois), Chicago, Illinois and its affiliates.
--------------------------------------------------------------------------------
57
--------------------------------------------------------------------------------
Table of contents for
Statement of Additional Information
PAGE
------------------------------------------------------------------
Organization of the Fund.................................... 2
Investment objective and policies........................... 2
Investment restrictions..................................... 9
Those responsible for management............................ 11
Investment advisory and other services...................... 15
Additional information concerning the auctions for the
preferred shares.......................................... 17
Rating agency guidelines.................................... 18
Net asset value............................................. 31
Brokerage allocation........................................ 31
U.S. federal income tax matters............................. 33
Performance................................................. 38
Custody of portfolio........................................ 38
Independent auditors........................................ 39
Additional information...................................... 39
Financial Statements........................................ 39
Appendix A--More about risk................................. A-1
Appendix B--Description of ratings.......................... B-1
Appendix C--Proxy voting guidelines and procedures.......... C-1
Appendix D--Auction procedures.............................. D-1
Appendix E--Settlement procedures........................... E-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.
--------------------------------------------------------------------------------
58
--------------------------------------------------------------------------------
Glossary
" 'AA' Financial Composite Commercial Paper Rate" on any 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 Securities
LLC; (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.
"APS" 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.
"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
--------------------------------------------------------------------------------
59
GLOSSARY
--------------------------------------------------------------------------------
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" with respect to any series of APS and any Rate Period, means the
Business Day next preceding the first day of such Rate Period.
"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 asset 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 APS, 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.
--------------------------------------------------------------------------------
60
GLOSSARY
--------------------------------------------------------------------------------
"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.
"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 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.
--------------------------------------------------------------------------------
61
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.
--------------------------------------------------------------------------------
62
[JHF LOGO]
P6PPN 10/03
JOHN HANCOCK INCOME SECURITIES TRUST
Statement of Additional Information
Dated October 30, 2003
John Hancock Income Securities Trust (the "Fund") is a 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 30, 2003 (the
"Prospectus"). This Statement of Additional Information does not include all
information that a prospective investor should consider before purchasing the
Fund's Series A auction preferred shares and Series B auction preferred shares
(collectively, the "Preferred Shares" or "APS"). This Statement of Additional
Information 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 OBJECTIVE AND POLICIES...................................... 2
INVESTMENT RESTRICTIONS................................................ 9
THOSE RESPONSIBLE FOR MANAGEMENT....................................... 11
INVESTMENT ADVISORY AND OTHER SERVICES................................. 15
ADDITIONAL INFORMATION CONCERNING THE AUCTIONS FOR THE PREFERRED SHARES 17
RATING AGENCY GUIDELINES............................................... 18
NET ASSET VALUE........................................................ 31
BROKERAGE ALLOCATION................................................... 31
U.S. FEDERAL INCOME TAX MATTERS........................................ 33
PERFORMANCE............................................................ 38
CUSTODY OF PORTFOLIO................................................... 38
INDEPENDENT AUDITORS................................................... 39
ADDITIONAL INFORMATION................................................. 39
FINANCIAL STATEMENTS................................................... 39
APPENDIX A - MORE ABOUT RISK........................................... A-1
APPENDIX B - DESCRIPTION OF RATINGS.................................... B-1
APPENDIX C - PROXY VOTING GUIDELINES AND PROCEDURES.................... C-1
APPENDIX D - AUCTION PROCEDURES........................................ D-1
APPENDIX E - SETTLEMENT PROCEDURES..................................... E-1
ORGANIZATION OF THE FUND
The Fund is a diversified, closed-end investment management company
originally organized as a Maryland corporation on October 20, 1972 and
reorganized as a Massachusetts business trust on October 5, 1984. 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 on February,
2000. On September 28, 2003, Manulife Financial Corporation and John Hancock
Financial Services, Inc. announced plans to merge, creating a leading global
insurance franchise. Company officials expect that the merger will close in the
first half of 2004.
INVESTMENT OBJECTIVE AND POLICIES
The following information supplements the discussion of the Fund's
investment objective and policies discussed in the Prospectus. Appendix A
contains further information describing investment risks. The investment
objective is non-fundamental and may be changed by the Trustees without
shareholder approval. There is no assurance that the Fund will achieve its
investment objective.
The Fund's investment objective is to generate a high level of current
income consisted with prudent investment risk.
PORTFOLIO CONTENTS. The Fund seeks to achieve its objective by investing
primarily in a diversified portfolio of freely marketable debt securities issued
by U.S. and foreign corporations and governments. Under normal circumstances the
Fund will invest at least 80% of its assets (net assets plus borrowing for
investment purposes) in income securities, consisting of: (i) marketable
corporate debt securities, (ii) governmental obligations and (iii) cash and
commercial paper. The Fund may also invest up to 20% of its total assets in
income-producing preferred and common stocks. At least 75% of Fund's total
assets will be represented by debt securities which are rated, at the time of
acquisition, 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. While the Fund focuses on intermediate and longer-term debt securities,
the Fund may acquire securities of any maturity and is not subject to any limits
as to the average maturity of its overall portfolio. There can be no assurance
that the Fund will achieve its investment objective.
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
2
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.
PREFERRED SECURITIES. Generally, preferred stocks receive dividends prior
to distributions on common stock and usually have a priority 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 stock typically qualifies for the
dividends received deduction (the "Dividends Received Deduction") under Section
243 of the Internal Revenue Code of 1986, as amended (the "Code"). 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 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 is 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.
Taxable preferred securities 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
3
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
and in 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 objective and policies. Since the
market for these instruments would be new, the Fund may have difficulty
disposing of them at a suitable price and time. In addition to limited
liquidity, these instruments may present other risks, such as high price
volatility.
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. The Fund may only invest in foreign securities which
are traded or denominated in U.S. dollars. 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.
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.
4
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.
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
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
5
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.
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.
6
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.
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 to facilitate portfolio management.
The Fund will not engage in futures and related options for speculative
purposes. 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. To the extent that the
Fund engages in nonhedging transactions in futures contracts and options on
futures to facilitate portfolio management, 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.
7
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.
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 facilitate
portfolio management, 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 only as a hedge or to facilitate portfolio management.
However, the Fund also may invest in interest rate swaps to facilitate portfolio
management. 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.
8
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 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.
The Fund may in the future employ new or additional investment strategies
and hedging instruments if those strategies and instruments are consistent with
the Fund's investment objective and are permissible under applicable regulations
governing the Fund.
SHORT-TERM TRADING. The Fund may engage in short-term trading in response
to stock market conditions, changes in interest rates or other economic trends
and developments, or to take advantage of yield disparities between various
fixed income securities in order to realize capital gains or improve income.
Short-term trading may have the effect of increasing portfolio turnover rate. A
high rate of portfolio turnover (100% or greater) involves correspondingly
greater brokerage expenses. The success of short-term trading will depend on the
ability of the Adviser to evaluate particular securities, to anticipate relevant
market factors, including trends of interest rates and earnings and variations
from such trends, to obtain relevant information, to evaluate it promptly, and
to take advantage of its evaluations by completing transactions on a favorable
basis. For the fiscal years ended December 31, 2001 and 2002, the Fund's annual
portfolio turnover rate was 299% and 371%, respectively. The Fund's annual
portfolio turnover rates are due to mortgage dollar roll transactions.
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 Investment
Company Act of 1940 Act, as amended (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 the Fund may be
deemed to be an underwriter for the purposes of the Securities Act
of 1933, as amended (the "1933 Act"), in connection with the
disposition of portfolio securities.
4. Purchase real estate or any interest therein, except through the
purchase of corporate or certain government securities (including
securities secured by mortgage or a leasehold interest or other
interest in real estate and securities of companies investing in
real estate) in accordance with the Fund's investment objective. The
Fund does not for this purpose treat a security issued by a real
estate or mortgage investment trust as an interest in real estate.
9
5. Make loans, except through the lending of portfolio securities and
the purchase of securities in accordance with the Fund's investment
policies set forth above. The Fund does not for this purpose
consider repurchase agreements, or the purchase of all or a portion
of an issue of publicly distributed bonds, debentures or other
securities, whether or not the purchase is made upon the original
issuance of the securities, to be the making of a loan.
6. Invest in commodities or in commodity contracts or in puts, calls or
combinations of both except options on securities and securities
indices, and futures contracts on securities and securities indices
and options on such futures.
7. Purchase securities of issuers conducting their principal business
activity in the same industry if immediately after such purchase the
value of its investment in such industry would exceed 25% of its
total assets taken at market value.
8. Purchase securities of any issuer if (a) more than 5% of the Fund's
total assets taken at market value would at the time be invested in
the securities of such issuer other than obligations of the United
States government or its agencies or instrumentalities or repurchase
agreements collateralized by such obligations or (b) such purchase
would at the time result in more than 10% of the outstanding voting
securities of such issuer being held by the Fund.
The Fund does not have a fundamental policy with respect to short
sales and purchases on margin.
NON-FUNDAMENTAL INVESTMENT RESTRICTIONS. The following investment restrictions
are designated as non-fundamental and may be changed by the Trustees without
shareholder approval.
1. The proportion of corporate debt securities and of income-producing
preferred and common stocks is determined by market conditions at
the time of investment, although no more than 20% of the Fund's
total assets will consist of such preferred and common stocks.
2. The Fund purchases those corporate debt securities which are issued
by the United States or foreign corporations and government
securities, domestic and foreign. Foreign securities will be
purchased only if they are payable in United States dollars.
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 objective.
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.
10
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").
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
HANCOCK
FUND
POSITION(S) COMPLEX
NAME, ADDRESS (1) HELD WITH TRUSTEE/OFFICER PRINCIPAL OCCUPATION(S) OVERSEEN OTHER
AND AGE FUND SINCE(2) DURING PAST 5 YEARS BY TRUSTEE DIRECTORSHIPS
------- ---- -------- ------------------- ---------- -------------
INTERESTED TRUSTEES
John M. DeCiccio (3) Trustee 2001 Executive Vice President and Chief 52 None
Born: 1948 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, Independence
Investment LLC, Declaration
Management & Research 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).
Maureen Ford Goldfarb Trustee, 2000 Executive Vice President, John 52 None
(3) Chairman, Hancock Financial Services, Inc.,
Born: 1955 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, President and Chief
Executive Officer, John Hancock
Funds; Chairman, Director,
President and Chief Executive
Officer, Sovereign Asset
Management Corporation
("SAMCorp."); Director, John
Hancock Subsidiaries, LLC;
Independence Investment LLC and
John Hancock Signature
Services, Inc. ("Signature
Services"); Investment Company
Institute, Board of Governors
(since 2002); Senior Vice
President, MassMutual Insurance
Co. (until 1999).
11
INDEPENDENT TRUSTEES
Dennis S. Aronowitz Trustee 1988 Professor of Law, Emeritus, Boston 21 Director,
Born: 1931 University School of Law (as of Brookline
1996). Bancorp.
Richard P. Chapman, Trustee 1975 President and Chief Executive 21 Chairman and
Jr. Officer, Brookline Bancorp., Inc. Director,
Born: 1935 (lending) (since 1972); Chairman Northeast
and Director, Lumber Insurance Co. Retirement
(insurance) (until 2000). Services, Inc.
(retirement
administration)
(since 1998).
William J. Cosgrove Trustee 1991 Vice President, Senior Banker and 21 Director,
Born: 1933 Senior Credit Officer, Citibank, Hudson City
N.A. (banking) (retired 1991); Bancorp
Executive Vice President, Citadel (banking);
Group Representatives, Inc. Trustee,
(financial reinsurance). Scholarship
Fund for Inner
City Children
(since 1986).
Richard A. Farrell Trustee 1996 President, Farrell, Healer & Co., 21 Trustee,
Born: 1932 Inc., (venture capital management Marblehead
firm)(since 1980) and General Savings Bank
Partner of the Venture Capital Fund (since 1994).
of NE; Prior to 1980, headed the
venture capital group at Bank of
Boston Corporation.
William F. Glavin Trustee 1996 President Emeritus, Babson College 21 None.
Born: 1932 (as of 1998); Vice Chairman, Xerox
Corporation (until 1989); Director,
Reebok, Inc. (until 2002) and Inco
Ltd. (until 2002).
John A. Moore Trustee 1996 President and Chief Executive 29 Director, CIIT
Born: 1939 Officer, Institute for Evaluating (nonprofit
Health Risks, (nonprofit
research). institution) (until
2001); Senior Scientist,
Sciences International (health
research)(since 1998);
Principal, Hollyhouse
(consulting)(since 2000).
Patti McGill Peterson Trustee 1996 Executive Director, Council for 29 Director,
Born: 1943 International Exchange of Scholars Niagara Mohawk
(since 1998); Vice President, Power
Institute of International Corporation
Education (since 1998); Senior (electric
Fellow, Cornell Institute of Public utility).
Affairs, Cornell University (until
1997); President Emerita of Wells
College and St. Lawrence
University.
12
John W. Pratt Trustee 1996 Professor of Business 21 None.
Born: 1931 Administration Emeritus, Harvard
University Graduate School of
Business Administration (as of
1998).
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 HANCOCK
POSITION(S) FUND COMPLEX
NAME, ADDRESS (1) HELD WITH TRUSTEE/OFFICER PRINCIPAL OCCUPATION(S) OVERSEEN BY OTHER
AND AGE FUND SINCE(2) DURING PAST 5 YEARS TRUSTEE DIRECTORSHIPS
------- ---- -------- ------------------- ------- -------------
PRINCIPAL OFFICERS
WHO ARE NOT TRUSTEES
Richard A. Brown Senior Vice 2000 Senior Vice President, Chief N/A
Born: 1949 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 1992 Vice President and Compliance N/A
Born: 1959 President Officer, the Adviser and the John
and Hancock Fund Complex; Vice
Compliance President, John Hancock Funds.
Officer
William H. King Vice 1991 Vice President and Assistant N/A
Born: 1952 President Treasurer, the Adviser; Vice
and President and Treasurer of the John
Treasurer Hancock Fund Complex; Assistant
Treasurer of John Hancock Funds
(until 2001).
Susan S. Newton Senior Vice 1991 Senior Vice President, Secretary N/A
Born: 1950 President, and Chief Legal Officer, SAMCorp.,
Secretary the Adviser, the John Hancock Fund
and Chief Complex, John Hancock Funds and The
Legal Berkeley Group; Vice President,
Officer 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.
The Fund's Board of Trustees currently has four standing Committees: the
Audit Committee, the Administration Committee, the Contracts/Operations
Committee and the Investment Performance Committee. Each Committee is comprised
of Independent Trustees who are not "interested persons".
The Audit Committee members are Mr. Glavin, Dr. Moore and Ms. Peterson.
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
13
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. For the fiscal year ended
December 31, 2002, the Audit Committee held four meetings.
The Administration Committee's members are all of the independent
Trustees. 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 and reviews Trustee compensation, evaluates
Trustee performance and considers committee membership rotations as well as
relevant corporate governance issues. For the fiscal year ended December 31,
2002, the Administration Committee held four meetings.
The Contracts/Operations Committee members are Messrs. Farrell and Pratt.
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. For the fiscal year
ended December 31, 2002, the Contract/Operations Committee held four meetings.
The Investment Performance Committee members are Messrs. Aronowitz,
Chapman and Cosgrove. 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. For the fiscal year ended December 31, 2002,
the Investment Performance Committee held four meetings.
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, 2002.
AGGREGATE DOLLAR RANGE OF
HOLDINGS IN JOHN
DOLLAR RANGE OF FUND SHARES HANCOCK FUND COMPLEX
NAME OF TRUSTEE OWNED BY TRUSTEE OVERSEEN BY TRUSTEE (1)
--------------- ---------------- -----------------------
INDEPENDENT TRUSTEES
Dennis S. Aronowitz $1-$10,000 $50,001-$100,000
Richard P. Chapman, Jr. $1-$10,000 Over $100,000
William J. Cosgrove $1-$10,000 Over $100,000
Richard A. Farrell Over $100,000 Over $100,000
William F. Glavin none Over $100,000
Dr. John A. Moore none Over $100,000
Patti McGill Peterson none Over $100,000
John W. Pratt $1-$10,000 Over $100,000
INTERESTED TRUSTEES
John M. DeCiccio none Over $100,000
Maureen Ford Goldfarb $1-$10,000 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
14
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 or deferred compensation, as of December 31,
2002, the respective "Dollar Range of Fund Shares Owned by Trustee" and
the "Aggregate Dollar Range of Holdings in the John Hancock Fund Complex
Overseen by Trustee" would be none and over $100,000 for Messrs. Chapman,
Cosgrove, Gavin and Dr. Moore.
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 Goldfarb and Mr.
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.
Total Compensation from All Funds in
Aggregate Compensation John Hancock Fund Complex to
Trustees from the Fund(1) Trustees(2)
-------- ---------------- -----------
Dennis S. Aronowitz $1,138 $72,000
Richard P. Chapman, Jr.* $1,243 $78,100
William J. Cosgrove* $1,191 $75,100
Richard A. Farrell $1,190 $75,000
Gail D. Fosler + $1,138 $72,000
William F. Glavin* $1,190 $75,000
Dr. John A. Moore* $1,138 $72,000
Patti McGill Peterson $1,138 $72,000
John W. Pratt $1,140 $72,100
------- --------
Total $10,506 $663,300
(1) Aggregate compensation from the Fund is for the calendar year ended
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, 2002. As
of that date, there were 61 funds in the John Hancock Fund Complex, of
which Dr. Moore and Ms. Peterson served on 39 funds and each other
independent Trustee served on 31 funds.
(*) As of December 31, 2002, the value of the aggregate accrued deferred
compensation from all Funds in the John Hancock Fund Complex for Mr.
Chapman was $46,844, Mr. Cosgrove was $166,358, Mr. Glavin was $219,230
and for Dr. Moore was $203,650 under the John Hancock Deferred
Compensation Plan for Independent Trustees (the "Plan").
(+) As of December 31, 2002, Ms. Fosler resigned as Trustee of the Fund.
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 October 15, 2003 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 had over $27 billion in assets under
management as of June 30, 2003 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
15
respected financial institutions in the nation. With total assets under
management of approximately $139 billion, as of June 30, 2003, 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, as amended
and restated as of August 22, 2003 (the "Advisory Agreement"), with the Adviser,
which was approved by the Fund's shareholders on August 22, 2003. Pursuant to
the Advisory Agreement, the Adviser will: (a) furnish the Fund with advice and
recommendations through an investment program consistent with the investment
policies of the Fund with respect to the purchase, holding and disposition of
portfolio securities, 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 Adviser provides the Fund with office space, supplies and other
facilities required for the business of the Fund. It pays the compensation of
all officers and employees of the Fund and pays the expenses of clerical
services relating to the administration of the Fund. All expenses which are not
specifically paid by the Adviser and which are incurred in the operation of the
Fund are borne by the Fund, including independent Trustees' fees and legal,
accounting, financial management, tax and auditing fees and expenses of the
Fund.
For its advisory and administrative services, the Fund will accrue and pay
to the Adviser quarterly, as compensation for the services rendered and expenses
paid by it, a fee on an annual basis equal to 0.650% of the Fund's average
weekly managed assets for the first $150 million, 0.375% of such assets for the
next $50 million, 0.350% of such assets for the next $100 million, and 0.300% of
such assets for any amounts over $300 million. 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 not a
liability.
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 objective 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. On May 20,
2003, the Board requested and received from the Adviser certain information the
Board deemed important in evaluating the Adviser's qualifications, the
reasonableness of the proposed fee, and the potential benefits that the Fund and
its common shareholders may realize from a leveraging strategy. 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:
16
- The performance results of the Fund and the Adviser's overall
management, as compared with relevant performance standards,
including the performance results of comparable intermediate and
long-term fixed income funds derived from data provided by Lipper
Inc. and appropriate market indices. In that regard, the Trustees
noted that the Fund's performance for the one, three and five year
periods ended December 31, 2002 exceeded the performance of the
comparative closed-end bond fund universe prepared by Lipper, Inc.
and the applicable Lipper index. Within the Lipper peer group, the
Fund ranked in the second or third quintile (with first being the
best in a one to five ranking) on a one, three, five and ten year
basis.
- The reasonableness of the advisory fees paid by the Fund based on
the average advisory fees for comparable funds. The Board also took
into account the nature of the fee arrangements, which include
breakpoints that adjust the fee downward as the size of the Fund's
portfolio increases. The Trustees noted that the Fund's management
fee and total expense ratio were slightly higher than the average
management fee and expense ratio of its Lipper peer group, but noted
that the fees and expenses were not significantly higher and as the
size of the Fund grew, including through the issuance of the
Preferred Shares, the Fund would benefit from the break point
structure of the management fee.
- The Adviser's investment team and portfolio management process, as
well as the composition and overall performance of the Fund's
portfolio on both a short-term and long-term basis. The Board
considered whether the Fund should obtain alternative portfolio
management services and concluded that, under all the circumstances
and based on its informed business judgment, it was in the best
interest of the Fund's shareholders to approve the Advisory
Agreement, as amended and restated to reflect the issuance of
preferred shares.
The Advisory Agreement was approved by all Trustees. 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. For the fiscal years ended December 31, 2000, 2001 and 2002, the Fund
paid fees in the amount of $31,377, $35,715 and $52,579, respectively.
PROXY VOTING. The Fund's Trustees have delegated to the Adviser the
authority to vote proxies on behalf of the Fund. The Trustees have approved the
proxy voting guidelines of the Adviser and will review the guidelines and
suggest changes as they deem advisable. A summary of the Adviser's proxy voting
guidelines and proxy voting procedures are attached to this Statement of
Additional Information as Appendix C.
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.
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.
17
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 that has entered into an agreement with the
Auction Agent (a "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 Fund) may submit orders in auctions for its own account, unless
the Fund notifies all Broker-Dealers that they may no longer do so, in which
case Broker-Dealers may continue to submit hold orders and sell orders for their
own accounts. Any Broker-Dealer that is an affiliate of the Fund may submit
orders in Auctions, but only if such orders are not for its own account. If a
Broker-Dealer submits an order for its own account in any Auction, it might have
an advantage over other bidders because it would have knowledge of all orders
submitted by it in that Auction; such Broker-Dealer, however, would not have
knowledge of orders submitted by other Broker-Dealers in that auction.
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.
18
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 year 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 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 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.
For purposes of calculating the discounted value of the Fund's portfolio
under current Rating Agency 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 ("Discounted Value") of a
portfolio security under Rating Agency Guidelines is the market value thereof,
determined as specified by Moody's, divided by the Moody's Discount Factor.
According to Rating Agency Guidelines, the portfolio coverage ratio of Moody's
Eligible Assets to liabilities should not be less than 130% to
19
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 the Rating Agency 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 Moody's 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
----------------------------------------------------------------
Below B
Term to Maturity of Corporate and
Debt Security (1) Aaa Aa A Baa Ba B Unrated (2)
----------------- --- -- - --- -- - -----------
1 year or less 109% 112% 115% 118% 137% 150% 250%
2 years or less (but longer than 1 year) ........ 115 118 122 125 146 160 250
3 years or less (but longer than 2 years) ....... 120 123 127 131 153 168 250
4 years or less (but longer than 3 years) ....... 126 129 133 138 161 176 250
5 years or less (but longer than 4 years) ....... 132 135 139 144 168 185 250
7 years or less (but longer than 5 years) ....... 139 143 147 152 179 197 250
10 years or less (but longer than 7 years) ...... 145 150 155 160 189 208 250
15 years or less (but longer than 10 years) ..... 150 155 160 165 196 216 250
20 years or less (but longer than 15 years) ..... 150 155 160 165 196 228 250
30 years or less (but longer than 20 years) ..... 150 155 160 165 196 229 250
Greater than 30 years ........................... 165 173 181 189 205 240 250
---------------------------
(1) The Moody's Discount Factor for debt securities shall also be applied to
any interest rate swap or cap, in which case the rating of the
counterparty shall determine the appropriate rating category.
(2) Unless conclusions regarding liquidity risk as well as estimates of both
the probability and severity of default for the corporation's assets can
be derived from other sources as well as combined with a number of sources
as present by the corporation to Moody's, securities rated below B by
Moody's and unrated securities, which are securities rated by neither
Moody's, S&P nor Fitch, are limited to 10% of Moody's Eligible Assets. If
a corporate debt security is unrated by Moody's, S&P or Fitch, the Fund
will use the percentage set forth under "Below B and Unrated" in the
corporate debt table above. Ratings assigned by S&P or Fitch are generally
accepted by Moody's at face value. However, adjustments to face value may
be made to particular categories of credits for which the S&P and/or Fitch
rating does not seem to approximate
20
a Moody's rating equivalent. Split rated securities assigned by S&P and
Fitch will be accepted at the lower of the two ratings.
For corporate debt securities that do not pay interest in U.S. dollars,
the Fund will contact Moody's to obtain the applicable currency conversion
rates.
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
Short-term instruments and cash. The Moody's Discount Factor applied to
short-term portfolio securities, including without limitation short-term
corporate debt securities, short term money market instruments and short-term
municipal debt obligations, is (A) 100%, so long as such portfolio securities
mature or have a demand feature at par exercisable within the Moody's exposure
period, as described below ("Moody's Exposure Period"); (B) 115%, so long as
such portfolio securities do not mature within the Moody's Exposure Period 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%.
Rule 144A securities. The Moody's Discount Factor applied to Rule 144A
securities whose terms include rights to registration under the 1933 Act, within
one year and Rule 144A securities which do not have registration rights within
one year will be 120% and 130%, respectively, of the Moody's Discount Factor
which would apply were the securities registered under the Securities Act of
1933.
21
Convertible securities (including convertible preferred securities).
Moody's Rating Utility Industrial Financial Transportation
-------------- ------- ---------- --------- --------------
Aaa 162% 256% 233% 250%
Aa 167% 261% 238% 265%
A 172% 266% 243% 275%
Baa 188% 282% 259% 285%
Ba 195% 290% 265% 290%
B 199% 293% 270% 295%
Below B and Unrated (1) 300% 300% 300% 300%
(1) Unless conclusions regarding liquidity risk as well as estimates of both
the probability and severity of default for the corporation's assets can
be derived from other sources as well as combined with a number of sources
as present by the corporation to Moody's, securities rated below B by
Moody's and unrated securities, which are securities rated by neither
Moody's, S&P nor Fitch, are limited to 10% of Moody's Eligible Assets. If
a corporate debt security is unrated by Moody's, S&P or Fitch, the Fund
will use the percentage set forth under "Below B and Unrated" in this
table. Ratings assigned by S&P or Fitch are generally accepted by Moody's
at face value. However, adjustments to face value may be made to
particular categories of credits for which the S&P and/or Fitch rating
does not seem to approximate a Moody's rating equivalent. Split rated
securities assigned by S&P and Fitch will be accepted at the lower of the
two ratings.
Common stock. The following Moody's Discount Factors will be applied to
the common stock holdings:
Common Stocks Utility Industrial Financial
------------- ------- ---------- ---------
7 week exposure period 170% 264% 241%
Common stock and preferred stock of REITs and other real estate companies.
Moody's Discount Factor (1)(2)(3)
---------------------------------
Common Stock of REITs 154%
Preferred Stock of REITs
with senior implied Moody's (or S&P) rating: 154%
without senior implied Moody's (or S&P) rating: 208%
Preferred Stock of other real estate companies
with senior implied Moody's (or S&P) rating: 208%
without senior implied Moody's (or S&P) rating: 250%
(1) A Moody's Discount Factor of 250% will be applied to those assets in a
single Moody's real estate industry / property sector classification which
exceed 30% of Moody's Eligible Assets but are not greater than 35% of
Moody's Eligible Assets.
22
(2) A Moody's Discount Factor of 250% will be applied if dividends on such
securities have not been paid consistently (either quarterly or annually)
over the previous three years, or for such shorter time period that such
securities have been outstanding.
(3) A Moody's Discount Factor of 250% will be applied if the market
capitalization (including common stock and preferred stock) of an issuer
is below $500 million.
Debt securities of REITS and other real estate companies.
Moody's Rating
---------------------------------------------------------------------
Below B
and
Term to maturity Aaa Aa A Baa Ba B Unrated (1)
---------------- --- -- - --- -- - -----------
1 year or less 109% 112% 115% 118% 137% 150% 250%
2 years or less (but longer than 1 year) 115 118 122 125 146 160 250
3 years or less (but longer than 2 years) 120 123 127 131 153 168 250
4 years or less (but longer than 3 years) 126 129 133 138 161 176 250
5 years or less (but longer than 4 years) 132 135 139 144 168 185 250
7 years or less (but longer than 5 years) 139 143 147 152 179 197 250
10 years or less (but longer than 7 years) 145 150 155 160 189 208 250
15 years or less (but longer than 10 years) 150 155 160 165 196 216 250
20 years or less (but longer than 15 years) 150 155 160 165 196 228 250
30 years or less (but longer than 20 years) 150 155 160 165 196 229 250
Greater than 30 years 165 173 181 189 205 240 250
(1) Unless conclusions regarding liquidity risk as well as estimates of both
the probability and severity of default for a corporation's assets can be
derived from other sources, securities rated below B by Moody's and
unrated securities, which are securities rated by neither Moody's, S&P nor
Fitch, are limited to 10% of Moody's Eligible Assets. If a corporate,
municipal or other debt security is unrated by Moody's, S&P or Fitch, the
Fund will use the percentage set forth under "Below B and Unrated" in this
table. Ratings assigned by S&P or Fitch are generally accepted by Moody's
at face value. However, adjustments to face value may be made to
particular categories of credits for which the S&P and/or Fitch rating
does not seem to approximate a Moody's rating equivalent. Split rated
securities assigned by S&P and Fitch will be accepted at the lower of the
two ratings.
Bank loans. The Moody's Discount Factor applied to bank loans means Senior
Loans(1) with outstanding amounts greater than $25 million(2).
Split Baa and Ba Split Ba, B, and Split B Caa and Split Caa incl. Distressed
---------------- ------------------------ ----------------------------------
136% 149% 250%
(1) Non-senior loans to be discounted using the factors, plus 10%.
(2) Loans with outstandings less than $250 million accorded discounts above,
plus incremental discounts of 20%.
Asset-backed and mortgage-backed securities. The Moody's Discount Factor
applied to asset-backed securities shall be 131%. The Moody's Discount Factor
applied to collateralized mortgage obligations, planned amortization class bonds
and targeted amortization class bonds shall be determined by reference to the
weighted average life of the security in accordance with the table set forth
below.
Remaining Term to Maturity Moody's Discount Factor
-------------------------- -----------------------
3 years or less 133%
7 years or less (but longer than 3 years) 142
10 years or less (but longerthan 7 years) 158
20 years or less (but longer than 10 years) 174
23
The Moody's Discount Factor applied to residential mortgage pass-throughs
(including private-placement mortgage pass-throughs) shall be determined
by reference to the coupon paid by such security in accordance with the
table set forth below.
Coupon Moody's Discount Factor
------ -----------------------
5% 166 %
6% 162
7% 158
8% 154
9% 151
10% 148
11% 144
12% 142
13% 139
adjustable 165
The Moody's Discount Factor applied to fixed-rate pass-through that are
not rated by Moody's and are serviced by a servicer approved by Moody's
shall be determined by reference to the table in the following paragraph
(relating to whole loans).
The Moody's Discount Factor applied to whole loans shall be determined by
reference to the coupon paid by such security in accordance with the table
set forth below.
Coupon Moody's Discount Factor
------ -----------------------
5% 172 %
6% 167
7% 163
8% 159
9% 155
10% 151
11% 148
12% 145
13% 142
adjustable 170
Municipal debt obligations. The Moody's Discount Factor applied to
municipal debt obligations shall be the percentage determined by reference to
the rating on such asset and the shortest Exposure Period set forth opposite
such rating that is the same length as or is longer than the Moody's Exposure
Period, in accordance with the table set forth below:
Exposure Period Aaa Aa A Baa MIG-1 (1) MIG-1 (2) Unrated (3)
--------------- --- -- - --- --------- --------- -----------
7 weeks 151% 159% 160% 173% 135% 148% 225%
8 weeks or less (but greater 154 161 168 176 137 149 231
than 7 weeks)
9 weeks or less (but greater 158 163 170 177 138 150 240
than 8 weeks)
-----------------------------
(1) Municipal debt obligations not rated by Moody's but rated equivalent to
MIG-1, VMIG-1 or P-1 by S&P and Fitch that have a maturity less than or
equal to 49 days.
(2) Municipal debt obligations not rated by Moody's but rated equivalent to
MIG-1, VMIG-1 or P-1 by S&P and Fitch that have a maturity greater than 49
days.
(3) Unless conclusions regarding liquidity risk as well as estimates of both
the probability and severity of default for the municipal issuer's assets
can be derived from other sources as well as combined with a number of
sources as presented
24
by the Fund to Moody's securities rated below Baa by Moody's and unrated
securities, which are securities rated by neither Moody's, S&P nor Fitch,
are limited to 10% of Moody's Eligible Assets. If a municipal debt
security is unrated by Moody's, S&P or Fitch, the Fund will use the
percentage set forth under "Unrated" in this table. Ratings assigned by
S&P or Fitch are generally accepted by Moody's at face value. However,
adjustments to face value may be made to particular categories of credits
for which the S&P and/or Fitch rating does not seem to approximate a
Moody's rating equivalent. Split rated securities assigned by S&P and
Fitch will be accepted at the lower of the two ratings.
By resolution of the Board of Trustees and without amending the By-Laws of
the Fund or otherwise submitting such resolution for Shareholder approval, (i)
the Moody's Discount Factors may be changed from those set forth above and (ii)
additional Moody's Discount Factors may be established for other Eligible Assets
if, in each case, the Rating Agency has advised the Fund in writing that such
change or addition would not adversely affect its then-current rating of the
Auction Preferred Shares, provided that the Fund shall cause to be made
available a written statement setting forth the Moody's Discount Factors, as
changed or as supplemented, for inspection by the Holders at the principal
executive office of the Fund.
MOODY'S ELIGIBLE ASSETS. Under current Rating Agency 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, as defined the Fund's By-Laws (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.
25
Senior loans and other bank loans approved by Moody's.
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 and do not provide for conversion or exchange
into, or have warrants attached entitling the holder to receive, equity capital
at any time over the respective lives of such securities, (C) the issuer of such
a preferred stock has common stock listed on either the New York Stock Exchange
or the American Stock Exchange, (D) the issuer of such a preferred stock has a
senior debt rating from Moody's of Baa1 or higher or a preferred stock rating
from Moody's of Baa3 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 rating of A1 (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). In addition, the preferred stocks must have the following
diversification requirements: (X) the preferred stock issue must be greater than
$50 million and (Y) the minimum holding by the Trust of each issue of preferred
stock is $500,000 and the maximum holding of preferred stock of each issue is $5
million. In addition, preferred stocks issued by transportation companies will
not be considered Moody's Eligible Assets.
Common stocks (i) which (A) are traded on a nationally recognized stock
exchange or in the over-the-counter market, (B) if cash dividend paying, pay
cash dividends in U.S/ dollars and (C) may be sold without restriction by the
corporation; provided, however, that (y) common stock which, while a Moody's
Eligible Asset owned by the Fund, ceases paying any regular cash dividend will
no longer be considered a Moody's Eligible Asset until 71 days after the date of
the announcement of such cessation, unless the issuer of the common stock has
senior debt securities rated at least A3 by Moody's and (z) the aggregate Market
Value of the Fund's holdings of the common stock of any issuer in excess of 4%
in the case of utility common stock and 6% in the case of non-utility common
stock of the aggregate Market Value of the Fund's holdings shall not be Moody's
Eligible Assets, (ii) which are securities denominated in any currency other
than the U.S. dollar or securities of issuers formed under the laws of
jurisdictions other than the United States, its states and the District of
Columbia for which there are dollar-denominated ADRs or their equivalents which
are traded in the United States on exchanges or over-the-counter and are issued
by banks formed under the laws of the United States, its states or the District
of Columbia or (iii) which are securities of issuers formed under the laws of
jurisdictions other than the United States (and in existence for at least five
years) for which no ADRs are traded; provided, however, that the aggregate
Market Value of the Fund's holdings of securities denominated in currencies
other than the U.S. dollar and ADRs in excess of (A) 6% of the aggregate Market
Value of the Outstanding shares of common stock of such issuer thereof or (B)
10% of the Market Value of the Fund's Moody's Eligible Assets with respect to
issuers formed under the laws of any single such non-U.S. jurisdiction other
than Australia, Belgium, Canada, Denmark, Finland, France, Germany, Ireland,
Italy, Japan, the Netherlands, New Zealand, Norway, Spain, Sweden, Switzerland
and the United Kingdom, shall not be a Moody's Eligible Asset.
Asset-backed and mortgage-backed securities,
26
(A) Asset-backed securities if (1) such securities are rated at least Aa3
by Moody's or at least AA- by S&P or Fitch, (2) the securities are part of an
issue that is $250 million or greater, or the issuer of such securities has a
total of $500 million or greater of asset-backed securities outstanding at the
time of purchase of the securities by the Fund and (3) the expected average life
of the securities is not greater than 4 years;
(B) Collateralized mortgage obligations ("CMOs"), including CMOs with
interest rates that float at a multiple of the change in the underlying index
according to a pre-set formula, provided that any CMO held by the Fund (1) has
been rated Aaa by Moody's or AAA by S&P or Fitch, (2) does not have a coupon
which floats inversely, (3) is not portioned as an interest-only or
principal-only strip and (4) is part of an issuance that had an original issue
size of at least $100 million;
(C) Planned amortization class bonds ("PACs") and targeted amortization
class bonds ("TACs") provided that such PACs or TACs are (1) backed by
certificates of either the Federal National Mortgage Association ("FNMA"), the
Government National Mortgage Association ("GNMA") or the Federal Home Loan
Mortgage Corporation ("FHLMC") representing ownership in single-family first
lien mortgage loans with original terms of 30 years, (2) part of an issuance
that had an original issue size of at least $10 million, (3) part of PAC or TAC
classes that have payment priority over other PAC or TAC classes, (4) if TACs,
TACs that do not support PAC classes, and (5) if TACs, not considered reverse
TACs (i.e., do not protect against extension risk);
(D) Consolidated senior debt obligations of Federal Home Loan Banks
("FHLBs"), senior long-term debt of the FNMA, and consolidated systemwide bonds
and FCS Financial Assistance Corporation Bonds of Federal Farm Credit Banks
("FFCBs") (collectively, "FHLB, FNMA and FFCB Debentures"), provided that such
FHLB, FNMA and FFCB Debentures are (1) direct issuance corporate debt rated Aaa
by Moody's, (2) senior debt obligations backed by the FHLBs, FFCBs or FNMA, (3)
part of an issue entirely denominated in U.S. dollars and (4) not callable or
exchangeable debt issues;
(E) Mortgage pass-throughs rated at least Aa by Moody's and pass-throughs
issued prior to 1987 (if rated AA by S&P and based on fixed-rate mortgage loans)
by Travelers Mortgage Services, Citicorp Homeowners, Citibank, N.A., Sears
Mortgage Security or RFC - Salomon Brothers Mortgage Securities, Inc., provided
that (1) certificates must evidence a proportional, undivided interest in
specified pools of fixed or adjustable rate mortgage loans, secured by a valid
first lien, on one- to four-family residential properties and (2) the securities
are publicly registered (not issued by FNMA, GNMA or FHLMC);
(F) Private-placement mortgage pass-throughs provided that (1)
certificates represent a proportional undivided interest in specified pools of
fixed-rate mortgage loans, secured by a valid first lien, on one- to four-family
residential properties, (2) documentation is held by a trustee or independent
custodian, (3) pools of mortgage loans are serviced by servicers that have been
approved by FNMA or FHLMC and funds shall be advanced to meet deficiencies to
the extent provided in the pooling and servicing agreements creating such
certificates, and (4) pools have been rated Aa or better by Moody's; and
(G) Whole loans (e.g., direct investments in mortgages) provided that (1)
at least 65% of such loans (a) have seasoning of no less than 6 months, (b) are
secured by single-family detached residences, (c) are owner-occupied primary
residences, (d) are secured by a first-lien, fully-documented mortgage, (e) are
neither currently delinquent (30 days or more) nor delinquent during the
preceding year, (f) have loan-to-value ratios of 80% or below, (g) carry normal
hazard insurance and title insurance, as well as special hazard insurance, if
applicable, (h) have original terms to maturity not greater than 30 years, with
at least one year remaining to maturity, (i) have a minimum of $10,000 remaining
principal balance, (j) for loans underwritten after January 1, 1978, FNMA and/or
FHLMC forms are used for fixed-rate loans, and (k) such loans are whole loans
and not participations; (2) for loans that do not satisfy the requirements set
forth in the foregoing clause (1), (a) non-owner occupied properties represent
no greater than 15% of the aggregate of either the adjustable-rate pool or the
fixed-rate pool, (b) multi-family properties (those with five or more units)
represent no greater than 15% of the aggregate of either the adjustable-rate
pool or the fixed-rate pool, (c) condominiums represent no greater than 10% of
the aggregate of either the adjustable-rate pool or the fixed-rate pool, and any
condominium project must be 80% occupied at the time the loan is originated, (d)
properties with loan-to-value ratios exceeding 80% represent no greater than 25%
of the aggregate of either the adjustable-rate pool or the fixed-rate pool and
the portion of the mortgage on any such property that exceeds a loan-to-value
ratio of 80% is insured with Primary Mortgage Insurance from an insurer rated at
least Baa3 by Moody's and (e) loan balances in excess of the current FHLMC limit
plus $75,000 represent no greater than 25% of the aggregate of either the
adjustable-rate pool or the fixed-rate pool, loan balances in excess of $350,000
27
represent no greater than 10% of the aggregate of either the adjustable-rate
pool or the fixed-rate pool, and loan balances in excess of $1,000,000 represent
no greater than 5% of the aggregate of either the adjustable-rate pool or the
fixed-rate pool; (3) no greater than 5% of the pool of loans is concentrated in
any one zip code; (4) the pool of loans contains at least 100 loans or $2
million in loans per servicer; (5) for adjustable-rate mortgages ("ARMs"), (a)
any ARM is indexed to the National Cost of Funds index, the 11th District Cost
of Funds index, the 1-year Treasury or the 6-month Treasury, (b) the margin over
the given index is between 0.15% and 0.25% for either cost-of-funds index and
between 0.175% and 0.325% for Treasuries, (c) the maximum yearly interest rate
increase is 2%, (d) the maximum life-time interest rate increase is 6.25% and
(e) ARMs may include Federal Housing Administration and Department of Veterans
Affairs loans; (6) for "teaser" loans, (a) the initial discount from the current
ARM market rate is no greater than 2%, (b) the loan is underwritten at the
market rate for ARMs, not the "teaser" rate, and (c) the loan is seasoned six
months beyond the "teaser" period.
Any municipal debt obligations that (A) pays interest in cash, (B) does
not have a Moody's rating, as applicable, suspended by Moody's, and (C) is part
of an issue of municipal debt obligations of at least $5,000,000, except for
municipal debt obligations rated below A by Moody's, in which case the minimum
issue size is $10,000,000.
Structured Notes and rated TRACERS; and TRAINS.
Financial contracts, as such term is defined in Section 3(c)(2)(B)(ii) of
the 1940 Act, not otherwise provided for in this definition but only upon
receipt by the Fund of a letter from Moody's specifying any conditions on
including such financial contract in Moody's Eligible Assets and assuring the
Fund that including such financial contract in the manner so specified would not
affect the credit rating assigned by Moody's to the APS.
Additionally, in order to merit consideration as a Moody's Eligible Asset,
securities should be issued by entities which:
- Have not filed for bankruptcy with the past year
- Are current on all principal and interest in their fixed income
obligations
- Are current on all preferred stock dividends
- Possess a current, unqualified auditor's report without qualified,
explanatory language.
DIVERSIFICATION. In addition, portfolio holdings as described below must
be within the following diversification and issue size requirements in order to
be included in Moody's Eligible Assets. The table below establishes maximum
limits for inclusion of corporate bonds and preferred stocks except convertibles
and common stocks as eligible assets prior to applying Moody's Discount Factors
to eligible securities:
Maximum Single Maximum Single Minimum Issue Size ($
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 or below............ 2 5 50(6)
-------------------
(1) Refers to the preferred stock and senior debt rating of the portfolio
holding.
(2) Companies subject to common ownership of 25% or more are considered as one
issuer.
(3) Percentages represent a portion of the aggregate market value of the
portfolio.
(4) Industries are determined according to Moody's Industry Classifications,
as defined herein.
28
(5) Except for preferred stock, which has a minimum issue size of $50 million.
(6) Portfolio holdings from issues ranging from $50 million to $100 million
and are limited to 20% of the Fund's total assets.
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 (i) has been irrevocably deposited for the
payment of (i)(A) through (i)(E) under the definition of Preferred Shares Basic
Maintenance Amount as described in the Fund's By-Laws or to the extent it is
subject to any liens, except for (A) liens which are being contested in good
faith by appropriate proceedings and which 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, or (ii) has been segregated
against obligations of the Fund in connection with any outstanding derivative
transaction.
The following are Moody's industry classifications for the purpose of the
foregoing diversification 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
29
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
30
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 Fund considers necessary.
MOODY'S EXPOSURE PERIOD means the period commencing on a given
Valuation Date and ending 42 days thereafter.
HEDGING. The Fund may purchase or sell exchange-traded financial
futures contracts based on any index approved by Moody's or Treasury bonds,
purchase, write or sell exchange-traded put options on such financial futures
contracts, and purchase, write or sell exchange-traded call options on such
financial futures contracts (collectively, "Moody's Hedging Transactions"),
subject to the following limitations:
- 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 Fund constituting Moody's Eligible Assets owned by the
Fund (other than Moody's Eligible Assets already subject to a
Moody's Hedging Transaction).
- 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 Fund and rated Aa by
Moody's (or, if not rated by Moody's but rated by S&P, rated
AA by S&P or Fitch); 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 Fund (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 BBB or A by S&P or
Fitch).
- 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 Fund).
- 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 Fund.
- 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.
- 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.
- 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 Fund'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 Fund's investment objective 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.
31
- 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 Fund is required to pay upon
repurchase of such asset will count as a liability for the purposes of the
Preferred Shares Basic Maintenance Amount. Where the Fund purchases an asset and
agrees to sell it to a third party in the future, cash receivable by the 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 as described in the Fund's By-Laws 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 Fund will not
affect the status of such asset as a Moody's Eligible Asset, (B) liens for taxes
that are not then due and payable or that can be paid thereafter without
penalty, (C) liens to secure payment for services rendered or cash advanced to
the Fund by its investment 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.
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 are generally valued
at last sale price on the day of valuation or, in the case of securities traded
on NASDAQ, the NASDAQ official closing price. 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.
32
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, indices 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.
33
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
based on account size, except if
34
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.
For the fiscal years ended December 31, 2000, 2001 and 2002, the Fund
paid brokerage commissions in the amount of $0, $0 and $9,104, respectively.
U.S. FEDERAL INCOME TAX MATTERS
The following is a summary discussion of the material U.S. federal
income tax consequences that may be relevant to a shareholder 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 holders, persons who hold their shares
as or in a hedge against currency risk, a constructive sale, or conversion
transaction, holders 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, Treasury or
the Internal Revenue Service (the "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 has elected to be treated, has qualified and intends to
continue to qualify each year as a "regulated investment company" under
Subchapter M of the Code 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. 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 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 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
35
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.
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 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. 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 shareholders 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 either as ordinary income or, if so designated by the
Fund, as qualified dividend income taxable to individual shareholders at a
maximum 15% federal income tax rate 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.
Most of the dividends distributed to shareholders will be attributable
to income from the Fund's investments in debt securities or other investments
that do not produce "qualified dividend income" as that term is defined in
Section 1(h)(11) of the Code, and thus will not qualify for the maximum 15%
federal income tax rate on qualified dividend income. A portion of the dividend
distributions to individual shareholders may qualify for such maximum 15%
federal income tax rate to the extent that such dividends are attributable to
qualified dividend income from the Fund's investments in common and preferred
stock of U.S. companies and stock of certain foreign corporations, provided that
certain holding period and other requirements are met. Capital gain dividends
distributed by the Fund (if any) to individual shareholders generally will
qualify for the maximum 15% federal income tax rate on long-term capital gains
to the extent that such dividends relate to capital gains recognized by the Fund
on or after May 6, 2003. Under current law, the maximum 15% federal income tax
rate on qualified dividend income and long-term capital gains will cease to
apply to taxable years beginning after December 31, 2008.
A fund's distributions to its corporate shareholders would potentially
qualify for the corporate Dividends Received Deduction, subject to certain
holding period requirements and limitations on debt financing under the Code,
only to the extent a fund earned dividend income from stock investments in U.S.
domestic corporations (including corporations qualifying as REITs) and certain
other requirements are met. The income to be received by the Fund from its
investment in debt securities is not expected to qualify for the Dividends
Received Deduction under the Code. As a result, the Fund expects that most of
its distributions to corporate shareholders will not qualify for such deduction.
The Fund is permitted to acquire stocks of U.S. domestic corporations, and it is
therefore possible that a small portion of the Fund's distributions from the
dividends attributable to such stocks, may qualify for the Dividends Received
Deduction. Such qualifying portion, if any, may affect a corporate shareholder's
liability for alternative minimum tax and/or result in basis reductions and
other consequences in certain circumstances.
36
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 generally including not only
stock but also (under Treasury regulations that may be promulgated in the
future, 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
deduction for such 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 such
passive foreign investment companies as ordinary income. The Fund will monitor
and 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.
37
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 or exchange
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
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.
Under recently promulgated Treasury regulations, if a shareholder
recognizes a loss with respect to shares of $2 million or more for an individual
shareholder, or $10 million or more for a corporate shareholder, in any single
taxable year (or greater amounts over a combination of years), the shareholder
must file a disclosure statement on Form 8886 with the IRS. Shareholders who own
portfolio securities directly are in many cases excepted from this reporting
requirement but, under current guidance, shareholders of regulated investment
companies are not excepted. The fact that a loss is reportable under these
regulations does not affect the legal determination of whether or not the
taxpayer's treatment of the loss is proper. Shareholders should consult with
their tax advisers to determine the applicability of these regulations in light
of their individual circumstances.
Options written or purchased and futures contracts entered into by the
Fund on certain securities, indices and foreign currencies 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 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 and futures 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, short sale or other transaction
that is not
38
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 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 or
futures 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 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 federal income tax treatment of the Fund's investment in preferred
securities and its participation in transactions involving interest rate swaps,
caps, floors or collars 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 or more 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 share
of such income. Thus, the Fund will designate distributions comprised of
particular types of income, including ordinary income, qualified dividend income
and 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 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 relates 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,
39
to backup withholding on certain other payments from the Fund. Shareholders
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.
INDEPENDENT AUDITORS
The independent auditors of the Fund are PricewaterhouseCoopers LLP,
160 Federal Street, Boston, Massachusetts 02110. PricewaterhouseCoopers LLP will
audit and render opinion on the Fund's annual financial statements for the
fiscal year ending December 31, 2003.
Until December 31, 2002, the independent auditors of the Fund were
Ernst & Young LLP, 200 Clarendon Street, Boston, Massachusetts 02116. The
financial statements of the Fund, incorporated by reference in the Prospectus
and this Statement of Additional Information, have been audited by Ernst & Young
LLP for the periods indicated in their report with respect to those financial
statements and are included in reliance upon the authority of Ernst & Young, LLP
as experts in accounting and auditing.
ADDITIONAL INFORMATION
A Registration Statement on Form N-2, relating to the shares offered
hereby, has been filed by the Fund with the SEC, Washington, D.C. The Prospectus
and this Statement of Additional Information do not contain all 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 SEC's principal office in Washington, D.C., and copies of all or any part
thereof may be obtained from the SEC upon the payment of certain fees prescribed
by the SEC.
40
The Fund's audited financial statements in its annual report to shareholders for
the fiscal year ended December 31, 2002, as filed with the SEC on February 24,
2003, and the Fund's unaudited financial statements in its semi-annual report to
shareholders for the period ended June 30, 2003, as filed with the SEC on August
28, 2003, are incorporated by reference into this Statement of Additional
Information. The financial statements have been audited by Ernst & Young LLP,
independent auditors, as indicated in their report thereon, appearing and
incorporated by reference herein, and are included in reliance upon such report,
given on the authority of Ernst & Young LLP as experts in accounting and
auditing. The Fund's annual and semi-annual reports referenced above are
available without charge upon request by contacting Mellon Investor Services, 85
Challenger Road, Ridgefield Park, New Jersey 07660 at 1-800-852-0218.
41
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).
HEDGING RISK. 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 RISK. 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-grade 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.
B-3
APPENDIX C - PROXY VOTING GUIDELINES AND PROCEDURES
JOHN HANCOCK ADVISERS, LLC
SOVEREIGN ASSET MANAGEMENT CORPORATION
PROXY VOTING SUMMARY
We believe in placing our clients' interests first. Before we invest in a
particular stock or bond, our team of portfolio managers and research analysts
look closely at the company by examining its earnings history, its management
team and its place in the market. Once we invest, we monitor all our clients'
holdings, to ensure that they maintain their potential to produce results for
investors.
As part of our active investment management strategy, we keep a close eye on
each company we invest in. Routinely, companies issue proxies by which they ask
investors like us to vote for or against a change, such as a new management
team, a new business procedure or an acquisition. We base our decisions on how
to vote these proxies with the goal of maximizing the value of our clients'
investments.
Currently, John Hancock Advisers, LLC ("JHA") and Sovereign Asset Management
Corporation ("Sovereign") manage open-end funds, closed-end funds and portfolios
for institutions and high-net-worth investors. Occasionally, we utilize the
expertise of an outside asset manager by means of a subadvisory agreement. In
all cases, JHA or Sovereign makes the final decision as to how to vote our
clients' proxies. There is one exception, however, and that pertains to our
international accounts. The investment management team for international
investments votes the proxies for the accounts they manage. Unless voting is
specifically retained by the named fiduciary of the client, JHA and Sovereign
will vote proxies for ERISA clients.
In order to ensure a consistent, balanced approach across all our investment
teams, we have established a proxy oversight group comprised of associates from
our investment, operations and legal teams. The group has developed a set of
policies and procedures that detail the standards for how JHA and Sovereign vote
proxies. The guidelines of JHA have been approved and adopted by each fund
client's board of trustees who have voted to delegate proxy voting authority to
their investment adviser, JHA. JHA and Sovereign's other clients have granted us
the authority to vote proxies in our advisory contracts or comparable documents.
JHA and Sovereign have hired a third party proxy voting service which has been
instructed to vote all proxies in accordance with our established guidelines
except as otherwise instructed.
In evaluating proxy issues, our proxy oversight group may consider information
from many sources, including the portfolio manager, management of a company
presenting a proposal, shareholder groups, and independent proxy research
services. Proxies for securities on loan through securities lending programs
will generally not be voted, however a decision may be made to recall a security
for voting purposes if the issue is material.
Below are the guidelines we adhere to when voting proxies. Please keep in mind
that these are purely guidelines. Our actual votes will be driven by the
particular circumstances of each proxy. From time to time votes may ultimately
be cast on a case-by-case basis, taking into consideration relevant facts and
circumstances at the time of the vote. Decisions on these matters (case-by-case,
abstention, recall) will normally be made by a portfolio manager under the
supervision of the chief investment officer and the proxy oversight group. We
may abstain from voting a proxy if we conclude that the effect on our clients'
economic interests or the value of the portfolio holding is indeterminable or
insignificant.
C-1
PROXY VOTING GUIDELINES
BOARD OF DIRECTORS
We believe good corporate governance evolves from an independent board.
We support the election of uncontested director nominees, but will withhold our
vote for any nominee attending less than 75% of the board and committee meetings
during the previous fiscal year. Contested elections will be considered on a
case by case basis by the proxy oversight group, taking into account the
nominee's qualifications. We will support management's ability to set the size
of the board of directors and to fill vacancies without shareholder approval but
will not support a board that has fewer than 3 directors or allows for the
removal of a director without cause.
We will support declassification of a board and block efforts to adopt a
classified board structure. This structure typically divides the board into
classes with each class serving a staggered term.
In addition, we support proposals for board indemnification and limitation of
director liability, as long as they are consistent with corporate law and
shareholders' interests. We believe that this is necessary to attract qualified
board members.
SELECTION OF AUDITORS
We believe an independent audit committee can best determine an auditor's
qualifications.
We will vote for management proposals to ratify the board's selection of
auditors, and for proposals to increase the independence of audit committees.
CAPITALIZATION
We will vote for a proposal to increase or decrease authorized common or
preferred stock and the issuance of common stock, but will vote against a
proposal to issue or convert preferred or multiple classes of stock if the board
has unlimited rights to set the terms and conditions of the shares, or if the
shares have voting rights inferior or superior to those of other shareholders.
In addition, we will support a management proposal to: create or restore
preemptive rights; approve a stock repurchase program; approve a stock split or
reverse stock split; and, approve the issuance or exercise of stock warrants
ACQUISITIONS, MERGERS AND CORPORATE RESTRUCTURING
Proposals to merge with or acquire another company will be voted on a
case-by-case basis, as will proposals for recapitalization, restructuring,
leveraged buyout, sale of assets, bankruptcy or liquidation. We will vote
against a reincorporation proposal if it would reduce shareholder rights. We
will vote against a management proposal to ratify or adopt a poison pill or to
establish a supermajority voting provision to approve a merger or other business
combination. We would however support a management proposal to opt out of a
state takeover statutory provision, to spin-off certain operations or divisions
and to establish a fair price provision.
CORPORATE STRUCTURE AND SHAREHOLDER RIGHTS
In general, we support proposals that foster good corporate governance
procedures and that provide shareholders with voting power equal to their equity
interest in the company.
To preserve shareholder rights, we will vote against a management proposal to
restrict shareholders' right to: call a special meeting and to eliminate a
shareholders' right to act by written consent. In addition, we will not support
a
C-2
management proposal to adopt a supermajority vote requirement to change certain
by-law or charter provisions or a non-technical amendment to by-laws or a
charter that reduces shareholder rights.
EQUITY-BASED COMPENSATION
Equity-based compensation is designed to attract, retain and motivate talented
executives and independent directors, but should not be so significant as to
materially dilute shareholders' interests.
We will vote against the adoption or amendment of a stock option plan if the:
- plan dilution is more than 10% of outstanding common stock,
- plan allows for non-qualified options to be priced at less than 85% of
the fair market value on the grant date,
- company allows or has allowed the re-pricing or replacement of
underwater options in the past fiscal year (or the exchange of
underwater options).
With respect to the adoption or amendment of employee stock purchase plans or a
stock award plan, we will vote against management if:
- the plan allows stock to be purchased at less than 85% of fair market
value;
- this plan dilutes outstanding common equity greater than 10%
- all stock purchase plans, including the proposed plan, exceed 15% of
outstanding common equity.
OTHER BUSINESS
For routine business matters which are the subject of many proxy related
questions, we will vote with management proposals to:
- change the company name;
- approve other business;
- adjourn meetings;
- make technical amendments to the by-laws or charters;
- approve financial statements;
- approve an employment agreement or contract.
SHAREHOLDER PROPOSALS
Shareholders are permitted per SEC regulations to submit proposals for inclusion
in a company's proxy statement. We will generally vote against shareholder
proposals and in accordance with the recommendation of management except as
follows where we will vote for proposals:
- calling for shareholder ratification of auditors;
- calling for auditors to attend annual meetings;
- seeking to increase board independence;
C-3
- requiring minimum stock ownership by directors;
- seeking to create a nominating committee or to increase the
independence of the nominating committee;
- seeking to increase the independence of the audit committee.
CORPORATE AND SOCIAL POLICY ISSUES
We believe that "ordinary business matters" are primarily the responsibility of
management and should be approved solely by the corporation's board of
directors.
Proposals in this category, initiated primarily by shareholders, typically
request that the company disclose or amend certain business practices. We
generally vote against business practice proposals and abstain on social policy
issues, though we may make exceptions in certain instances where we believe a
proposal has substantial economic implications.
C-4
JOHN HANCOCK ADVISERS, LLC
SOVEREIGN ASSET MANAGEMENT CORPORATION
PROXY VOTING PROCEDURES
THE ROLE OF THE PROXY VOTING SERVICE
John Hancock Advisers, LLC ("JHA") and Sovereign Asset Management Corporation
("Sovereign") have hired a proxy voting service to assist with the voting of
client proxies. The proxy service coordinates with client custodians to ensure
that proxies are received for securities held in client accounts and acted on in
a timely manner. The proxy service votes all proxies received in accordance with
the proxy voting guidelines established and adopted by JHA and Sovereign. When
it is unclear how to apply a particular proxy voting guideline or when a
particular proposal is not covered by the guidelines, the proxy voting service
will contact the proxy oversight group coordinator for a resolution.
THE ROLE OF THE PROXY OVERSIGHT GROUP AND COORDINATOR
The coordinator will interact directly with the proxy voting service to resolve
any issues the proxy voting service brings to the attention of JHA or Sovereign.
When a question arises regarding how a proxy should be voted the coordinator
contacts the firm's investment professionals and the proxy oversight group for a
resolution. In addition the coordinator ensures that the proxy voting service
receives responses in a timely manner. Also, the coordinator is responsible for
identifying whether, when a voting issue arises, there is a potential conflict
of interest situation and then escalating the issue to the firm's Executive
Committee. For securities out on loan as part of a securities lending program,
if a decision is made to vote a proxy, the coordinator will manage the
return/recall of the securities so the proxy can be voted.
THE ROLE OF MUTUAL FUND TRUSTEES
The boards of trustees of our mutual fund clients have reviewed and adopted the
proxy voting guidelines of the funds' investment adviser, JHA. The trustees will
periodically review the proxy voting guidelines and suggest changes they deem
advisable.
CONFLICTS OF INTEREST
Conflicts of interest are resolved in the best interest of clients.
With respect to potential conflicts of interest, proxies will be voted in
accordance with JHA's or Sovereign's predetermined policies. If application of
the predetermined policy is unclear or does not address a particular proposal, a
special internal review by the JHA Executive Committee or Sovereign Executive
Committee will determine the vote. After voting, a report will be made to the
client (in the case of an investment company, to the fund's board of trustees),
if requested. An example of a conflict of interest created with respect to a
proxy solicitation is when JHA or Sovereign must vote the proxies of companies
that they provide investment advice to or are currently seeking to provide
investment advice to, such as to pension plans.
C-5
APPENDIX D - 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 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.
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;
D-1
(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
Applicable 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
Applicable 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:
D-2
(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
D-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 Applicable 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 Applicable 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
D-4
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.
(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 Applicable 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 Applicable 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
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
D-5
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 Applicable 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 Applicable
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 Applicable 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
D-6
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 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.
D-7
(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.
D-8
APPENDIX E - 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 constitutes a
representation by the Fund that in each Auction each party referred to herein
will actually 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 Existing Holder or Potential Holder 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 an Existing Holder, the number of shares, if
any, of APS to be sold by such Existing Holder;
(iv) if such Broker-Dealer (a "Buyer's Broker-Dealer") submitted a
Bid on behalf of a Potential Holder, the number of shares, if any, of APS to be
purchased by such Potential Holder;
(v) if the aggregate number of APS to be sold by all Existing
Holders on whose behalf such Broker-Dealer submitted a Bid or a Sell Order
exceeds the aggregate number of APS to be purchased by all potential Holders 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 APS and the number of such shares to be purchased from one or more
Existing Holders on whose behalf such Broker-Dealer acted by one or more
Potential Holders on whose behalf each of such Buyer's Broker-Dealers acted;
(vi) if the aggregate number of APS to be purchased by all Potential
Holders on whose behalf such Broker-Dealer submitted a Bid exceeds the aggregate
number of APS to be sold by all Existing Holders 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
APS and the number of such shares to be sold to one or more Potential Holders on
whose behalf such Broker-Dealer acted by one or more Existing Holders 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 APS.
(b) On each Auction Date, each Broker-Dealer that submitted an Order on
behalf of any Existing Holder or Potential Holder shall:
(i) in the case of a Broker-Dealer that is a Buyer's Broker-Dealer,
instruct each Potential Holder on whose behalf such Broker-Dealer submitted a
Bid that was accepted, in whole or in part, to instruct such Potential Holder'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 APS to be
purchased pursuant to such Bid against receipt of such shares and advise such
Potential Holder 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 Existing Holder on whose behalf such Broker-Dealer
submitted a Sell Order that was accepted, in whole or in part, to instruct such
Existing Holder's Agent Member to deliver to such Broker-Dealer (or its Agent
Member) through the
E-1
Securities Depository the number of APS to be sold pursuant to such Order
against payment therefor and advise any such Existing Holder that will continue
to hold APS of the Applicable Rate for the next succeeding Dividend Period;
(iii) advise each Existing Holder on whose behalf such Broker-Dealer
submitted a Hold Order of the Applicable Rate for the next succeeding Dividend
Period;
(iv) advise each Existing Holder on whose behalf such Broker-Dealer
submitted an Order of the Auction Date for the next succeeding Auction; and
(v) advise each Potential Holder 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
Holder or an Existing Holder shall, in such manner and at such time or times as
in its sole discretion it may determine, allocated any funds received by it
pursuant to (b)(i) above and any APS received by it pursuant to (b)(ii) above
among the Potential Holders, if any, on whose behalf such Broker-Dealer
submitted Bids, the Existing Holders, 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 Holder and Existing Holder 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 Existing Holder 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 under
(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 an Existing Holder selling APS in an Auction fails to deliver such
shares (by authorized book-entry), a Broker-Dealer may deliver to the Potential
Holder on behalf of which it submitted a Bid that was accepted a number of whole
APS that is less than the number of shares that otherwise was to be purchased by
such Potential Holder. In such event, the number of APS to be so delivered shall
be determined solely by such Broker-Dealer.
E-2
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 Agent Agreement
and the Broker-Dealer Agreements.
E-3