Filed pursuant to Rule 497(h)
File Number 333-73130
ALLIANCE NATIONAL MUNICIPAL INCOME FUND, INC.
STATEMENT OF ADDITIONAL INFORMATION
January 28, 2002
Alliance National Municipal Income Fund, Inc., a
Maryland corporation (the "Fund"), is a newly organized,
diversified, closed-end management investment company.
This Statement of Additional Information ("SAI")
relating to common shares of the Fund ("Common Shares"), par
value $.001 per share, is not a prospectus, but should be read in
conjunction with the Fund's Prospectus dated January 28, 2002
(the "Prospectus"). This SAI does not include all information
that a prospective investor should consider before purchasing
Common Shares, and investors should obtain and read the
Prospectus prior to purchasing such shares. A copy of the
Prospectus may be obtained without charge by calling (800) 227-
4618. You may also obtain a copy of the Prospectus on the
Securities and Exchange Commission's ("SEC") web site
http://www.sec.gov). Capitalized terms used but not defined in
this SAI have the meanings ascribed to them in the Prospectus.
TABLE OF CONTENTS
USE OF PROCEEDS
INVESTMENT OBJECTIVE AND POLICIES
INVESTMENT RESTRICTIONS
MANAGEMENT OF THE FUND
VALUATION OF SECURITIES
PORTFOLIO TRANSACTIONS
DISTRIBUTIONS
DESCRIPTION OF SHARES
CERTAIN PROVISIONS IN THE CHARTER
REPURCHASE OF FUND SHARES; CONVERSION TO OPEN-END FUND
TAX MATTERS
PERFORMANCE RELATED AND COMPARATIVE INFORMATION
CUSTODIAN, TRANSFER AGENT AND DIVIDEND DISBURSING AGENT
INDEPENDENT AUDITORS
COUNSEL
REGISTRATION STATEMENT
REPORT OF INDEPENDENT AUDITORS
FINANCIAL STATEMENTS
APPENDIX A - Bond Ratings A-1
APPENDIX B - Futures Contracts and Related Options B-1
This Statement of Additional Information is dated January 28,
2002
USE OF PROCEEDS
The net proceeds of the offering of Common Shares of the
Fund will be approximately $270,189,388 (or $310,800,763 if the
Underwriters exercise the over-allotment option in full) after
payment of organization and offering costs.
The Fund will pay organizational and offering expenses
estimated at $553,112 from the proceeds of the offering.
Alliance Capital Management L.P. ("Alliance" or the "Adviser"),
the Fund's investment adviser, has agreed to pay the amount by
which the aggregate of all organizational expenses and offering
costs (other than the sales load) exceeds $0.03 per Common Share.
Pending investment in municipal bonds that meet the Fund's
investment objective and policies, the net proceeds of the
offering will be primarily invested in high quality, short-term
tax-exempt money market securities or in high quality municipal
bonds with relatively low volatility (such as pre-refunded and
intermediate-term bonds), to the extent such securities are
available. If necessary to invest fully the net proceeds of the
offering immediately, the Fund may also purchase, as temporary
investments or for defensive purposes, short-term tax-exempt or
taxable investments, the income on which is subject to regular
federal income tax, of the type described under "Investment
Objective and Policies -- Short-Term Investments/Temporary
Defensive Strategies."
INVESTMENT OBJECTIVE AND POLICIES
The investment objective and general investment policies
of the Fund are described in the Prospectus. Additional
information concerning the characteristics of certain of the
Fund's investments is set forth below.
Municipal Bonds
Municipal bonds share the attributes of debt/fixed
income securities in general, but are generally issued by states,
municipalities and other political subdivisions, agencies,
authorities and instrumentalities of states and multi-state
agencies or authorities. Municipal bonds have two principal
classifications: general obligation bonds and revenue or special
obligation bonds . General obligation bonds are secured by an
issuer's pledge of its faith, credit, and taxing power for the
payment of principal and interest. They are payable from such
issuer's general revenues and not from any particular source.
Revenue or special obligation bonds are payable only from the
revenues derived from a particular facility or class of
facilities or, in some cases, from the proceeds of a special
excise or other specific revenue source. Tax-exempt private
activity bonds and industrial development bonds generally are
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also revenue bonds and thus are not payable from the issuer's
general revenues. The credit and quality of private activity
bonds and industrial development bonds are usually related to the
credit of the corporate user of the facilities. Payment of
interest on and repayment of principal of such bonds is the
responsibility of the corporate user (and/or any guarantor).
The Fund will primarily invest in municipal bonds with
long-term maturities in order to maintain a weighted average
maturity of 15-30 years, but the average weighted maturity of
obligations held by the Fund may be shortened, depending on
market conditions. As a result, the Fund's portfolio at any
given time may include both long-term and intermediate-term
municipal bonds. Moreover, during temporary or defensive periods
(e.g., times when Alliance believes that temporary imbalances of
supply and demand or other temporary dislocations in the tax-
exempt bond market adversely affect the price at which long-term
or intermediate-term municipal bonds are available), and in order
to keep the Fund's cash fully invested, including the period
during which the net proceeds of the offering are being invested,
the Fund may invest any percentage of its net assets in short-
term investments including high quality, short-term securities
that may be either tax-exempt or taxable. See "Short-Term
Investments/Temporary Defensive Strategies."
Also included within the general category of municipal
bonds in which the Fund may invest are participations in lease
obligations or installment purchase contract obligations of
municipal authorities or entities ("Municipal Lease
Obligations"). Although a Municipal Lease Obligation does not
constitute a general obligation of the municipality for which the
municipality's taxing power is pledged, a Municipal Lease
Obligation is ordinarily backed by the municipality's covenant to
budget for, appropriate and make the payments due under the
Municipal Lease Obligation. However, certain Municipal Lease
Obligations contain "non-appropriation" clauses which provide
that the municipality has no obligation to make lease or
installment purchase payments in future years unless money is
appropriated for such purpose on a yearly basis. In the case of
a "non-appropriation" lease, the Fund's ability to recover under
the lease in the event of non-appropriation or default will be
limited solely to the repossession of the leased property,
without recourse to the general credit of the lessee, and
disposition or releasing of the property might prove difficult.
There have been challenges to the legality of lease financing in
numerous states, and, from time to time, certain municipalities
have considered not appropriating money for lease payments. In
deciding whether to purchase a Municipal Lease Obligation, the
Fund will consider all relevant factors including the financial
condition of the borrower, the merits of the project, the level
of public support for the project, and the legislative history of
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lease financing in the state. These securities may be less
readily marketable than other municipal bonds. The Fund may also
purchase unrated lease obligations if determined by Alliance to
be of comparable quality to rated securities in which the Fund is
permitted to invest.
Some longer-term municipal bonds give the investor the
right to "put" or sell the security at par (face value) within a
specified number of days following the investor's request-
-usually one to seven days. This demand feature enhances a
security's liquidity by shortening its effective maturity and
enables it to trade at a price equal to or very close to par. If
a demand feature terminates prior to being exercised, the Fund
would hold the longer-term security, which could experience
substantially more volatility.
The Fund may invest in municipal bonds with credit
enhancements such as letters of credit, municipal bond insurance
and Standby Bond Purchase Agreements ("SBPAs"). Letters of
credit are issued by a third party, usually a bank, to enhance
liquidity and ensure repayment of principal and any accrued
interest if the underlying municipal bond should default.
Municipal bond insurance, which is usually purchased by the bond
issuer from a private, nongovernmental insurance company,
provides an unconditional and irrevocable guarantee that the
insured bond's principal and interest will be paid when due.
Insurance does not guarantee the price of the bond or the share
price of the Fund. The credit rating of an insured bond reflects
the credit rating of the insurer, based on its claims-paying
ability. The obligation of a municipal bond insurance company to
pay a claim extends over the life of each insured bond. Although
defaults on insured municipal bonds have been low to date and
municipal bond insurers have met their claims, there is no
assurance this will continue. A higher-than-expected default
rate could strain the insurer's loss reserves and adversely
affect its ability to pay claims to bondholders. The number of
municipal bond insurers is relatively small, and not all of them
have the highest rating. An SBPA is a liquidity facility
provided to pay the purchase price of bonds that cannot be re-
marketed. The obligation of the liquidity provider (usually a
bank) is only to advance funds to purchase tendered bonds that
cannot be remarketed and does not cover principal or interest
under any other circumstances. The liquidity provider's
obligations under the SBPA are usually subject to numerous
conditions, including the continued creditworthiness of the
underlying borrower.
Unless otherwise indicated, all limitations applicable
to the Fund's investments (as stated above and elsewhere in this
SAI) apply only at the time a transaction is entered into. Any
subsequent change in a rating assigned by any rating service to a
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security (or, if unrated, determined by Alliance to be of
comparable quality), or change in the percentage of the Fund's
assets invested in certain securities or other instruments, or
change in the average maturity or duration of the Fund's
investment portfolio, resulting from market fluctuations or other
changes in the Fund's total assets, will not require the Fund to
dispose of a particular investment. In determining whether to
sell such a security, Alliance may consider such factors as its
assessment of the credit quality of the issuer of the security,
the price at which the security could be sold and the rating, if
any, assigned to the security by other rating agencies. In the
event that ratings services assign different ratings to the same
security, Alliance will determine which rating it believes best
reflects the security's quality and risk at that time, which may
be the higher of the several assigned ratings.
Municipal bonds are subject to credit and market risk.
Generally, prices of higher quality issues tend to fluctuate less
with changes in market interest rates than prices of lower
quality issues and prices of longer maturity issues tend to
fluctuate more than prices of shorter maturity issues.
The Fund may purchase and sell portfolio investments to
take advantage of changes or anticipated changes in yield
relationships, markets or economic conditions. The Fund may also
sell municipal bonds due to changes in Alliance's evaluation of
the issuer. The secondary market for municipal bonds typically
has been less liquid than that for taxable debt/fixed income
securities, and this may affect the Fund's ability to sell
particular municipal bonds at then-current market prices,
especially in periods when other investors are attempting to sell
the same securities.
Prices and yields on municipal bonds are dependent on a
variety of factors, including general money-market conditions,
the financial condition of the issuer, general conditions of the
municipal bond market, the size of a particular offering, the
maturity of the obligation and the rating of the issue. A number
of these factors, including the ratings of particular issues, are
subject to change from time to time. Information about the
financial condition of an issuer of municipal bonds may not be as
extensive as that which is made available by corporations whose
securities are publicly traded.
Obligations of issuers of municipal bonds are subject to
the provisions of bankruptcy, insolvency, and other laws
affecting the rights and remedies of creditors, such as the
Federal Bankruptcy Code. In addition, the obligations of such
issuers may become subject to laws enacted in the future by
Congress, state legislatures, or referenda extending the time for
payment of principal and/or interest, or imposing other
5
constraints upon enforcement of such obligations or upon the
ability of municipalities to levy taxes. There is also the
possibility that, as a result of litigation or other conditions,
the ability of any issuer to pay, when due, the principal or the
interest on its municipal bonds may be materially affected.
Short-Term Investments/Temporary Defensive Strategies
For temporary or for defensive purposes, including the
period during which the net proceeds of the offering are being
invested, the Fund may invest up to 100% of its net assets in
short-term investments including high quality, short-term
securities that may be either tax-exempt or taxable. The Fund
intends to invest in taxable short-term investments only in the
event that suitable tax-exempt short-term investments are not
available at reasonable prices and yields. Tax-exempt short-term
investments include various obligations issued by state and local
governmental issuers, such as tax-exempt notes (bond anticipation
notes, tax anticipation notes and revenue anticipation notes or
other such municipal bonds maturing in three years or less from
the date of issuance) and municipal commercial paper. The Fund
will invest only in taxable short-term investments that are U.S.
Government securities or securities rated within the highest
grade by Moody's Investors Service, Inc. ("Moody's"), Standard &
Poor's Ratings Service ("S&P") or Fitch, Inc. ("Fitch"), and
which mature within one year from the date of purchase or carry a
variable or floating rate of interest. See Appendix A for a
general description of Moody's, S&P's and Fitch's ratings of
securities in such categories. The Fund's taxable short-term
investments may include certificates of deposit issued by U.S.
banks with assets of at least $1 billion, or commercial paper or
corporate notes, bonds or debentures with a remaining maturity of
one year or less, or repurchase agreements. To the extent the
Fund invests in taxable short-term investments, the Fund may not
achieve its investment objective of providing current income
exempt from federal income tax.
Other Municipal Securities
Municipal notes in which the Fund may invest include
demand notes, which are tax-exempt obligations that have stated
maturities in excess of one year, but permit the holder to sell
back the security (at par) to the issuer within one to seven days
notice. The payment of principal and interest by the issuer of
these obligations will ordinarily be guaranteed by letters of
credit offered by banks. The interest rate on a demand note may
be based upon a known lending rate, such as a bank's prime rate,
and may be adjusted when such rate changes, or the interest rate
on a demand note may be a market rate that is adjusted at
specified intervals.
6
Other short-term obligations constituting municipal
notes include tax anticipation notes, revenue anticipation notes,
bond anticipation notes and tax-exempt commercial paper. Tax
anticipation notes are issued to finance working capital needs of
municipalities. Generally, they are issued in anticipation of
various seasonal tax revenues, such as ad valorem, income, sales,
and use and business taxes. Revenue anticipation notes are
issued in expectation of receipt of other types of revenues, such
as federal revenues available under the Federal Revenue Sharing
Programs. Bond anticipation notes are issued to provide interim
financing until long-term financing can be arranged. In most
such cases, the long-term bonds provide the money for the
repayment of the notes.
Tax-Exempt Commercial Paper ("Municipal Paper") is a
short-term obligation with a stated maturity of 365 days or less
(however, issuers typically do not issue such obligations with
maturities longer than seven days). Such obligations are issued
by state and local municipalities to finance seasonal working
capital needs or as short-term financing in anticipation of
longer-term financing.
Certain municipal bonds may carry variable or floating
rates of interest whereby the rate of interest is not fixed but
varies with changes in specified market rates or indices, such as
a bank prime rate or a tax-exempt money market index.
While the various types of notes described above as a
group represent the major portion of the tax-exempt note market,
other types of notes are available in the marketplace and the
Fund may invest in such other types of notes to the extent
permitted under its investment objective, policies and
limitations. Such notes may be issued for different purposes and
may be secured differently from those mentioned above.
High Yield Securities ("Junk Bonds")
Bonds of below investment grade quality (Ba/BB or below)
are commonly referred to as "high yield securities" or "junk
bonds." Issuers of bonds rated below investment grade are
regarded as having current capacity to make principal and
interest payments but are subject to business, financial or
economic conditions that could adversely affect such payment
capacity. Municipal bonds rated Baa or BBB are considered
"investment grade" securities, although such bonds may be
considered to possess some speculative characteristics.
Municipal bonds rated AAA in which the Fund may invest may have
been so rated on the basis of the existence of insurance
guaranteeing the timely payment, when due, of all principal and
interest.
7
High yield securities are regarded as predominantly
speculative with respect to the issuer's continuing ability to
meet principal and interest payments and, therefore, carry
greater price volatility and principal and income risk, including
the possibility of issuer default and bankruptcy and increased
market price volatility.
High yield securities may be more susceptible to real or
perceived adverse economic and competitive industry conditions
than investment grade securities. A projection of an economic
downturn or of a period of rising interest rates, for example,
could cause a decline in high yield security prices because the
advent of a recession could lessen the ability of an issuer to
make principal and interest payments on its debt securities. If
an issuer of high yield securities defaults, in addition to
risking payment of all or a portion of interest and principal,
the Fund may incur additional expenses to seek recovery. Market
prices of high yield securities structured as zero-coupon bonds
are affected to a greater extent by interest rate changes, and
therefore tend to be more volatile than securities which pay
interest periodically and in cash. Alliance seeks to reduce
these risks through diversification, credit analysis and
attention to current developments and trends in both the economy
and financial markets.
The secondary market on which high yield securities are
traded may be less liquid than the market for higher-grade
securities. Less liquidity in the secondary trading market could
adversely affect the price at which the Fund could sell a high
yield security, and could adversely affect the daily net asset
value of the shares. Adverse publicity and investor perceptions,
whether or not based on fundamental analysis, may decrease the
values and liquidity of high yield securities, especially in a
thinly traded market. When secondary markets for high yield
securities are less liquid than the market for higher grade
securities, it may be more difficult to value the securities
because such valuation may require more research, and elements of
judgment may play a greater role in the valuation because there
is less reliable objective data available. During periods of
thin trading in these markets, the spread between bid and asked
prices is likely to increase significantly and the Fund may have
greater difficulty selling its portfolio securities. The Fund
will be more dependent on Alliance's research and analysis when
investing in high yield securities. Alliance seeks to minimize
the risks of investing in all securities through diversification,
in-depth credit analysis and attention to current developments in
interest rates and market conditions.
A general description of Moody's, S&P's and Fitch's
ratings of municipal bonds is set forth in Appendix A hereto.
The ratings of Moody's, S&P and Fitch represent their opinions as
8
to the quality of the municipal bonds they rate. It should be
emphasized, however, that ratings are general and are not
absolute standards of quality. Consequently, municipal bonds
with the same maturity, coupon and rating may have different
yields while obligations with the same maturity and coupon with
different ratings may have the same yield. For these reasons,
the use of credit ratings as the sole method of evaluating high
yield securities can involve certain risks. For example, credit
ratings evaluate the safety of principal and interest payments,
not the market value risk of high yield securities. Also, credit
rating agencies may fail to change credit ratings in a timely
fashion to reflect events since the security was last rated.
Alliance does not rely solely on credit ratings when selecting
securities for the Fund and develops its own independent analysis
of issuer credit quality.
Variable and Floating Rate Securities
Variable and floating rate securities provide for a
periodic adjustment in the interest rate paid on the obligations.
The terms of such obligations must provide that interest rates
are adjusted periodically based upon an interest rate adjustment
index as provided in the respective obligations. The adjustment
intervals may be regular, and range from daily up to annually, or
may be event based, such as based on a change in the prime rate.
Derivative Instruments
The Fund may enter into interest rate and index futures
contracts and purchase and sell options on such futures contracts
("futures options"). The Fund also may enter into swap
agreements with respect to interest rates and indexes of
securities. While the Fund does not currently intend to utilize
any of these types of derivative instruments, it reserves the
flexibility to use these techniques under appropriate
circumstances and without limitation, except as described herein.
If other types of financial instruments, including other types of
options, futures contracts, or futures options are traded in the
future, the Fund may also determine to use those instruments.
The value of some derivative instruments in which the
Fund may invest may be particularly sensitive to changes in
prevailing interest rates, and, like the other investments of the
Fund, the ability of the Fund to successfully utilize these
instruments may depend in part upon the ability of Alliance to
forecast interest rates and other economic factors correctly. If
Alliance incorrectly forecasts such factors and has taken
positions in derivative instruments contrary to prevailing market
trends, the Fund could be exposed to the risk of loss. The Fund
might not employ any of the strategies described below, and no
assurance can be given that any strategy used will succeed. If
9
Alliance incorrectly forecasts interest rates, market values or
other economic factors in utilizing a derivatives strategy for
the Fund, the Fund might have been in a better position if it had
not entered into the transaction. Also, suitable derivative
transactions may not be available in all circumstances. The use
of these strategies involves certain special risks, including a
possible imperfect correlation, or even no correlation, between
price movements of derivative instruments and price movements of
related investments. While some strategies involving derivative
instruments can reduce the risk of loss, they can also reduce the
opportunity for gain or even result in losses by offsetting
favorable price movements in related investments or otherwise,
due to the possible inability of the Fund to purchase or sell a
portfolio security at a time that otherwise would be favorable or
the possible need to sell a portfolio security at a
disadvantageous time because the Fund is required to maintain
asset coverage or offsetting positions in connection with
transactions in derivative instruments, and the possible
inability of the Fund to close out or to liquidate its
derivatives positions. Income earned by the Fund from many
derivative strategies will be treated as capital gain and, if not
offset by net realized capital loss, will be distributed to
shareholders in taxable distributions.
Futures Contracts and Options on Futures Contracts
While the Fund does not currently intend to do so, it
may enter into contracts for the purchase or sale for future
delivery of municipal securities or obligations of the U.S.
Government securities or contracts based on financial indices,
including an index of municipal securities or U.S. Government
securities ("futures contracts") and may purchase and write put
and call options to buy or sell futures contracts ("options on
futures contracts"). A "sale" of a futures contract means the
acquisition of a contractual obligation to deliver the securities
called for by the contract at a specified price on a specified
date. A "purchase" of a futures contract means the incurring of
a contractual obligation to acquire the securities called for by
the contract at a specified price on a specified date. The
purchaser of a futures contract on an index agrees to take or
make delivery of an amount of cash equal to the difference
between a specified dollar multiple of the value of the index on
the expiration date of the contract ("current contract value")
and the price at which the contract was originally struck. No
physical delivery of the fixed-income securities underlying the
index is made. Options on futures contracts written or
purchased, and futures contracts purchased or sold, by the Fund
will be traded on U.S. exchanges. These investment techniques
will be used only to hedge against anticipated future changes in
interest rates which otherwise might either adversely affect the
value of the securities held by the Fund or adversely affect the
10
prices of securities which a Fund intends to purchase at a later
date.
The correlation between movements in the price of
futures contracts or options on futures contracts and movements
in the price of the securities hedged or used for cover will not
be perfect and could produce unanticipated losses. If the value
of the index increases, the purchaser of the futures contract
thereon will be entitled to a cash payment. Conversely, if the
value of the index declines, the seller of a futures contract
will be entitled to a cash payment. In connection with its
purchase of index futures the Fund will deposit liquid assets
equal to the market value of the futures contract (less related
margin) in a segregated account with the Fund's custodian or a
futures margin account with a broker. If Alliance were to
forecast incorrectly, the Fund might suffer a loss arising from
adverse changes in the current contract values of the bond
futures or index futures which it had purchased or sold. A
Fund's ability to hedge its positions through transactions in
index futures depends on the degree of correlation between
fluctuations in the index and the values of the securities which
the Fund owns or intends to purchase, or general interest rate
movements.
For additional information on the use, risks and costs
of futures contracts and options on futures contracts, see
Appendix B.
Risks Associated with Futures and Futures Options.
There are several risks associated with the use of
futures contracts and futures options as hedging techniques. A
purchase or sale of a futures contract may result in losses in
excess of the amount invested in the futures contract. There can
be no guarantee that there will be a correlation between price
movements in the hedging vehicle and in the Fund securities being
hedged. In addition, there are significant differences between
the securities and futures markets that could result in an
imperfect correlation between the markets, causing a given hedge
not to achieve its objectives. The degree of imperfection of
correlation depends on circumstances such as variations in
speculative market demand for futures and futures options on
securities, including technical influences in futures trading and
futures options, and differences between the financial
instruments being hedged and the instruments underlying the
standard contracts available for trading in such respects as
interest rate levels, maturities, and creditworthiness of
issuers. A decision as to whether, when and how to hedge
involves the exercise of skill and judgment, and even a well-
conceived hedge may be unsuccessful to some degree because of
market behavior or unexpected interest rate trends.
11
Futures contracts on U.S. Government securities
historically have reacted to an increase or decrease in interest
rates in a manner similar to that in which the underlying U.S.
Government securities reacted. To the extent, however, that the
Fund enters into such futures contracts, the value of such
futures may not vary in direct proportion to the value of the
Fund's holdings of municipal bonds. Thus, the anticipated spread
between the price of the futures contract and the hedged security
may be distorted due to differences in the nature of the markets.
The spread also may be distorted by differences in initial and
variation margin requirements, the liquidity of such markets and
the participation of speculators in such markets.
Futures exchanges may limit the amount of fluctuation
permitted in certain futures contract prices during a single
trading day. The daily limit establishes the maximum amount that
the price of a futures contract may vary either up or down from
the previous day's settlement price at the end of the current
trading session. Once the daily limit has been reached in a
futures contract subject to the limit, no more trades may be made
on that day at a price beyond that limit. The daily limit
governs only price movements during a particular trading day and
therefore does not limit potential losses because the limit may
work to prevent the liquidation of unfavorable positions. For
example, futures prices have occasionally moved to the daily
limit for several consecutive trading days with little or no
trading, thereby preventing prompt liquidation of positions and
subjecting some holders of futures contracts to substantial
losses.
There can be no assurance that a liquid market will
exist at a time when the Fund seeks to close out a futures or a
futures option position, and the Fund would remain obligated to
meet margin requirements until the position is closed. In
addition, many of the contracts discussed above are relatively
new instruments without a significant trading history. As a
result, there can be no assurance that an active secondary market
will develop or continue to exist.
Interest Rate Transactions (Swaps, Caps, and Floors)
While the Fund does not currently intend to do so, it
may enter into interest rate swaps and may purchase or sell
interest rate caps and floors.
The Fund would enter into these transactions primarily
to preserve a return or spread on a particular investment or
portion of the Fund. The Fund may also enter into these
transactions to protect against price increases of securities
Alliance anticipates purchasing for the Fund at a later date. The
Fund does not intend to use these transactions in a speculative
12
manner. Interest rate swaps involve the exchange by the Fund
with another party of their respective commitments to pay or
receive interest, e.g., an exchange of floating rate payments for
fixed rate payments. 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 on a contractually-based principal amount 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 on a contractually-based principal amount
from the party selling such interest rate floor.
Interest rate swaps, caps and floors may be entered into
on either an asset-based or liability-based basis, depending upon
whether they are hedging their assets or their liabilities, and
will usually enter into interest rate swaps on a net basis, i.e.,
the two payment streams are netted out, with the Fund 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 daily, and an amount of liquid assets
having an aggregate net asset value at least equal to the accrued
excess will be maintained in a segregated account by the
custodian. If the Fund enters into an interest rate swap on other
than a net basis, the Fund will maintain in a segregated account
with the custodian the full amount, accrued daily, of the Fund's
obligations with respect to the swap. Alliance will monitor the
creditworthiness of counterparties on an ongoing basis. If there
were a default by such a counterparty, the Fund would have
contractual remedies. The swap market has grown substantially in
recent years, with a large number of banks and investment banking
firms acting both as principals and agents utilizing standardized
swap documentation. Alliance has determined that, as a result,
the swap market has become relatively liquid. Caps and floors are
more recent innovations for which standardized documentation has
not yet been developed and, accordingly they are less liquid than
swaps. To the extent the Fund sells (i.e., writes) caps and
floors it will maintain in a segregated account with the
custodian liquid assets equal to the full amount, accrued daily,
of the Fund's obligations with respect to any caps or floors.
The use of interest rate swaps is a highly specialized
activity which involves investment techniques and risks different
from those associated with ordinary Fund securities transactions.
If Alliance were incorrect in its forecasts of market values,
interest rates and other applicable factors, the investment
performance of the Fund would diminish compared with what they
would have been if these investment techniques were not used.
Moreover, even if Alliance is correct in its forecasts, there is
13
a risk that the swap position may correlate imperfectly with the
price of the asset or liability being hedged.
Interest rate swap transactions do not involve the
delivery of securities or other underlying assets of 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 other party to an
interest rate swap defaults, the Fund's risk of loss consists of
the net amount of interest payments that the Fund contractually
is entitled to receive. The Fund may purchase and sell (i.e.,
write) caps and floors without limitation, subject to the
segregated account requirement described above.
Repurchase Agreements
While the Fund does not currently intend to do so, it
may seek additional income by investing in repurchase agreements
pertaining only to U.S. Government securities. A repurchase
agreement arises when a buyer purchases a security and
simultaneously agrees to resell it to the vendor at an agreed-
upon future date, normally one day or a few days later. The
resale price is greater than the purchase price, reflecting an
agreed-upon market rate which is effective for the period of time
the buyer's money is invested in the security and which is not
related to the coupon rate on the purchased security. Such
agreements would permit the Fund to keep all of its assets at
work while retaining "overnight" flexibility in pursuit of
investments of a longer-term nature. In addition, the Fund will
require continual maintenance of collateral held by the Fund's
custodian in an amount equal to, or in excess of, the market
value of the securities which are the subject of the agreement.
In the event that a vendor defaulted on its repurchase
obligation, the Fund would suffer a loss to the extent that the
proceeds from the sale of the collateral were less than the
repurchase price. In the event of a vendor's bankruptcy, the
Fund might be delayed in, or prevented from, selling the
collateral for its benefit. Repurchase agreements may be entered
into with member banks of the Federal Reserve System including
the Fund's custodian or "primary dealers" (as designated by the
Federal Reserve Bank of New York) in U.S. Government securities.
The Fund's current practice would be to enter into repurchase
agreements only with such primary dealers.
Illiquid Securities
The Fund may invest in illiquid securities. Illiquid
securities include, among others, (a) direct placements or other
securities which are subject to legal or contractual restrictions
on resale or for which there is no readily available market
(e.g., trading in the security is suspended or, in the case of
14
unlisted securities, market makers do not exist or will not
entertain bids or offers), (b) options purchased by the Fund
over-the-counter and the cover for options written by the Fund
over-the-counter, and (c) repurchase agreements not terminable
within seven days. Securities that have legal or contractual
restrictions on resale but have a readily available market are
not deemed illiquid for purposes of this limitation.
Illiquid securities generally include securities subject
to contractual or legal restrictions on resale because they have
not been registered under the Securities Act of 1933, as amended
(the "Securities Act"), securities which are otherwise not
readily marketable and repurchase agreements having a maturity of
longer than seven days. Securities which have not been
registered under the Securities Act are referred to as private
placements or restricted securities and are purchased directly
from the issuer or in the secondary market.
Rule 144A under the Securities Act permits a broader
institutional trading market for securities otherwise subject to
restriction on resale to the general public. Rule 144A
establishes a "safe harbor" from the registration requirements of
the Securities Act for resales of certain securities to qualified
institutional buyers. An insufficient number of qualified
institutional buyers interested in purchasing certain restricted
securities held by the Fund, however, could affect adversely the
marketability of such Fund securities.
Alliance, acting under the supervision of the Board of
Directors, will monitor the liquidity of restricted securities in
the Fund that are eligible for resale pursuant to Rule 144A. In
reaching liquidity decisions, Alliance will consider, among
others, the following factors: (1) the frequency of trades and
quotes for the security; (2) the number of dealers issuing
quotations to purchase or sell the security; (3) the number of
other potential purchasers of the security; (4) the number of
dealers undertaking to make a market in the security; (5) the
nature of the security (including its unregistered nature) and
the nature of the marketplace for the security (e.g., the time
needed to dispose of the security, the method of soliciting
offers and the mechanics of the transfer); and (6) any applicable
Commission interpretation or position with respect to such type
of securities.
Portfolio Trading and Turnover Rate
Portfolio trading may be undertaken to accomplish the
investment objective of the Fund in relation to actual and
anticipated movements in interest rates. In addition, a security
may be sold and another of comparable quality purchased at
approximately the same time to take advantage of what Alliance
15
believes to be a temporary price disparity between the two
securities. Temporary price disparities between two comparable
securities may result from supply and demand imbalances where,
for example, a temporary oversupply of certain bonds may cause a
temporarily low price for such bonds, as compared with other
bonds of like quality and characteristics. The Fund may also
engage to a limited extent in short-term trading consistent with
its investment objective. Securities may be sold in anticipation
of a market decline (a rise in interest rates) or purchased in
anticipation of a market rise (a decline in interest rates) and
later sold, or to recognize a gain.
A change in the securities held by the Fund is known as
"portfolio turnover." Alliance manages the Fund without regard
generally to restrictions on portfolio turnover. The use of
certain derivative instruments with relatively short maturities
may tend to exaggerate the portfolio turnover rate for the Fund.
Trading in fixed income securities does not generally involve the
payment of brokerage commissions, but does involve indirect
transaction costs. The use of futures contracts may involve the
payment of commissions to futures commission merchants. Higher
portfolio turnover involves correspondingly greater expenses to
the Fund, including brokerage commissions or dealer mark-ups and
other transaction costs on the sale of securities and
reinvestments in other securities. Transactions in the Fund's
portfolio securities may result in realization of taxable capital
gains (including short-term capital gains which are generally
taxed to shareholders at ordinary income tax rates). The trading
costs and tax effects associated with portfolio turnover may
adversely affect the Fund's performance.
Other Investment Companies
The Fund may invest in other investment companies either
during periods when it has large amounts of uninvested cash, such
as the period shortly after the Fund receives the proceeds of the
offering of its Common Shares or the Fund's preferred shares
("Preferred Shares"), during periods when there is a shortage of
attractive, high-yielding municipal bonds available in the
market, or when Alliance believes share prices of other
investment companies offer attractive values. The Fund may
invest in investment companies that are advised by Alliance or
its affiliates to the extent permitted by applicable law and/or
pursuant to exemptive relief from the SEC. As a stockholder in
an investment company, the Fund will bear its ratable share of
that investment company's expenses and would remain subject to
payment of the Fund's management and other fees with respect to
assets so invested. Holders of Common Shares ("Common
Shareholders") would therefore be subject to duplicative expenses
to the extent the Fund invests in other investment companies. In
addition, the securities of other investment companies may also
16
be leveraged and will therefore be subject to the same leverage
risks described herein. As described in the Fund's Prospectus in
the section entitled "Risks," the net asset value and market
value of leveraged shares will be more volatile and the yield to
shareholders will tend to fluctuate more than the yield generated
by unleveraged shares. Alliance will consider all relevant
factors, including expenses and leverage, when evaluating the
investment merits of an investment in an investment company
relative to available municipal bond investments.
When-Issued, Delayed Delivery and Forward Commitment Transactions
The Fund may purchase or sell municipal bonds on a
"forward commitment" basis. When such transactions are
negotiated, the price, which is generally expressed in yield
terms, is fixed at the time the commitment is made, but delivery
and payment for the securities take place at a later date.
Normally, the settlement date occurs within two months after the
transaction, but delayed settlements beyond two months may be
negotiated. During the period between a commitment by the Fund
and settlement, no payment is made for the securities purchased
by the purchaser, and, thus, no interest accrues to the purchaser
from the transaction. The use of forward commitments enables the
Fund to hedge against anticipated changes in interest rates and
prices. For instance, in periods of rising interest rates and
falling bond prices, the Fund might sell municipal bonds which it
owned on a forward commitment basis to limit its exposure to
falling bond prices. In periods of falling interest rates and
rising bond prices, the Fund might sell a municipal security held
by the Fund and purchase the same or a similar security on a
when-issued or forward commitment basis, thereby obtaining the
benefit of currently higher cash yields. However, if Alliance
were to forecast incorrectly the direction of interest rate
movements, the Fund might be required to complete such when-
issued or forward transactions at prices less favorable than the
current market value.
When-issued municipal securities and forward commitments
may be sold prior to the settlement date, but the Fund enters
into when-issued and forward commitment transactions only with
the intention of actually receiving or delivering the municipal
securities, as the case may be. To facilitate such transactions,
the Fund's custodian bank will maintain, in a separate account of
the Fund, liquid assets having value equal to, or greater than,
any commitments to purchase municipal securities on a when-issued
or forward commitment basis and, with respect to forward
commitments to sell portfolio securities of the Fund, the
portfolio securities themselves. If the Fund, however, chooses
to dispose of the right to acquire a when-issued security prior
to its acquisition or dispose of its right to deliver or receive
against a forward commitment, it can incur a gain or loss. When-
17
issued municipal securities may include bonds purchased on a
"when, as and if issued" basis under which the issuance of the
securities depends upon the occurrence of a subsequent event,
such as approval of a proposed financing by appropriate municipal
authorities. Any significant commitment of Fund assets to the
purchase of securities on a "when, as and if issued" basis may
increase the volatility of the Fund's net asset value. At the
time the Fund makes the commitment to purchase or sell a
municipal security on a when-issued or forward commitment basis,
it records the transaction and reflects the value of the security
purchased or, if a sale, the proceeds to be received, in
determining its net asset value. No forward commitments will be
made by the Fund if, as a result, more than 10% of the value of
such Fund's total assets would be committed to such transactions.
Zero Coupon Bonds
The Fund may invest in zero coupon bonds, which are debt
obligations that do not entitle the holder to any periodic
payments prior to maturity and are issued and traded at a
discount from their face amounts. The discount varies depending
on the time remaining until maturity, prevailing interest rates,
liquidity of the security and perceived credit quality of the
issuer. Even though the Fund does not receive any interest on
zero coupon bonds during their life, the Fund accrues income with
respect to such bonds and thus may have to dispose of portfolio
securities under disadvantageous circumstances in order to obtain
cash needed to pay dividends in amounts necessary to avoid
unfavorable tax consequences. The market prices of zero coupon
bonds are generally more volatile than the market prices of
securities that pay interest periodically and are likely to
respond to changes in interest rates to a greater degree than do
securities having similar maturities and credit quality that do
pay periodic interest.
General
The successful use of the foregoing investment
practices, all of which are highly specialized investment
activities, draws upon the Adviser's special skill and experience
with respect to such instruments and usually depends on the
Adviser's ability to forecast interest rate movements correctly.
Should interest rates move in an unexpected manner, the Fund may
not achieve the anticipated benefits of futures contracts,
options, interest rate transactions or forward commitment
contracts, or may realize losses and thus be in a worse position
than if such strategies had not been used. Unlike many exchange-
traded futures contracts and options on futures contracts, there
are no daily price fluctuation limits with respect to forward
contracts, and adverse market movements could therefore continue
to an unlimited extent over a period of time. In addition, the
18
correlation between movements in the price of such instruments
and movements in the price of the securities hedged or used for
cover may not be perfect and could produce unanticipated losses.
The Fund's ability to dispose of its position in futures
contracts, options, interest rate transactions and forward
commitment contracts will depend on the availability of liquid
markets in such instruments. Markets for all these vehicles with
respect to municipal securities are relatively new and still
developing. It is impossible to predict the amount of trading
interest that may exist in various types of futures contracts and
options on futures contracts. No assurance can be given that the
Fund will be able to utilize these instruments effectively for
the purposes set forth above. Furthermore, the Fund's ability to
engage in options and futures transactions may be limited by tax
considerations.
INVESTMENT RESTRICTIONS
Fundamental Investment Restrictions
Unless specified to the contrary, the Fund cannot change
its investment objective or fundamental policies without the
approval of the holders of a "majority of the outstanding" voting
shares of the Fund and of the holders of a "majority of the
outstanding" Preferred Shares, subsequent to their issuance,
voting as a separate class. A "majority of the outstanding"
shares (whether voting together as a single class or voting as a
separate class) means (i) 67% or more of such shares present at a
meeting, if the holders of more than 50% of those shares are
present or represented by proxy, or (ii) more than 50% of such
shares, whichever is less.
The Fund may not:
(1) Concentrate its investments in a particular
industry, as that term is used in the 1940 Act and as
interpreted, modified, or otherwise permitted by regulatory
authority having jurisdiction, from time to time.
(2) Purchase or sell real estate, although it may
purchase securities(including municipal bonds) secured by real
estate or interests therein, or securities issued by companies
which invest in real estate, or interests therein.
(3) Make loans except through (i) the purchase of debt
obligations in accordance with its investment objectives and
policies; or (ii) the use of repurchase agreements.
(4) Purchase or sell commodities or commodities
contracts or oil, gas or mineral programs. This restriction
19
shall not prohibit the Fund, subject to restrictions described in
the Prospectus and elsewhere in this SAI, from purchasing,
selling or entering into futures contracts, options on futures
contracts, forward contracts, or any interest rate, securities-
related or other hedging instruments, including swap agreements
and other derivative instruments, subject to compliance with any
applicable provisions of the federal securities or commodities
laws.
(5) Borrow money or issue any senior security, except
in accordance with provisions of the 1940 Act and specifically
the Fund may (a) borrow from a bank or other entity in a
privately arranged transaction and issue commercial paper, bonds,
debentures or notes, in series or otherwise, with such interest
rates, conversion rights and other terms and provisions as are
determined by the Fund's Board of Directors, if after such
borrowing or issuance there is asset coverage of at least 300% as
defined in the 1940 Act; and (b) issue Preferred Shares with such
preferences, conversion and other rights, voting powers,
restrictions, limitations as to dividends, qualifications, and
terms and conditions of redemption as are determined by the
Fund's Board of Directors, if after such issuance there is asset
coverage of at least 200% as defined in the 1940 Act.
(6) Pledge, hypothecate, mortgage or otherwise encumber
its assets, except (i) to secure permitted borrowings, (ii) in
connection with initial and variation margin deposits relating to
futures contracts and (iii) any segregated accounts established
in accordance with its investment objective and policies.
(7) Act as an underwriter of securities of other
issuers, except to the extent that in connection with the
disposition of portfolio securities, it maybe deemed to be an
underwriter under the federal securities laws.
The Fund's industry concentration policy does not
preclude it from focusing investments in issuers in a group of
related industries (such as different types of utilities).
MANAGEMENT OF THE FUND
Directors and Officers
The business and affairs of the Fund are managed under
the direction of the Board of Directors. The Directors and
officers of the Fund, their ages and their principal occupations
during the past five years are set forth below. Each such
Director and officer is also a trustee, director or officer of
other registered investment companies sponsored by the Adviser.
Unless otherwise specified, the address of each such person is
1345 Avenue of the Americas, New York, New York 10105.
20
Directors
JOHN D. CARIFA* , 56, Chairman of the Board, is the
President, Chief Operating Officer and a Director of Alliance
Capital Management Corporation ("ACMC"), with which he has been
associated since prior to 1996.
RUTH BLOCK, 70, was formerly an Executive Vice President
and the Chief Insurance Officer of The Equitable Life Assurance
Society of the United States; Chairman and Chief Executive
Officer of Evlico; a Director of Avon, Tandem Financial Group and
Donaldson, Lufkin & Jenrette Securities Corporation. She is
currently a Director of Ecolab Incorporated (specialty chemicals)
and BP Amoco Corporation (oil and gas). Her address is P.O. Box
4623, Stamford, Connecticut 06903.
DAVID H. DIEVLER, 72, is an independent consultant.
Until December 1994 he was Senior Vice President of ACMC
responsible for mutual fund administration. Prior to joining
ACMC in 1984 he was Chief Financial Officer of Eberstadt Asset
Management since 1968. Prior to that he was a Senior Manager at
Price Waterhouse & Co., member of American Institute of Certified
Public Accountants since 1953. His address is P.O. Box 167,
Spring Lake, New Jersey 07762.
JOHN H. DOBKIN, 59, is a consultant. Currently
President of the Board of Save Venice, Inc. (preservation
organization). Formerly, he was a Senior Adviser (June 1999 -
June 2000) and President (December 1989 - May 1999) of Historic
Hudson Valley (historic preservation). Previously, he was
Director of the National Academy of Design. During 1988-92, he
was a Director and Chairman of the Audit Committee of ACMC. His
address is P.O. Box 12, Annandale, New York 12504.
WILLIAM H. FOULK, JR., 69, is an Investment Adviser and
an independent consultant. He was formerly Senior Manager of
Barrett Associates, Inc., a registered investment adviser, with
which he had been associated since prior to 1996. He was
formerly Deputy Comptroller of the State of New York and, prior
thereto, Chief Investment Officer of the New York Bank for
Savings. His address is Room 100, 2 Greenwich Plaza, Greenwich,
Connecticut 06830.
DR. JAMES HESTER, 77, has been President of the Harry
Frank Guggenheim Foundation, with which he has been associated
since prior to 1996. He was formerly President of New York
University and the New York Botanical Garden, Rector of the
____________________
* An "interested person" of the Fund as defined in the 1940
Act.
21
United Nations University and Vice Chairman of the Board of the
Federal Reserve Bank of New York. His address is 25 Cleveland
Lane, Princeton, New Jersey 08540.
CLIFFORD L. MICHEL, 62, is Senior Counsel of the law
firm of Cahill Gordon & Reindel with which he has been associated
since prior to 1996. He is President and Chief Executive Officer
of Wenonah Development Company (investments) and a Director of
Placer Dome, Inc. (mining). His address is St. Bernard's Road,
Gladstone, New Jersey 07934.
DONALD J. ROBINSON, 67, is Senior Counsel of the law
firm of Orrick, Herrington & Sutcliffe LLP since prior to 1996.
He was formerly a senior partner and a member of the Executive
Committee of that firm. He was also a member of the Municipal
Securities Rulemaking Board and Trustee of the Museum of the City
of New York. His address is 98 Hell's Peak Road, Weston, Vermont
05161.
Officers
JOHN D. CARIFA, Director, Chairman and President (see
biographical information above).
DAVID M. DOWDEN, 35, Vice President. Vice President of
ACMC, with which he has been associated since prior to 1997.
TERRANCE T. HULTS, 34, Vice President. Vice President
of ACMC, with which he has been associated since prior to 1997.
EDMUND P. BERGAN, JR., 51, Secretary. Senior Vice
President and the General Counsel of Alliance Fund Distributors,
Inc. ("AFD") and Alliance Global Investor Services, Inc.
("AGIS"), with which he has been associated since prior to 1997.
MARK D. GERSTEN, 51, Treasurer and Chief Financial
Officer. Senior Vice President of AGIS, with which he has been
associated since prior to 1997.
THOMAS R. MANLEY, 50, Controller. Vice President of
ACMC, with which he has been associated since prior to 1997.
ANDREW L. GANGOLF, 47, Assistant Secretary. Senior Vice
President and Assistant General Counsel of AFD, with which he has
been associated since prior to 1997.
DOMENICK PUGLIESE, 40, Assistant Secretary. Senior Vice
President and Assistant General Counsel of AFD, with which he has
been associated since prior to 1997.
22
The Fund does not pay any fees to, or reimburse expenses
of, its Directors who are considered "interested persons" of the
Fund.
The Adviser
Alliance, 1345 Avenue of the Americas, New York, New
York 10105, is the Fund's investment adviser. The Adviser is a
leading global investment management firm supervising client
accounts with assets as of December 31, 2001 totaling
approximately $455 billion. The Adviser provides diversified
investment management and related services globally to a broad
range of clients including: institutional investors such as
corporate and public employee pension funds, endowment funds,
domestic and foreign institutions and governments and affiliates;
private clients, consisting of high net worth individuals, trusts
and estates, charitable foundations, partnerships, private and
family corporations and other entities; individual investors by
means of retail mutual funds sponsored by the Adviser; and
institutional investors by means of in-depth research, portfolio
strategy, trading and brokerage-related services.
Alliance Capital Management Corporation is the general
partner of the Adviser and an indirect wholly-owned subsidiary of
AXA Financial, Inc. ("AXA Financial"). As of September 30, 2001,
AXA, its wholly-owned subsidiaries, AXA Financial and The
Equitable Life Assurance Society of the United States
("Equitable") and some subsidiaries of Equitable (other than the
Adviser and its subsidiaries) were the beneficial owners of
approximately 51.7% of the issued and outstanding units of the
Adviser and approximately 2.1% of the issued and outstanding
units of Alliance Capital Management Holding L.P. ("Alliance
Holding"). Alliance Holding is an entity the business of which
consists of holding units of the Adviser and engaging in related
activities. As of September 30, 2001, SCB Partners Inc., a
wholly-owned subsidiary of SCB Inc., was the owner of
approximately 16.4% of the issued and outstanding units of the
Adviser. The business and assets of SCB Inc., formerly known as
Sanford C. Bernstein, Inc., were acquired by the Adviser on
October 2, 2000.
As of September 30, 2001, AXA and its subsidiaries owned
all of the issued and outstanding shares of the common stock of
AXA Financial. AXA Financial owns all of the issued and
outstanding shares of Equitable. For insurance regulatory
purposes all shares of common stock of AXA Financial beneficially
owned by AXA and its affiliates have been deposited into a voting
trust.
AXA, a French company, is the holding company for an
international group of insurance and related financial services
23
companies. AXA's insurance operations include activities in life
insurance, property and casualty insurance and reinsurance. The
insurance operations are diverse geographically with activities
principally in Western Europe, North America, the Asia/Pacific
area, and, to a lesser extent, in Africa and South America. AXA
is also engaged in asset management, real estate and other
financial services activities principally in the United States,
as well as in Western Europe and the Asia/Pacific area.
Under the Advisory Agreement, Alliance furnishes advice
and recommendations with respect to the Fund's portfolio of
securities, order placement facilities and investments and
provides persons satisfactory to the Board of Directors to act as
officers and employees of the Fund. Such officers and employees,
as well as certain Directors of the Fund may be employees of
Alliance or its affiliates.
Alliance is, under the Advisory Agreement, responsible
for certain expenses incurred by the Fund, including, for
example, office space and certain other equipment, investment
advisory and administrative services, and any expenses incurred
in promoting the sale of Fund shares (other than the costs of
printing Fund prospectuses and other reports to shareholders and
fees related to registration with the SEC and with state
regulatory authorities).
The Fund has, under the Advisory Agreement, assumed the
obligation for payment of all of its other expenses. As to the
obtaining of clerical, accounting and other services not required
to be specifically provided to the Fund by Alliance under the
Advisory Agreement, the Fund may utilize personnel employed by
Alliance or its affiliates. The Fund may employ its own
personnel or contract for services to be performed by third
parties. In the event the Fund utilizes personnel employed by
Alliance or its affiliates (as expected), the services will be
provided to the Fund at no more than cost and the payments
specifically approved by the Fund's Board of Directors.
Under the terms of the Advisory Agreement, the Fund pays
the Adviser a monthly advisory fee at an annual rate of .65% of
the Fund's average daily net assets. Alliance has voluntarily
agreed to waive a portion of its fees or to reimburse the Fund
for fees and expenses in the amount of .25% of average daily net
assets for the first 5 full years of the Fund's operations, .20%
of average daily net assets in year 6, .15% in year 7, .10% in
year 8 and .05% in year 9.
The Adviser also provides administrative services to the
Fund. These services include, among others, preparation and
dissemination of shareholder reports and proxy materials,
accounting and bookkeeping, calculation of net asset value,
24
monitoring compliance, and negotiating certain terms and
conditions of custodian and dividend disbursing services.
The Advisory Agreement has been approved by the Fund's
Board of Directors and its initial shareholder. The Advisory
Agreement by its terms continues in effect from year to year
after January 28, 2002 if such continuance is specifically
approved, at least annually, by a majority vote of the Directors
who neither are interested persons of the Fund nor have any
direct or indirect financial interest in the Advisory Agreement,
cast in person at a meeting called for the purpose of voting on
such approval.
The Advisory Agreement may be terminated without penalty
on 60 days' written notice by a vote of a majority of the
outstanding voting securities, by a vote of the majority of the
Directors or by Alliance on 60 days' written notice, and will
automatically terminate in the event of assignment. The Advisory
Agreement provides that Alliance shall not be liable under the
Advisory Agreement for any mistake of judgment, or in any event
whatsoever, except for lack of good faith, provided that Alliance
shall be liable to the Fund and security holders by reason of
willful misfeasance, bad faith or gross negligence or of reckless
disregard of its obligations and duties under the Advisory
Agreement.
Certain other clients of Alliance may have investment
objectives and policies similar to those of the Fund. Alliance
and any of its affiliates may, from time to time, make
recommendations which result in the purchase or sale of a
particular security by their other clients simultaneously with
the Fund. If transactions on behalf of more than one client
during the same period increase the demand for securities being
purchased or the supply of securities being sold, there may be an
adverse effect on price or quantity. It is the policy of Alliance
and any of its affiliates to allocate advisory recommendations
and the placing of orders in a manner which is deemed equitable
by Alliance and any of its affiliates to the accounts involved,
including the Fund. When two or more of the clients of Alliance
and any of its affiliates (including the Fund) are purchasing or
selling the same security on a given day from the same broker-
dealer, such transactions may be averaged as to price.
The Adviser may act as an investment adviser to other
persons, firms or corporations, including investment companies,
and is the investment adviser to the following registered
investment companies: AFD Exchange Reserves, Alliance All-Asia
Investment Fund, Inc., Alliance Balanced Shares, Inc., Alliance
Bond Fund, Inc., Alliance Capital Reserves, Alliance Global
Dollar Government Fund, Inc., Alliance Global Small Cap Fund,
Inc., Alliance Global Strategic Income Trust, Inc., Alliance
25
Government Reserves, Alliance Greater China '97 Fund, Inc.,
Alliance Growth and Income Fund, Inc., Alliance Health Care Fund,
Inc., Alliance High Yield Fund, Inc., Alliance Institutional
Funds, Inc., Alliance Institutional Reserves, Inc., Alliance
International Fund, Alliance International Premier Growth Fund,
Inc., Alliance Money Market Fund, Alliance Multi-Market Strategy
Trust, Inc., Alliance Municipal Income Fund, Inc., Alliance
Municipal Income Fund II, Alliance Municipal Trust, Alliance New
Europe Fund, Inc., Alliance North American Government Income
Trust, Inc., Alliance Premier Growth Fund, Inc., Alliance Quasar
Fund, Inc., Alliance Select Investor Series, Inc., Alliance
Technology Fund, Inc., Alliance Variable Products Series Fund,
Inc., Alliance Worldwide Privatization Fund, Inc.,
AllianceBernstein Disciplined Value Fund, Inc., AllianceBernstein
Real Estate Investment Fund, Inc., AllianceBernstein Utility
Income Fund, Inc., The Alliance Fund, Inc., The Alliance Funds,
The AllianceBernstein Trust, The Korean Investment Fund, Inc.,
Sanford C. Bernstein Fund, Inc. and EQ Advisors Trust, all
registered open-end investment companies; and to ACM Government
Opportunity Fund, Inc., ACM Income Fund, Inc., ACM Managed Dollar
Income Fund, Inc., ACM Managed Income Fund, Inc., ACM Municipal
Securities Income Fund, Inc., Alliance All-Market Advantage Fund,
Inc., Alliance California Municipal Income Fund, Inc., Alliance
New York Municipal Income Fund, Inc., Alliance World Dollar
Government Fund, Inc., Alliance World Dollar Government Fund II,
Inc., The Austria Fund, Inc., The Southern Africa Fund, Inc. and
The Spain Fund, Inc., all registered closed-end investment
companies.
Codes of Ethics
The Fund and Alliance have each adopted codes of ethics
pursuant to Rule 17j-1 of the 1940 Act. These codes of ethics
permit personnel subject to the codes to invest in securities,
including securities that may be purchased or held by the Fund.
Text-only versions of the codes of ethics can be viewed on line
or downloaded from the EDGAR Database on the SEC's web site at
http://www.sec.gov. You may also review and copy those documents
by visiting the SEC's Public Reference Room in Washington, D.C.
Information on the operation of the Public Reference Room may be
obtained by calling the SEC at 202-942-8090. In addition, copies
of the codes of ethics may be obtained, after mailing the
appropriate duplicating fee, by writing to the SEC's Public
Reference Section, 450 5th Street, N.W., Washington, D.C. 20549-
0102 or by e-mail request at publicinfo@sec.gov.
VALUATION OF SECURITIES
The Fund intends to calculate and make available daily
the net asset value of its Common Shares. The net asset value
per Common Share will be determined as of the close of trading on
26
the New York Stock Exchange (the "Exchange") each day the
Exchange is open. To calculate net asset value, the Fund's
assets are valued and totaled, liabilities and the aggregate
liquidation value of the outstanding Preferred Shares, if any,
are subtracted, and the balance, called net assets attributable
to Common Shares, is divided by the total number of the Fund's
Common Shares then outstanding.
In accordance with applicable rules under the 1940 Act,
portfolio securities are valued at current market value or at
fair value as determined in good faith by the Board of Directors.
The Board of Directors has delegated to the Adviser certain of
the Board's duties with respect to the following procedures.
Readily marketable securities listed on the Exchange are valued,
except as indicated below, at the last sale price reflected on
the consolidated tape at the close of the Exchange on the
business day as of which such value is being determined. If
there has been no sale on such day, the securities are valued at
the quoted bid prices on such day. If no bid prices are quoted
on such day, then the security is valued at the mean of the bid
and asked prices at the close of the Exchange on such day as
obtained from one or more dealers regularly making a market in
such security. Where a bid and asked price can be obtained from
only one such dealer, such security is valued at the mean of the
bid and asked price obtained from such dealer unless it is
determined that such price does not represent current market
value, in which case the security shall be valued in good faith
at fair value by, or in accordance with procedures established
by, the Board of Directors. Securities for which no bid and
asked price quotations are readily available are valued in good
faith at fair value by, or in accordance with procedures
established by, the Board of Directors. Readily marketable
securities not listed on the Exchange but listed on other
national securities exchanges, and portfolio securities not
traded on the Exchange but traded on one or more other national
securities exchanges are valued in accordance with these
procedures by reference to the principal exchange on which the
securities are traded.
Readily marketable securities traded only in the over-
the-counter market, and debt securities listed on a U.S. national
securities exchange whose primary market is believed to be over-
the-counter, are valued at the mean of the bid and asked prices
at the close of the Exchange on such day as obtained from two or
more dealers regularly making a market in such security. Where a
bid and asked price can be obtained from only one such dealer,
such security is valued at the mean of the bid and asked price
obtained from such dealer unless it is determined that such price
does not represent current market value, in which case the
security shall be valued in good faith at fair value by, or in
27
accordance with procedures established by, the Board of
Directors.
Listed put and call options purchased by the Fund are
valued at the last sale price. If there has been no sale on that
day, such securities will be valued at the closing bid prices on
that day.
Open futures contracts and options thereon will be
valued using the closing settlement price or, in the absence of
such a price, the most recent quoted bid price. If there are no
quotations available for the day of valuations, the last
available closing settlement price will be used.
U.S. Government securities and other debt instruments
having 60 days or less remaining until maturity are valued at
amortized cost if their original maturity was 60 days or less, or
by amortizing their fair value as of the 61st day prior to
maturity if their original term to maturity exceeded 60 days
(unless in either case the Board of Directors determines that
this method does not represent fair value).
Fixed-income securities may be valued on the basis of
prices provided by a pricing service when such prices are
believed to reflect the fair market value of such securities.
The prices provided by a pricing service take into account many
factors, including institutional size trading in similar groups-
of securities and any developments related to specific
securities.
All other assets of the Fund are valued in good faith at
fair value by, or in accordance with procedures established by,
the Board of Directors.
PORTFOLIO TRANSACTIONS
Subject to the general supervision of the Board of
Directors of the Fund, the Adviser is responsible for the
investment decisions and the placing of the orders for portfolio
transactions for the Fund. The Fund's portfolio transactions
occur primarily with issuers, underwriters or major dealers
acting as principals. Such transactions are normally on a net
basis which do not involve payment of brokerage commissions. The
cost of securities purchased from an underwriter usually includes
a commission paid by the issuer to the underwriters; transactions
with dealers normally reflect the spread between bid and asked
prices. Premiums are paid with respect to options purchased by
the Fund and brokerage commissions are payable with respect to
transactions in exchange-traded futures contracts.
28
The Fund has no obligation to enter into transactions in
portfolio securities with any dealer, issuer, underwriter or
other entity. In placing orders, it is the policy of the Fund to
obtain the best price and execution for its transactions. Where
best price and execution may be obtained from more than one
dealer, the Adviser may, in its discretion, purchase and sell
securities through dealers who provide research, statistical and
other information to the Adviser. Such services may be used by
the Adviser for all of its investment advisory accounts and,
accordingly, not all such services may be used by the Adviser in
connection with the Fund. The supplemental information received
from a dealer is in addition to the services required to be
performed by the Adviser under the Advisory Agreement, and the
expenses of the Adviser will not necessarily be reduced as a
result of the receipt of such information. Consistent with the
Conduct Rules of the National Association of Securities Dealers,
Inc., and subject to seeking best price and execution, the Fund
may consider sales of its shares as a factor in the selection of
dealers to enter into portfolio transactions with the Fund.
The Fund may deal in some instances in securities which
are not listed on a national stock exchange but are traded in the
over-the-counter market. The Fund may also purchase listed
securities through the third market, i.e., from a dealer which is
not a member of the exchange on which a security is listed. Where
transactions are executed in the over-the-counter market or third
market, the Fund will seek to deal with the primary market
makers; but when necessary in order to obtain the best price and
execution, it will utilize the services of others. In all cases,
the Fund will attempt to negotiate best execution.
The Fund may from time to time place orders for the
purchase or sale of securities with Sanford C. Bernstein & Co.,
LLC ("SCB & Co."), an affiliate of Alliance. In such instances,
the placement of orders would be consistent with the Fund's
objective of obtaining best execution and would not be dependent
upon the fact that SCB & Co. is an affiliate of Alliance. With
respect to orders placed by SCB & Co. for execution on a national
securities exchange, commissions received must conform to Section
17(e)(2)(A) of the 1940 Act and Rule 17e-1 thereunder, which
permit an affiliated person of a registered investment company
(such as the Fund), or any affiliated person of such person, to
receive a brokerage commission from such registered investment
company provided that such commission is reasonable and fair
compared to the commissions received by other brokers in
connection with comparable transactions involving similar
securities during a comparable period of time.
29
DISTRIBUTIONS
The Fund intends to distribute all of its net investment
income, subject to the solvency requirements of Maryland law. As
described in the Fund's Prospectus, initial distributions to
Common Shareholders are expected to be declared approximately 45
days, and paid approximately 60 to 90 days, from the completion
of the offering of the Common Shares, depending on market
conditions. From and after issuance of the Preferred Shares,
monthly distributions to Common Shareholders will consist of net
investment income remaining after the payment of dividends on
Preferred Shares. Net capital gains, if any, will be distributed
at least annually to Common Shareholders to the extent such net
capital gains are not necessary to satisfy the dividend,
redemption or liquidation preferences of Preferred Shares.
For tax purposes, the Fund is currently required to
allocate net capital gain and other taxable income, if any,
between Common Shares and any Preferred Shares in proportion to
total dividends paid to each class for the year in which such net
capital gain or other taxable income is realized. For
information relating to the impact of the issuance of Preferred
Shares on the distributions made by the Fund to Common
Shareholders, see the Fund's Prospectus under "Preferred Shares
and Related Leverage."
While any Preferred Shares are outstanding, the Fund may
not declare any cash dividend or other distribution on its Common
Shares unless at the time of such declaration (1) all accumulated
dividends on the Preferred Shares have been paid and (2) the net
asset value of the Fund's portfolio (determined after deducting
the amount of such dividend or other distribution) is at least
200% of the liquidation value of any outstanding Preferred
Shares. This latter limitation on the Fund's ability to make
distributions on its Common Shares could cause the Fund to incur
income and excise tax and, under certain circumstances, impair
the ability of the Fund to maintain its qualification for
taxation as a regulated investment company. See "Tax Matters."
DESCRIPTION OF SHARES
Common Shares
The Fund's charter (the "Charter") authorizes the
issuance of up to 2,000,000,000 Common Shares, $.001 par value
per share. Upon completion of this offering, 18,906,667 Common
Shares, and no Preferred Shares, will be issued and outstanding.
However, it is the intention of the Board of Directors, under a
power contained in the Charter, to classify and issue Preferred
Shares with the voting powers, restrictions, limitations as to
dividends, qualifications and terms and conditions of redemption
30
as described in "-- Preferred Shares" below. The Board of
Directors, without any action by the shareholders of the Fund,
may amend the Charter from time to time to increase or decrease
the aggregate number of shares of stock or the number of shares
of stock of any class or series that the Fund has the authority
to issue. Under Maryland law, the Fund's shareholders generally
are not liable for the Fund's debts or obligations.
All Common Shares offered by the Prospectus will be duly
authorized, fully paid and nonassessable. Common Shareholders
are entitled to receive dividends when authorized by the Board of
Directors out of assets legally available for the payment of
dividends. They are also entitled to share ratably in the Fund's
assets legally available for distribution to the Fund's
shareholders in the event of the Fund's liquidation, dissolution
or winding up, after payment of or adequate provision for all of
the Fund's known debts and liabilities. These rights are subject
to the preferential rights of any other class or series of the
Fund's stock. At any time when the Fund's Preferred Shares are
outstanding, Common Shareholders will not be entitled to receive
any distributions from the Fund unless all accrued dividends on
Preferred Shares have been paid, 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. See
"-- Preferred Shares" below.
Each outstanding Common Share entitles the holder to one
vote on all matters submitted to a vote of shareholders,
including the election of directors. Except as provided with
respect to the Preferred Shares, the Common Shareholders will
possess the exclusive voting power. See "-- Preferred Shares"
below. There is no cumulative voting in the election of
directors, which means that, subject to the rights of holders of
Preferred Shares ("Preferred Shareholders") to separately elect
directors, the holders of a majority of the outstanding shares
entitled to vote in the election of directors can elect all of
the directors then standing for election, and the holders of the
remaining shares will not be able to elect any directors.
Common Shareholders have no preference, conversion,
exchange, sinking fund, redemption or appraisal rights and have
no preemptive rights to subscribe for any of the Fund's
securities. All Common Shares will have equal dividend,
liquidation and other rights.
Under Maryland law, a Maryland corporation generally
cannot dissolve, amend its charter, merge, sell all or
substantially all of its assets, engage in a share exchange or
engage in similar transactions outside the ordinary course of
business, unless approved by the affirmative vote of shareholders
holding at least two-thirds of the shares entitled to vote on the
31
matter. However, a Maryland corporation may provide in its
charter for approval of these matters by a lesser percentage, but
not less than a majority of all of the votes entitled to be cast
on the matter. The Fund's Charter provides for the approval of
such actions by the concurrence of a majority of the aggregate
number of votes entitled to be cast on the matter, subject to the
applicable requirements of the 1940 Act, or rules, regulations or
orders issued by the SEC under the 1940 Act, and pursuant to
certain exceptions in the Charter.
Power to Reclassify Shares of Stock
The Charter authorizes the Board of Directors to
classify and reclassify any unissued shares into other classes or
series of stock. Prior to issuance of shares of each class or
series, the Board is required by Maryland law and by the Charter
to set the terms, preferences, conversion or other rights, voting
powers, restrictions, limitations as to dividends or other
distributions, qualifications and terms or conditions of
redemption for each class or series.
Power to Issue Additional Shares of Stock
The Fund believes that the power to increase the
authorized shares of stock, to issue additional shares of stock
and to classify or reclassify unissued shares of stock and
thereafter to issue the classified or reclassified shares
provides it with increased flexibility in structuring possible
future financings and acquisitions and in meeting other needs
that might arise. These actions can be taken without shareholder
approval, unless shareholder approval is required by applicable
law or the rules of any stock exchange or automated quotation
system on which the Fund's securities may be listed or traded.
The Fund has been approved for listing of its Common
Shares on the Exchange. The Fund will hold annual meetings of
shareholders.
Shares of closed-end investment companies frequently
trade at prices lower than net asset value. Shares of closed-end
investment companies like the Fund that invest predominantly in
investment grade municipal bonds have during some periods traded
at prices higher than net asset value and during other periods
traded at prices lower than net asset value. There can be no
assurance that Common Shares or shares of other municipal funds
will trade at a price higher than net asset value in the future.
Net asset value will be reduced immediately following the
offering of Common Shares after payment of the sales load and
organization and offering expenses. Net asset value generally
increases when interest rates decline, and decreases when
interest rates rise, and these changes are likely to be greater
32
in the case of a fund having a leveraged capital structure.
Whether investors will realize gains or losses upon the sale of
Common Shares will not depend upon the Fund's net asset value but
will depend entirely upon whether the market price of the Common
Shares at the time of sale is above or below the original
purchase price for the shares. Since the market price of the
Fund's Common Shares will be determined by factors beyond the
control of the Fund, the Fund cannot predict whether the Common
Shares will trade at, below, or above net asset value or at,
below or above the initial public offering price. Accordingly,
the Common Shares are designed primarily for long-term investors,
and investors in the Common Shares should not view the Fund as a
vehicle for trading purposes. See "Repurchase of Fund Shares;
Conversion to Open-End Fund" and the Fund's Prospectus under
"Preferred Shares and Related Leverage" and "The Fund's
Investments--Municipal Bonds."
Preferred Shares
The Charter authorizes the Board of Directors to
classify any unissued shares of stock in one or more classes or
series, including Preferred Shares, and to reclassify any
previously classified but unissued shares of any series, as
authorized by the Board of Directors. Preferred Shares may be
issued, in one or more classes or series with such par value and
preferences, conversion or other rights, voting powers,
restrictions, limitations as to dividends, qualifications or
terms and conditions of redemption as determined by the Board of
Directors of the Fund, by action of the Board of Directors
without the approval of the Common Shareholders.
The Fund expects to make an offering of Preferred Shares
(representing approximately 40% of the Fund's capital immediately
after the time the Preferred Shares are issued) within
approximately one to three months after completion of the
offering of Common Shares, subject to market conditions and to
the Board of Directors' continuing belief that leveraging the
Fund's capital structure through the issuance of Preferred Shares
is likely to achieve the benefits to the Common Shareholders
described in the Prospectus and this SAI. Although the terms of
the Preferred Shares, including their dividend rate, voting
rights, liquidation preference and redemption provisions, will be
determined by the Board of Directors (subject to applicable law
and the Charter) if and when it authorizes a Preferred Shares
offering, the Fund expects that the initial series of Preferred
Shares would likely pay cumulative dividends at relatively
shorter-term periods (such as seven days) by providing for the
periodic adjustment of the dividend rate through an auction,
remarketing or other procedure. The liquidation preference,
preference on distribution, voting rights and redemption
33
provisions of the Preferred Shares are expected to be as stated
below.
Limited Issuance of Preferred Shares. Under the 1940
Act, the Fund could issue Preferred Shares with an aggregate
liquidation value of up to one-half of the value of the Fund's
total net assets, measured immediately after issuance of the
Preferred Shares. "Liquidation value" means the original
purchase price of the shares being liquidated plus any accrued
and unpaid dividends. In addition, the Fund is not permitted to
declare any cash dividend or other distribution on its Common
Shares if the liquidation value of the Preferred Shares is less
than one-half of the value of the Fund's total net assets
(determined after deducting the amount of such dividend or
distribution) immediately after the distribution. If the Fund
sells all the Common Shares and Preferred Shares discussed in the
Prospectus, the liquidation value of the Preferred Shares is
expected to be approximately 40% of the value of the Fund's total
net assets. The Fund intends to purchase or redeem Preferred
Shares, if necessary, to keep that fraction below one-half.
Distribution Preference. The Preferred Shares would
have complete priority over the Common Shares as to distribution
of assets.
Liquidation Preference. In the event of any voluntary
or involuntary liquidation, dissolution or winding up of the
affairs of the Fund, Preferred Shareholders will be entitled to
receive a preferential liquidating distribution (expected to
equal the original purchase price per share plus accumulated and
unpaid dividends thereon, whether or not earned or declared)
before any distribution of assets is made to Common Shareholders.
After payment of the full amount of the liquidating distribution
to which they are entitled, Preferred Shareholders will not be
entitled to any further participation in any distribution of
assets by the Fund. A consolidation or merger of the Fund with
or into any trust or corporation or a sale of all or
substantially all of the assets of the Fund shall not be deemed
to be a liquidation, dissolution or winding up of the Fund.
Voting Rights. In connection with any issuance of
Preferred Shares, the Fund must comply with Section 18(i) of the
1940 Act which requires, among other things, that Preferred
Shares be voting shares. Except as otherwise provided in the
Charter or otherwise required by applicable law, Preferred
Shareholders will vote together with Common Shareholders as a
single class.
In connection with the election of the Fund's Directors,
Preferred Shareholders, voting as a separate class, would also be
entitled to elect two of the Fund's Directors. The remaining
34
Directors would be elected by Common and Preferred Shareholders,
voting together as a single class. In the unlikely event that
two full years of dividends are not paid on the Preferred Shares,
the holders of the outstanding Preferred Shares, voting as a
separate class, would be entitled to elect a majority of the
Fund's Directors until all dividends in default have been paid or
declared and set apart for payment.
Unless a higher percentage is provided for under the
Charter or the Fund's By-laws (together, the "Charter
Documents"), the affirmative vote of the holders of a majority of
the outstanding Preferred Shares, voting as a separate class,
shall be required to approve any action requiring a vote of
security holders under Section 13(a) of the 1940 Act, including,
among other things, changes in the Fund's investment objective or
fundamental policies. The affirmative vote of 75% (which is
higher than that required under Maryland law or the 1940 Act) of
the outstanding Common Shares and Preferred Shares, voting
separately by class, is required to convert the Fund from a
closed-end to an open-end fund. The class or series vote of
Preferred Shareholders described above shall in each case be in
addition to any separate vote of the requisite percentage of
Common Shares and Preferred Shares necessary to authorize the
action in question.
The foregoing voting provisions will not apply with
respect to the Fund's Preferred Shares if, at or prior to the
time when a vote is required, such shares shall have been (1)
redeemed or (2) called for redemption and sufficient funds shall
have been deposited in trust to effect such redemption.
Redemption, Purchase and Sale of Preferred Shares by the
Fund. The terms of the Preferred Shares may provide that they
are redeemable at certain times, in whole or in part, at the
original purchase price per share plus accumulated dividends,
that the Fund may tender for or purchase Preferred Shares and
that the Fund may subsequently resell any shares so tendered for
or purchased. Any redemption or purchase of Preferred Shares by
the Fund will reduce the leverage applicable to Common Shares,
while any resale of shares by the Fund will increase such
leverage.
The discussion above describes the Fund's Board of
Directors' present intention with respect to a possible offering
of Preferred Shares. If the Board of Directors determines to
authorize such an offering, the terms of the Preferred Shares may
be the same as, or different from, the terms described above,
subject to applicable law and the Charter.
35
CERTAIN PROVISIONS IN THE CHARTER
Pursuant to the Charter, at the first annual meeting of
shareholders after this public offering, the Board of Directors
will be divided into three classes of Directors. The initial
terms of the first, second and third classes will expire in 2003,
2004 and 2005, respectively. Beginning in 2003, Directors of
each class will be chosen for three-year terms upon the
expiration of their current terms and each year one class of
Directors will be elected by the shareholders. The Fund believes
that classification of the Board of Directors will help to assure
the continuity and stability of our business strategies and
policies as determined by the Board of Directors.
The classified board could have the effect of making the
replacement of incumbent Directors more time-consuming and
difficult. At least two annual meetings of shareholders, instead
of one, will generally be required to effect a change in a
majority of the Board of Directors. Thus, the classified board
provision could increase the likelihood that incumbent Directors
will retain their positions. The staggered terms of Directors
may delay, defer or prevent a tender offer or an attempt to
change control of the Fund, even though the tender offer or
change in control might be in the best interest of the
shareholders.
Removal of Directors
A Director may be removed only for cause and only by the
affirmative vote of at least 75% of the votes entitled to be cast
in the election of such Director. This provision, when coupled
with the provision in the Charter authorizing only the Board of
Directors to fill vacant directorships, precludes shareholders
from removing incumbent Directors except for cause and by a
substantial affirmative vote.
Amendment to the Charter
Certain provisions of the Charter, including its
provisions on classification of the Board of Directors and
removal of Directors, may be amended only by the affirmative vote
of the holders of not less than 75% of all of the votes entitled
to be cast on the matter. Other provisions of the Charter may be
amended by a majority of the aggregate number of votes entitled
to be cast on the amendment. The required vote shall be in
addition to the vote of the holders of shares of the Fund
otherwise required by law or any agreement between the Fund and
any national securities exchange.
36
Dissolution of the Company
Subject to Board approval, the liquidation or
dissolution of the Fund or an amendment to the Charter to
terminate the Fund must be approved by the affirmative vote of
the holders of not less than 75% of all of the votes entitled to
be cast on the matter. However, if a majority of the Continuing
Directors (as such term is defined in the Charter) approves the
liquidation or dissolution of the Fund, such action requires the
affirmative vote of a majority of the votes entitled to be cast.
Other Charter Provisions
The affirmative vote of 75% (which is higher than that
required under Maryland law or the 1940 Act) of the Fund's
outstanding Common Shares and Preferred Shares, is required
generally to authorize any of the following involving a
corporation, person or entity that is directly, or indirectly
through affiliates, the beneficial owner of more than 5% of the
outstanding shares of the Fund (a "Principal Shareholder"), or to
amend the provisions of the Charter relating to such
transactions:
(i) merger, consolidation or statutory share exchange
of the Fund with or into any Principal Shareholder;
(ii) the issuance of any securities of the Fund to any
Principal Shareholder for cash except upon (1) reinvestment of
dividends pursuant to a dividend reinvestment plan of the Fund or
(2) issuance of any securities of the Fund upon the exercise of
any stock subscription rights distributed by the Fund or (3) a
public offering by the Fund registered under the Securities Act;
(iii) the sale, lease or exchange of all or any
substantial part of the assets of the Fund to any Principal
Shareholder (except assets having an aggregate fair market value
of less than $1,000,000, aggregating for the purpose of such
computation all assets sold, leased or exchanged in any series of
similar transactions within a twelve-month period); or
(iv) the sale, lease or exchange to the Fund or any
subsidiary thereof, in exchange for securities of the Fund, of
any assets of any Principal Shareholder (except assets having an
aggregate fair market value of less than $1,000,000, aggregating
for the purposes of such computation all assets sold, leased or
exchanged in any series of similar transactions within a twelve-
month period).
As noted, the voting provisions described above could
have the effect of depriving Common Shareholders of an
opportunity to sell their Common Shares at a premium over
37
prevailing market prices by discouraging a third party from
seeking to obtain control of the Fund in a tender offer or
similar transaction. In the view of the Fund's Board of
Directors, however, these provisions offer several possible
advantages, including: (1) requiring persons seeking control of
the Fund to negotiate with its management regarding the price to
be paid for the amount of Common Shares required to obtain
control; (2) promoting continuity and stability; and (3)
enhancing the Fund's ability to pursue long-term strategies that
are consistent with its investment objective and management
policies. The Board of Directors has determined that the voting
requirements described above are in the best interests of the
Fund and its shareholders generally.
The foregoing is intended only as a summary and is
qualified in its entirety by reference to the full text of the
Charter Documents, which have been filed as exhibits to the
Fund's registration statement on file with the SEC.
Liability of Directors
Maryland law permits a Maryland corporation to include
in its charter a provision limiting the liability of its
directors and officers to the corporation and its shareholders
for money damages except for liability resulting from (a) actual
receipt of an improper benefit or profit in money, property or
services or (b) active and deliberate dishonesty established by a
final judgment and which is material to the cause of action. The
Charter contains such a provision which eliminates directors' and
officers' liability to the maximum extent permitted by Maryland
law. Nothing in the Charter, however, protects a Director
against any liability to which he would otherwise be subject by
reason of willful misfeasance, bad faith, gross negligence or
reckless disregard of the duties involved in the conduct of his
office.
REPURCHASE OF FUND SHARES; CONVERSION TO OPEN-END FUND
The Fund is a closed-end investment company and as such
its shareholders will not have the right to cause the Fund to
redeem their shares. Instead, the Fund's Common Shares will
trade in the open market at prices that will be a function of
several factors, including dividend levels (which are in turn
affected by expenses), net asset value, quality, average maturity
and call protection of its portfolio securities, price, dividend
stability, relative demand for and supply of such shares in the
market, general market and economic conditions and other factors.
Shares of a closed-end investment company may frequently trade at
prices lower than net asset value. The Fund's Board of Directors
will regularly monitor the relationship between the market price
and net asset value of the Common Shares. If the Common Shares
38
were to trade at a significant discount to net asset value for an
extended period of time, the Board of Directors may consider the
repurchase by the Fund of its Common Shares or the making of a
tender offer for such shares. There can be no assurance,
however, that the Fund will take any of these actions, or that
share repurchases or tender offers, if undertaken, will reduce
market discount. The Fund has no present intention to repurchase
its Common Shares.
Notwithstanding the foregoing, at any time when
Preferred Shares are outstanding, the Fund may not purchase,
redeem or otherwise acquire any of its Common Shares unless (1)
all accrued Preferred Shares dividends have been paid and (2) at
the time of such purchase, redemption or acquisition, the net
asset value of the Fund's portfolio (determined after deducting
the acquisition price of the Common Shares) is at least 200% of
the liquidation value of the outstanding Preferred Shares
(expected to equal the original purchase price per share plus any
accrued and unpaid dividends thereon).
Subject to its investment limitations, the Fund may
borrow to finance the repurchase of shares or to make a tender
offer. Interest on any borrowings to finance share repurchase
transactions or the accumulation of cash by the Fund in
anticipation of share repurchases or tenders will reduce the
Fund's net income. Any share repurchase, tender offer or
borrowing by the Fund would have to comply with the Securities
Exchange Act of 1934, as amended, and the 1940 Act and the rules
and regulations thereunder.
The Fund's Board of Directors may also from time to time
consider submitting for a shareholder vote a proposal to convert
the Fund to an open-end investment company in an attempt to
reduce or eliminate the significant market discounts from net
asset value. The Charter requires the affirmative vote or
consent of holders of at least seventy-five percent (75%) of each
class of the Fund's shares entitled to vote on the matter to
authorize a conversion of the Fund from a closed-end to an open-
end investment company. This seventy-five percent (75%)
shareholder approval requirement is higher than is required under
the 1940 Act.
If the Fund converted to an open-end company, it would
be required to redeem all Preferred Shares then outstanding
(requiring in turn that it liquidate a portion of its investment
portfolio), and the Fund's Common Shares would no longer be
listed on the Exchange. Shareholders of an open-end investment
company may require the company to redeem their shares on any
business day (except in certain circumstances as authorized by or
under the 1940 Act) at their net asset value, less such
redemption charge, if any, as might be in effect at the time of
39
redemption. In order to avoid maintaining large cash positions
or liquidating favorable investments to meet redemptions, open-
end companies typically engage in a continuous offering of their
shares. Open-end companies are thus subject to periodic asset
in-flows and out-flows that can complicate portfolio management.
The repurchase by the Fund of its shares at prices below
net asset value will result in an increase in the net asset value
of those shares that remain outstanding. However, there can be
no assurance that share repurchases or tender offers at or below
net asset value will result in the Fund's shares trading at a
price equal to their net asset value. Nevertheless, the fact
that the Fund's shares may be the subject of repurchase or tender
offers at net asset value from time to time, or that the Fund may
be converted to an open-end company, may reduce any spread
between market price and net asset value that might otherwise
exist.
In addition, a purchase by the Fund of its Common Shares
would decrease the Fund's total assets which would likely have
the effect of increasing the Fund's expense ratio and may also
require the redemption of a portion of any outstanding Preferred
Shares in order to maintain coverage ratios. Any purchase by the
Fund of its Common Shares at a time when Preferred Shares are
outstanding will increase the leverage applicable to the
outstanding Common Shares then remaining. See the Fund's
Prospectus under "Risks--Leverage Risk."
Before deciding whether to take any action if the Fund's
Common Shares trade significantly below net asset value, the
Board of Directors would consider all factors that they deemed
relevant. Such factors may include the extent and duration of
the discount, the liquidity of the Fund's portfolio, the
relationship of the market price of the Common Shares to net
asset value, the extent to which the Fund's capital structure is
leveraged and the possibility of re-leveraging, the spread, if
any, between the yields on securities in the Fund's portfolio and
interest and dividend charges on Preferred Shares issued by the
Fund, the impact of any action that might be taken on the Fund or
its shareholders and general market and economic considerations.
Based on these considerations, even if the Fund's shares should
trade at a significant discount for a significant period of time,
the Board of Directors may determine thatno action should be
taken.
TAX MATTERS
Taxation of the Fund. The Fund intends to qualify each
year as a regulated investment company under Subchapter M of the
Internal Revenue Code of 1986, as amended (the "Code"). In order
to qualify for the special tax treatment accorded regulated
40
investment companies and their shareholders, the Fund must, among
other things:
(a) derive at least 90% of its gross income from
dividends, interest, payments with respect to
certain securities loans, gains from the sale of
stock, securities or foreign currencies, or other
income (including but not limited to gains from
options, futures, or forward contracts) derived
with respect to its business of investing in such
stock, securities, or currencies;
(b) distribute with respect to each taxable year at
least 90% of the sum of its taxable net investment
income (which includes the excess, if any, of net
short-term capital gains over net long-term capital
losses) and its net tax-exempt income for such
year; and
(c) diversify its holdings so that, at the end of each
fiscal quarter of the Fund's taxable year, (i) at
least 50% of the market value of the Fund's assets
is represented by cash and cash items, U.S.
Government securities, securities of other
regulated investment companies, and other
securities limited in respect of any one issuer to
a value not greater than 5% of the value of the
Fund's total assets and not more than 10% of the
outstanding voting securities of such issuer, and
(ii) not more than 25% of the value of the Fund's
assets is invested in the securities (other than
those of the U.S. Government or other regulated
investment companies) of any one issuer or of two
or more issuers which the Fund controls and which
are engaged in the same, similar, or related trades
or businesses.
If the Fund qualifies as a regulated investment company that is
accorded special tax treatment, the Fund will not be subject to
federal income tax on income distributed in a timely manner to
its shareholders in the form of dividends (including capital gain
dividends).
If the Fund failed to qualify as a regulated investment
company accorded special tax treatment in any taxable year, the
Fund would be subject to tax on its taxable income at corporate
rates, and all distributions from earnings and profits, including
any distributions of net tax-exempt income and net long-term
capital gains, would be taxable to shareholders as ordinary
income. Such distributions generally would be eligible for the
dividends received deduction in the case of corporate
41
shareholders. In addition, the Fund could be required to
recognize unrealized gains, pay substantial taxes and interest
and make substantial distributions before requalifying as a
regulated investment company that is accorded special tax
treatment.
The Fund may retain for investment its net capital gain.
However, if the Fund retains any net capital gain or any net
investment income, it will be subject to tax at regular corporate
rates on the amount retained. The Fund intends to distribute at
least annually to its shareholders all or substantially all of
its net tax-exempt interest and any net investment income and net
capital gain.
If the Fund fails to distribute in a calendar year at
least an amount equal to the sum of 98% of its ordinary income
for such year and 98% of its capital gain net income for the one-
year period ending October 31 of such calendar year, plus any
undistributed ordinary income and capital gain net income from
previous years, the Fund will be subject to a 4% excise tax on
the undistributed amounts. For this purpose, any income or gain
retained by the Fund that is subject to corporate tax will be
considered to have been distributed by year end. A dividend paid
to shareholders in January of a year generally is deemed to have
been paid by the Fund on December 31 of the preceding year, if
the dividend was declared and payable to shareholders of record
on a date in October, November or December of that preceding
year. The Fund intends generally to make distributions
sufficient to avoid imposition of the 4% excise tax.
If at any time when Preferred Shares are outstanding the
Fund does not meet applicable asset coverage requirements, it
will be required to suspend distributions to Common Shareholders
until the requisite asset coverage is restored. Any such
suspension may cause the Fund to pay the 4% federal excise tax
and may, in certain circumstances, prevent the Fund from
qualifying for treatment as a regulated investment company. The
Fund may redeem Preferred Shares in an effort to comply with the
distribution requirement applicable to regulated investment
companies and to avoid income and excise taxes. There can be no
assurance, however, that any such action would achieve such
objectives.
Fund Distributions. Distributions from the Fund (other
than exempt-interest dividends, as discussed below) will be
taxable to shareholders as ordinary income to the extent derived
from net investment income (which includes any net short-term
capital gains). Distributions of net capital gain (that is, the
excess of net gains from the sale of capital assets held more
than one year over net losses from the sale of capital assets
held for not more than one year) will be taxable to shareholders
42
as long-term capital gain, regardless of how long a shareholder
has held the shares in the Fund. The Fund's distributions will
not qualify for the dividends received deduction for corporate
shareholders.
Exempt-interest dividends. The Fund will be qualified
to pay exempt-interest dividends to its shareholders only if, at
the close of each quarter of the Fund's taxable year, at least
50% of the total value of the Fund's assets consists of
obligations the interest on which is exempt from federal income
tax under Code Section 103(a). Distributions from the Fund will
constitute exempt-interest dividends to the extent of the Fund's
tax-exempt interest income (net of expenses and amortized bond
premium). Distributions that the Fund properly designates as
exempt-interest dividends are treated as interest excludable from
shareholders' gross income for federal income tax purposes,
although such distributions are required to be reported on the
shareholders' federal income tax returns and may be taxable for
state and local purposes. Because the Fund intends to qualify to
pay exempt-interest dividends, the Fund may be limited in its
ability to enter into taxable transactions involving forward
commitments, repurchase agreements, financial futures and options
contracts on financial futures, tax-exempt bond indices and other
assets.
The Fund designates distributions made to the share
classes as consisting of a portion of each type of income
distributed by the Fund. The portion of each type of income
deemed received by each class of shareholders is equal to the
portion of total Fund dividends received by such class for that
taxable year. Thus, the Fund will designate dividends paid as
exempt-interest dividends in a manner that allocates such
dividends between the Preferred and Common Shareholders in
proportion to the total dividends paid to each class during or
with respect to the taxable year, or otherwise as required by
applicable law. Long-term capital gain distributions and other
income subject to regular federal income tax will similarly be
allocated between the two (or more) classes.
Dividend and capital gains distributions will be taxable
as described above whether received in cash or in shares. A
shareholder whose distributions are reinvested in shares will be
treated as having received a dividend equal to the fair market
value of the new shares issued to the shareholder, or the amount
of cash allocated to the shareholder for the purchase of shares
on its behalf.
Part or all of the interest on indebtedness, if any,
incurred or continued by a shareholder to purchase or carry
shares of the Fund paying exempt-interest dividends is not
deductible. Under rules used by the Internal Revenue Service (the
43
"Service") to determine when borrowed funds are considered used
for the purpose of purchasing or carrying particular assets, the
purchase of shares may be considered to have been made with
borrowed funds even though such funds are not directly traceable
to the purchase of shares.
The Fund may invest in tax-exempt municipal securities
subject to the alternative minimum tax ("AMT"). Under current
federal income tax law, (i) interest on tax-exempt municipal
securities issued after August 7, 1986 which are "specified
private activity bonds" and the proportionate share of any
exempt-interest dividend paid by a regulated investment company
which receives interest from such specified private activity
bonds will be treated as an item of tax preference for purposes
of the AMT imposed on individuals and corporations although for
regular federal income tax purposes such interest will remain
fully tax-exempt, and (ii) interest on all tax-exempt obligations
and all exempt-interest dividends will be included in "adjusted
current earnings" of corporations for AMT purposes.
In general, exempt-interest dividends, if any,
attributable to interest received on certain private activity
obligations and certain industrial development bonds will not be
tax-exempt to any shareholders who are "substantial users,"
within the meaning of Section 147(a) of the Code, of the
facilities financed by such obligations or bonds or who are
"related persons" of such substantial users.
The Fund will inform investors within 60 days of the
Fund's taxable year-end of the percentage of its income
distributions designated as tax-exempt. The percentage is
applied uniformly to all distributions made during the year. The
percentage of income designated as tax-exempt for any particular
distribution may be substantially different from the percentage
of the Fund's income that was tax-exempt during the period
covered by the distribution.
The Fund will allocate distributions to shareholders
that are treated as tax-exempt interest and as long-term capital
gain and ordinary income, if any, among the Common Shares and
Preferred Shares in proportion to total dividends paid to each
class for the year.
Hedging Transactions. If the Fund engages in hedging
transactions, including hedging transactions in options, futures
contracts, and straddles, or other similar transactions, it will
be subject to special tax rules (including constructive sale,
mark-to-market, straddle, wash sale, and short sale rules), the
effect of which may be to accelerate income to the Fund, defer
losses to the Fund, cause adjustments in the holding periods of
the Fund's securities, affect whether gains and losses realized
44
by the Fund are ordinary or capital, convert long-term capital
gains into short-term capital gains or convert short-term capital
losses into long-term capital losses. These rules could
therefore affect the amount, timing and character of
distributions to shareholders. Income earned as a result of the
Fund's hedging activities will not be eligible to be treated as
exempt-interest dividends when distributed to shareholders. The
Fund will endeavor to make any available elections and entries in
its books and records pertaining to such transactions in a manner
believed to be in the best interests of the Fund and its
shareholders.
Return of Capital Distributions. If the Fund makes a
distribution to you in excess of its current and accumulated
earnings and profits in any taxable year, the excess distribution
will be treated as a return of capital to the extent of your tax
basis in your shares, and thereafter as capital gain. A return
of capital is not taxable, but it reduces your tax basis in your
shares, thus reducing any loss or increasing any gain on a
subsequent taxable disposition by you of your shares.
Dividends and distributions on the Fund's shares are
generally subject to federal income tax as described herein ,
even though such dividends and distributions may economically
represent a return of a particular shareholder's investment.
Such distributions are likely to occur in respect of shares
purchased at a time when the Fund's net asset value reflects
gains that are either unrealized, or realized but not
distributed. Such realized gains may be required to be
distributed even when the Fund's net asset value also reflects
unrealized losses. Distributions are taxable to a shareholder
even if they are paid from income or gains earned by the Fund
prior to the shareholder's investment (and thus included in the
price paid by the shareholder).
Securities Issued or Purchased at a Discount. The
Fund's investment in securities issued at a more than de minimis
discount and certain other obligations will (and investments in
securities purchased at a discount may) require the Fund to
accrue and distribute income not yet received. In order to
generate sufficient cash to make the requisite distributions, the
Fund may be required to sell securities in its portfolio that it
otherwise would have continued to hold.
Sale or Redemption of Shares. The sale, exchange or
redemption of Fund shares will give rise to gain or loss in an
amount equal to the difference between the proceeds of the sale,
exchange or redemption and the shareholder's adjusted tax basis
in the shares. Any gain or loss realized upon a taxable
disposition of shares held as a capital asset will be treated as
long-term capital gain or loss if the shares have been held for
45
more than 12 months. Otherwise, the gain or loss on the taxable
disposition of Fund shares held as a capital asset will be
treated as short-term capital gain or loss. However, if a
shareholder sells shares at a loss within six months of purchase,
any loss will be disallowed for federal income tax purposes to
the extent of any exempt-interest dividends received on such
shares. In addition, any loss realized upon a taxable
disposition of shares held for six months or less but not
disallowed as provided in the preceding sentence will be treated
as long-term, rather than short-term, to the extent of any long-
term capital gain distributions received by the shareholder with
respect to the shares. All or a portion of any loss realized
upon a taxable disposition of Fund shares will be disallowed if
other substantially identical shares of the Fund are purchased
within 30 days before or after the disposition. In such a case,
the basis of the newly purchased shares will be adjusted to
reflect the disallowed loss.
From time to time the Fund may make a tender offer for
its Common Shares. It is expected that the terms of any such
offer will require a tendering shareholder to tender all Common
Shares and dispose of all Preferred Shares held, or considered
under certain attribution rules of the Code to be held, by such
shareholder. Shareholders who tender all Common Shares and
dispose of all Preferred Shares held, or considered to be held,
by them will be treated as having sold their shares and generally
will realize a capital gain or loss. If a shareholder tenders
fewer than all of its Common Shares, or retains a substantial
portion of its Preferred Shares, such shareholder may be treated
as having received a taxable dividend upon the tender of its
Common Shares. In such a case, there is a remote risk that non-
tendering shareholders will be treated as having received taxable
distributions from the Fund. Likewise, if the Fund redeems some
but not all of the Preferred Shares held by a Preferred
Shareholder and such shareholder is treated as having received a
taxable dividend upon such redemption, there is a remote risk
that Common Shareholders and non-redeeming Preferred Shareholders
will be treated as having received taxable distributions from the
Fund. To the extent that the Fund recognizes net gains on the
liquidation of portfolio securities to meet such tenders of
Common Shares, the Fund will be required to make additional
distributions to its shareholders.
Backup Withholding. The Fund generally is required to
withhold and remit to the U.S. Treasury a percentage of the
taxable dividends and other distributions paid to any non-
corporate shareholder who fails to properly furnish the Fund with
a correct taxpayer identification number (TIN), who has under-
reported dividend or interest income, or who fails to certify to
the Fund that he or she is not subject to such withholding.
Backup withholding is not an additional tax; any amounts withheld
46
may be credited against the shareholder's U.S. federal income tax
liability.
General. The federal income tax discussion set forth
above is for general information only. Prospective investors
should consult their tax advisers regarding the specific federal
tax consequences of purchasing, holding, and disposing of shares
of the Fund, as well as the effects of state, local and foreign
tax law and any proposed tax law changes.
PERFORMANCE RELATED AND COMPARATIVE INFORMATION
The suitability of an investment in Common Shares will
depend upon a comparison of the after-tax yield likely to be
provided from the Fund with that from comparable tax-exempt
investments (including those not subject to the AMT), and from
comparable fully taxable investments, in light of each such
investor's tax position.
The Fund may quote certain performance-related
information and may compare certain aspects of its portfolio and
structure to other substantially similar closed-end funds as
categorized by Lipper Inc. ("Lipper"), Morningstar Inc. or other
independent services. Comparison of the Fund to an alternative
investment should be made with consideration of differences in
features and expected performance. The Fund may obtain data from
sources or reporting services, such as Bloomberg Financial and
Lipper, that the Fund believes to be generally accurate.
The Fund may employ advertising or sales literature that
provides information relating to hypothetical yields on municipal
securities in the form of charts such as the following:
After-Tax Yields*
Assumed Hypothetical Tax Exempt Yield 5.00% 5.50% 6.00%
Assumed Hypothetical Tax Equivalent
Yield
National 8.21% 9.03% 9.85%
California 9.05% 9.96% 10.86%
New York 9.19% 10.10% 11.02%
* Each of these examples assumes the maximum 39.1% federal income
tax rate. The California example assumes 9.3% maximum state
income tax, and the New York example assumes the maximum 6.85%
New York State and 3.779% New York City tax rate.
The Fund may disclose information concerning its
anticipated average maturity, which is 25 years, and average
ratings quality, which is AA. These are expectations only and
47
will not necessarily be the Fund's actual average maturity or
ratings quality.
The Fund may employ advertising or sales literature that
provides a line graph or other presentation demonstrating the
historical long-term after-tax growth of an initial $100,000
investment in various asset classes. For example, the Fund may
use a line graph showing the after-tax values of an investment in
these securities in 2000 beginning with an initial investment of
$100,000 in 1980, including Municipal Bonds-$551,385, Treasury
Bonds-$397,582, Corporate Bonds-$365,479, and Treasury Bills-
$209,824.
The Fund, in its advertisements, may refer to pending
legislation from time to time and the possible impact of such
legislation on investors, investment strategy and related
matters. This would include any tax proposals and their effect
on marginal tax rates and tax-equivalent yields. At any time in
the future, yields and total return may be higher or lower than
past yields and there can be no assurance that any historical
results will continue.
Past performance is not indicative of future results.
At the time Common Shareholders sell their shares, they may be
worth more or less than their original investment.
CUSTODIAN, TRANSFER AGENT AND DIVIDEND DISBURSING AGENT
State Street Bank & Trust Company serves as custodian
for assets of the Fund. The custodian performs custodial and
fund accounting services.
Equiserve Trust Company, N.A. serves as the Fund's
transfer agent, registrar, dividend disbursing agent and
shareholder servicing agent, as well as agent for the Fund's
dividend reinvestment plan.
INDEPENDENT AUDITORS
Ernst & Young LLP, 787 Seventh Avenue, New York, New
York 10019 serves as independent auditors for the Fund.
COUNSEL
Seward & Kissel LLP, One Battery Park Plaza, New York,
New York, passes upon certain legal matters in connection with
shares offered by the Fund, and also acts as counsel to the Fund.
Seward & Kissel LLP will rely upon the opinion of Ballard Spahr
Andrews & Ingersoll, LLP for certain matters of Maryland law.
48
REGISTRATION STATEMENT
A Registration Statement on Form N-2, including any
amendments thereto, relating to the shares of the Fund offered
hereby, has been filed by the Fund with the SEC, Washington, D.C.
The Fund's Prospectus and this SAI 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 or to be offered
hereby, reference is made to the Fund's Registration Statement.
Statements contained in the Fund's Prospectus and this SAI 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. Copies 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.
49
Report of Independent Auditors
To the Shareholder and Board of Directors
Alliance National Municipal Income Fund, Inc.
We have audited the accompanying statement of assets and
liabilities of Alliance National Municipal Income Fund, Inc. (the
"Fund") as of January 23, 2002. This financial statement is the
responsibility of the Fund's management. Our responsibility is to
express an opinion on this financial statement based on our
audit.
We conducted our audit in accordance with auditing standards
generally accepted in the United States. Those standards require
that we plan and perform the audit to obtain reasonable assurance
about whether the financial statement is free of material
misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial
statement. An audit also includes assessing the accounting
principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the financial statement referred to above
presents fairly, in all material respects, the financial position
of Alliance National Municipal Income Fund, Inc. at January 23,
2002, in conformity with accounting principles generally accepted
in the United States.
ERNST & YOUNG LLP
New York, New York
January 24, 2002
50
FINANCIAL STATEMENTS
Alliance National Municipal Income Fund, Inc.
Statement of Assets and Liabilities
January 23, 2002
Assets:
Cash $100,005
Deferred offering costs 500,000
--------
Total assets 600,005
--------
Liabilities
Payable for offering costs 500,000
--------
Net Assets $100,005
========
Composition of Net Assets
Common stock, at par $ 7
Additional paid-in capital 99,998
--------
$100,005
========
Net asset value per share:
Equivalent to 6,667 shares of
common stock issued and
outstanding, par value $0.001,
2,000,000,000 shares authorized $15.00
========
See notes to statement of assets and liabilities.
51
Alliance National Municipal Income Fund, Inc.
Notes to Statement of Assets and Liabilities
January 23, 2002
Note A - Organization:
Alliance National Municipal Income Fund, Inc. (the "Fund") was
organized as a Maryland corporation on November 9, 2001. The
Fund is registered under the Investment Company Act of 1940 as a
newly organized, diversified, closed-end management investment
company. The Fund has had no operations to date, other than the
sale to Alliance Capital Management L.P. (the "Adviser") on
January 23, 2002 of 6,667 shares of common stock for $100,005
($15.00 per share).
Note B - Investment Advisory Agreement:
Under the terms of an Investment Advisory Agreement, the Fund
pays the Adviser a monthly fee at an annualized rate of .65% of
the Fund's average daily net assets. The Adviser has agreed to
waive a portion of its fees or reimburse the Fund for expenses in
the amount of 0.25% of average daily net assets for the first 5
full years of the Fund's operations, 0.20% of average daily net
assets in year 6, 0.15% in year 7, 0.10% in year 8, and 0.05% in
year 9.
Note C - Organization Expenses and Offering Costs:
Based on an estimated Fund offering of 16,666,666 shares,
organization and offering costs are estimated to be $29,500 and
$501,780, respectively. Alliance Capital Management L.P., the
Fund's investment adviser, has agreed to pay the amount by which
the aggregate of all of the Fund's organizational expenses and
all offering costs (other than sales load) exceeds $0.03 per
share. Such amount to be paid by the Adviser is estimated to be
$31,280. The Fund will pay offering costs estimated at $500,000
from the proceeds of the offering. Offering costs paid by the
Fund will be charged as a reduction of paid-in capital at the
completion of the Fund offering.
52
APPENDIX A: BOND RATINGS
Standard & Poor's Bond Ratings
A Standard & Poor's municipal bond rating is a current
assessment of the creditworthiness of an obligor with respect to
a specific obligation. Debt rated "AAA" has the highest rating
assigned by Standard & Poor's. Capacity to pay interest and
repay principal is extremely strong. Debt rated "AA" has a very
strong capacity to pay interest and to repay principal and
differs from the highest rated issues only in small degree. 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
a debt of a higher rated category. 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 to repay principal for debt in this category than for higher
rated categories.
Debt rated "BB," "B," "CCC" or "CC" is regarded, on
balance, as predominately 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. The rating "C" is reserved for income bonds
on which no interest is being paid. Debt rated "D" is in default
and payments of interest and/or repayment of principal are in
arrears.
The ratings from "AAA" to "B" may be modified by the
addition of a plus or minus sign to show relative standing within
the major rating categories.
Moody's Bond Ratings
Excerpts from Moody's description of its municipal bond
ratings: Aaa - judged to be the best quality, carry the smallest
degree of investment risk; Aa - judged to be of high quality by
all standards; A - possess many favorable investment attributes
and are to be considered as higher upper grade obligations; Baa -
considered as medium grade obligations, i.e., they are neither
highly protected nor poorly secured and have speculative
characteristics as well; Ba, B, Caa, Ca, C - protection of
interest and principal payments is questionable; Ba indicates
some speculative elements while Ca represents a high degree of
A-1
speculation and C represents the lowest rated class of bonds;
Caa, Ca and C bonds may be in default. Moody's applies numerical
modifiers 1, 2 and 3 in each generic rating classification from
Aa to B in its corporate bond rating system. The modifier 1
indicates that the security ranks in the higher end of its
generic rating category; the modifier 2 indicates a mid-range
ranking; and the modifier 3 indicates that the issue ranks at the
lower end of its generic rating category.
Short-Term Municipal Loans
Moody's highest rating for short-term municipal loans is
MIG-1/VMIG-1. Moody's states that short-term municipal
securities rated MIG-1/VMIG-1 are of the best quality, enjoying
strong protection from established cash flows of funds for their
servicing or from established and broad-based access to the
market for refinancing, or both. Loans bearing the MIG-2/VMIG-2
designation are of high quality, with margins of protection ample
although not so large as in the MIG-l/VMIG-1 group.
S&P's highest rating for short-term municipal loans is
SP-1. S&P states that short-term municipal securities bearing
the SP-1 designation have very strong or strong capacity to pay
principal and interest. Those issues rated SP-1 which are
determined to possess overwhelming safety characteristics will be
given a plus (+) designation. Issues rated SP-2 have
satisfactory capacity to pay principal and interest.
Other Municipal Securities
"Prime-1" is the highest rating assigned by Moody's for
other short-term municipal securities and commercial paper, and
A-1+" and "A-1" are the two highest ratings for commercial paper
assigned by S&P (S&P does not rate short-term tax-free
obligations). Moody's uses the numbers 1, 2 and 3 to denote
relative strength within its highest classification of "Prime,"
while S&P uses the number 1+, 1, 2 and 3 to denote relative
strength within its highest classification of "A." Issuers rated
"Prime" by Moody's have the following characteristics: their
short-term debt obligations carry the smallest degree of
investment risk, margins of support for current indebtedness are
large or stable with cash flow and asset protection well assured,
current liquidity provides ample coverage of near-term
liabilities and unused alternative financing arrangements are
generally available. While protective elements may change over
the intermediate or longer-term, such changes are most unlikely
to impair the fundamentally strong position of short-term
obligations. Commercial paper issuers rated "A" by S&P have the
following characteristics: liquidity ratios are better than
industry average, long-term debt rating is A or better, the
issuer has access to at least two additional channels of
A-2
borrowing, and basic earnings and cash flow are in an upward
trend. Typically, the issuer is a strong company in a well-
established industry and has superior management.
Fitch, Inc. International Long-Term Credit Ratings
Investment Grade
AAA - Highest credit quality. 'AAA' ratings denote the
lowest expectation of credit risk. They 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.
AA - Very high credit quality. 'AA' ratings denote a
very low expectation of credit risk. They indicate very strong
capacity for timely payment of financial commitments. This
capacity is not significantly vulnerable to foreseeable events.
A - High credit quality. 'A' ratings denote a low
expectation of credit risk. The capacity for timely payment of
financial commitments is considered strong. This capacity may,
nevertheless, be more vulnerable to changes in circumstances or
in economic conditions than is the case for higher ratings.
BBB - Good credit quality. 'BBB' ratings indicate that
there is currently a low expectation of credit risk. The capacity
for timely payment of financial commitments is considered
adequate, but adverse changes in circumstances and in economic
conditions are more likely to impair this capacity. This is the
lowest investment-grade category.
Speculative Grade
BB - Speculative. 'BB' ratings indicate that there is a
possibility of credit risk developing, particularly as the result
of adverse economic change over time; however, business or
financial alternatives may be available to allow financial
commitments to be met. Securities rated in this category are not
investment grade.
B - Highly speculative. 'B' ratings indicate that
significant credit risk is present, but a limited margin of
safety remains. Financial commitments are currently being met;
however, capacity for continued payment is contingent upon a
sustained, favorable business and economic environment.
CCC, CC, C - High default risk. Default is a real
possibility. Capacity for meeting financial commitments is solely
reliant upon sustained, favorable business or economic
A-3
developments. A 'CC' rating indicates that default of some kind
appears probable. 'C' ratings signal imminent default.
DDD, DD, D - Default. The ratings of obligations in this
category are based on their prospects for achieving partial or
full recovery in a reorganization or liquidation of the obligor.
While expected recovery values are highly speculative and cannot
be estimated with any precision, the following serve as general
guidelines. 'DDD' obligations have the highest potential for
recovery, around 90% - 100% of outstanding amounts and accrued
interest. 'DD' indicates potential recoveries in the range of
50% - 90% and 'D' the lowest recovery potential, i.e., below 50%.
Entities rated in this category have defaulted on some
or all of their obligations. Entities rated 'DDD' have the
highest prospect for resumption of performance or continued
operation with or without a formal reorganization process.
Entities rated 'DD' and 'D' are generally undergoing a formal
reorganization or liquidation process; those rated 'DD' are
likely to satisfy a higher portion of their outstanding
obligations, while entities rated 'D' have a poor prospect of
repaying all obligations.
Fitch, Inc. International Short-Term Credit Ratings
F1 - Highest credit quality. Indicates the strongest
capacity for timely payment of financial commitments; may have an
added "+" to denote any exceptionally strong credit feature.
F2 - Good credit quality. A satisfactory capacity for
timely payment of financial commitments, but the margin of safety
is not as great as in the case of the higher ratings.
F3 - Fair credit quality. The capacity for timely
payment of financial commitments is adequate; however, near-term
adverse changes could result in a reduction to non-investment
grade.
B - Speculative. Minimal capacity for timely payment of
financial commitments, plus vulnerability to near-term adverse
changes in financial and economic conditions.
C - High default risk. Default is a real possibility.
Capacity for meeting financial commitments is solely reliant upon
a sustained, favorable business and economic environment.
D - Default. Denotes actual or imminent payment default.
Notes to Long-term and Short-term ratings:
A-4
"+" or "-" may be appended to a rating to denote relative status
within major rating categories. Such suffixes are not added to
the 'AAA' Long-term rating category, to categories below 'CCC',
or to Short-term ratings other than 'F1'.
'NR' indicates that Fitch does not rate the issuer or issue in
question.
'Withdrawn': A rating is withdrawn when Fitch deems the amount of
information available to be inadequate for rating purposes, or
when an obligation matures, is called, or refinanced.
Rating Watch: Ratings are placed on Rating Watch to notify
investors that there is a reasonable probability of a rating
change and the likely direction of such change. These are
designated as "Positive", indicating a potential upgrade,
"Negative", for a potential downgrade, or "Evolving", if ratings
may be raised, lowered or maintained. Rating Watch is typically
resolved over a relatively short period.
A Rating Outlook indicates the direction a rating is likely to
move over a one to two-year period. Outlooks may be positive,
stable or negative. A positive or negative Rating Outlook does
not imply a rating change is inevitable. Similarly, companies
whose outlooks are 'stable' could be upgraded or downgraded
before an outlook moves to positive or negative if circumstances
warrant such an action. Occasionally, Fitch may be unable to
identify the fundamental trend. In these cases, the Rating
Outlook may be described as evolving.
Further Rating Distinctions
While ratings provide an assessment of the obligor's
capacity to pay debt service, it should be noted that the
definition of obligor expands as layers of security are added. If
municipal securities are guaranteed by third parties then the
"underlying" issuers as well as the "primary" issuer will be
evaluated during the rating process. In some cases, depending on
the scope of the guaranty, such as bond insurance, bank letters
of credit or collateral, the credit enhancement will provide the
sole basis for the rating given.
Minimum Rating(s) Requirements
For minimum rating(s) requirements for the Fund's
securities, please refer to "The Fund's Investments - Investment
Objectives and Policies" in the Prospectus.
A-5
APPENDIX B: FUTURES CONTRACTS AND RELATED OPTIONS
Futures Contracts
The Fund may enter into contracts for the purchase or
sale for future delivery of municipal securities or U.S.
Government Securities, or contracts based on financial indices
including any index of municipal securities or U.S. Government
Securities. U.S. futures contracts have been designed by
exchanges which have been designated "contracts markets" by the
Commodity Futures Trading Commission ("CFTC"), and must be
executed through a futures commission merchant, or brokerage
firm, which is a member of the relevant contract market. Futures
contracts trade on a number of exchange markets, and, through
their clearing corporations, the exchanges guarantee performance
of the contracts as between the clearing members of the exchange.
At the same time a futures contract is purchased or
sold, the Fund must allocate cash or securities as a deposit
payment ("initial deposit"). It is expected that the initial
deposit would be approximately 1/2% to 5% of a contract's face
value. Daily thereafter, the futures contract is valued and the
payment of "variation margin" may be required, since each day the
Fund would provide or receive cash that reflects any decline or
increase in the contract's value.
At the time of delivery of securities pursuant to such a
contract, adjustments are made to recognize differences in value
arising from the delivery of securities with a different interest
rate from that specified in the contract. In some (but not many)
cases, securities called for by a futures contract may not have
been issued when the contract was written.
Although futures contracts by their terms call for the
actual delivery or acquisition of securities, in most cases the
contractual obligation is fulfilled before the date of the
contract without having to make or take delivery of the
securities. The offsetting of a contractual obligation is
accomplished by buying (or selling, as the case may be) on a
commodities exchange an identical futures contract calling for
delivery in the same month. Such a transaction, which is
effected through a member of an exchange, cancels the obligation
to make or take delivery of the securities. Since all
transactions in the futures market are made, offset or fulfilled
through a clearinghouse associated with the exchange on which the
contracts are traded, the Fund will incur brokerage fees when it
purchases or sells futures contracts.
B-1
Interest Rate Futures
The purpose of the acquisition or sale of a futures
contract, in the case of the Fund, which holds or intends to
acquire fixed-income securities, is to attempt to protect the
Fund from fluctuations in interest rates without actually buying
or selling fixed-income securities. For example, if interest
rates were expected to increase, the Fund might enter into
futures contracts for the sale of debt securities. Such a sale
would have much the same effect as selling an equivalent value of
the debt securities owned by the Fund. If interest rates did
increase, the value of the debt securities in the Fund would
decline, but the value of the futures contracts to the Fund would
increase at approximately the same rate, thereby keeping the net
asset value of the Fund from declining as much as it otherwise
would have. The Fund could accomplish similar results by selling
debt securities and investing in bonds with short maturities when
interest rates are expected to increase. However, since the
futures market is more liquid than the cash market, the use of
futures contracts as an investment technique allows the Fund to
maintain a defensive position without having to sell its
portfolio securities.
Similarly, when it is expected that interest rates may
decline, futures contracts may be purchased to attempt to hedge
against anticipated purchases of debt securities at higher
prices. Since the fluctuations in the value of futures contracts
should be similar to those of debt securities, a Fund could take
advantage of the anticipated rise in the value of debt securities
without actually buying them until the market had stabilized. At
that time, the futures contracts could be liquidated and the Fund
could then buy debt securities on the cash market. To the extent
the Fund enters into futures contracts for this purpose, the
assets in the segregated account maintained to cover the Fund's
obligations with respect to such futures contracts will consist
of cash, cash equivalents or high-quality liquid debt securities
from its portfolio in an amount equal to the difference between
the fluctuating market value of such futures contracts and the
aggregate value of the initial and variation margin payments made
by the Fund with respect to such futures contracts.
The ordinary spreads between prices in the cash and
futures markets, due to differences in the nature of those
markets, are subject to distortions. First, all participants in
the futures market are subject to initial deposit and variation
margin requirements. Rather than meeting additional variation
margin requirements, investors may close futures contracts
through offsetting transactions which could distort the normal
relationship between the cash and futures markets. Second, the
liquidity of the futures market depends on participants entering
into offsetting transactions rather than making or taking
B-2
delivery. To the extent participants decide to make or take
delivery, liquidity in the futures market could be reduced, thus
producing distortion. Third, from the point of view of
speculators, the margin deposit requirements in the futures
market are less onerous than margin requirements in the
securities market. Therefore, increased participation by
speculators in the futures market may cause temporary price
distortions. Due to the possibility of distortion, a correct
forecast of general interest rate trends by the Adviser may still
not result in a successful transaction.
In addition, futures contracts entail risks. Although
the Fund believes that use of such contracts will benefit the
Fund, if the Adviser's investment judgment about the general
direction of interest rates is incorrect, the Fund's overall
performance would be poorer than if it had not entered into any
such contract. For example, if the Fund has hedged against the
possibility of an increase in interest rates which would
adversely affect the price of debt securities held in its
portfolio and interest rates decrease instead, the Fund will lose
part or all of the benefit of the increased value of its debt
securities which it has hedged because it will have offsetting
losses in its futures positions. In addition, in such
situations, if the Fund has insufficient cash, it may have to
sell debt securities from its portfolio to meet daily variation
margin requirements. Such sales of bonds may be, but will not
necessarily be, at increased prices which reflect the rising
market. The Fund may have to sell securities at a time when it
may be disadvantageous to do so.
Options on Futures Contracts
The Fund intends to purchase and write options on
futures contracts for hedging purposes. The Funds are not
commodity pools and all transactions in futures contracts and
options on futures contracts engaged in by the Funds must
constitute bona fide hedging or other permissible transactions in
accordance with the rules and regulations promulgated by the
CFTC. The purchase of a call option on a futures contract is
similar in some respects to the purchase of a call option on an
individual security. Depending on the pricing of the option
compared to either the price of the futures contract upon which
it is based or the price of the underlying debt securities, it
may or may not be less risky than ownership of the futures
contract or underlying debt securities. As with the purchase of
futures contracts, when the Fund is not fully invested it may
purchase a call option on a futures contract to hedge against a
market advance due to declining interest rates.
The writing of a call option on a futures contract
constitutes a partial hedge against declining prices of the
B-3
security which is deliverable upon exercise of the futures
contract or securities comprising an index. If the futures price
at expiration of the option is below the exercise price, the Fund
that has written a call will retain the full amount of the option
premium which provides a partial hedge against any decline that
may have occurred in its portfolio holdings. The writing of a
put option on a futures contract constitutes a partial hedge
against increasing prices of the security which is deliverable
upon the exercise of futures contract or securities comprising an
index. If the futures price at the expiration of the option is
higher than the exercise price, the Fund that has written a put
will retain the full amount of the option premium which provides
a partial hedge against any increase in the price of securities
which it intends to purchase. If a put or call option the Fund
has written is exercised, the Fund will incur a loss which will
be reduced by the amount of the premium it receives. Depending
on the degree of correlation between changes in the value of its
portfolio securities and changes in the value of its futures
positions, the Fund's losses from existing options on futures may
to some extent be reduced or increased by changes in the value of
portfolio securities.
The purchase of a put option on a futures contract is
similar in some respects to the purchase of protective put
options on portfolio securities. For example, the Fund may
purchase a put option on a futures contract to hedge its
portfolio against the risk of rising interest rates.
The amount of risk the Fund assumes when it purchases an
option on a futures contract is the premium paid for the option
plus related transaction costs. In addition to the correlation
risks discussed above, the purchase of an option also entails the
risk that changes in the value of the underlying futures contract
will not be fully reflected in the value of the option purchased.
B-4
00250209.AN0