nv2za
As filed
with the Securities and Exchange Commission on February 23, 2012
Securities
Act File No. 333-175925
Investment Company Act File No. 811-22593
United States
Securities and Exchange Commission
Washington, D.C. 20549
FORM N-2
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Registration Statement under the Securities Act of 1933 |
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Pre-Effective Amendment No. 4 |
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Post-Effective Amendment No. |
and/or
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Registration Statement under the Investment Company Act of 1940 |
THE CUSHING® ROYALTY & INCOME FUND
(Exact Name of Registrant as Specified in Charter)
8117 Preston Road, Suite 440
Dallas, Texas 75225
(Address of Principal Executive Offices)
Registrants Telephone Number, Including Area Code: (214) 692-6334
Jerry V. Swank
Cushing® MLP Asset Management, LP
8117 Preston Road, Suite 440
Dallas, Texas 75225
(Name and Address of Agent for Service)
Copies to:
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Philip H. Harris, Esq.
Skadden, Arps, Slate, Meagher & Flom LLP
Four Times Square
New York, New York 10036 |
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Richard H. Kronthal, Esq.
Andrews Kurth LLP
450 Lexington Avenue
New York, New York 10017 |
Approximate date of proposed public offering: As soon as practicable after the effective date of
this Registration Statement.
If any securities being registered on this form will be offered on a delayed or continuous basis in
reliance on Rule 415 under the Securities Act of 1933, as amended, other than securities offered in
connection with a dividend reinvestment plan, check the following box . . . .o
It is proposed that this filing will become effective (check appropriate box):
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When declared effective pursuant to section 8(c). |
If appropriate, check the following box:
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This [post-effective] amendment designates a new effective date for a previously filed
[post-effective amendment] [registration statement]. |
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This form is filed to register additional securities for an offering pursuant to Rule 462(b)
under the Securities Act and the Securities Act registration statement number of the earlier
effective registration statement for the same offering is . |
CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933
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Proposed Maximum |
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Proposed Maximum |
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Amount Being |
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Offering Price Per |
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Aggregate Offering |
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Amount of |
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Title of Securities Being Registered |
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Registered |
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Share(1) |
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Price(1) |
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Registration
Fee(2) |
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Common Shares, $.001 par value
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8,000,000 Shares
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$25.00
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$200,000,000
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$22,920 |
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(1) |
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Estimated solely for the purpose of calculating the registration fee. |
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(2) |
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$116.10 of this amount was previously paid. |
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The Registrant hereby amends this Registration Statement on such date or dates as may be necessary
to delay its effective date until the Registrant shall file a further amendment which specifically
states that this Registration Statement shall thereafter become effective in accordance with
Section 8(a) of the Securities Act of 1933 or until this Registration Statement shall become
effective on such date as the Securities and Exchange Commission, acting pursuant to Section 8(a),
may determine.
The
information in this Prospectus is not complete and may be
changed. We may not sell these securities until the Registration
Statement filed with the Securities and Exchange Commission is
effective. This Prospectus is not an offer to sell these
securities and is not soliciting an offer to buy these
securities in any state where the offer or sale is not
permitted.
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SUBJECT TO COMPLETION, DATED
FEBRUARY 23, 2012
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PRELIMINARY PROSPECTUS
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Shares
The
Cushing®
Royalty & Income Fund
$25.00 per Share
Investment Objective. The
Cushing®
Royalty & Income Fund (the Fund) is
organized as a Delaware statutory trust and is a newly
organized, non-diversified, closed-end management investment
company. The Funds investment objective is to seek a high
total return with an emphasis on current income. No assurance
can be given that the Funds investment objective will be
achieved.
Investment Strategy. The Fund seeks to achieve
its investment objective by investing, under normal market
conditions, at least 80% of its net assets, plus any borrowings
for investment purposes, in securities of energy-related
U.S. royalty trusts and Canadian royalty trusts and
exploration and production companies (collectively, Energy
Trusts), exploration and production master limited
partnerships (MLPs) and securities of other
companies based in North America that are generally engaged in
the same lines of business as those in which Energy Trusts and
MLPs engage (Other Energy Companies, and together
with Energy Trusts and MLPs, Energy Companies). The
Fund is managed by Cushing MLP Asset Management, LP (the
Investment Adviser).
The Funds common shares are expected to be listed on the
New York Stock Exchange, subject to notice of issuance, under
the symbol SRF.
Investment in the Funds common shares involves
substantial risks arising from the Funds investments in
the securities of Energy Companies, its concentration in the
energy sector and its use of leverage. Before buying any of the
Funds common shares, you should read the discussion of the
material risks of investing in the Fund in Principal Risks
of the Fund beginning on page 46 of this
Prospectus.
No Prior History. Because the Fund is newly
organized, its common shares have no history of public trading.
Shares of closed-end investment companies frequently trade at a
discount from their net asset value. This risk may be greater
for investors who expect to sell their shares in a relatively
short period after completion of the public offering.
Neither the Securities and Exchange Commission nor any state
securities commission has approved or disapproved of these
securities or determined if this Prospectus is truthful or
complete. Any representation to the contrary is a criminal
offense.
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Per Share
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Total(1)
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Public offering price
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$
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25.00
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$
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Sales
load(2)
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$
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1.125
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$
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Estimated offering
expenses(3)
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$
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0.05
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$
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Proceeds, after expenses, to the Fund
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$
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23.85
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$
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(1)
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The Fund has granted the
underwriters an option to purchase up to an
additional common
shares at the public offering price, less the sales load, within
45 days of the date of this prospectus solely to cover
overallotments, if any. If such option is exercised in full, the
public offering price, sales load, estimated offering expenses
and proceeds, after expenses, to the Fund will be
$ ,
$ , $
and $ , respectively. See
Underwriting.
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(2)
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The Investment Adviser has agreed
to pay from its own assets a structuring fee to Stifel, Nicolaus
& Company, Incorporated, in an amount not to exceed 1.15%
of the common shares sold in the offering. This fee is not
reflected in the sales load in the table above. The Investment
Adviser has agreed to pay certain qualifying underwriters
additional compensation or a sales incentive fee in connection
with the offering in an aggregate amount not to exceed 0.50% of
the total price of the common shares sold in the offering. See
UnderwritingAdditional Compensation to
Underwriters.
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(3)
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The Investment Adviser has agreed
to pay (i) all of the Funds organizational costs and
(ii) offering costs of the Fund (other than sales load)
that exceed $0.05 per common share. The costs of the offering
are estimated to be approximately
$ of which
$ ($0.05 per common share) will be
borne by the Fund and $ of which
($ per common share) will be borne
by the Investment Adviser.
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The underwriters expect to deliver the common shares to
purchasers on or
about ,
2012.
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Stifel
Nicolaus Weisel |
RBC Capital Markets |
Oppenheimer & Co. |
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Baird |
BB&T Capital
Markets |
Janney Montgomery Scott |
Ladenburg Thalmann & Co.
Inc. |
Mitsubishi UFJ
Securities |
Wunderlich Securities |
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Boenning
& Scattergood, Inc. |
Global Hunter Securities |
Knight |
Maxim Group LLC |
National Securities Corporation |
Pershing LLC |
Southwest Securities, Inc. |
The date of this prospectus
is ,
2012.
The Energy Trusts in which the Fund will invest will principally
be U.S. royalty trusts and Canadian royalty trusts and
exploration and production (E&P) companies.
U.S. royalty trusts manage net royalty
and/or net
working interests in mature crude oil and natural gas producing
properties in the United States. Canadian royalty trusts and
Canadian E&P companies engage in the acquisition,
development and production of crude oil and natural gas in
Canada and the U.S.
The Fund will also invest in the upstream E&P MLP sector.
E&P MLPs are focused on the exploration, development, and
acquisition of oil and natural gas producing properties,
including exploration and production of oil and natural gas at
the wellhead for sale to third parties. MLPs are limited
partnerships or limited liability companies which receive at
least 90% of their income from the development, production,
processing, refining, transportation, storage and marketing of
natural resources.
The Fund may also invest in securities of other companies based
in North America that are generally engaged in the same lines of
business as those in which Energy Trusts and MLPs engage,
including companies which operate assets used in gathering,
transporting, processing, storing, refining, distributing,
mining, or marketing natural gas, natural gas liquids, crude oil
or refined petroleum products, as well as other energy companies
(Other Energy Companies, and together with Energy
Trusts and MLPs, Energy Companies).
The Fund seeks to achieve its investment objective through
investments in public and private Energy Companies that, in the
Investment Advisers view, have the most attractive
fundamental growth prospects. The Fund expects to make equity
investments in a mix of publicly traded securities and
non-readily marketable securities that may be issued by public
or private companies. The Fund may seek to hedge certain risks
such as overall market, interest rate and commodity price risk.
The Funds Investment Adviser selects a core group of
Energy Companies utilizing a proprietary quantitative ranking
system and seeks to build a strategically developed core
portfolio of Energy Trusts, E&P MLPs and Other Energy
Companies to take advantage of the changing dynamics within the
upstream energy sector. The Fund will be actively managed and
the quantitative analysis will be dynamic in conjunction with
the Investment Advisers proprietary research process. The
Investment Adviser utilizes its vast financial and industry
experience to identify the absolute and relative value
opportunities across the different upstream energy subsectors
that, in the Investment Advisers view, present the best
investments. The results of the Investment Advisers
analysis and comprehensive investment process will influence the
weightings of positions held by the Fund within each subsector.
The Fund will generally seek to invest in 20 to 40 issuers with
generally no more than 10% of Managed Assets (as defined in this
Prospectus) in any one issue and no more than 20% of Managed
Assets in any one issuer, in each case, determined at the time
of investment. For purposes of this limit, an issuer
includes both an issuer and its controlling general partner,
managing member or sponsor and an issue is a class
of an issuers securities or a derivative security that
tracks that class of securities. Among other things, the
Investment Adviser will use fundamental, proprietary research to
seek to identify the most attractive Energy Companies with
strong fundamental growth prospects and may seek to invest in
initial public offerings (IPOs) and secondary market
issuances, private investment in public equity
(PIPE) transactions and private transactions,
including pre-acquisition and pre-IPO equity issuances and
investments in related private upstream energy companies or
direct royalty or working interests in crude oil, natural gas or
natural gas liquids. Generally, no more than 30% of the
Funds portfolio will be in PIPE or other private or
restricted securities at the time of investment.
Leverage. The Fund may seek to increase
current income and capital appreciation by utilizing leverage.
The Fund may utilize leverage through the issuance of commercial
paper or notes and other forms of borrowing
(Indebtedness) or the issuance of preferred shares,
in each case within the applicable limits of the Investment
Company Act of 1940, as amended (the 1940 Act).
Under the 1940 Act, the Fund may leverage through Indebtedness
in an aggregate amount of up to
331/3%
of its Managed Assets (i.e., 50% of its net assets attributable
to the Funds common shares). Under current market
conditions, the Fund may utilize leverage principally through
Indebtedness in an amount equal to approximately
331/3%
of the Funds Managed Assets, including the proceeds of
such leverage. The Fund has no present intention to issue
preferred shares. The costs associated with the issuance and use
of leverage will be borne by the holders of the common shares.
Leverage is a speculative technique and investors should note
that there are special risks and costs associated with leverage.
There can be no assurance that a leveraging strategy will be
successful during any period in which it is employed. See
Use of Leverage.
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U.S. Federal Income Tax
Considerations. Because of the Funds
concentration in Energy Trusts and E&P MLP investments, the
Fund is not eligible to be treated as a regulated
investment company under the Internal Revenue Code of
1986, as amended (the Code). Instead, the Fund will
be treated as a regular corporation, or a C
corporation, for U.S. federal income tax purposes and, as a
result, unlike most investment companies, will be subject to
corporate income tax to the extent the Fund recognizes taxable
income. The Fund believes that as a result of the tax
characterization of cash distributions made by Energy Trust and
MLPs to their investors (such as the Fund), a significant
portion of the Funds income will be tax-deferred, which
will allow distributions by the Fund to its shareholders to
include high levels of tax-deferred income. However, there can
be no assurance in this regard. If this expectation is not
realized, the Fund will have a larger corporate income tax
expense than expected, which will result in less cash available
to distribute to shareholders.
You should read this Prospectus, which contains important
information about the Fund that you should know before deciding
whether to invest, and retain it for future reference. A
Statement of Additional Information,
dated ,
2012 (SAI), containing additional information about
the Fund, has been filed with the Securities and Exchange
Commission (the SEC) and is incorporated by
reference in its entirety into this Prospectus. You may request
a free copy of the Statement of Additional Information, the
table of contents of which is on page 84 of this
Prospectus, by calling toll-free (800)
662-7232, or
you may obtain a copy (and other information regarding the Fund)
from the SECs web site
(http://www.sec.gov).
Free copies of the Funds reports will also be available
from the Funds web site at www.cushingcef.com.
Information on, or accessible through, the Funds website
is not a part of, and is not incorporated into, this Prospectus.
The Funds common shares do not represent a deposit or
obligation of, and are not guaranteed or endorsed by, any bank
or other insured depository institution and are not federally
insured by the Federal Deposit Insurance Corporation, the
Federal Reserve Board or any other government agency.
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TABLE OF
CONTENTS
You should rely only on the information contained or
incorporated by reference in this Prospectus. The Fund has not,
and the underwriters have not, authorized any other person to
provide you with different information. If anyone provides you
with different or inconsistent information, you should not rely
on it. The Fund is not, and the underwriters are not, making an
offer to sell these securities in any jurisdiction where the
offer or sale is not permitted. You should assume that the
information in this Prospectus is accurate only as of the date
of this Prospectus. The Funds business, financial
condition and prospects may have changed since that date. The
Fund will amend this Prospectus if, during the period that this
Prospectus is required to be delivered, there are any subsequent
material changes.
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CAUTIONARY
NOTICE REGARDING FORWARD-LOOKING STATEMENTS
This Prospectus, including documents incorporated by reference,
contain forward-looking statements. Forward-looking
statements can be identified by the words may,
will, intend, expect,
estimate, continue, plan,
anticipate, and similar terms and the negative of
such terms. By their nature, all forward-looking statements
involve risks and uncertainties, and actual results could differ
materially from those contemplated by the forward-looking
statements. Many factors that could materially affect the
Funds actual results are the performance of the portfolio
of securities held by the Fund, the conditions in the
U.S. and international financial, petroleum and other
markets, the price at which the Funds common shares will
trade in the public markets and other factors discussed in this
Prospectus and to be discussed in the Funds periodic
filings with the SEC.
Although the Fund believes that the expectations expressed in
such forward-looking statements are reasonable, actual results
could differ materially from those expressed or implied in such
forward-looking statements. The Funds future financial
condition and results of operations, as well as any
forward-looking statements, are subject to change and are
subject to inherent risks and uncertainties, such as those
disclosed in the Principal Risks of the Fund section
of this Prospectus. You are cautioned not to place undue
reliance on these forward-looking statements. All
forward-looking statements contained or incorporated by
reference in this Prospectus are made as of the date of this
Prospectus. Except for the Funds ongoing obligations under
the federal securities laws, the Fund does not intend, and the
Fund undertakes no obligation, to update any forward-looking
statement. The forward-looking statements contained in this
Prospectus are excluded from the safe harbor protection provided
by section 27A of the Securities Act of 1933, as amended
(the Securities Act).
Currently known risk factors that could cause actual results to
differ materially from the Funds expectations include, but
are not limited to, the factors described in the Principal
Risks of the Fund section of this Prospectus. The Fund
urges you to review carefully this section for a more detailed
discussion of the risks of an investment in the Funds
securities.
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PROSPECTUS
SUMMARY
This is only a summary of information contained elsewhere in
this Prospectus. This summary does not contain all of the
information that you should consider before investing in the
Funds common shares. You should carefully read the more
detailed information contained in this Prospectus and the
Statement of Additional Information,
dated ,
2012 (the SAI), especially the information set forth
under the heading Principal Risks of the Fund.
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The Fund |
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The
Cushing®
Royalty & Income Fund (the Fund) is
organized as a Delaware statutory trust and is a newly
organized, non-diversified, closed-end management investment
company registered under the Investment Company Act of 1940 (the
1940 Act). The Funds investments are managed
by its investment adviser, Cushing MLP Asset Management, LP (the
Investment Adviser). |
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The Offering |
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The Fund is
offering
common shares of beneficial interest, par value $.001 per share,
through a group of underwriters. The Funds common shares
of beneficial interest are called common shares and
the holders of common shares are sometimes referred to as
common shareholders in this Prospectus. The initial
public offering price is $25.00 per common share. You must
purchase at least 100 common shares ($2,500) in order to
participate in the offering. The Fund has given the underwriters
an option to purchase up
to additional common shares
to cover orders in excess of common shares. The Investment
Adviser has agreed to pay (i) all of the Funds
organizational costs and (ii) offering costs of the Fund
(other than sales load) that exceed $0.05 per common share. See
Underwriting. |
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Who May Want to Invest |
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Investors should consider their own investment goals, time
horizon and risk tolerance before investing in the Fund. An
investment in the Fund may not be appropriate for all investors
and is not intended to be a complete investment program. The
Fund may be an appropriate investment for you if you are seeking: |
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The opportunity for a high level of current income
and capital appreciation, with an emphasis on cash distributions
to common shareholders, in a fund managed by an experienced team
of portfolio and investment professionals.
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The opportunity for current income with exposure to
crude oil and natural gas prices.
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Exposure to the growing upstream energy sector.
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Access through a single investment vehicle to a
portfolio of securities issued by energy-related U.S. royalty
trusts and Canadian royalty trusts and exploration and
production (E&P) companies (collectively,
Energy Trusts), E&P master limited partnerships
(MLPs) and securities of other companies based in
North America that are generally engaged in the same lines of
business as those in which Energy Trusts and MLPs engage
(Other Energy Companies) researched and sourced by
experienced investment professionals at the Investment Adviser.
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The potential to act as a hedge against rising
inflation.
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However, an investment in the Fund involves certain associated
investment risks. See Principal Risks of the Fund. |
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An Investment in the Fund vs. Direct Investment in Energy
Companies |
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The Investment Adviser believes that an investment in the Fund
has certain advantages over direct investment in Energy
Companies, such as: |
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An investment in the Fund offers access to a number
of Energy Companies, providing diversification within the North
American energy sector through a single professionally-managed
investment vehicle;
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The Fund expects to have access to Energy Trust and
E&P MLP securities issued in initial public offerings and
follow-on offerings. These securities may offer the potential
for increased returns;
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For tax reporting purposes, each of the Funds
shareholders will receive a single U.S. Form 1099, rather
than a Canadian NR4 Form, U.S. Form 1099,
Schedule K-1
or other document containing similar information, as applicable,
from each Energy Company investment as would be the case if a
shareholder invested directly; and
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Ability for
non-U.S.
shareholders to avoid being directly subject to regular net
based U.S. federal income tax and return filing requirements
with respect to investments in Energy Trusts and E&P MLPs,
provided such
non-U.S.
shareholders investment in the Fund is not effectively
connected with the conduct of a trade or business in the United
States by such shareholder.
Non-U.S.
shareholders would generally be subject to regular net based
U.S. federal income tax on income from direct investments in
Energy Trusts and E&P MLPs treated as effectively connected
with a U.S. trade or business.
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Investment Objective |
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The Funds investment objective is to seek a high total
return with an emphasis on current income. There can be no
assurance that the Funds investment objective will be
achieved. |
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Principal Investment Policies |
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The Fund seeks to achieve its investment objective by investing,
under normal market conditions, at least 80% of its net assets,
plus any borrowings for investment purposes, in public and
private securities of energy-related U.S. royalty trusts and
Canadian royalty trusts and exploration and production companies
(collectively, Energy Trusts), exploration and
production master limited partnerships (MLPs) and
securities of other companies based in North America that are
generally engaged in the same lines of business as those in
which Energy Trusts and MLPs engage (Other Energy
Companies, and together with Energy Trusts and MLPs,
Energy Companies). |
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The Fund generally will generally seek to invest in 20 to 40
issuers with generally no more than 10% of Managed Assets (as
defined herein) in any one issue and no more than 20% of Managed
Assets in any one issuer, in each case, determined at the time
of investment. For purposes of this limit, an issuer
includes both an issuer and its controlling general partner,
managing member or sponsor, and an issue is a class
of an issuers securities or a derivative security that
tracks that class of securities. |
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The Fund may invest up to 25% of its Managed Assets in
unregistered or otherwise restricted securities, including
securities issued by private companies. |
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The Fund may invest up to 25% of its Managed Assets in debt
securities, preferred shares and convertible securities of
Energy Companies and other issuers, provided that such
securities are (a) rated, at the time of investment, at
least (i) B3 by Moodys Investors Service, Inc.
(Moodys), (ii) B- by Standard &
Poors (S&P) or Fitch Ratings
(Fitch), or (iii) of a comparable rating by
another Nationally Recognized Statistical Rating Organization
(NRSRO) or (b) with respect to up to 10% of its
Managed Assets in debt securities, preferred shares and
convertible securities that have lower ratings or are unrated at
the time of investment. |
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The Fund may invest up to 20% of its Managed Assets in
securities of companies that are not Energy Companies. These
investments may include securities such as partnership
interests, limited liability company interests or units, trust
units, common stock, preferred stock, convertible securities,
warrants and depositary receipts and debt securities. |
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The Fund will not invest directly in commodities. |
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The Funds investment objective and percentage parameters,
are not fundamental policies of the Fund and may be changed
without shareholder approval. |
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Investment Philosophy |
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The Fund seeks to achieve its investment objective through
investments in public and private Energy Companies that, in the
Investment Advisers view, have the most attractive
fundamental growth prospects. The Fund expects to make equity
investments predominantly in publicly traded securities and
non-readily marketable securities that may be issued by public
or private companies. The Fund may seek to hedge risks to the
portfolio as deemed prudent by the Investment Adviser. |
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The Investment Adviser seeks to invest in Energy Companies that
have dividend or distribution yields that, in the Investment
Advisers view, are attractive relative to comparable
companies. The Investment Adviser seeks to make investments in
Energy Companies with operations in the development and
production of crude oil and natural gas. Among other things, the
Investment Adviser will use fundamental, proprietary research to
seek to identify the most attractive investments with attractive
dividend or distribution yields and distribution growth
prospects. |
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The Fund will primarily focus on Energy Companies that manage
royalties and net working interests in mature oil and gas
producing properties in the United States and Canada.
Unitholders generally receive most of the cash flows from these
investments in the form of monthly or quarterly distributions. |
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The Investment Adviser selects a core group of Energy Trusts
utilizing a proprietary quantitative ranking system and seeks to
build a strategically developed core portfolio of Energy Trusts,
E&P MLPs and Other Energy Companies to take advantage of
the changing dynamics within the upstream energy sector. The
Fund will be actively managed and the quantitative analysis will
be dynamic in conjunction with the Investment Advisers
proprietary research process. The Investment |
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Adviser utilizes its financial and industry experience to
identify the absolute and relative value Energy Trusts that, in
the Investment Advisers view, present the best investment
opportunities. The results of the Investment Advisers
analysis and comprehensive investment process will influence the
weightings of positions held by the Fund. |
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Certain of the Energy Companies in which the Fund may invest may
have small- or medium-sized market capitalizations
(small-cap and mid-cap companies,
respectively). A companys market capitalization is
generally calculated by multiplying the number of a
companys shares outstanding by its stock price. The
Investment Adviser defines small-cap companies as
those with a low market capitalization, generally less than
$1 billion, and mid-cap companies as those with
a market capitalization between $1 billion and
$3 billion. |
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The Funds Investments |
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U.S. Royalty Trusts. U.S. royalty trusts
passively manage royalties and net working interests in mature
oil and gas producing properties in the United States. U.S.
royalty trusts own the property rights to the wells or mines,
and typically rely on an outside drilling or mining company to
extract the resources. The outside company then pays a royalty
to the royalty trust or exploration and production company.
Unitholders generally receive most of the cash flows from these
investments in the form of distributions. U.S. royalty trusts do
not acquire new properties, operate the existing properties
within the trust, issue new equity or debt and engage in limited
hedging of production. Since they are restricted to their
original properties for example, a group of oil
fields or natural-gas-bearing rock formations U.S.
royalty trusts deplete over time and are eventually dissolved. A
U.S. royalty trust typically has no employees or other
operations. |
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The business and affairs of U.S. royalty trusts are typically
managed by a bank as trustee. No unitholder of a U.S. royalty
trust has the ability to manage or influence the management of
the trust (except through its limited voting rights as a holder
of trust units). The trustee can authorize the trust to borrow
money to pay trust administrative or incidental expenses and the
trustee may also hold funds awaiting distribution. U.S. royalty
trusts typically make periodic cash distributions of
substantially all of their cash receipts, after deducting the
trusts administrative and
out-of-pocket
expenses. Distributions will rise and fall with the underlying
commodity price, as they are directly linked to the
profitability of the trust, and can be paid monthly, quarterly
or annually, at the discretion of the trustee. U.S. royalty
trusts are exposed to commodity risk and, to a lesser extent,
production and reserve risk, as well as operating risk. |
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U.S. royalty trusts are generally not subject to U.S. federal
corporate income taxation at the trust or entity level. Instead,
each unitholder of the U.S. royalty trust is required to take
into account its share of all items of the U.S. royalty
trusts income, gain, loss, deduction and expense. It is
possible that the Funds share of taxable income from a
U.S. royalty trust may exceed the cash actually distributed to
it from the U.S. royalty trust in a given year. In such a case,
the Fund will have less after-tax cash available for
distribution to shareholders. |
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Canadian Royalty Trusts and Canadian Exploration and
Production Companies. Similar to U.S. royalty
trusts, the principal business of Canadian royalty trusts is the
production and sale of crude oil and natural gas. Canadian
royalty trusts pay out to unitholders a varying amount of the
cash flow that they receive from the production and sale of
underlying crude oil and natural gas assets. The amount of
distributions paid to unitholders will vary based upon
production levels, commodity prices and expenses. Unlike U.S.
royalty trusts, Canadian royalty trusts and Canadian E&P
companies may engage in the acquisition, development and
production of natural gas and crude oil to replace depleting
reserves. They may have employees, issue new shares, borrow
money, acquire additional properties, and may manage the
resources themselves. Thus, Canadian royalty trusts and E&P
companies may grow through acquisition of additional oil and gas
properties or producing companies with proven reserves, funded
through the issuance of additional equity or debt. As a result,
Canadian royalty trusts and Canadian E&P companies are
exposed to commodity risk and production and reserve risk, as
well as operating risk. |
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On October 31, 2006, the Canadian Minister of Finance
announced a Tax Fairness Plan for Canadians. A principal
component of the plan involved changing the taxation rules
governing income trusts. As a result of this change in taxation
rules, Canadian income trusts are now taxed as regular Canadian
corporations and are now subject to double taxation
at both the corporate level and on the income distributed to
investors. In response to this change, most Canadian royalty
trusts converted to corporations and have reduced their
dividends. |
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Master Limited Partnerships. MLPs are formed
as limited partnerships or limited liability companies and taxed
as partnerships for federal income tax purposes. The securities
issued by many MLPs are listed and traded on a U.S. exchange. An
MLP typically issues general partner and limited partner
interests or managing member and member interests. The general
partner or managing member manages and often controls, has an
ownership stake in, and may receive incentive distribution
payments from, the MLP. If publicly traded, to be treated as a
partnership for U.S. federal income tax purposes, an MLP must
derive at least 90% of its gross income for each taxable year
from qualifying sources as described in Section 7704 of the
Internal Revenue Code of 1986, as amended (the
Code). These qualifying sources include natural
resources-based activities such as the exploration, development,
mining, production, processing, refining, transportation,
storage and certain marketing of mineral or natural resources. |
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The general partner or managing member may be structured as a
private or publicly-traded corporation or other entity. The
general partner or managing member typically controls the
operations and management of the entity and has an up to 2%
general partner or managing member interest in the entity plus,
in many cases, ownership of some percentage of the outstanding
limited partner or member interests. The limited partners or
members, through their ownership of limited partner or member
interests, provide capital to the entity, are intended to have
no role in the operation and management of the entity and
receive cash distributions. |
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Due to their structure as partnerships for U.S. federal income
tax purposes and the expected character of their income, MLPs
generally do not pay federal income taxes. Thus, unlike
investors in corporate securities, direct MLP investors are
generally not subject to double taxation (i.e., corporate
level tax and tax on corporate dividends). Currently, most MLPs
operate in the energy and midstream, natural resources, shipping
or real estate sectors. |
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The Fund intends to concentrate its investments in the upstream
E&P MLP sector. E&P MLPs are focused on the
exploration, development, and acquisition of oil and natural gas
producing properties, including exploration and production of
oil and natural gas at the wellhead for sale to third parties. |
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Equity securities issued by MLPs typically consist of common and
subordinated units (which represent the limited partner or
member interests) and a general partner or managing member
interest. |
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Other Equity Securities. The Fund may invest
in equity securities of Other Energy Companies, including
companies that operate assets used in gathering, transporting,
processing, storing, refining, distributing, mining, or
marketing natural gas, natural gas liquids, crude oil or refined
petroleum products. The Fund may also invest in equity
securities of other issuers engaged in other sectors, including
the finance and real estate sectors. Other Energy Companies and
other issuers in which the Fund may invest may be organized
and/or taxed as corporations and therefore may not offer the
advantageous tax characteristics of Energy Trusts or MLP units. |
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Restricted Securities. The Fund may invest up
to 25% of its Managed Assets in unregistered or otherwise
restricted securities, including securities issued by private
companies. Restricted securities are securities that
are unregistered, held by control persons of the issuer or are
subject to contractual restrictions on resale. The Fund will
typically acquire restricted securities in directly negotiated
transactions. The Funds investments in restricted
securities may include privately issued securities of both
public and private issuers. |
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Debt Securities. The Fund may invest up to 25%
of its Managed Assets in debt securities, preferred shares and
convertible securities of Energy Companies and other issuers,
provided that such securities are (a) rated, at the time of
investment, at least (i) B3 by Moodys, (ii) B-
by S&P or Fitch, or (iii) of a comparable rating by
another NRSRO or (b) with respect to up to 10% of its
Managed Assets in debt securities, preferred shares and
convertible securities that have lower ratings or are unrated at
the time of investment. Debt securities rated below investment
grade are commonly known as junk bonds and are
regarded as predominantly speculative with respect to the
issuers capacity to pay interest and repay principal in
accordance with the terms of the obligations, and involve major
risk exposure to adverse conditions. |
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Non-U.S.
Securities. The Fund may invest in
non-U.S.
securities, including, among other things,
non-U.S.
securities represented by American Depositary Receipts or
ADRs. ADRs are certificates evidencing ownership of
shares of a
non-U.S.
issuer that are issued |
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by depositary banks and generally trade on an established market
in the United States or elsewhere. |
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Investment Characteristics of Energy Trusts and E&P
MLPs |
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The Investment Adviser believes that the following
characteristics of Energy Trusts and E&P MLPs make them
attractive investments: |
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Energy Trusts receive their revenue stream directly
from the cash flows generated by the sale of crude oil, natural
gas and natural gas liquids taken from the producing assets and
acreage, and therefore higher commodity prices flow directly
through to the cash flow paid to unitholders.
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Energy Trusts and E&P MLPs provide direct
exposure to fluctuations in crude oil and natural gas prices
because future distributions by these vehicles are a function of
production volume and commodity prices.
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The majority of Energy Trusts own crude oil, natural
gas and natural gas liquid assets with stable production profiles
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Energy Trusts and E&P MLPs typically distribute
the majority of their cash flows either in the form of dividends
or return of invested capital.
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Energy Trusts provide the potential for current
income through monthly or quarterly distributions.
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Energy Trusts formed within the last two years
typically hedged production for the first two to four years of
the trusts existence as a means to establish regular
distributions and minimize the impact of fluctuating commodity
prices; thereafter, distributions will fluctuate with production
volume and commodity prices.
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Energy Trusts provide commodity exposure without the
increased complexities of investing directly in commodity
futures or the potential tracking error of investing in
commodity funds.
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An investment in Energy Trusts also involves risks, some of
which are described below under Principal Risks of the
Fund. |
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Leverage |
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The Fund may seek to increase current income and capital
appreciation by utilizing leverage. The Fund may utilize
leverage through the issuance of commercial paper or notes and
other forms of borrowing (Indebtedness) or the
issuance of preferred shares, in each case within the applicable
limits of the Investment Company Act of 1940, as amended (the
1940 Act). Under the 1940 Act, the Fund may leverage
through Indebtedness in an aggregate amount of up to
331/3%
of its Managed Assets (i.e., 50% of its net assets attributable
to the Funds common shares). Under current market
conditions, the Fund may utilize leverage principally through
Indebtedness in an amount equal to approximately
331/3%
of the Funds Managed Assets, including the proceeds of
such leverage. The Fund has no present intention to issue
preferred shares. The costs associated with the issuance and use
of leverage will be borne by the holders of the common shares.
Leverage is a speculative technique and investors should note
that there are special risks and costs associated with leverage.
There can be |
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no assurance that a leveraging strategy will be successful
during any period in which it is employed. |
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The Fund will only utilize leverage when it expects to be able
to invest the proceeds at a higher rate of return than its cost
of borrowing. The use of leverage for investment purposes
creates opportunities for greater current income and capital
appreciation, but at the same time increases risk. When leverage
is employed, the net asset value, market price of the common
shares and the yield to holders of common shares may be more
volatile. Any investment income or gains earned with respect to
the amounts borrowed in excess of the interest due on the
borrowing will augment the Funds income. Conversely, if
the investment performance with respect to the amounts borrowed
fails to cover the interest on such borrowings, the value of the
Funds common shares may decrease more quickly than would
otherwise be the case, and distributions on the common shares
would be reduced or eliminated. Interest payments and fees
incurred in connection with such borrowings will reduce the
amount of net income available for distribution to common
shareholders. |
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The costs associated with the issuance and use of leverage will
be borne by the holders of the common shares. Because the
investment management fee paid to the Investment Adviser is
calculated on the basis of the Funds Managed Assets, which
include the proceeds of leverage, the dollar amount of the
management fee paid by the Fund to the Investment Adviser will
be higher (and the Investment Adviser will be benefited to that
extent) when leverage is utilized. The Investment Adviser will
utilize leverage only if it believes such action would result in
a net benefit to the Funds shareholders after taking into
account the higher fees and expenses associated with leverage
(including higher management fees). There can be no assurance
that a leveraging strategy will be successful during any period
in which it is employed. See Use of Leverage. |
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Other Investment Practices |
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Strategic Transactions. The Fund may, but is
not required to, use investment strategies (referred to herein
as Strategic Transactions) for hedging, risk
management or portfolio management purposes or to earn income.
These strategies may be executed through the use of derivative
contracts. In the course of pursuing these investment
strategies, the Fund may purchase and sell exchange-listed and
over-the-counter
put and call options on securities, equity and fixed-income
indices and other instruments, purchase and sell futures
contracts and options thereon, and enter into various
transactions such as swaps, caps, floors or collars. In
addition, derivative transactions may also include new
techniques, instruments or strategies that are permitted as
regulatory changes occur. For a more complete discussion of the
Funds investment practices involving transactions in
derivatives and certain other investment techniques, see
The Funds Investments Other Investment
Practices Strategic Transactions in this
Prospectus and Strategic Transactions in the
Funds SAI. |
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Other Investment Companies. The Fund may
invest in securities of other closed-end or open-end investment
companies (including ETFs) that invest primarily in Energy
Companies in which the Fund may invest directly to the extent
permitted by the 1940 Act. The Fund may |
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invest in other investment companies 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 Stock, during periods when there is a shortage of
attractive Energy Company securities available in the market, or
when the Investment Adviser believes share prices of other
investment companies offer attractive values. To the extent that
the Fund invests in investment companies that invest primarily
in Energy Companies, such investments will be counted for
purposes of the Funds policy of investing at least 80% of
its Managed Assets in Energy Companies. |
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Exchange-Traded Notes. The Fund may invest in
exchange-traded notes (ETNs), which are typically
unsecured, unsubordinated debt securities that trade on a
securities exchange and are designed to replicate the returns of
market benchmarks minus applicable fees. To the extent that the
Fund invests in ETNs that are designed to replicate indices
comprised primarily of securities issued by Energy Trust
entities, such investments will be counted for purposes of the
Funds policy of investing at least 80% of its Managed
Assets in Energy Trust investments. |
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New Securities and Other Investment
Techniques. New types of securities and other
investment and hedging practices are developed from time to
time. The Investment Adviser expects, consistent with the
Funds investment objective and policies, to invest in such
new types of securities and to engage in such new types of
investment practices if the Investment Adviser believes that
these investments and investment techniques may assist the Fund
in achieving its investment objective. |
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Short Sales, Arbitrage and Other
Strategies. The Fund may use short sales,
arbitrage and other strategies to try to generate additional
return. As part of such strategies, the Fund may engage in
paired long-short trades to arbitrage pricing disparities in
securities issued by Energy Companies, write (or sell) covered
call options on the securities of Energy Companies or other
securities held in its portfolio, write (or sell) uncovered call
options on the securities of Energy Companies, purchase call
options or enter into swap contracts to increase its exposure to
Energy Companies, or sell securities short. With a long
position, the Fund purchases a stock outright, but with a short
position, it would sell a security that it does not own and must
borrow to meet its settlement obligations. The Fund will realize
a profit or incur a loss from a short position depending on
whether the value of the underlying stock decreases or
increases, respectively, between the time the stock is sold and
when the Fund replaces the borrowed security. To increase its
exposure to certain issuers, the Fund may purchase call options
or use swap agreements. The Fund expects to use these strategies
on a limited basis. See Principal Risks of the
Fund Short Sales Risk and Principal
Risks of the Fund Strategic Transactions Risk. |
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Lending of Portfolio Securities. The Fund may
lend its portfolio securities to broker-dealers and banks. Any
such loan must be continuously secured by collateral in cash or
cash equivalents maintained on a current basis in an amount at
least equal to 102% of the value of the securities loaned. The
Fund would continue to receive the equivalent of the interest or
dividends paid by the issuer on the securities |
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loaned and would also receive an additional return that may be
in the form of a fixed fee or a percentage of the collateral.
The Fund may pay reasonable fees for services in arranging these
loans. |
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Temporary Defensive Strategies. When market
conditions dictate a more defensive investment strategy, the
Fund may, on a temporary basis, hold cash or invest a portion or
all of its assets in money-market instruments including
obligations of the U.S. government, its agencies or
instrumentalities, other high-quality debt securities, including
prime commercial paper, repurchase agreements and bank
obligations, such as bankers acceptances and certificates
of deposit. Under normal market conditions, the potential for
capital appreciation on these securities will tend to be lower
than the potential for capital appreciation on other securities
that may be owned by the Fund. In taking such a defensive
position, the Fund would temporarily not be pursuing its
principal investment strategies and may not achieve its
investment objective. |
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Investment Adviser |
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The Funds investments are managed by its Investment
Adviser,
Cushing®
MLP Asset Management, LP, whose principal business address is
8117 Preston Road, Suite 440, Dallas, Texas 75225. The
Investment Adviser serves as investment adviser to registered
and unregistered funds, which invest primarily in securities of
MLPs and Other Energy Companies. The Investment Adviser is also
the sponsor of The
Cushing®
30 MLP Index which is a fundamentally based MLP index, comprised
of 30 equally weighted publicly traded energy infrastructure
MLPs and The
Cushing®
High Income MLP Index which tracks the performance of 30
publicly traded MLP securities with an emphasis on current
yield. The Investment Adviser continues to seek to expand its
platform of energy-related investment products, leveraging
extensive industry contacts and significant research depth to
drive both passive and actively managed investment opportunities
for individual and institutional investors. The Investment
Adviser seeks to identify and exploit investment niches that it
believes are generally less understood and less followed by the
broader investor community. |
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The Investment Adviser considers itself one of the principal
professional institutional investors in the Energy Company and
MLP space based on the following: |
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An investment team with extensive experience in
analysis, portfolio management, risk management, and private
securities transactions.
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A focus on
bottom-up,
fundamental analysis performed by its experienced investment
team is core to the Investment Advisers investment process.
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The investment teams wide range of
professional backgrounds, market knowledge, industry
relationships, and experience in the analysis, financing, and
structuring of energy income investments give the Investment
Adviser insight into, and the ability to identify and capitalize
on, investment opportunities in Energy Companies.
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Its central location in Dallas, Texas and proximity
to major players and assets in the midstream and upstream
sectors.
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Tax Treatment of the Fund |
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Because of the Funds concentration in Energy Trust and MLP
investments, the Fund is not eligible to elect to be treated as
a regulated investment company under the Code. Accordingly, the
Fund generally is subject to U.S. federal income tax on its
taxable income at the graduated rates applicable to corporations
(currently a maximum rate of 35%) and is subject to state income
tax by reason of its investments in equity securities of Energy
Trusts and MLPs. The Fund may be subject to a 20% alternative
minimum tax on its alternative minimum taxable income to the
extent that the alternative minimum tax exceeds the Funds
regular income tax liability. The Funds payments of U.S.
corporate income tax or alternative minimum tax could materially
reduce the amount of cash available for the Fund to make
distributions on the shares. In addition, distributions to
shareholders of the Fund will be taxed under federal income tax
laws applicable to corporate distributions, and thus a
significant portion of the Funds taxable income may be
subject to a double layer of taxation. |
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The Fund believes that as a result of the tax characterization
of cash distributions made by Energy Trusts and MLPs to their
investors (such as the Fund), a portion of the Funds
income will be tax-deferred, which will allow distributions by
the Fund to its shareholders to include tax-deferred income.
However, there can be no assurance in this regard. If this
expectation is not realized, the Fund will have a larger
corporate income tax expense than expected, which will result in
less cash available to distribute to shareholders. |
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The Fund will accrue deferred income taxes for its future tax
liability associated with that portion of distributions on
equity securities of Energy Trusts and MLPs considered to be a
return of capital, as well as for its future tax liability
associated with the capital appreciation of its investments.
These accrued deferred income taxes will be reflected in the
calculation of the Funds net asset value per common share.
Upon the Funds sale of an Energy Trust or MLP equity
security, the Fund may be liable for previously deferred taxes.
The Fund will rely to some extent on information provided by
Energy Trusts and MLPs, which is not necessarily timely, to
estimate deferred tax liability for purposes of financial
statement reporting and determining its net asset value. From
time to time, the Fund will modify its estimates or assumptions
regarding its deferred tax liability as new information becomes
available, which could have a material impact on the Funds
net asset value. |
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Distributions |
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The Fund intends to make regular quarterly cash distributions of
all or a portion of its income to its common shareholders. |
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The Fund believes that as a result of the tax characterization
of cash distributions made by Energy Trusts and MLPs to their
investors (such as the Fund), a portion of the Funds
income will be tax-deferred, which will allow distributions by
the Fund to its shareholders to include tax-deferred income.
However, there can be no assurance in this regard. If this
expectation is not realized, the Fund will have a larger
corporate income tax expense than expected, which will result in
less cash available to distribute to shareholders. |
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In general, a portion of the distribution will constitute a
return of capital to a common shareholder, rather than a
dividend, to the extent |
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such distribution exceeds the Funds current and
accumulated earnings and profits. The portion of any
distribution treated as a return of capital will not be subject
to tax currently, but will result in a corresponding reduction
in a shareholders basis in common shares of the Fund and
in the shareholders recognizing more gain or less loss
(that is, will result in an increase of a shareholders tax
liability) when the shareholder later sells common shares of the
Fund. Distributions in excess of the Funds current and
accumulated earnings and profits that are in excess of a
shareholders adjusted tax basis in its shares are
generally treated as capital gains. |
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Initial distributions to common shareholders are expected to be
declared within 60 to 90 days, and paid within 90 to
120 days, after completion of the common share offering,
depending upon market conditions. Due to the timing of the
Funds offering of common shares and expected receipt of
initial distributions from Energy Trusts and MLPs in which the
Fund will invest, the Fund anticipates that a significant
portion of its first distribution to common shareholders will be
made from sources other than cash distributions from Energy
Trusts and MLPs and may consist of a return of capital. |
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The Funds distribution rate will vary based upon the
distributions received from underlying investments in Energy
Trusts and MLPs. To permit it to maintain a more stable
quarterly distribution rate, the Fund may distribute less or
more than the entire amount of cash it receives from its
investments in a particular period. Any undistributed cash would
be available to supplement future distributions and, until
distributed, would add to the Funds net asset value.
Correspondingly, such amounts, once distributed, will be
deducted from the Funds net asset value. See
Distributions. |
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Dividend Reinvestment Plan |
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Shareholders will automatically have all distributions
reinvested in common shares issued by the Fund or common shares
of the Fund purchased on the open market in accordance with the
Funds dividend reinvestment plan unless an election is
made to receive cash. Common shareholders who receive dividends
in the form of additional common shares will be subject to the
same U.S. federal, state and local tax consequences as common
shareholders who elect to receive their dividends in cash. See
Dividend Reinvestment Plan. |
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Listing and Symbol |
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The common shares of the Fund are expected to be listed on the
New York Stock Exchange (the NYSE), subject to
notice of issuance, under the symbol SRF. |
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Principal Risks of the Fund |
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Risk is inherent in all investing. The following discussion
summarizes some of the risks that a potential investor should
consider before deciding to purchase the Funds common
shares. |
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No Operating or Trading History. The Fund is
a newly organized, non-diversified, closed-end management
investment company and it has no operating or public trading
history. Being a recently organized company, the Fund is subject
to all of the business risks and uncertainties associated with
any new business, including the risk that the Fund will not
achieve its investment objective and that the value of an
investment in the Fund could decline substantially. |
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Investment and Market Risk. An investment in
the Funds common shares is subject to investment risk,
including the possible loss of an investors entire
investment. The Funds common shares at any point in time
may be worth less than at the time of original investment, even
after taking into account the reinvestment of the Funds
dividends. The Fund is primarily a long-term investment vehicle
and should not be used for short-term trading. An investment in
the Funds common shares is not intended to constitute a
complete investment program and should not be viewed as such. |
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Energy Companies Risks. Under normal
circumstances, the Fund concentrates its investments in the
energy sector, with an emphasis on securities issued by Energy
Trusts and E&P MLPs. Energy Trusts, MLPs and Other Energy
Companies are subject to certain risks, including, but not
limited to, the following: |
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Commodity Price Risk. Energy Companies may be
affected by fluctuations in the prices of commodities,
including, for example, natural gas, natural gas liquids and
crude oil, in the short- and long-term. Natural resources
commodity prices have been very volatile in the past and such
volatility is expected to continue. Fluctuations in commodity
prices can result from changes in general economic conditions or
political circumstances (especially of key energy-consuming
countries); market conditions; weather patterns; domestic
production levels; volume of imports; energy conservation;
domestic and foreign governmental regulation; international
politics; policies of the Organization of Petroleum Exporting
Countries (OPEC); taxation; tariffs; and the
availability and costs of local, intrastate and interstate
transportation methods. Companies engaged in crude oil and
natural gas exploration, development or production, natural gas
gathering and processing and crude oil refining and
transportation may be directly affected by their respective
natural resources commodity prices. The volatility of, and
interrelationships between, commodity prices can also indirectly
affect certain companies due to the potential impact on the
volume of commodities transported, processed, stored or
distributed. Some companies that own the underlying commodities
may be unable to effectively mitigate or manage direct margin
exposure to commodity price levels. The energy sector as a whole
may also be impacted by the perception that the performance of
energy sector companies is directly linked to commodity prices.
See Principal Risks of the Fund Energy
Companies Risks Commodity Price Risk. |
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Cyclicality Risk. The operating results of
companies in the broader energy sector are cyclical, with
fluctuations in commodity prices and demand for commodities
driven by a variety of factors. The highly cyclical nature of
the energy sector may adversely affect the earnings or operating
cash flows of certain Energy Companies in which the Fund will
invest. |
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Supply Risk. A significant decrease in the
production of natural gas, crude oil or other energy
commodities, due to the decline of production from existing
resources, import supply disruption, depressed commodity prices
or otherwise, would reduce the revenue, operating income and
operating cash flows of certain Energy Companies and, |
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therefore, their ability to make distributions or pay dividends.
See Principal Risks of the Fund Energy
Companies Risks Supply Risk. |
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Demand Risk. A sustained decline in demand for
natural gas, natural gas liquids, crude oil and refined
petroleum products could adversely affect an Energy
Companys revenues and cash flows. See Principal
Risks of the Fund Energy Companies Risks
Demand Risk. |
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Risks Relating to Expansions and
Acquisitions. Some Energy Companies employ a
variety of means to increase cash flow, including increasing
utilization of existing facilities, expanding operations through
new construction or development activities, expanding operations
through acquisitions, or securing additional long-term
contracts. Thus, some Energy Companies may be subject to
construction risk, development risk, acquisition risk or other
risks arising from their specific business strategies. Energy
Companies that attempt to grow through acquisitions may not be
able to effectively integrate acquired operations with their
existing operations. See Principal Risks of the
Fund Energy Companies Risks Risks
Relating to Expansions and Acquisitions. |
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Competition Risk. The energy sector is highly
competitive. To the extent that the Energy Companies in which
the Fund will invest are unable to compete effectively, their
operating results, financial position, growth potential and cash
flows may be adversely affected, which could in turn adversely
affect the results of the Fund. See Principal Risks of the
Fund Energy Companies Risks Competition
Risk. |
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Weather Risk. Extreme weather conditions, such
as Hurricane Ivan in 2004, Hurricanes Katrina and Rita in 2005
and Hurricane Ike in 2008, could result in substantial damage to
the facilities of certain Energy Companies located in the
affected areas and significant volatility in the supply of
natural resources, commodity prices and the earnings of Energy
Companies, and could therefore adversely affect their securities. |
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Interest Rate Risk. The prices of debt
securities of the Energy Companies the Fund expects to hold in
its portfolio are, and the prices of equity securities held in
its portfolio may be, susceptible in the short term to a decline
when interest rates rise. Rising interest rates could limit the
capital appreciation of securities of certain Energy Companies
as a result of the increased availability of alternative
investments with yields comparable to those of Energy Companies.
Rising interest rates could adversely impact the financial
performance of Energy Companies by increasing their cost of
capital. This may reduce their ability to execute acquisitions
or expansion projects in a cost effective manner. |
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Sub-Sector
Specific Risk. Energy Companies are also subject
to risks that are specific to the particular
sub-sector
of the energy sector in which they operate. |
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Gathering and
processing. Gathering and processing
companies are subject to natural declines in the production of
oil and natural gas
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fields, which utilize their gathering and processing facilities
as a way to market their production, prolonged declines in the
price of natural gas or crude oil, which curtails drilling
activity and therefore production, and declines in the prices of
natural gas liquids and refined petroleum products, which cause
lower processing margins. In addition, some gathering and
processing contracts subject the gathering or processing company
to direct commodities price risk. |
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Exploration and
production. Exploration, development and
production companies are particularly vulnerable to declines in
the demand for and prices of crude oil and natural gas.
Reductions in prices for crude oil and natural gas can cause a
given reservoir to become uneconomic for continued production
earlier than it would if prices were higher, resulting in the
plugging and abandonment of, and cessation of production from,
that reservoir. In addition, lower commodity prices not only
reduce revenues but also can result in substantial downward
adjustments in reserve estimates.
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Oil. In addition to
the risk described above applicable to gathering and processing
companies and exploration and production companies, companies
involved in the transportation, gathering, processing,
exploration, development or production of crude oil or refined
petroleum products may be adversely affected by increased
regulations, increased operating costs and reductions in the
supply of and/or demand for crude oil and refined petroleum
products as a result of the 2010 Deepwater Horizon oil spill and
the reaction thereto. Increased regulation may result in a
decline in production and/or increased cost associated with
offshore oil exploration in the United States and around the
world, which may adversely affect certain Energy Companies and
the oil industry in general. Continued financial deterioration
of BP plc as a result of the 2010 Deepwater Horizon oil spill
may have wide-ranging and unforeseen impacts on the oil industry
and the broader energy sector.
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Cash Flow Risk. The Fund will derive
substantially all of its cash flow from investments in equity
securities of Energy Companies. The amount of cash that the Fund
has available to distribute to shareholders will depend on the
ability of the Energy Companies in which the Fund has an
interest to make distributions or pay dividends to their
investors and the tax character of those distributions or
dividends. The Fund will likely have limited or no influence
over the actions of the Energy Companies in which it invests
with respect to the payment of distributions or dividends. See
Principal Risks of the Fund Energy Companies
Risks Cash Flow Risk. |
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Regulatory Risk. The profitability of Energy
Companies could be adversely affected by changes in the
regulatory environment. Energy Companies are subject to
significant foreign, federal, state and local regulation in
virtually every aspect of their operations, including with
respect to how facilities are constructed, maintained and
operated, environmental and safety controls, and the prices they
may charge for the products and services they provide. Energy
Companies may be adversely affected by future regulatory
requirements. While the nature of such regulations cannot be
predicated at this time, they may impose additional costs or
limit certain operations by Energy Companies |
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operating in various sectors. See Principal Risks of the
Fund Energy Companies Risks Regulatory
Risk. |
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Environmental Risk. There is an inherent risk
that Energy Companies may incur environmental costs and
liabilities due to the nature of their businesses and the
substances they handle. For example, an accidental release from
wells or gathering pipelines could subject them to substantial
liabilities for environmental cleanup and restoration costs,
claims made by neighboring landowners and other third parties
for personal injury and property damage, and fines or penalties
for related violations of environmental laws or regulations.
Moreover, the possibility exists that stricter laws, regulations
or enforcement policies could significantly increase the
compliance costs of Energy Companies, and the cost of any
remediation that may become necessary. Energy Companies may not
be able to recover these costs from insurance. In addition,
regulation can change over time in both scope and intensity, may
have adverse effects on Energy Companies and may be implemented
in unforeseen manners on an emergency basis in
response to catastrophes or other events. For example, the Obama
Administration imposed a six-month moratorium on virtually all
deepwater drilling activity in the Gulf of Mexico in response to
the 2010 Deepwater Horizon blowout and resulting oil spill. See
Principal Risks of the Fund Energy Companies
Risks Environmental Risk. |
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Affiliated Party Risk. Certain Energy
Companies are dependent on their parents or sponsors for a
majority of their revenues. Any failure by an Energy
Companys parents or sponsors to satisfy their payments or
obligations would impact the Energy Companys revenues and
cash flows and ability to make distributions. Moreover, the
terms of an Energy Companys transactions with its parent
or sponsor are typically not arrived at on an arms-length
basis, and may not be as favorable to the Energy Company as a
transaction with a non-affiliate. |
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Catastrophe Risk. The operations of Energy
Companies are subject to many hazards inherent in the
exploration for, and development, production, gathering,
transportation, processing, storage, refining, distribution,
mining or marketing of natural gas, natural gas liquids, crude
oil, refined petroleum products or other hydrocarbons,
including: damage to production equipment, pipelines, storage
tanks or related equipment and surrounding properties caused by
hurricanes, tornadoes, floods, fires and other natural disasters
or by acts of terrorism; inadvertent damage from construction or
other equipment; leaks of natural gas, natural gas liquids,
crude oil, refined petroleum products or other hydrocarbons; and
fires and explosions. Since the September 11th terrorist
attacks, the U.S. government has issued warnings that energy
assets, specifically U.S. pipeline infrastructure, may be
targeted in future terrorist attacks. These dangers give rise to
risks of substantial losses as a result of loss or destruction
of commodity reserves; damage to or destruction of property,
facilities and equipment; pollution and environmental damage;
and personal injury or loss of life. Any occurrence of such
catastrophic events could bring about a limitation, suspension
or discontinuation of the operations of Energy Companies. Energy
Companies may not be fully insured against all risks inherent in
their business operations and therefore |
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accidents and catastrophic events could adversely affect such
companies operations, financial conditions and ability to
pay distributions to shareholders. |
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Legislation Risk. There have been proposals in
Congress to eliminate certain tax incentives widely used by oil
and gas companies and to impose new fees on certain energy
producers. The elimination of such tax incentives and imposition
of such fees could adversely affect Energy Companies in which
the Fund invests and/or the energy sector generally. |
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Risks Associated with U.S. Royalty Trusts. The
U.S. royalty trusts in which the Fund invests are heavily
invested in crude oil and natural gas. Potential growth may be
sacrificed because revenue is passed on to a royalty
trusts unitholders (such as the Fund), rather than
reinvested in the business. Royalty trusts generally do not
guarantee minimum distributions or even return of capital. If
the assets underlying a royalty trust do not perform as
expected, the royalty trust may reduce or even eliminate
distributions. The declaration of such distributions generally
depends upon various factors, including the operating
performance and financial condition of the royalty trust and
general economic conditions. |
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Risks Associated with Canadian Royalty Trusts and Canadian
Exploration and Production Companies. Canadian
royalty trusts are generally subject to similar risks as U.S.
royalty trusts, as described above. However, unlike U.S. royalty
trusts and Canadian royalty trusts and E&P companies may
engage in the acquisition, development and production of natural
gas and crude oil to replace depleting reserves. They may have
employees, issue new shares, borrow money, acquire additional
properties, and may manage the resources themselves. As a
result, Canadian royalty trusts and Canadian E&P companies
are exposed to commodity risk and production and reserve risk,
as well as operating risk. |
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Under amendments to the Income Tax Act (Canada) passed in 2007
(the SIFT Rules), certain trusts (defined as
SIFT trusts) are taxable on certain income and gains
on a basis similar to that which applies to a corporation, with
the result that tax efficiencies formerly available in respect
of an investment in the trust may cease to be available. A
royalty trust may be a SIFT trust. A trust that began public
trading before November 1, 2006 did not become subject to
the SIFT Rules until the first year of the trust that ended in
2011, or earlier if the trust exceeded normal growth
guidelines incorporated by reference into the Income Tax
Act (Canada). In addition, as a result of the SIFT Rules, some
trusts may undertake reorganization transactions, the costs of
which may affect the return earned on an investment in the
trust. After any such conversion, tax efficiencies that were
formerly available in respect of an investment in the trust may
cease to be available. Accordingly, the SIFT Rules have had and
may continue to have an effect on the trading price of
investments in royalty trusts, and consequently could impact the
value of shares of the Fund. |
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Risks Associated with MLP Structure. Holders
of MLP units are subject to certain risks inherent in the
structure of MLPs, including |
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(i) tax risks (described further below), (ii) the
limited ability to elect or remove management or the general
partner or managing member, (iii) limited voting rights,
except with respect to extraordinary transactions, and
(iv) conflicts of interest between the general partner or
managing member and its affiliates, on the one hand, and the
limited partners or members, on the other hand, including those
arising from incentive distribution payments or corporate
opportunities. |
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The benefit the Fund will derive from its investment in MLPs is
largely dependent on the MLPs being treated as partnerships for
U.S. federal income tax purposes. As a partnership, an MLP has
no U.S. federal income tax liability at the entity level. If, as
a result of a change in current law or a change in an MLPs
business, an MLP were to be treated as a corporation for U.S.
federal income tax purposes, it would be subject to U.S. federal
income tax on its income at the graduated tax rates applicable
to corporations (currently a maximum rate of 35%). In addition,
if an MLP were to be classified as a corporation for
U.S. federal income tax purposes, the amount of cash
available for distribution by it would be reduced and
distributions received by the Fund from it would be taxed under
U.S. federal income tax laws applicable to corporate
distributions (as dividend income, return of capital, or capital
gain). Therefore, treatment of MLPs as corporations for U.S.
federal income tax purposes would result in a reduction in the
after-tax return to the Fund, likely causing a reduction in the
value of the Funds common shares. |
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MLP subordinated units are not typically listed on an exchange
or publicly traded. Holders of MLP subordinated units are
entitled to receive a distribution only after the minimum
quarterly distribution (the MQD) has been paid to
holders of common units, but prior to payment of incentive
distributions to the general partner or managing member. MLP
subordinated units generally do not provide arrearage rights. |
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General partner and managing member interests are not publicly
traded, though they may be owned by publicly traded entities
such as general partners of MLPs. A holder of general partner or
managing member interests can be liable in certain circumstances
for amounts greater than the amount of the holders
investment. In addition, while a general partner or managing
members incentive distribution rights can mean that
general partners and managing members have higher distribution
growth prospects than their underlying MLPs, these incentive
distribution payments would decline at a greater rate than the
decline rate in quarterly distributions to common or
subordinated unitholders in the event of a reduction in the
MLPs quarterly distribution. A general partner or managing
member interest can be redeemed by the MLP if the MLP
unitholders choose to remove the general partner, typically by a
supermajority vote of the limited partners or members. |
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Risks Associated with an Investment in
IPOs. Securities purchased in IPOs are often
subject to the general risks associated with investments in
companies with small market capitalizations, and typically to a
heightened degree. Securities issued in IPOs have no trading
history, and information about the companies may be available
for very |
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limited periods. In addition, the prices of securities sold in
an IPO may be highly volatile, thus the Fund cannot predict
whether investments in IPOs will be successful. As the Fund
grows in size, the positive effect of IPO investments on the
Fund may decrease. See Principal Risks of the
Fund Risks Associated with an Investment in
IPOs. |
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Risks Associated with an Investment in PIPE
Transactions. PIPE investors purchase securities
directly from a publicly traded company in a private placement
transaction, typically at a discount to the market price of the
companys common stock. Because the sale of the securities
is not registered under the Securities Act of 1933, as amended
(the Securities Act), the securities are
restricted and cannot be immediately resold by the
investors into the public markets. Accordingly, the company
typically agrees as part of the PIPE deal to register the
restricted securities with the Securities and Exchange
Commission (the SEC). PIPE securities may be deemed
illiquid. |
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Privately Held Company Risk. Investing in
privately held companies involves risk. For example, privately
held companies are not subject to SEC reporting requirements,
are not required to maintain their accounting records in
accordance with generally accepted accounting principles, and
are not required to maintain effective internal controls over
financial reporting. As a result, the Investment Adviser may not
have timely or accurate information about the business,
financial condition and results of operations of the privately
held companies in which the Fund invests. In addition, the
securities of privately held companies are generally illiquid,
and entail the risks described under Principal Risks of
the Fund Liquidity Risk. |
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Liquidity Risk. The investments made by the
Fund, including investments in Energy Companies, may be illiquid
and consequently the Fund may not be able to sell such
investments at prices that reflect the Investment Advisers
assessment of their value, the value at which the Fund is
carrying the securities on its books or the amount paid for such
investments by the Fund. Furthermore, the nature of the
Funds investments may require a long holding period prior
to profitability. See Principal Risks of the
Fund Liquidity Risk. |
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Tax Risks. In addition to other risk
considerations, an investment in the Funds common shares
will involve certain tax risks, including, but not limited to,
the risks summarized below and discussed in more detail
elsewhere in this Prospectus. Tax matters are complicated, and
the foreign and U.S. federal, state and local tax consequences
of the purchase and ownership of the Funds common shares
will depend on the facts of each investors situation.
Prospective investors are encouraged to consult their own tax
advisors regarding the specific tax consequences that may affect
such investors. See Certain U.S. Federal Income Tax
Considerations. |
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C Corporation Structure Tax Risks. The Fund
will be treated as a regular corporation, or C
corporation, for U.S. federal income tax purposes. Because of
the Funds concentration in MLP investments and Energy
Trusts, the Fund will not be eligible for passthrough-like tax
treatment as a regulated investment company under the Code.
Accordingly, the Fund generally will be subject to U.S. federal
income |
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tax on its taxable income at the graduated rates applicable to
corporations (currently a maximum rate of 35%) and will be
subject to state and local income tax by reason of its
investments in equity securities of MLPs and Energy Trusts. |
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U.S. Royalty Trust Tax Risks. U.S.
Royalty Trusts are generally not subject to U.S. federal
corporate income taxation at the trust or entity level. Instead,
each unitholder of the U.S. Royalty Trust is required to take
into account its share of all items of the U.S. Royalty
Trusts income, gain, loss, deduction and expense. It is
possible that the Funds share of taxable income from a
U.S. Royalty Trust may exceed the cash actually distributed to
it from the U.S. Royalty Trust in a given year. In such a case,
the Fund will have less after-tax cash available for
distribution to shareholders. |
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MLP Tax Risks. As a limited partner or member
in the MLPs in which the Fund will invest, the Fund will be
required to include in its taxable income its allocable share of
income, gains, losses, deductions, and credits from those MLPs,
regardless of whether they distribute any cash to the Fund.
Historically, a significant portion of the distributions on MLPs
equity securities has been offset by tax deductions. As the
holder of an MLP equity security, the Fund will incur a current
tax liability on its allocable share of an MLPs income and
gains that is not offset by tax deductions, losses and credits,
or the Funds net operating loss carryforwards, if any. The
portion, if any, of a distribution received by the Fund as the
holder of an MLP equity security that is offset by the
MLPs tax deductions or losses generally will be treated as
a return of capital. However, those distributions will reduce
the Funds adjusted tax basis in the equity securities of
the MLP, which will result in an increase in the amount of
income or gain (or decrease in the amount of loss) that will be
recognized by the Fund for tax purposes upon the sale of any
such equity securities or upon subsequent distributions in
respect of such equity securities. The percentage of an
MLPs income and gains that is offset by tax deductions,
losses and credits will fluctuate over time for various reasons.
A significant slowdown in acquisition activity or capital
spending by MLPs held in the Funds portfolio could result
in a reduction of accelerated depreciation generated by new
acquisitions, which may result in increased current tax
liability for the Fund. The final portion of the distributions
received by the Fund that are considered return of capital will
not be known until the Funds receives a
schedule K-1
with respect to each of its MLP investments. The Funds tax
liability will not be known until the Fund completes its annual
tax return. The Funds tax estimates could vary
substantially from the actual liability and therefore the
determination of the Funds actual tax liability may have a
material impact on the Funds net asset value. The payment
of corporate income taxes imposed on the Fund will decrease cash
available for distribution to shareholders. |
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Deferred Tax Risks. Because the Fund is
treated as a regular corporation, or C corporation,
for U.S. federal income tax purposes, the Fund will incur tax
expenses. In calculating the Funds net asset value in
accordance with generally accepted accounting principles, the
Fund |
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will, among other things, account for its deferred tax liability
and/or asset balances. |
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The Fund will accrue a deferred income tax liability balance, at
the currently effective statutory U.S. federal income tax rate
(currently 35%) plus an estimated state and local income tax
rate, for its future tax liability associated with the capital
appreciation of its investments and the distributions received
by the Fund on equity securities of MLPs considered to be return
of capital and for any net operating gains. Any deferred tax
liability balance will reduce the Funds net asset value.
The portion, if any, of a distribution on an MLP equity security
received by the Fund that is offset by the MLPs tax
deductions or losses will be treated as a return of capital.
However, those distributions will reduce the Funds
adjusted tax basis in the equity securities of the MLP, which
will result in an increase in the amount of income or gain (or a
decrease in the amount of loss) that will be recognized on the
sale of the equity security in the MLP by the Fund. Upon the
Funds sale of a portfolio security, the Fund will be
liable for previously deferred taxes. If the Fund is required to
sell portfolio securities to meet redemption requests, the Fund
may recognize gains for U.S. federal, state and local income tax
purposes, which will result in corporate income taxes imposed on
the Fund. No assurance can be given that such taxes will not
exceed the Funds deferred tax liability assumptions for
purposes of computing the Funds net asset value per share,
which would result in an immediate reduction of the Funds
net asset value per share, which could be material. |
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The Fund will accrue a deferred tax asset balance which reflects
an estimate of the Funds future tax benefit associated
with net operating losses and unrealized losses. Any deferred
tax asset balance will increase the Funds net asset value.
A deferred tax asset may be used to reduce a subsequent
periods income tax expense, subject to certain
limitations. To the extent the Fund has a deferred tax asset
balance, the Fund will assess whether a valuation allowance,
which would offset some or all of the value of the Funds
deferred tax asset balance, is required, considering all
positive and negative evidence related to the realization of the
Funds deferred tax asset. The Fund will assess whether a
valuation allowance is required to offset some or all of any
deferred tax asset balance based on estimates of the Fund in
connection with the calculation of the Funds net asset
value per share each day; however, to the extent the final
valuation allowance differs from the estimates of the Fund used
in calculating the Funds net asset value, the application
of such final valuation allowance could have a material impact
on the Funds net asset value. |
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The Funds deferred tax liability and/or asset balances are
estimated using estimates of effective tax rates expected to
apply to taxable income in the years such balances are realized.
The Fund will rely to some extent on information provided by
MLPs regarding the tax characterization of the distributions
made by such MLPs, which may not be provided to the Fund on a
timely basis, to estimate the Funds deferred tax liability
and/or asset balances for purposes of financial statement
reporting and determining its net asset value. The Funds
estimates regarding its deferred tax liability and/or asset
balances are |
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made in good faith; however, the estimate of the Funds
deferred tax liability and/or asset balances used to calculate
the Funds net asset value could vary dramatically from the
Funds actual tax liability, and, as a result, the
determination of the Funds actual tax liability may have a
material impact on the Funds net asset value. From time to
time, the Fund may modify its estimates or assumptions regarding
its deferred tax liability and/or asset balances as new
information becomes available. Modifications of the Funds
estimates or assumptions regarding its deferred tax liability
and/or asset balances and any applicable valuation allowance,
changes in generally accepted accounting principles or related
guidance or interpretations thereof, limitations imposed on net
operating losses (if any) and changes in applicable tax law
could result in increases or decreases in the Funds net
asset value per share, which could be material. |
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The investment strategy of investing primarily in Energy Trusts
and MLPs and electing to be taxed as a regular corporation, or
C corporation, rather than as a regulated investment
company for U.S. federal income tax purposes, involves
complicated and in some cases unsettled accounting, tax and net
asset and share valuation aspects that cause the Fund to differ
significantly from most other registered investment companies.
This may result in unexpected and potentially significant
accounting, tax and valuation consequences for the Fund and for
its shareholders. In addition, accounting, tax and valuation
practices in this area are still developing, and there may not
always be a clear consensus among industry participants as to
the most appropriate approach. This may result in changes over
time in the practices applied by the Fund, which, in turn, could
have material adverse consequences on the Fund and its
shareholders. |
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Tax Law Changes Risk. Changes in tax laws,
regulations or interpretations of those laws or regulations in
the future could adversely affect the Fund or the Energy
Companies in which the Fund will invest. Any such changes could
negatively impact the Funds common shareholders.
Legislation could also negatively impact the amount and tax
characterization of dividends received by the Funds common
shareholders. Federal legislation has reduced the U.S. federal
income tax rate on qualified dividend income to the rate
applicable to long-term capital gains, which is generally 15%
for individuals, provided a holding period requirement and
certain other requirements are met. This reduced rate of tax on
dividends is currently scheduled to revert to ordinary income
tax rates for taxable years beginning after December 31,
2012, and the 15% federal income tax rate for long-term capital
gains is scheduled to revert to 20% for such taxable years. |
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Equity Securities Risk. Equity securities of
Energy Companies can be affected by macroeconomic, political,
global and other factors affecting the stock market in general,
expectations of interest rates, investor sentiment towards the
energy sector, changes in a particular companys financial
condition, or the unfavorable or unanticipated poor performance
of a particular Energy Company (which, in the case of an Energy
Trust or MLP, is generally measured in terms of distributable
cash flow). Prices of equity securities of individual |
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Energy Companies can also be affected by fundamentals unique to
the company, including earnings power and coverage ratios. |
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Small-Cap and Mid-Cap Company Risk. Certain of
the Energy Companies in which the Fund may invest may have small
or medium-sized market capitalizations (small-cap
and mid-cap companies, respectively). Investing in
the securities of small-cap or mid-cap Energy Companies presents
some particular investment risks. These Energy Companies may
have limited product lines and markets, as well as shorter
operating histories, less experienced management and more
limited financial resources than larger Energy Companies, and
may be more vulnerable to adverse general market or economic
developments. Stocks of these Energy Companies may be less
liquid than those of larger Energy Companies, and may experience
greater price fluctuations than larger Energy Companies. In
addition, small-cap or mid-cap company securities may not be
widely followed by investors, which may result in reduced demand. |
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Canadian Risk. The Canadian economy is very
dependent on the demand for, and supply and price of, natural
resources. The Canadian market is relatively concentrated in
issuers involved in the production and distribution of natural
resources. There is a risk that any changes in these sectors
could have an adverse impact on the Canadian economy. The
Canadian economy is dependent on the economies of the
United States as a key trading partner. Reduction in
spending on Canadian products and services or changes in the
U.S. economy may cause an impact in the Canadian economy. The
Canadian economy may be significantly affected by the U.S.
economy, given that the United States is Canadas largest
trading partner and foreign investor. Since the implementation
of the North American Free Trade Agreement (NAFTA) in 1994,
total two-way merchandise trade between the United States and
Canada has more than doubled. To further this relationship, all
three NAFTA countries entered into The Security and Prosperity
Partnership of North America in March 2005, which addressed
economic and security related issues. These agreements may
further affect Canadas dependency on the U.S. economy.
Past periodic demands by the Province of Quebec for sovereignty
have significantly affected equity valuations and foreign
currency movements in the Canadian market. |
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Interest Rate Risk. The costs associated with
any leverage used by the Fund are likely to increase when
interest rates rise. Accordingly, the market price of the
Funds common shares may decline when interest rates rise. |
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Interest Rate Hedging Risk. The Fund may from
time to time hedge against interest rate risk resulting from the
Funds portfolio holdings and any financial leverage it may
incur. Interest rate transactions the Fund may use for hedging
purposes will expose the Fund to certain risks that differ from
the risks associated with its portfolio holdings. There are
economic costs of hedging reflected in the price of interest
rate swaps, caps and similar techniques, the cost of which can
be significant. In addition, the Funds success in using
hedging instruments is subject to the Investment Advisers
ability to correctly predict changes in the relationships of
such hedging instruments to the Funds |
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leverage risk, and there can be no assurance that the Investment
Advisers judgment in this respect will be accurate. See
Principal Risks of the Fund Interest Rate
Hedging Risk. |
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Arbitrage Risk. A part of the Investment
Advisers investment operations may involve spread
positions between two or more securities, or derivatives
positions including commodities hedging positions, or a
combination of the foregoing. The Investment Advisers
trading operations also may involve arbitraging between two
securities or commodities, between the security, commodity and
related options or derivatives markets, between spot and futures
or forward markets, and/or any combination of the above. To the
extent the price relationships between such positions remain
constant, no gain or loss on the positions will occur. These
offsetting positions entail substantial risk that the price
differential could change unfavorably, causing a loss to the
position. |
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Leverage Risk. The Fund may use leverage
through the issuance of Indebtedness or the issuance of
preferred shares. The use of leverage magnifies both the
favorable and unfavorable effects of price movements in the
investments made by the Fund. Insofar as the Fund employs
leverage in its investment operations, the Fund will be subject
to increased risk of loss. In addition, the Fund will pay (and
the holders of common shares will bear) all costs and expenses
relating to the issuance and ongoing maintenance of leverage,
including higher advisory fees. Similarly, any decline in the
net asset value of the Funds investments will be borne
entirely by the holders of common shares. Therefore, if the
market value of the Funds portfolio declines, the leverage
will result in a greater decrease in net asset value to the
holders of common shares than if the Fund were not leveraged.
This greater net asset value decrease will also tend to cause a
greater decline in the market price for the common shares. See
Principal Risks of the Fund Leverage
Risk. |
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Credit Facility Risk. The Fund may negotiate
with commercial banks to arrange a credit facility pursuant to
which the Fund would be entitled to borrow an amount equal to
approximately
331/3%
of the Funds Managed Assets (i.e., 50% of the
Funds net assets attributable to the Funds common
shares). Any such borrowings would constitute leverage. Such a
facility is not expected to be convertible into any other
securities of the Fund. Any outstanding amounts are expected to
be prepayable by the Fund prior to final maturity without
significant penalty, and there are not expected to be any
sinking fund or mandatory retirement provisions. Outstanding
amounts would be payable at maturity or such earlier times as
required by the agreement. The Fund may be required to prepay
outstanding amounts under a facility or incur a penalty rate of
interest in the event of the occurrence of certain events of
default. The Fund would be expected to indemnify the lenders
under the facility against liabilities they may incur in
connection with the facility. The Fund may be required to pay
commitment fees under the terms of any such facility. With the
use of borrowings, there is a risk that the interest rates paid
by the Fund on the amount it borrows will be higher than the
return on the Funds investments. The Fund may enter into
fully-collateralized borrowing |
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arrangements in which the collateral maintained in a segregated
account exceeds the amount borrowed. If the Fund is unable to
repay the loan, the lender may realize upon the collateral. Such
arrangements are also subject to interest rate risk. |
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Preferred Share Risk. Preferred share risk is
the risk associated with the issuance of preferred shares to
leverage the common shares. If the Fund issues preferred shares,
the yield to the holders of common shares will tend to fluctuate
with changes in the shorter-term dividend rates on the preferred
shares. If preferred shares are issued, holders of preferred
shares may have differing interests than holders of common
shares and holders of preferred shares may at times have
disproportionate influence over the Funds affairs. If
preferred shares are issued, holders of preferred shares, voting
separately as a single class, would have the right to elect two
members of the Board of Trustees at all times. The remaining
members of the Board of Trustees would be elected by holders of
common shares and preferred shares, voting as a single class.
The Fund has no present intention of issuing preferred shares.
See Principal Risks of the Fund Leverage
Risk Preferred Share Risk. |
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Portfolio Guidelines. Pursuant to the terms of
any Indebtedness or in connection with obtaining and maintaining
a rating issued with respect to Indebtedness or preferred
shares, the Fund may be required to comply with investment
quality, diversification and other guidelines established by a
rating agency then providing a rating on the Funds
Indebtedness or preferred shares. See Principal Risks of
the Fund Leverage Risk Portfolio
Guidelines of Rating Agencies. |
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Securities Lending Risk. The Fund may lend its
portfolio securities (up to a maximum of one-third of its
Managed Assets) to banks or dealers which meet the
creditworthiness standards established by the Board of Trustees
of the Fund. Securities lending is subject to the risk that
loaned securities may not be available to the Fund on a timely
basis and the Fund may, therefore, lose the opportunity to sell
the securities at a desirable price. Any loss in the market
price of securities loaned by the Fund that occurs during the
term of the loan would be borne by the Fund and would adversely
affect the Funds performance. There may also be delays in
recovery, or no recovery, of securities loaned or even a loss of
rights in the collateral should the borrower of the securities
fail financially while the loan is outstanding. These risks may
be greater for
non-U.S.
securities. |
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Non-Diversification Risk. The Fund is a
non-diversified, closed-end management investment company under
the 1940 Act and will not elect to be treated as a regulated
investment company under the Code. As a result, there are no
regulatory requirements under the 1940 Act or the Code that
limit the proportion of the Funds assets that may be
invested in securities of a single issuer. Accordingly, the Fund
may invest a greater portion of its assets in a more limited
number of issuers than a diversified fund. An investment in the
Fund may present greater risk to an investor than an investment
in a diversified portfolio because changes in the financial
condition or market assessment of a single issuer may cause
greater fluctuations in the value of the Funds shares. |
25
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Valuation Risk. Market prices may not be
readily available for certain of the Funds investments,
and the value of such investments will ordinarily be determined
based on fair valuations determined by the Board of Trustees or
its designee pursuant to procedures adopted by the Board of
Trustees. Restrictions on resale or the absence of a liquid
secondary market may adversely affect the Funds ability to
determine its net asset value. The sale price of securities that
are not readily marketable may be lower or higher than the
Funds most recent determination of their fair value. |
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When determining the fair value of an asset, the Investment
Adviser will seek to determine the price that the Fund might
reasonably expect to receive from the current sale of that asset
in an arms length transaction. |
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Fair value pricing, however, involves judgments that are
inherently subjective and inexact, since fair valuation
procedures are used only when it is not possible to be sure what
value should be attributed to a particular asset or when an
event will affect the market price of an asset and to what
extent. As a result, there can be no assurance that fair value
pricing will reflect actual market value and it is possible that
the fair value determined for a security will be materially
different from the value that actually could be or is realized
upon the sale of that asset. |
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Portfolio Turnover Risk. The Fund anticipates
that its annual portfolio turnover rate will be approximately
35% under normal market conditions, but that rate may vary
greatly from year to year. Portfolio turnover rate is not
considered a limiting factor in the Investment Advisers
execution of investment decisions. A higher portfolio turnover
rate results in correspondingly greater brokerage commissions
and other transactional expenses that are borne by the Fund.
High portfolio turnover may result in an increased realization
of net short-term capital gains or capital losses by the Fund. |
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Strategic Transactions Risk. The Fund may, but
is not required to, use investment strategies (referred to
herein as Strategic Transactions) for hedging, risk
management or portfolio management purposes or to earn income.
The Funds use of Strategic Transactions may involve the
purchase and sale of derivative instruments. The Fund may
purchase and sell exchange-listed and
over-the-counter
put and call options on securities, indices and other
instruments, enter into forward contracts, purchase and sell
futures contracts and options thereon, enter into swap, cap,
floor or collar transactions, purchase structured investment
products and enter into transactions that combine multiple
derivative instruments. Strategic Transactions often have risks
similar to the securities underlying the Strategic Transactions.
However, the use of Strategic Transactions also involves risks
that are different from, and possibly greater than, the risks
associated with other portfolio investments. Strategic
Transactions may involve the use of highly specialized
instruments that require investment techniques and risk analyses
different from those associated with other portfolio
investments. The use of derivative instruments has risks,
including the imperfect correlation between the value of the
derivative instruments and the underlying assets, the possible
default of the counterparty to the transaction or illiquidity of
the derivative investments. |
26
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Furthermore, the ability to successfully use these techniques
depends on the Investment Advisers ability to predict
pertinent market movements, which cannot be assured. Thus, the
use of Strategic Transactions may result in losses greater than
if they had not been used, may require the Fund to sell or
purchase portfolio securities at inopportune times or for prices
other than current market values, may limit the amount of
appreciation the Fund can realize on an investment or may cause
the Fund to hold a security that it might otherwise sell. In
addition, amounts paid by the Fund as premiums and cash, or
other assets held in margin accounts with respect to Strategic
Transactions are not otherwise available to the Fund for
investment purposes. It is possible that government regulation
of various types of derivative instruments, including
regulations enacted pursuant to the Dodd-Frank Wall Street
Reform and Consumer Protection Act (the Dodd-Frank
Act), which was signed into law in July 2010, may impact
the availability, liquidity and cost of derivative instruments.
There can be no assurance that such regulation will not have a
material adverse effect on the Fund or will not impair the
ability of the Fund to implement certain Strategic Transactions
or to achieve its investment objective. Although the Investment
Adviser seeks to use Strategic Transactions to further the
Funds investment objective, no assurance can be given that
the use of Strategic Transactions will achieve this result. A
more complete discussion of Strategic Transactions and their
risks is included in the Funds Statement of Additional
Information under the heading Strategic Transactions. |
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Convertible Instrument Risk. The Fund may
invest in convertible instruments. A convertible instrument is a
bond, debenture, note, preferred stock or other security that
may be converted into or exchanged for a prescribed amount of
common shares of the same or a different issuer within a
particular period of time at a specified price or formula.
Convertible debt instruments have characteristics of both fixed
income and equity investments. Convertible instruments are
subject both to the stock market risk associated with equity
securities and to the credit and interest rate risks associated
with fixed-income securities. As the market price of the equity
security underlying a convertible instrument falls, the
convertible instrument tends to trade on the basis of its yield
and other fixed-income characteristics. As the market price of
such equity security rises, the convertible security tends to
trade on the basis of its equity conversion features. See
Principal Risks of the Fund Convertible
Instrument Risk. |
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Short Sales Risk. Short selling involves
selling securities which may or may not be owned and borrowing
the same securities for delivery to the purchaser, with an
obligation to replace the borrowed securities at a later date.
Short selling allows the short seller to profit from declines in
market prices to the extent such declines exceed the transaction
costs and the costs of borrowing the securities. A naked short
sale creates the risk of an unlimited loss because the price of
the underlying security could theoretically increase without
limit, thus increasing the cost of buying those securities to
cover the short position. There can be no assurance that the
securities necessary to cover a short position will be available
for purchase. Purchasing securities to close out the short
position can itself cause the price of the securities to rise,
further |
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exacerbating the loss. See Principal Risks of the
Fund Short Sales Risk. |
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Inflation Risk. Inflation risk is the risk
that the value of assets or income from investment will be worth
less in the future as inflation decreases the value of money. As
inflation increases, the real value of the Funds common
shares and dividends can decline. |
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Debt Securities Risk. Debt securities are
subject to many of the risks described elsewhere in this
section. In addition, they are subject to credit risk,
prepayment risk and, depending on their quality, other special
risks. |
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The Fund may invest up to 10% of its Managed Assets in debt
securities, preferred shares and convertible securities rated
below investment grade and unrated debt securities. Below
investment grade and unrated debt securities generally pay a
premium above the yields of U.S. government securities or debt
securities of investment grade issuers because they are subject
to greater risks than these securities. These risks, which
reflect their speculative character, include the following:
greater yield and price volatility; greater credit risk and risk
of default; potentially greater sensitivity to general economic
or industry conditions; potential lack of attractive resale
opportunities (illiquidity); and additional expenses to seek
recovery from issuers who default. Debt securities rated below
investment grade are commonly known as junk bonds
and are regarded as predominantly speculative with respect to
the issuers capacity to pay interest and repay principal
in accordance with the terms of the obligations, and involve
major risk exposure to adverse conditions. |
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Certain debt instruments, particularly below investment grade
securities, may contain call or redemption provisions which
would allow the issuer of the debt instrument to prepay
principal prior to the debt instruments stated maturity.
This is also sometimes known as prepayment risk. See
Principal Risks of the Fund Debt Securities
Risks. |
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Other Investment Companies Risk. The Fund may
invest in securities of other investment companies, including
other closed-end or open-end investment companies (including
ETFs). The market value of their shares may differ from the net
asset value of the particular fund. To the extent the Fund
invests a portion of its assets in investment company
securities, those assets will be subject to the risks of the
purchased investment companys portfolio securities. In
addition, if the Fund invests in such investment companies or
investment funds, the Funds shareholders will bear not
only their proportionate share of the expenses of the Fund
(including operating expenses and the fees of the Investment
Adviser), but also will indirectly bear similar expenses of the
underlying investment company. In addition, the securities of
other investment companies may also be leveraged and will
therefore be subject to the same leverage risks described
herein. As described in the section entitled Principal
Risks of the Fund Leverage Risk, the net asset
value and market value of leveraged shares will be more volatile
and the yield to stockholders will tend to fluctuate more than
the yield generated by unleveraged shares. Other investment |
28
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companies may have investment policies that differ from those of
the Fund. In addition, to the extent the Fund invests in other
investment companies, the Fund will be dependent upon the
investment and research abilities of persons other than the
Investment Adviser. |
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ETN and ETF Risk. An exchange traded note
(ETN) or exchange traded fund (ETF) that
is based on a specific index may not be able to replicate and
maintain exactly the composition and relative weighting of
securities in the index. An ETN or ETF also incurs certain
expenses not incurred by its applicable index. The market value
of an ETN or ETF share may differ from its net asset value; the
share may trade at a premium or discount to its net asset value,
which may be due to, among other things, differences in the
supply and demand in the market for the share and the supply and
demand in the market for the underlying assets of the ETN or
ETF. See Principal Risks of the Fund ETN and
ETF Risk. |
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Investment Management Risk. The Funds
portfolio is subject to investment management risk because it
will be actively managed. The Investment Adviser will apply
investment techniques and risk analyses in making investment
decisions for the Fund, but there can be no guarantee that they
will produce the desired results. See Principal Risks of
the Fund Investment Management Risk. |
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Dependence on Key Personnel of the Investment
Adviser. The Fund is dependent upon the
Investment Advisers key personnel for its future success
and upon their access to certain individuals and investments in
the energy sector. In particular, the Fund will depend on the
diligence, skill and network of business contacts of the
personnel of the Investment Adviser and its portfolio managers,
who will evaluate, negotiate, structure, close and monitor the
Funds investments. The portfolio managers do not have a
long-term employment contract with the Investment Adviser,
although they do have equity interests and other financial
incentives to remain with the firm. See Principal Risks of
the Fund Dependence on Key Personnel of the
Investment Adviser. |
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Conflicts of Interest with the Investment
Adviser. Conflicts of interest may arise because
the Investment Adviser and its affiliates generally will be
carrying on substantial investment activities for other clients,
including, but not limited to, other client accounts and funds
managed or advised by the Investment Adviser in which the Fund
will have no interest. The Investment Adviser or its affiliates
may have financial incentives to favor certain of such accounts
over the Fund. Any of their proprietary accounts and other
customer accounts may compete with the Fund for specific trades.
Notwithstanding these potential conflicts of interest, the
Funds Board of Trustees and officers have a fiduciary
obligation to act in the Funds best interest. See
Principal Risks of the Fund Conflicts of
Interest with the Investment Adviser. |
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Market Discount From Net Asset Value. Shares
of closed-end investment companies frequently trade at a
discount from their net asset value, which is a risk separate
and distinct from the risk that the Funds net asset value
could decrease as a result of its investment activities. |
29
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Although the value of the Funds net assets is generally
considered by market participants in determining whether to
purchase or sell common shares, whether investors will realize
gains or losses upon the sale of common shares will depend
entirely upon whether the market price of common shares at the
time of sale is above or below the investors purchase
price for common shares. Because the market price of common
shares will be determined by factors such as net asset value,
dividend and distribution levels (which are dependent, in part,
on expenses), supply of and demand for common shares, stability
of dividends or distributions, trading volume of common shares,
general market and economic conditions and other factors beyond
the control of the Fund, the Fund cannot predict whether common
shares will trade at, below or above net asset value or at,
below or above the initial public offering price. This risk may
be greater for investors expecting to sell their common shares
soon after the completion of the public offering, as the net
asset value of the common shares will be reduced immediately
following the offering as a result of the payment of certain
offering costs. Common shares of the Fund are designed primarily
for long-term investors; investors in common shares should not
view the Fund as a vehicle for trading purposes. |
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Recent Economic Events. Global financial
markets have experienced periods of unprecedented turmoil. The
debt and equity capital markets in the United States were
negatively impacted by significant write-offs in the financial
services sector relating to subprime mortgages and the
re-pricing of credit risk in the broader market, among other
things. These events, along with the deterioration of the
housing market, the failure of major financial institutions and
the concerns that other financial institutions as well as the
global financial system were also experiencing severe economic
distress materially and adversely impacted the broader financial
and credit markets and reduced the availability of debt and
equity capital for the market as a whole and financial firms in
particular. These events contributed to severe market volatility
and caused severe liquidity strains in the credit markets.
Volatile financial markets can expose the Fund to greater market
and liquidity risk and potential difficulty in valuing portfolio
instruments held by the Fund. |
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While the U.S. and global markets had experienced extreme
volatility and disruption for an extended period of time, some
recent fiscal periods have witnessed more stabilized economic
activity as expectations for an economic recovery increased,
although other recent periods have witnessed more economic
disruption and adverse economic conditions may persist. Risks to
a robust resumption of growth persist: a weak consumer weighed
down by too much debt and persistent joblessness, the growing
size of the federal budget deficit and national debt, existing
home sales plunging to their lowest levels in 15 years, and
the threat of inflation. A return to unfavorable economic
conditions or a sustained economic slowdown may place downward
pressure on oil and natural gas prices and may adversely affect
the ability of MLPs to sustain their historical distribution
levels, which in turn, may adversely affect the Fund. MLPs that
have historically relied heavily on outside capital to fund
their growth have been impacted by the contraction in the
capital markets. The continued |
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recovery of the MLP sector is dependent on several factors,
including the recovery of the financial sector, the general
economy and the commodity markets. |
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The current financial market situation, as well as various
social, political, and psychological tensions in the United
States and around the world, may continue to contribute to
increased market volatility, may have long-term effects on the
U.S. and worldwide financial markets, and may cause further
economic uncertainties or deterioration in the United States and
worldwide. Since 2010, several European Union (EU)
countries, including Greece, Ireland, Italy, Spain, and
Portugal, have faced budget issues, some of which may have
negative long-term effects for the economies of those countries
and other EU countries. There is continued concern about
national-level support for the euro and the accompanying
coordination of fiscal and wage policy among European Economic
and Monetary Union member countries. The prolonged continuation
or further deterioration of the current U.S. and global economic
downturn could adversely impact the Funds portfolio. The
Investment Adviser does not know how long the financial markets
will continue to be affected by these events and cannot predict
the effects of these or similar events in the future on the U.S.
economy and securities markets or on the Funds portfolio.
The Investment Adviser intends to monitor developments and seek
to manage the Funds portfolio in a manner consistent with
achieving the Funds investment objective, but there can be
no assurance that it will be successful in doing so; and the
Investment Adviser may not timely anticipate or manage existing,
new or additional risks, contingencies or developments,
including regulatory developments and trends in new products and
services, in the current or future market environment. Given the
risks described above, an investment in common shares may not be
appropriate for all prospective investors. A prospective
investor should carefully consider his or her ability to assume
these risks before making an investment in the Fund. |
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Government Intervention in Financial
Markets. The instability in the financial markets
discussed above has led the United States government to take a
number of unprecedented actions designed to support certain
financial institutions and segments of the financial markets
that have experienced extreme volatility, and, in some cases, a
lack of liquidity. Federal, state, and other governments, their
regulatory agencies, or self-regulatory organizations may take
actions that affect the regulation of the instruments in which
the Fund invests, or the issuers of such instruments. The
Dodd-Frank Act, which was signed into law in July 2010, is
expected to result in a significant revision of the U.S.
financial regulatory framework. The Dodd-Frank Act covers a
broad range of topics, including, among many others, a
reorganization of federal financial regulators; a process
designed to ensure financial system stability and the resolution
of potentially insolvent financial firms; new rules for
derivatives trading; the creation of a consumer financial
protection watchdog; the registration and regulation of managers
of private funds; the regulation of credit rating agencies; and
new federal requirements for residential mortgage loans. The
regulation of various types of derivative instruments pursuant
to the Dodd-Frank Act may adversely affect MLPs and other |
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issuers in which the Fund invests that utilize derivatives
strategies for hedging or other purposes. The ultimate impact of
the Dodd-Frank Act, and any resulting regulation, is not yet
certain and issuers in which the Fund invests may also be
affected by the new legislation and regulation in ways that are
currently unforeseeable. Governments or their agencies may
acquire distressed assets from financial institutions and
acquire ownership interests in those institutions. The long-term
implications of government ownership and disposition of these
assets are unclear, and may have positive or negative effects on
the liquidity, valuation and performance of the Funds
portfolio holdings. |
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Legal and Regulatory Risk. Legal and
regulatory changes could occur that may adversely affect the
Fund. See Principal Risks of the Fund Legal
and Regulatory Risk. |
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Terrorism and Market Disruption Risk. As a
result of the terrorist attacks on the World Trade Center and
the Pentagon on September 11, 2001, some of the U.S.
securities markets were closed for a
four-day
period. These terrorist attacks, the wars in Iraq and
Afghanistan and their aftermaths and other geopolitical events
have led to, and may in the future lead to, increased short-term
market volatility and may have long-term effects on U.S. and
world economies and markets. Global political and economic
instability could affect the operations of Energy Companies in
unpredictable ways, including through disruptions of natural
resources supplies and markets and the resulting volatility in
commodity prices. The U.S. government has issued warnings that
natural resources assets, specifically pipeline infrastructure
and production, transmission and distribution facilities, may be
future targets of terrorist activities. In addition, changes in
the insurance markets have made certain types of insurance more
difficult, if not impossible, to obtain and have generally
resulted in increased premium costs. |
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Anti-Takeover Provisions in the Funds Agreement
and Declaration of Trust and Bylaws |
|
The Funds Agreement and Declaration of Trust and Bylaws
include provisions that could have the effect of limiting the
ability of other entities or persons to acquire control of the
Fund or to change the composition of its Board of Trustees. For
example, the Funds Agreement and Declaration of Trust
limits the ability of persons to beneficially own (within the
meaning of Section 382 of the Code) more than 4.99% of the
outstanding common shares of the Fund. This restriction is
intended to reduce the risk of the Fund undergoing an
ownership change within the meaning of
Section 382 of the Code, which would limit the Funds
ability to use a net operating loss carryforward, a capital loss
carryforward and certain unrealized losses (if such tax
attributes exist). In general, an ownership change occurs if 5%
shareholders (and certain persons or groups treated as 5%
shareholders) of the Fund increase their ownership percentage in
the Fund by more than 50 percentage points in the aggregate
within any three-year period ending on certain defined testing
dates. If an ownership change were to occur, Section 382
would impose an annual limitation on the amount of
post-ownership change income that the Fund may offset with
pre-ownership change losses, and might impose |
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restrictions on the Funds ability to use certain
unrealized losses existing at the time of the ownership change.
Such a limitation arising under Section 382 could reduce
the benefit of the Funds then existing net operating loss
carryforward, capital loss carryforward or unrealized losses, if
any. This could have the effect of depriving shareholders of an
opportunity to sell their shares at a premium over prevailing
market prices by discouraging a third party from seeking to
obtain control over the Fund. Such attempts could have the
effect of increasing the expenses of the Fund and disrupting the
normal operation of the Fund. See Anti-Takeover Provisions
in the Agreement and Declaration of Trust and
Certain Provisions of Delaware Law, the Agreement and
Declaration of Trust and Bylaws. |
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Other Service Providers |
|
Under a transfer agent servicing agreement among U.S. Bancorp
Fund Services, LLC and the Fund, U.S. Bancorp Fund Services, LLC
serves as the Funds transfer agent, registrar, and
dividend disbursing agent. |
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U.S. Bancorp Fund Services, LLC (the
Administrator) will provide the Fund with
administrative services. The Administrator also performs fund
accounting for the Fund. |
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U.S. Bank National Association serves as the custodian of the
Funds securities and other assets. |
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See Other Service Providers. |
33
SUMMARY
OF FUND EXPENSES
The following tables are intended to assist you in understanding
the various costs and expenses directly or indirectly associated
with investing in the Funds common shares as a percentage
of net assets attributable to common shares. The following table
assumes the Fund has borrowed in the amount equal to
331/3%
of the Funds Managed Assets (i.e., 50% of its net
assets attributable to the Funds common shares) and shows
the Funds expenses as a percentage of net assets
attributable to its common shares. Footnote 4 to the table also
shows Fund expenses as a percentage of net assets attributable
to common shares but assumes no use of leverage by the Fund. The
following table and example should not be considered a
representation of the Funds future expenses. Actual
expenses may be greater or less than shown.
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Shareholder Transaction Expenses
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Sales load (as a percentage of offering price)
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4.50
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%
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Offering expenses borne by the Fund (as a percentage of offering
price)(1)
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0.20
|
%
|
Dividend Reinvestment Plan fees
|
|
|
None
|
|
|
|
|
|
|
|
|
Percentage of Net Assets
|
|
|
|
Attributable to Common Shares
|
|
Annual Expenses
|
|
(Assumes Use of
Leverage)(2)(3)
|
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|
Management
fees(4)
|
|
|
2.25
|
%
|
Interest payments on borrowed funds
|
|
|
0.63
|
%
|
Current Income Tax
Expenses(5)
|
|
|
0.00
|
%
|
Deferred Income Tax Expenses
|
|
|
0.00
|
%
|
Acquired Fund Fees and
Expenses(6)
|
|
|
0.00
|
%
|
Other
expenses(7)
|
|
|
0.50
|
%
|
Total annual expenses
|
|
|
3.38
|
%
|
|
|
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(1)
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The Investment Adviser has agreed
to pay (i) all organizational costs of the Fund and
(ii) offering costs of the Fund (other than the sales load)
that exceed $0.05 per common share (0.20 % of the offering
price). Assuming the Fund issues 6 million common shares,
total proceeds of the offering are estimated to be $150,000,000,
and the costs of the offering are estimated to be approximately
$1,890,000, of which $300,000 ($0.05 per common share) will
be borne by the Fund and $1,590,000 ($0.265 per common share)
will be borne by the Investment Adviser.
|
|
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(2)
|
|
Assumes a cost on leveraging of
1.25%. This rate is an estimate and may differ based on varying
market conditions that may exist at the time leverage is
utilized and depending on the type of leverage used. If the Fund
leverages in an amount greater than
331/3%
of Managed Assets, this amount could increase.
|
|
|
|
(3)
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|
The Fund anticipates utilizing
leverage, however, at times the Fund may not utilize leverage.
Consequently, the table presented below in this footnote also
shows the Funds expenses as a percentage of the same
amount of net assets attributable to its common shares, but
unlike the table above, assumes that the Fund does not utilize
leverage. Consequently, the table below does not reflect any
interest on borrowed funds or other costs and expenses of
leverage. In accordance with these assumptions, the Funds
expenses would be as follows:
|
|
|
|
|
|
|
|
Percentage of Net Assets
|
|
|
|
Attributable to Common Shares
|
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Annual Expenses
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|
(Assumes No Leverage)
|
|
|
Management fees
|
|
|
1.50
|
%
|
Interest payments on borrowed funds
|
|
|
None
|
|
Current Income Tax
Expenses(4)
|
|
|
0.00
|
%
|
|
|
|
|
|
Deferred Income Tax
Expenses(5)
|
|
|
0.00
|
%
|
Acquired Fund Fees and
Expenses(6)
|
|
|
0.00
|
%
|
Other
expenses(7)
|
|
|
0.50
|
%
|
Total annual expenses
|
|
|
2.00
|
%
|
|
|
|
(4)
|
|
The Investment Adviser has agreed
to waive 0.25% of its management fee from the time the Fund
commences operation through at least February 28, 2013. The
amount shown in the table does not reflect the waiver.
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(5)
|
|
As of the date of this Prospectus,
the Fund has not commenced investment operations. Because it
cannot be predicted whether the Fund will incur a benefit or
expense, a current income tax expense of 0.00% has been assumed.
|
|
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(6)
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|
Acquired fund fees and expenses are
those expenses incurred indirectly by the Fund as a result of
acquiring investments in shares of one or more other investment
companies.
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|
|
|
(7)
|
|
The Other expenses
shown in the table and related footnotes are based on estimated
amounts for the Funds first year of operations unless
otherwise indicated and assume that the Fund issues
approximately 6 million common shares. Other
Expenses includes estimated orgnizational expenses and our
overhead expenses based on estimated amounts for the current
fiscal year. If the Fund issues fewer common
|
34
|
|
|
|
|
shares, all other things being
equal, the Funds expense ratio as a percentage of net
assets attributable to common shares would increase. In
addition, the costs of this offering are not included as an
annual expense in the expenses shown in this table, but are
included in the Shareholder Transaction Expense so table above.
Please see footnote (1) above.
|
The expenses shown in the table above and example below are
based on estimated amounts for the Funds first fiscal year
of operations, unless otherwise indicated, and assume that the
Fund issues approximately 6 million common shares. If the
Fund issues fewer common shares, all other things being equal,
these expenses would increase as a percentage of the Funds
net assets attributable to common shares.
Example
As required by relevant SEC regulations, the following example
illustrates the expenses (including the sales load of 4.50% or
$1.125 per common share and estimated offering expenses of 0.20%
or $0.05 per common share) that an investor would pay on a
$1,000 investment in the Funds common shares, assuming
total annual expenses of 3.38% of net assets attributable to the
Funds common shares, the Fund utilizes leverage in an
amount equal to
331/3%
of Managed Assets (i.e., 50% of net assets attributable
to the Funds common shares), and a 5% annual return:
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|
|
|
|
|
|
|
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|
|
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|
|
1 Year
|
|
|
3 Years
|
|
|
5 Years
|
|
|
10 Years
|
|
|
Total Expenses Incurred
|
|
$
|
79.00
|
|
|
$
|
146.00
|
|
|
$
|
215.00
|
|
|
$
|
396.00
|
|
The example should not be considered a representation of
future expenses or returns. Actual expenses may be greater or
less than those shown. Moreover, the Funds
actual rate of return may be greater or less than the
hypothetical 5% return shown in the example. The example assumes
that the estimated Other Expenses set out in the
Annual Expenses table are accurate and that all dividends and
distributions are reinvested at net asset value. In the event
that the Fund does not use any leverage, an investor would pay
the following expenses based on the assumptions in the example
and total annual expenses of 2.00% of net assets attributable to
the Funds common shares: 1 Year, $66.00;
3 Years, $107.00; 5 Years, $150.00; and 10 Years,
$269.00.
35
THE
FUND
The
Cushing®
Royalty & Income Fund (the Fund) is
organized as a Delaware statutory trust and is a newly
organized, non-diversified, closed-end management investment
company registered under the 1940 Act. The Funds principal
office is located at 8117 Preston Road, Suite 440, Dallas,
TX 75225.
The Cushing name originates from a city in Oklahoma
of the same name that was a center for the exploration,
production and storage of crude oil during the early
20th century. Cushing, Oklahoma, with its large amount of
energy infrastructure assets, is currently a major storage and
trading clearing hub for crude oil and refined products in the
United States.
USE OF
PROCEEDS
The net proceeds of this offering of common shares will be
approximately $
($ if the underwriters exercise
their over-allotment option in full), after sales loads and
payment by the Fund of estimated offering expenses of
$ . The Investment Adviser has
agreed to pay (i) all of the Funds organizational
costs and (ii) offering costs of the Fund (other than sales
load) that exceed $0.05 per common share. As a result of the
size of the Energy Trust and MLP markets and the limited
liquidity of certain Energy Trust and MLP securities, it may
take a period of time before the Fund can accumulate positions
in such securities. The Fund currently anticipates that it will
be able to invest primarily in securities that meet its
investment objective and policies within three to six months
after the completion of this offering, depending on the
availability of appropriate investment opportunities consistent
with its investment objective and market conditions, and the
Fund may then use leverage. We anticipate that until the
proceeds are fully invested in accordance with the Funds
objective and policies, the proceeds will be invested in cash,
cash equivalents, or in debt securities that are rated AA or
higher. The return on the Funds common shares is initially
expected to be lower than it will be after full investment in
accordance with the Funds investment objective and
policies.
INVESTMENT
OBJECTIVE AND POLICIES
Investment
Objective
The Funds investment objective is to seek a high total
return with an emphasis on current income. There can be no
assurance that the Funds investment objective will be
achieved.
Principal
Investment Policies
The Energy Trusts in which the Company will invest will
principally be U.S. royalty trusts and Canadian royalty
trusts and exploration and production (E&P)
companies. U.S. royalty trusts manage net royalty
and/or net
working interests in mature crude oil and natural gas producing
properties in the United States. Canadian royalty trusts and
Canadian E&P companies engage in the acquisition,
development and production of natural gas and crude oil in
Canada and the U.S.
The Fund will also invest in the upstream E&P MLP sector.
E&P MLPs are focused on the exploration, development, and
acquisition of oil and natural gas producing properties,
including exploration and production of oil and natural gas at
the wellhead for sale to third parties. MLPs are limited
partnerships or limited liability companies which receive at
least 90% of their income from specified qualifying sources,
including the development, production, processing, refining,
transportation, storage and marketing of natural resources.
The Fund may also invest in securities of other companies based
in North America that are generally engaged in the same lines of
business as those in which Energy Trusts and MLPs engage,
including companies which operate assets used in gathering,
transporting, processing, storing, refining, distributing,
mining, or marketing natural gas, natural gas liquids, crude
oil, or refined petroleum products, as well as other energy
companies (Other Energy Companies, and together with
Energy Trusts and MLPs, Energy Companies).
The Fund seeks to achieve its investment objective through
investments in public and private Energy Companies that, in the
Investment Advisers view, have the most attractive
fundamental growth prospects. The
36
Fund expects to make equity investments in a mix of publicly
traded securities and non-readily marketable securities that may
be issued by public or private companies. The Fund may seek to
hedge certain risks such as overall market, interest rate and
commodity price risk.
The Funds Investment Adviser selects a core group of
Energy Companies utilizing a proprietary quantitative ranking
system and seeks to build a strategically developed core
portfolio of Energy Trusts, E&P MLPs and Other Energy
Companies to take advantage of the changing dynamics within the
upstream energy sector. The Fund will be actively managed and
the quantitative analysis will be dynamic in conjunction with
the Investment Advisers proprietary research process. The
Investment Adviser utilizes its vast financial and industry
experience to identify the absolute and relative value
opportunities across the different upstream energy subsectors
that, in the Investment Advisers view, present the best
investments. The results of the Investment Advisers
analysis and comprehensive investment process will influence the
weightings of positions held by the Fund within each subsector.
Certain of the Energy Companies in which the Fund may invest may
have small- or medium-sized market capitalizations
(small-cap and mid-cap companies,
respectively). A companys market capitalization is
generally calculated by multiplying the number of a
companys shares outstanding by its stock price. The
Investment Adviser defines small-cap companies as
those with a low market capitalization, generally less than
$1 billion, and mid-cap companies as those with
a market capitalization between $1 billion and
$3 billion.
The Fund will generally seek to invest in 20 to 40 issuers with
generally no more than 10% of Managed Assets (as defined in this
Prospectus) in any one issue and no more than 20% of Managed
Assets in any one issuer, in each case, determined at the time
of investment. For purposes of this limit, an issuer
includes both an issuer and its controlling general partner,
managing member or sponsor, and an issue is a class
of an issuers securities or a derivative security that
tracks that class of securities. Among other things, the
Investment Adviser will use fundamental, proprietary research to
seek to identify the most attractive Energy Companies with
strong fundamental growth prospects and may seek to invest in
initial public offerings (IPOs) and secondary market
issuances, private investment in public equity
(PIPE) transactions and private transactions,
including pre-acquisition and pre-IPO equity issuances and
investments in related private upstream energy companies or
direct royalty or working interests in crude oil, natural gas or
natural gas liquids . Generally, no more than 30% of the
Funds portfolio will be in PIPE or other private or
restricted securities at the time of investment.
THE
FUNDS INVESTMENTS
Energy
Trusts
U.S. royalty trusts and Canadian royalty trusts and
exploration and production companies (Energy Trusts)
are publicly traded vehicles investing in commodities such as
oil or natural gas. Shares of U.S. and Canadian royalty
trusts typically trade on the public stock markets.
U.S. Royalty Trusts. U.S. royalty
trusts passively manage royalties and net working interests in
mature oil and gas producing properties in the United States.
U.S. royalty trusts own the property rights to the wells or
mines, and typically rely on an outside drilling or mining
company to extract the resources. The outside company then pays
a royalty to the royalty trust or exploration and production
company. Unitholders generally receive most of the cash flows
from these investments in the form of distributions.
U.S. royalty trusts do not acquire new properties, operate
the existing properties within the trust, issue new equity or
debt and engage in limited hedging of production. Since they are
restricted to their original properties for example,
a group of oil fields or natural-gas-bearing rock
formations U.S. royalty trusts deplete over
time and are eventually dissolved. A U.S. royalty trust
typically has no employees or other operations.
The business and affairs of U.S. royalty trusts are
typically managed by a bank as trustee. No unitholder of a
U.S. royalty trust has the ability to manage or influence
the management of the trust (except through its limited voting
rights as a holder of trust units). The trustee can authorize
the trust to borrow money to pay trust administrative or
incidental expenses and the trustee may also hold funds awaiting
distribution. U.S. royalty trusts typically make periodic
cash distributions of substantially all of their cash receipts,
after deducting the trusts administrative and
out-of-pocket
expenses. Distributions will rise and fall with the underlying
commodity price, as
37
they are directly linked to the profitability of the trust, and
can be paid monthly, quarterly or annually, at the discretion of
the trust. U.S. royalty trusts are exposed to commodity
risk and, to a lesser extent, production and reserve risk, as
well as operating risk.
U.S. Royalty Trusts are generally not subject to
U.S. federal corporate income taxation at the trust or
entity level. Instead, each unitholder of the U.S. Royalty
Trust is required to take into account its share of all items of
the U.S. Royalty Trusts income, gain, loss, deduction
and expense. It is possible that the Funds share of
taxable income from a U.S. Royalty Trust may exceed the
cash actually distributed to it from the U.S. Royalty Trust
in a given year. In such a case, the Fund will have less
after-tax cash available for distribution to shareholders.
Canadian Royalty Trusts and Canadian Exploration and
Production Companies. Similar to
U.S. royalty trusts, the principal business of Canadian
royalty trusts is the production and sale of crude oil and
natural gas in the U.S. Canadian royalty trusts pay out to
unitholders a varying amount of the cash flow that they receive
from the production and sale of underlying crude oil and natural
gas assets. The amount of distributions paid to unitholders will
vary based upon production levels, commodity prices and
expenses. Unlike U.S. royalty trusts, Canadian royalty
trusts and E&P companies may engage in the acquisition,
development and production of natural gas and crude oil to
replace depleting reserves. They may have employees, issue new
shares, borrow money and acquire additional properties, and they
may manage the resources themselves. Thus, Canadian royalty
trusts and Canadian E&P companies may grow through
acquisition of additional oil and gas properties or producing
companies with proven reserves, funded through the issuance of
additional equity or debt. As a result, Canadian royalty trusts
and Canadian E&P companies are exposed to commodity risk
and production and reserve risk, as well as operating risk.
On October 31, 2006, the Canadian Minister of Finance
announced a Tax Fairness Plan for Canadians. A principal
component of the plan involved changing the taxation rules
governing income trusts. As a result of this change in taxation
rules, Canadian income trusts are now taxed as regular Canadian
corporations and are now subject to double taxation
at both the corporate level and on the income distributed to
investors. In response to this change, most Canadian royalty
trusts converted to corporations and have reduced their
dividends.
Master
Limited Partnerships
Master limited partnerships are formed as limited partnerships
or limited liability companies and taxed as partnerships for
federal income tax purposes. The securities issued by many MLPs
are listed and traded on a U.S. exchange. An MLP typically
issues general partner and limited partner interests, or
managing member and member interests. The general partner or
managing member manages and often controls, has an ownership
stake in, and may receive incentive distribution payments from,
the MLP. If publicly traded, to be treated as a partnership for
U.S. federal income tax purposes, an MLP must derive at
least 90% of its gross income for each taxable year from
specified qualifying sources as described in Section 7704
of the Code. These qualifying sources include natural
resources-based activities such as the exploration, development,
mining, production, processing, refining, transportation,
storage and certain marketing of mineral or natural resources.
Currently, most MLPs operate in the energy and midstream,
natural resources, shipping or real estate sectors. The Fund
intends to concentrate its investments in the E&P MLP
sector. E&P MLPs include MLPs that are engaged in the
exploration, development, production and acquisition of crude
oil and natural gas properties. E&P MLP cash flows
generally depend on the volume of crude oil and natural gas
produced and the realized prices received for crude oil and
natural gas sales.
The general partner or managing member may be structured as a
private or publicly traded corporation or other entity. The
general partner or managing member typically controls the
operations and management of the entity and has an up to 2%
general partner or managing member interest in the entity plus,
in many cases, ownership of some percentage of the outstanding
limited partner or member interests. The limited partners or
members, through their ownership of limited partner or member
interests, provide capital to the entity, are intended to have
no role in the operation and management of the entity and
receive cash distributions. Due to their structure as
partnerships for federal income tax purposes and the expected
character of their income, MLPs generally do not pay federal
income taxes. Thus, unlike investors in corporate securities,
direct MLP investors are generally not subject to double
taxation (i.e., corporate level tax and tax on corporate
dividends).
MLPs are typically structured such that common units and general
partner interests have first priority to receive the minimum
qualified distribution (MQD). Common and general
partner interests also accrue arrearages
38
in distributions to the extent the MQD is not paid. Once common
units and general partner interests have been paid, subordinated
units generally receive distributions; however, subordinated
units generally do not accrue arrearages. The subordinated units
are normally owned by the owners or affiliates of the general
partner and convert on a one for one basis into common units,
generally in three to five years after the MLPs initial
public offering or after certain distribution levels have been
exceeded. Distributable cash in excess of the MQD is distributed
to both common and subordinated units generally on a pro rata
basis. The general partner may also receive incentive
distributions if the general partner operates the business in a
manner which results in payment of per unit distributions that
exceed threshold levels above the MQD. As the general partner
increases cash distributions to the limited partners, the
general partner receives an increasingly higher percentage of
the incremental cash distributions. A common arrangement
provides that the general partner can reach a tier where it
receives 50% of every incremental dollar distributed by the MLP.
These incentive distributions encourage the general partner to
increase the partnerships cash flow and raise the
quarterly cash distribution by pursuing steady cash flow
investment opportunities, streamlining costs and acquiring
assets. Such results benefit all security holders of the MLP.
Equity securities issued by MLPs typically consist of common and
subordinated units (which represent the limited partner or
member interests) and a general partner or managing member
interest.
|
|
|
|
|
Common Units. The common units of many MLPs
are listed and traded on national securities exchanges,
including the NYSE, the NYSE Amex and the NASDAQ Stock Market
(the NASDAQ). The Fund will typically purchase such
common units through open market transactions and underwritten
offerings, but may also acquire common units through direct
placements and privately negotiated transactions. Holders of MLP
common units typically have very limited control and voting
rights. Holders of such common units are typically entitled to
receive the MQD, including arrearage rights, from the issuer.
Generally, an MLP is contractually obligated to pay (or set
aside for payment) the MQD to holders of common units before any
distributions may be paid to subordinated unitholders. In
addition, incentive distributions are typically not paid to the
general partner or managing member unless the quarterly
distributions on the common units exceed specified threshold
levels above the MQD. In the event of a liquidation, common
unitholders are intended to have a preference to the remaining
assets of the issuer over holders of subordinated units. Master
limited partnerships also issue different classes of common
units that may have different voting, trading, and distribution
rights. The Fund may invest in different classes of common units.
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|
|
|
Subordinated Units. Subordinated units, which,
like common units, represent limited partner or member
interests, are not typically listed on an exchange or publicly
traded. The Fund will typically purchase outstanding
subordinated units through negotiated transactions directly with
holders of such units or newly-issued subordinated units
directly from the issuer. Holders of such subordinated units are
generally entitled to receive a distribution only after the MQD
and any arrearages from prior quarters have been paid to holders
of common units. Holders of subordinated units typically have
the right to receive distributions before any incentive
distributions are payable to the general partner or managing
member. Subordinated units generally do not provide arrearage
rights. Most MLP subordinated units are convertible into common
units after the passage of a specified period of time or upon
the achievement by the issuer of specified financial goals.
Master limited partnerships also issue different classes of
subordinated units that may have different voting, trading, and
distribution rights. The Fund may invest in different classes of
subordinated units.
|
|
|
|
General Partner or Managing Member
Interests. The general partner or managing member
interest in MLPs or limited liability companies is typically
retained by the original sponsors of an MLP or limited liability
company, such as its founders, corporate partners and entities
that sell assets to the MLP or limited liability company. The
holder of the general partner or managing member interest can be
liable in certain circumstances for amounts greater than the
amount of the holders investment in the general partner or
managing member. General partner or managing member interests
often confer direct board participation rights in, and in many
cases control over the operations of, the MLP. General partner
or managing member interests can be privately held or owned by
publicly traded entities. General partner or managing member
interests receive cash distributions, typically in an amount of
up to 2% of available cash, which is contractually defined in
the partnership or limited liability company agreement. In
addition, holders of general partner or managing member
interests may receive incentive distribution rights, which
provide them with an increasing share of the entitys
aggregate cash distributions upon the payment of per common unit
|
39
|
|
|
|
|
distributions that exceed specified threshold levels above the
MQD. Due to the incentive distribution rights, general partners
of MLPs have higher distribution growth prospects than their
underlying MLPs, but quarterly incentive distribution payments
would also decline at a greater rate than the decline rate in
quarterly distributions to common and subordinated unitholders
in the event of a reduction in the MLPs quarterly
distribution. The ability of the limited partners or members to
remove the general partner or managing member without cause is
typically very limited. In addition, some MLPs permit the holder
of incentive distribution rights to reset, under specified
circumstances, the incentive distribution levels and receive
compensation in exchange for the distribution rights given up in
the reset.
|
The Investment Adviser believes that the following are
characteristics of Energy Trusts and E&P MLPs that make
them attractive investments:
|
|
|
|
|
Energy Trusts receive their revenue stream directly from the
cash flows generated by the sale of crude oil, natural gas and
natural gas liquids taken from the producing assets and acreage,
and therefore higher commodity prices flow directly through to
the cash flow paid to unitholders.
|
|
|
|
Energy Trusts and E&P MLPs provide direct exposure to
fluctuations in crude oil and natural gas prices because future
distributions by these vehicles are a function of production
volume and commodity prices.
|
|
|
|
The majority of Energy Trusts own crude oil, natural gas and
natural gas liquid assets with stable production profiles
|
|
|
|
Energy Trusts and E&P MLPs typically distribute the
majority of their cash flows either in the form of dividends or
return of invested capital.
|
|
|
|
Energy Trusts provide the potential for current income through
monthly or quarterly distributions.
|
|
|
|
Energy Trusts formed within the last two years typically hedged
production for the first two to four years of the trusts
existence as a means to establish regular distributions and
minimize the impact of fluctuating commodity prices; thereafter,
distributions will fluctuate with production volume and
commodity prices.
|
|
|
|
Energy Trusts provide commodity exposure without the increased
complexities of investing directly in commodity futures or the
potential tracking error of investing in commodity funds.
|
Nonetheless, there are certain risk associated with investing in
Energy Trusts and E&P MLPs. See Principal Risks of
the Fund Energy Companies Risks.
Risks Associated with U.S. Royalty
Trusts, Risks Associated with Canadian
Royalty Trusts and Canadian Exploration and Development
Companies and Risks Associated with MLP
Structure.
Other
Portfolio Holdings
Other Equity Securities. The Fund may invest
in equity securities of Other Energy Companies and issuers
engaged in other sectors, including the finance and real estate
sectors. Such issuers may be organized
and/or taxed
as corporations and therefore may not offer the advantageous tax
characteristics of MLP units.
Debt Securities. The Fund may invest up to 25%
of its Managed Assets in debt securities, preferred shares and
convertible securities of Energy Companies and other issuers.
The Fund may invest in debt securities rated, at the time of
investment, at least (i) (i) B3 by Moodys Investors
Service, Inc. (Moodys), (ii) B- by
Standard & Poors (S&P) or Fitch
Ratings (Fitch), or (iii) a comparable rating
by another rating agency, provided, however, that the Fund may
invest up to 10% of the Funds Managed Assets in debt
securities, preferred shares and convertible securities that
have lower ratings or are unrated at the time of investment.
Debt securities rated below investment grade are commonly known
as junk bonds and are regarded as predominantly
speculative with respect to the issuers capacity to pay
interest and repay principal in accordance with the terms of the
obligations, and involve major risk exposure to adverse
conditions. The credit quality policies noted above apply only
at the time a security is purchased, and the Fund is not
required to dispose of a security in the event that a rating
agency downgrades its assessment of the credit characteristics
of a particular issue. In determining whether to retain or sell
such a security, the Investment Adviser may consider such
factors as the Investment Advisers assessment of the
credit quality of the issuer of such security, the price at
which such security could be sold and the rating, if any,
40
assigned to such security by other rating agencies. Rating
agencies are private services that provide ratings of the credit
quality of debt obligations. Ratings assigned by a rating agency
are not absolute standards of credit quality and do not evaluate
market risks or the liquidity of securities. Rating agencies may
fail to make timely changes in credit ratings and an
issuers current financial condition may be better or worse
than a rating indicates. To the extent that the issuer of a
security pays a rating agency for the analysis of its security,
an inherent conflict of interest may exist that could affect the
reliability of the rating. See
Appendix A: Description of Securities
Ratings in the SAI.
Non-U.S. Securities. The
Fund may invest in
non-U.S. securities,
including, among other things,
non-U.S. securities
represented by ADRs. ADRs are certificates evidencing ownership
of shares of a
non-U.S. issuer
that are issued by depositary banks and generally trade on an
established market in the United States or elsewhere.
Other Sector Investments. The Fund may invest
in other issuers in other sectors of the economy. For example,
the Fund may invest in entities operating in the energy sector
including companies principally engaged in owning or developing
non-energy natural resources (including timber and minerals) and
industrial materials, or supplying goods or services to such
companies.
Other
Investment Practices
In addition to holding the portfolio investments described
above, the Fund may, but is not required to, use the following
investment practices:
Strategic Transactions. The Fund may, but is
not required to, use investment strategies (referred to herein
as Strategic Transactions) for hedging, risk
management or portfolio management purposes or to earn income.
Strategic Transactions may involve the purchase and sale of
derivative instruments. The Fund may purchase and sell
exchange-listed and
over-the-counter
put and call options on securities, indices and other
instruments, enter into forward contracts, purchase and sell
futures contracts and options thereon, enter into swap, cap,
floor or collar transactions, purchase structured investment
products and enter into transactions that combine multiple
derivative instruments. The Funds use of Strategic
Transactions may also include newly developed or permitted
instruments, strategies and techniques, consistent with the
Funds investment objectives and applicable regulatory
requirements.
Strategic Transactions often have risks similar to the
securities underlying the Strategic Transactions. However, the
use of Strategic Transactions also involves risks that are
different from, and possibly greater than, the risks associated
with other portfolio investments. Strategic Transactions may
involve the use of highly specialized instruments that require
investment techniques and risk analyses different from those
associated with other portfolio investments. The Fund complies
with applicable regulatory requirements when implementing
Strategic Transactions, including the segregation of cash
and/or
liquid securities on the books of the Funds custodian, as
mandated by SEC rules or SEC staff positions. Although the
Investment Adviser seeks to use Strategic Transactions to
further the Funds investment objective, no assurance can
be given that the use of Strategic Transactions will achieve
this result. The Fund has claimed exclusion from the definition
of the term commodity pool operator adopted by the
CFTC and the National Futures Association, which regulate
trading in the futures markets. Therefore, the Fund is not
subject to commodity pool operator registration and regulation
under the Commodity Exchange Act.
Examples of how the Fund may use Strategic Transactions include,
but are not limited to:
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Using derivative investments to hedge certain risks such as
overall market, interest rate and commodity price risks. The
Fund may engage in various interest rate and currency hedging
transactions, including buying or selling options or futures,
entering into other transactions including forward contracts,
swaps or options on futures and other derivatives transactions.
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Using Strategic Transactions to manage its effective interest
rate exposure, including the effective yield paid on any
leverage used by the Fund, protect against possible adverse
changes in the market value of the securities held in or to be
purchased for its portfolio, or otherwise protect the value of
its portfolio.
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Engaging in Strategic Transactions to hedge the currency risk to
which it may be exposed by, for example, buying or selling
options or futures or entering into other foreign currency
transactions including forward
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41
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foreign currency contracts, currency swaps or options on
currency and currency futures and other derivatives transactions.
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Selling short Treasury securities to hedge its interest rate
exposure. When shorting Treasury securities, the loss is limited
to the principal amount that is contractually required to be
repaid at maturity and the interest expense that must be paid at
the specified times. See Principal Risks of the
Fund Short Sales Risk.
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Engaging in paired long-short trades to arbitrage pricing
disparities in securities issued by Energy Companies, write (or
sell) covered call options on the securities of Energy Trusts,
MLPs and Other Energy Companies or other securities held in its
portfolio, write (or sell) uncovered call options on the
securities of Energy Trusts, MLPs and Other Energy Companies,
purchase call options or enter into swap contracts to increase
its exposure to Energy Trusts, MLPs and Other Energy Companies,
or sell securities short.
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Hedging transactions can be expensive and have risks, including
the imperfect correlation between the value of such instruments
and the underlying assets, the possible default of the other
party to the transaction or illiquidity of the derivative
instruments. Furthermore, the ability to successfully use
hedging transactions depends on the Investment Advisers
ability to predict pertinent market movements, which cannot be
assured. A more complete discussion of Strategic Transactions
and their risks is included in the Funds Statement of
Additional Information under the heading Strategic
Transactions.
Other Investment Companies. The Fund may
invest in securities of other closed-end or open-end investment
companies (including exchange-traded funds (ETFs),
that invest primarily in Energy Companies in which the Fund may
invest directly to the extent permitted by the 1940 Act. The
Fund may invest in other investment companies 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, during periods when there is a shortage of
attractive Energy Company securities available in the market, or
when the Investment Adviser believes share prices of other
investment companies offer attractive values. The Fund may
invest in investment companies that are advised by the
Investment Adviser 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 companys expenses, and would remain
subject to payment of the Funds management fees and other
expenses with respect to assets so invested. Stockholders would
therefore be subject to duplicative expenses to the extent the
Fund invests in other investment companies. The Investment
Adviser will take expenses into account when evaluating the
investment merits of an investment in an investment company
relative to other available investments. To the extent that the
Fund invests in investment companies that invest primarily in
Energy Companies, such investments will be counted for purposes
of the Funds policy of investing at least 80% of its
Managed Assets in Energy Companies.
Exchange-Traded Notes. The Fund may invest in
exchange-traded notes (ETNs), which are typically,
unsecured, unsubordinated debt securities that trade on a
securities exchange and are designed to replicate the returns of
market benchmarks minus applicable fees. To the extent that the
Fund invests in ETNs that are designed to replicate indices
comprised primarily of securities issued by Energy Company
entities, such investments will be counted for purposes of the
Funds policy of investing at least 80% of its Managed
Assets in Energy Company investments.
New Securities and Other Investment
Techniques. New types of securities and other
investment and hedging practices are developed from time to
time. The Investment Adviser expects, consistent with the
Funds investment objective and policies, to invest in such
new types of securities and to engage in such new types of
investment practices if the Investment Adviser believes that
these investments and investment techniques may assist the Fund
in achieving its investment objective. In addition, the
Investment Adviser may use investment techniques and instruments
that are not specifically described herein.
Short Sales, Arbitrage and Other
Strategies. The Fund may use short sales,
arbitrage and other strategies to try to generate additional
return. As part of such strategies, the Fund may engage in
paired long-short trades to arbitrage pricing disparities in
securities issued by Energy Companies, write (or sell) covered
call options on the securities of Energy Companies or other
securities held in its portfolio, write (or sell) uncovered call
options on the securities of Energy Companies, purchase call
options or enter into swap contracts to increase its exposure to
Energy Companies, or sell securities short. With a long
position, the Fund purchases a stock outright, but with a
42
short position, it would sell a security that it does not own
and must borrow to meet its settlement obligations. The Fund
will realize a profit or incur a loss from a short position
depending on whether the value of the underlying stock decreases
or increases, respectively, between the time the stock is sold
and when the Fund replaces the borrowed security. To increase
its exposure to certain issuers, the Fund may purchase call
options or use swap agreements. The Fund expects to use these
strategies on a limited basis. See Principal Risks of the
Fund Short Sales Risk and Principal
Risks of the Fund Strategic Transactions Risk.
Lending of Portfolio Securities. The Fund may
lend its portfolio securities to broker-dealers and banks. Any
such loan must be continuously secured by collateral in cash or
cash equivalents maintained on a current basis in an amount at
least equal to 102% of the value of the securities loaned. The
Fund would continue to receive the equivalent of the interest or
dividends paid by the issuer on the securities loaned and would
also receive an additional return that may be in the form of a
fixed fee or a percentage of the collateral. The Fund may pay
reasonable fees for services in arranging these loans. The Fund
would have the right to call the loan and obtain the securities
loaned at any time on notice of not more than five
(5) business days. The Fund would not have the right to
vote the securities during the existence of the loan but would
call the loan to permit voting of the securities, if, in the
Investment Advisers judgment, a material event requiring a
shareholder vote would otherwise occur before the loans were
repaid. In the event of bankruptcy or other default of the
borrower, the Fund could experience both delays in liquidating
the loan collateral or recovering the loaned securities and
losses, including (a) possible decline in the value of the
collateral or in the value of the securities loaned during the
period while the Fund seeks to enforce its rights to the
collateral or loaned securities, (b) possible subnormal
levels of income and lack of access to income during this
period, and (c) expenses of enforcing its rights.
Temporary
Defensive Investments
When market conditions dictate a more defensive investment
strategy, the Fund may, on a temporary basis, hold cash or
invest a portion or all of its assets in money-market
instruments, including obligations of the U.S. government,
its agencies or instrumentalities, other high-quality debt
securities, including prime commercial paper, repurchase
agreements and bank obligations, such as bankers
acceptances and certificates of deposit. Under normal market
conditions, the potential for capital appreciation on these
securities will tend to be lower than the potential for capital
appreciation on other securities that may be owned by the Fund.
In taking such a defensive position, the Fund would temporarily
not be pursuing its principal investment strategies and may not
achieve its investment objective.
Portfolio
Turnover
The Fund anticipates that its annual portfolio turnover rate
will be approximately 35% under normal market conditions, but
that rate may vary greatly from year to year. Portfolio turnover
rate is not considered a limiting factor in the Investment
Advisers execution of investment decisions. A higher
portfolio turnover rate results in correspondingly greater
brokerage commissions and other transactional expenses that are
borne by the Fund.
Investment
Restrictions
The Fund has adopted certain other investment limitations
designed to limit investment risk. These limitations are, unless
otherwise indicated, fundamental and may not be changed without
the approval of the holders of a majority of the outstanding
voting securities of the Fund, as defined in the 1940 Act. See
Investment Restrictions in the Funds SAI for a
complete list of the fundamental investment policies of the
Fund. The Funds investment objective and percentage
parameters are not fundamental policies of the Fund and may be
changed without shareholder approval.
USE OF
LEVERAGE
The Fund may seek to increase current income and capital
appreciation by utilizing leverage. The Fund may utilize
leverage through the issuance of commercial paper or notes and
other forms of borrowing (Indebtedness) or the
issuance of preferred shares, in each case within the applicable
limits of the 1940 Act. Under current market conditions, the
Fund may utilize leverage principally through Indebtedness in an
amount equal to approximately
43
331/3%
of the Funds Managed Assets, including the proceeds of
such leverage. The Fund has no present intention to issue
preferred shares. The costs associated with the issuance and use
of leverage will be borne by the holders of the common shares.
Leverage is a speculative technique and investors should note
that there are special risks and costs associated with leverage.
There can be no assurance that a leveraging strategy will be
successful during any period in which it is employed. The use of
leverage creates risks and involves special considerations. See
Principal Risks of the Fund Leverage
Risk. To the extent that the Fund uses leverage, it
expects to utilize hedging techniques such as swaps and caps on
a portion of its leverage to mitigate potential interest rate
risk. See Principal Risks of the Fund Interest
Rate Hedging Risk.
Borrowing
Delaware trust law and the Funds governing documents
authorize the Fund, without prior approval of its common
shareholders, to borrow money. In this regard, the Fund may
issue notes or other evidence of Indebtedness (including bank
borrowings or commercial paper) and may secure any such
borrowings by mortgaging, pledging or otherwise subjecting as
security its assets. In connection with any borrowing, the Fund
may be required to maintain minimum average balances with the
lender or to pay a commitment or other fee to maintain a line of
credit. Any such requirements will increase the cost of
borrowing over the stated interest rate. The rights of the
Funds lenders to receive interest on and repayment of
principal of borrowings will be senior to those of the
Funds common shareholders, and the terms of any such
borrowings may contain provisions which limit certain of the
Funds activities, including the payment of dividends to
the Funds common shareholders in certain circumstances. A
borrowing will likely be ranked senior or equal to all of the
Funds other existing and future borrowings.
Certain types of borrowings may result in the Fund being subject
to covenants in credit agreements relating to asset coverage and
portfolio composition requirements. The Fund may be subject to
certain restrictions on investments imposed by guidelines of one
or more rating agencies, which may issue ratings for
Indebtedness issued by the Fund. These guidelines may impose
asset coverage or portfolio composition requirements that are
more stringent than those imposed by the 1940 Act. It is not
anticipated that these covenants or guidelines will impede the
Investment Adviser from managing the Funds portfolio in
accordance with the Funds investment objective and
policies.
Indebtedness. The Fund may borrow through the
issuance of Indebtedness. The Fund may secure any such
borrowings by mortgaging, pledging or otherwise subjecting as
security its assets. Except as set forth below, under the
requirements of the 1940 Act the Fund, immediately after any
issuance of Indebtedness, must have asset coverage
of at least 300%
(331/3%
of its Managed Assets, or 50% of its net assets attributable to
the Funds common shares). With respect to Indebtedness,
asset coverage means the ratio which the value of the
Funds total assets, less all liabilities and indebtedness
not represented by senior securities (as defined in the 1940
Act), bears to the aggregate amount of such borrowing
represented by senior securities issued by the Fund.
Under the 1940 Act, the Fund may not declare any dividend or
other distribution on any class of its shares, or purchase any
such shares, unless its aggregate Indebtedness has, at the time
of the declaration of any such dividend or distribution, or at
the time of any such purchase, an asset coverage of at least
300% after declaring the amount of such dividend, distribution
or purchase price, as the case may be. Furthermore, the 1940 Act
(in certain circumstances) grants the Funds lenders
certain voting rights in the event of default in the payment of
interest on or repayment of principal. Such restrictions do not
apply with respect to evidence of Indebtedness in consideration
of a loan, extension or renewal thereof that is privately
arranged and not intended for public distribution.
The Fund may negotiate with commercial banks to arrange a credit
facility. Such a facility is not expected to be convertible into
any other securities of the Fund. Any outstanding amounts are
expected to be prepayable by the Fund prior to final maturity
without significant penalty, and there are not expected to be
any sinking fund or mandatory retirement provisions. Outstanding
amounts would be payable at maturity or such earlier times as
required by the credit agreement. The Fund may be required to
prepay outstanding amounts under a facility or incur a penalty
rate of interest in the event of the occurrence of certain
events of default. The Fund would be expected to indemnify the
lenders under the facility against liabilities they may incur in
connection with the facility. The Fund may be required to pay
commitment fees under the terms of any such facility. With the
use of borrowings, there is a
44
risk that the interest rates paid by the Fund on the amount it
borrows will be higher than the return on the Funds
investments. In addition, the Fund expects that any such credit
facility would contain covenants that, among other things,
likely will limit the Funds ability to: (i) pay
distributions in certain circumstances, (ii) incur
additional debt, and (iii) change its fundamental
investment policies and engage in certain transactions,
including mergers and consolidations. In addition, it may
contain a covenant requiring asset coverage ratios in addition
to those required by the 1940 Act. The Fund may be required to
pledge its assets and to maintain a portion of its assets in
cash or high- grade securities as a reserve against interest or
principal payments and expenses. The Fund expects that any
credit facility would have customary covenant, negative covenant
and default provisions. There can be no assurance that the Fund
will enter into an agreement for a credit facility on terms and
conditions representative of the foregoing or that additional
material terms will not apply. In addition, any such credit
facility may in the future be replaced or refinanced by one or
more credit facilities having substantially different terms or
by the issuance of preferred shares.
The Fund may also borrow money as a temporary measure for
extraordinary or emergency purposes, including the payment of
dividends and the settlement of securities transactions that
otherwise might require untimely dispositions of its securities.
Temporary borrowings not exceeding 5% of the Funds total
assets are not subject to the asset coverage
limitation under the 1940 Act.
Preferred
Shares
The Funds Declaration of Trust provides that the
Funds Board of Trustees may authorize and issue preferred
shares with rights as determined by the Board of Trustees, by
action of the Board of Trustees without prior approval of the
holders of the common shares. Common shareholders have no
preemptive right to purchase any preferred shares that might be
issued. Any such preferred share offering would be subject to
the limits imposed by the 1940 Act. Under the 1940 Act, the Fund
is not permitted to issue preferred shares unless immediately
after such issuance the value of its total assets is at least
200% of the liquidation value of the outstanding preferred
shares (i.e., the liquidation value may not exceed 50% of
the Funds total assets). In addition, the Fund is not
permitted to declare any cash dividend or other distribution on
its common shares unless, at the time of such declaration, the
value of its total assets is at least 200% of such liquidation
value. If the Fund issues preferred shares, it intends, to the
extent possible, to purchase or redeem them from time to time to
the extent necessary in order to maintain asset coverage on such
preferred shares of at least 200%. In addition, as a condition
to obtaining ratings on the preferred shares, the terms of any
preferred shares issued are expected to include asset coverage
maintenance provisions which will require the redemption of the
preferred shares in the event of non-compliance by the Fund and
may also prohibit dividends and other distributions on the
Funds common shares in such circumstances. In order to
meet redemption requirements to maintain asset coverage or
otherwise, the Fund may have to liquidate portfolio securities.
Such liquidations and redemptions would cause the Fund to incur
related transaction costs and could result in capital losses to
the Fund. If the Fund has preferred shares outstanding, two of
its Trustees will be elected by the holders of preferred shares,
voting as a separate class. The Funds remaining Trustees
will be elected by holders of its common shares and preferred
shares voting together as a single class. In the event the Fund
fails to pay dividends on its preferred shares for two years,
holders of preferred shares would be entitled to elect a
majority of the Funds Trustees. The Fund has no present
intention to issue preferred shares.
Effects
of Leverage
The amount of the leverage utilized by the Fund may vary over
time. Assuming the utilization of leverage in the amount of
331/3%
of the Funds Managed Assets (i.e., 50% of its net
assets attributable to the Funds common shares) and an
annual interest rate of 1.25% on borrowings payable on such
leverage based on market rates as of the date of this
Prospectus, the annual return that the Fund must earn (net of
expenses) in order to cover such interest expense is 0.63%. The
Funds actual cost of leverage will be based on market
rates, which may vary over time, and such actual costs of
leverage may be higher or lower than that assumed in the
previous example.
The following table is designed to assist the investor in
understanding the effects of leverage by illustrating the effect
on the return to a holder of the Funds common shares of
leverage in the amount of approximately
331/3%
of the Funds Managed Assets (i.e., 50% of its net
assets attributable to the Funds common shares), assuming
hypothetical annual returns of the Funds portfolio of
minus 10% to plus 10%. As the table shows, leverage generally
increases the return to holders of common shares when portfolio
return is positive and greater than the cost
45
of leverage and decreases the return when the portfolio return
is negative or less than the cost of leverage. The figures
appearing in the table are hypothetical and actual returns may
be greater or less than those appearing in the table.
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Assumed portfolio total return (net of expenses)
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(10.00
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)%
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(5.00
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)%
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0.00
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%
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5.00
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%
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10.00
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%
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Common share total return
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(15.63
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)%
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(8.13
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)%
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(0.62
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)%
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6.88
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%
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14.38
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%
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Common share total return is composed of two elements:
distributions on common shares paid by the Fund (the amount of
which is largely determined by the Funds net investment
income after paying dividends or interest on its outstanding
leverage) and gains or losses on the value of the securities the
Fund owns. As required by SEC rules, the table above assumes
that the Fund is more likely to suffer capital losses than to
enjoy capital appreciation. For example, to assume a total
return of 0%, the Fund must assume that the distributions it
receives on its investments are entirely offset by losses in the
value of those securities.
During the time in which the Fund is utilizing leverage, the
amount of the fees paid to the Investment Adviser for investment
advisory services will be higher than if the Fund did not
utilize such leverage because the fees paid will be calculated
based on the Funds Managed Assets, which may create a
conflict of interest between the Investment Adviser and the
common shareholders. Because the Funds leverage costs will
be borne by the Fund at a specified rate, only the Funds
common shareholders will bear the cost associated with such
leverage.
PRINCIPAL
RISKS OF THE FUND
Risk is inherent in all investing. The following discussion
summarizes some of the risks that a potential investor should
consider before deciding to purchase the Funds common
shares.
No
Operating or Trading History
The Fund is a newly organized, non-diversified, closed-end
management investment company and it has no operating or public
trading history. Being a recently organized company, the Fund is
subject to all of the business risks and uncertainties
associated with any new business, including the risk that the
Fund will not achieve its investment objective and that the
value of an investment in the Fund could decline substantially.
Investment
and Market Risk
An investment in the Funds common shares is subject to
investment risk, including the possible loss of an
investors entire investment. The Funds common shares
at any point in time may be worth less than at the time of
original investment, even after taking into account the
reinvestment of the Funds dividends. The Fund is primarily
a long-term investment vehicle and should not be used for
short-term trading. An investment in the Funds common
shares is not intended to constitute a complete investment
program and should not be viewed as such.
Energy
Companies Risks
Under normal circumstances, the Fund concentrates its
investments in the energy sector, with an emphasis on securities
issued by Energy Trusts, MLPs and Other Energy Companies. Energy
Trusts, MLPs and Other Energy Companies are subject to certain
risks, including, but not limited to, the following:
Commodity Price Risk. Energy Companies may be
affected by fluctuations in the prices of commodities,
including, for example, natural gas, natural gas liquids and
crude oil, in the short- and long-term. Natural resources
commodity prices have been very volatile in the past and such
volatility is expected to continue. Fluctuations in commodity
prices can result from changes in general economic conditions or
political circumstances (especially of key energy-consuming
countries); market conditions; weather patterns; domestic
production levels; volume of imports; energy conservation;
domestic and foreign governmental regulation; international
politics; policies of the Organization of Petroleum Exporting
Countries (OPEC); taxation; tariffs; and the
availability and costs of local, intrastate and interstate
transportation methods. Companies engaged in crude oil and
natural gas exploration, development or production, natural gas
gathering and processing and crude oil refining and
transportation may be directly affected by their respective
natural
46
resources commodity prices. The volatility of, and
interrelationships between, commodity prices can also indirectly
affect certain companies due to the potential impact on the
volume of commodities transported, processed, stored or
distributed. Some companies that own the underlying commodities
may be unable to effectively mitigate or manage direct margin
exposure to commodity price levels. The energy sector as a whole
may also be impacted by the perception that the performance of
energy sector companies is directly linked to commodity prices.
The prices of companies securities can be adversely
affected by market perceptions that their performance and
distributions or dividends are directly tied to commodity
prices. High commodity prices may drive further energy
conservation efforts and a slowing economy may adversely impact
energy consumption which may adversely affect the performance of
Energy Companies. Recent economic and market events have fueled
concerns regarding potential liquidations of commodity futures
and options positions.
Cyclicality Risk. The operating results of
companies in the broader energy sector are cyclical, with
fluctuations in commodity prices and demand for commodities
driven by a variety of factors. The highly cyclical nature of
the energy sector may adversely affect the earnings or operating
cash flows of certain Energy Companies in which the Fund will
invest.
Supply Risk. A significant decrease in the
production of natural gas, crude oil, or other energy
commodities would reduce the revenue, operating income and
operating cash flows of certain Energy Companies and, therefore,
their ability to make distributions or pay dividends. The volume
of production of energy commodities and the volume of energy
commodities available for transportation, storage, processing or
distribution could be affected by a variety of factors,
including depletion of resources; depressed commodity prices;
catastrophic events; labor relations; increased environmental or
other governmental regulation; equipment malfunctions and
maintenance difficulties; import volumes; international
politics; policies of OPEC; and increased competition from
alternative energy sources.
Demand Risk. A sustained decline in demand for
natural gas, natural gas liquids, crude oil and refined
petroleum products could adversely affect an Energy
Companys revenues and cash flows. Factors that could lead
to a sustained decrease in market demand include a recession or
other adverse economic conditions, an increase in the market
price of the underlying commodity that is not, or is not
expected to be, merely a short-term increase, higher taxes or
other regulatory actions that increase costs, or a shift in
consumer demand for such products. Demand may also be adversely
affected by consumer sentiment with respect to global warming
and by state or federal legislation intended to promote the use
of alternative energy sources.
Risks Relating to Expansions and
Acquisitions. Energy Companies employ a variety
of means to increase cash flow, including increasing utilization
of existing facilities, expanding operations through new
construction or development activities, expanding operations
through acquisitions, or securing additional long-term
contracts. Thus, some Energy Companies may be subject to
construction risk, development risk, acquisition risk or other
risks arising from their specific business strategies. Energy
Companies that attempt to grow through acquisitions may not be
able to effectively integrate acquired operations with their
existing operations. In addition, acquisition or expansion
projects may not perform as anticipated. A significant slowdown
in merger and acquisition activity in the energy sector could
reduce the growth rate of cash flows received by the Fund from
Energy Companies that grow through acquisitions.
Competition Risk. The energy sector is highly
competitive. The Energy Companies in which the Fund will invest
will face substantial competition from other companies, many of
which will have greater financial, technological, human and
other resources, in acquiring natural resources assets,
obtaining and retaining customers and contracts and hiring and
retaining qualified personnel. Larger companies may be able to
pay more for assets and may have a greater ability to continue
their operations during periods of low commodity prices. To the
extent that the Energy Companies in which the Fund will invest
are unable to compete effectively, their operating results,
financial position, growth potential and cash flows may be
adversely affected, which could in turn adversely affect the
results of the Fund.
Weather Risk. Extreme weather conditions, such
as Hurricane Ivan in 2004, Hurricanes Katrina and Rita in 2005
and Hurricane Ike in 2008, could result in substantial damage to
the facilities of certain Energy
47
Companies located in the affected areas and significant
volatility in the supply of natural resources, commodity prices
and the earnings of Energy Companies, and could therefore
adversely affect their securities.
Interest Rate Risk. The prices of debt
securities of the Energy Companies the Fund expects to hold in
its portfolio, and the prices of the equity securities held in
its portfolio may be, are susceptible in the short term to a
decline when interest rates rise. Rising interest rates could
limit the capital appreciation of securities of certain Energy
Companies as a result of the increased availability of
alternative investments with yields comparable to those of
Energy Companies. Rising interest rates could adversely impact
the financial performance of Energy Companies by increasing
their cost of capital. This may reduce their ability to execute
acquisitions or expansion projects in a cost effective manner.
Sub-Sector
Specific Risk. Energy Companies are also subject
to risks that are specific to the particular
sub-sector
of the energy sector in which they operate.
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Gathering and processing. Gathering
and processing companies are subject to natural declines in the
production of oil and natural gas fields, which utilize their
gathering and processing facilities as a way to market their
production, prolonged declines in the price of natural gas or
crude oil, which curtails drilling activity and therefore
production, and declines in the prices of natural gas liquids
and refined petroleum products, which cause lower processing
margins. In addition, some gathering and processing contracts
subject the gathering or processing company to direct
commodities price risk.
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Exploration and production.
Exploration, development and production companies are
particularly vulnerable to declines in the demand for and prices
of crude oil and natural gas. Reductions in prices for crude oil
and natural gas can cause a given reservoir to become uneconomic
for continued production earlier than it would if prices were
higher, resulting in the plugging and abandonment of, and
cessation of production from, that reservoir. In addition, lower
commodity prices not only reduce revenues but also can result in
substantial downward adjustments in reserve estimates. The
accuracy of any reserve estimate is a function of the quality of
available data, the accuracy of assumptions regarding future
commodity prices and future exploration and development costs
and engineering and geological interpretations and judgments.
Different reserve engineers may make different estimates of
reserve quantities and related revenue based on the same data.
Actual oil and gas prices, development expenditures and
operating expenses will vary from those assumed in reserve
estimates, and these variances may be significant. Any
significant variance from the assumptions used could result in
the actual quantity of reserves and future net cash flow being
materially different from those estimated in reserve reports. In
addition, results of drilling, testing and production and
changes in prices after the date of reserve estimates may result
in downward revisions to such estimates. Substantial downward
adjustments in reserve estimates could have a material adverse
effect on a given exploration and production companys
financial position and results of operations. In addition, due
to natural declines in reserves and production, exploration and
production companies must economically find or acquire and
develop additional reserves in order to maintain and grow their
revenues and distributions.
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Oil. In addition to the risk described
above applicable to gathering and processing companies and
exploration and production companies, companies involved in the
transportation, gathering, processing, exploration, development
or production of crude oil or refined petroleum products may be
adversely affected by increased regulations, increased operating
costs and reductions in the supply of
and/or
demand for crude oil and refined petroleum products as a result
of the 2010 Deepwater Horizon oil spill and the reaction
thereto. Increased regulation may result in a decline in
production
and/or
increased cost associated with offshore oil exploration in the
United States and around the world, which may adversely affect
certain Energy Companies and the oil industry in general.
Continued financial deterioration of BP plc as a result of the
2010 Deepwater Horizon oil spill may have wide-ranging and
unforeseen impacts on the oil industry and the broader energy
sector.
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Cash Flow Risk. The Fund will derive
substantially all of its cash flow from investments in equity
securities of Energy Companies. The amount of cash that the Fund
has available to distribute to shareholders will depend on the
ability of the Energy Companies in which the Fund has an
interest to make distributions or pay dividends to their
investors and the tax character of those distributions or
dividends. The Fund will likely
48
have no influence over the actions of the Energy Companies in
which it invests with respect to the payment of distributions or
dividends. The amount of cash that any individual Energy Company
can distribute to its investors, including the Fund, will depend
on the amount of cash it generates from operations, which will
vary from quarter to quarter depending on factors affecting the
energy sector generally and the particular business lines of the
issuer. Available cash will depend on the Energy Companys
operating costs, capital expenditures, debt service
requirements, acquisition costs (if any), fluctuations in
working capital needs and other factors. The cash that an MLP
will have available for distribution will also depend on the
incentive distributions payable to its general partner or
managing member in connection with distributions paid to its
equity investors.
Regulatory Risk. The profitability of Energy
Companies could be adversely affected by changes in the
regulatory environment. Energy Companies are subject to
significant foreign, federal, state and local regulation in
virtually every aspect of their operations, including with
respect to how facilities are constructed, maintained and
operated, environmental and safety controls, and the prices they
may charge for the products and services they provide. Such
regulation can change over time in both scope and intensity. For
example, a particular by-product may be declared hazardous by a
regulatory agency and unexpectedly increase production costs.
Various governmental authorities have the power to enforce
compliance with these regulations and the permits issued under
them, and violators are subject to administrative, civil and
criminal penalties, including civil fines, injunctions or both.
Stricter laws, regulations or enforcement policies could be
enacted in the future which would likely increase compliance
costs and may adversely affect the financial performance of
Energy Companies. Energy Companies may be adversely affected by
future regulatory requirements. While the nature of such
regulations cannot be predicted at this time, they may impose
additional costs or limit certain operations by Energy Companies
operating in various sectors.
Environmental Risk. There is an inherent risk
that Energy Companies may incur environmental costs and
liabilities due to the nature of their businesses and the
substances they handle. For example, an accidental release from
wells or gathering pipelines could subject them to substantial
liabilities for environmental cleanup and restoration costs,
claims made by neighboring landowners and other third parties
for personal injury and property damage, and fines or penalties
for related violations of environmental laws or regulations.
Moreover, the possibility exists that stricter laws, regulations
or enforcement policies could significantly increase the
compliance costs of Energy Companies, and the cost of any
remediation that may become necessary. Energy Companies may not
be able to recover these costs from insurance.
Specifically, the operations of wells, gathering systems,
pipelines, refineries and other facilities are subject to
stringent and complex federal, state and local environmental
laws and regulations. These include, for example:
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the federal Clean Air Act and comparable state laws and
regulations that impose obligations related to air emissions;
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the federal Clean Water Act and comparable state laws and
regulations that impose obligations related to discharges of
pollutants into regulated bodies of water;
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the federal Resource Conservation and Recovery Act
(RCRA) and comparable state laws and regulations
that impose requirements for the handling and disposal of waste
from facilities; and
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the federal Comprehensive Environmental Response, Compensation
and Liability Act of 1980 (CERCLA), also known as
Superfund, and comparable state laws and regulations
that regulate the cleanup of hazardous substances that may have
been released at properties currently or previously owned or
operated by Energy Companies or at locations to which they have
sent waste for disposal.
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Failure to comply with these laws and regulations may trigger a
variety of administrative, civil and criminal enforcement
measures, including the assessment of monetary penalties, the
imposition of remedial requirements, and the issuance of orders
enjoining future operations. Certain environmental statutes,
including RCRA, CERCLA, the federal Oil Pollution Act and
analogous state laws and regulations, impose strict, joint and
several liability for costs required to clean up and restore
sites where hazardous substances have been disposed or otherwise
released. Moreover, it is not uncommon for neighboring
landowners and other third parties to file claims for personal
injury and property damage allegedly caused by the release of
hazardous substances or other waste products into the
environment.
49
Voluntary initiatives and mandatory controls have been adopted
or are being discussed both in the United States and
worldwide to reduce emissions of greenhouse gases
such as carbon dioxide, a by-product of burning fossil fuels,
and methane, the major constituent of natural gas. These
measures and future measures could result in increased costs to
certain companies in which the Fund may invest to operate and
maintain facilities and administer and manage a greenhouse gas
emissions program and may reduce demand for fuels that generate
greenhouse gases and that are managed or produced by companies
in which the Fund may invest.
In the wake of a Supreme Court decision holding that the
Environmental Protection Agency (EPA) has some legal
authority to deal with climate change under federal Clean Air
Act of 1990, as amended (the Clean Air Act), the EPA
and the Department of Transportation jointly wrote regulations
to cut gasoline use and control greenhouse gas emissions from
cars and trucks. These measures, and other programs addressing
greenhouse gas emissions, could reduce demand for energy or
raise prices, which may adversely affect the total return of
certain of the Funds investments.
The types of regulations described above can change over time in
both scope and intensity, may have adverse effects on Energy
Companies and may be implemented in unforeseen manners on an
emergency basis in response to catastrophes or other
events. For example, the Obama Administration imposed a
six-month moratorium on virtually all deepwater drilling
activity in the Gulf of Mexico in response to the 2010 Deepwater
Horizon blowout and resulting oil spill. Energy Companies may be
subject to increased environmental regulations and increased
liability for environmental contamination, which may be enacted
in response to the 2010 Deepwater Horizon oil spill.
Affiliated Party Risk. Certain Energy
Companies, particularly those organized as MLPs, are dependent
on their parents or sponsors for a majority of their revenues.
Any failure by an Energy Companys parents or sponsors to
satisfy their payments or obligations would impact the Energy
Companys revenues and cash flows and ability to make
distributions. Moreover, the terms of an Energy Companys
transactions with its parent or sponsor are typically not
arrived at on an arms-length basis, and may not be as
favorable to the Energy Company as a transaction with a
non-affiliate.
Catastrophe Risk. The operations of Energy
Companies are subject to many hazards inherent in the
exploration for, and development, production, gathering,
transportation, processing, storage, refining, distribution,
mining or marketing of natural gas, natural gas liquids, crude
oil, refined petroleum products or other hydrocarbons,
including: damage to production equipment, pipelines, storage
tanks or related equipment and surrounding properties caused by
hurricanes, tornadoes, floods, fires and other natural disasters
or by acts of terrorism; inadvertent damage from construction or
other equipment; leaks of natural gas, natural gas liquids,
crude oil, refined petroleum products or other hydrocarbons; and
fires and explosions. Since the
September 11th terrorist attacks, the
U.S. government has issued warnings that energy assets,
specifically U.S. pipeline infrastructure, may be targeted
in future terrorist attacks. These dangers give rise to risks of
substantial losses as a result of loss or destruction of
commodity reserves; damage to or destruction of property,
facilities and equipment; pollution and environmental damage;
and personal injury or loss of life. Any occurrence of such
catastrophic events could bring about a limitation, suspension
or discontinuation of the operations of Energy Companies. Energy
Companies may not be fully insured against all risks inherent in
their business operations and therefore accidents and
catastrophic events could adversely affect such companies
operations, financial conditions and ability to pay
distributions to shareholders.
Legislation Risk. There have been proposals in
Congress to eliminate certain tax incentives widely used by oil
and gas companies and to impose new fees on certain energy
producers. The elimination of such tax incentives and imposition
of such fees could adversely affect Energy Companies in which
the Fund invests
and/or the
energy sector generally.
Risks
Associated with U.S. Royalty Trusts
The U.S. royalty trusts in which the Fund invests are
heavily invested in oil and gas. Potential growth may be
sacrificed because revenue is passed on to a royalty
trusts unitholders (such as the Fund), rather than
reinvested in the business. Royalty trusts generally do not
guarantee minimum distributions or even return of capital. If
the assets underlying a royalty trust do not perform as
expected, the royalty trust may reduce or even eliminate
distributions.
50
The declaration of such distributions generally depends upon
various factors, including the operating performance and
financial condition of the royalty trust and general economic
conditions.
Risks
Associated with Canadian Royalty Trusts and Canadian Exploration
and Production Companies
Canadian royalty trusts are generally subject to similar risks
as U.S. royalty trusts, as described above. However, unlike
U.S. royalty trusts, Canadian royalty trusts and E&P
companies may engage in the acquisition, development and
production of natural gas and crude oil to replace depleting
reserves. They may have employees, issue new shares, borrow
money, acquire additional properties, and manage the resources
themselves. As a result, Canadian royalty trusts and Canadian
E&P companies are exposed to commodity risk and production
and reserve risk, as well as operating risk.
Under amendments to the Income Tax Act (Canada) passed in 2007
(the SIFT Rules), certain trusts (defined as
SIFT trusts) are taxable on certain income and gains
on a basis similar to that which applies to a corporation, with
the result that tax efficiencies formerly available in respect
of an investment in the trust may cease to be available. A
royalty trust may be a SIFT trust. A trust that began public
trading before November 1, 2006 did not become subject to
the SIFT Rules until the first year of the trust that ended in
2011, or earlier if the trust exceeded normal growth
guidelines incorporated by reference into the Income Tax
Act (Canada). In addition, as a result of the SIFT Rules, some
trusts may undertake reorganization transactions, the costs of
which may affect the return earned on an investment in the
trust. After any such conversion, tax efficiencies that were
formerly available in respect of an investment in the trust may
cease to be available. Accordingly, the SIFT Rules have had and
may continue to have an effect on the trading price of
investments in royalty trusts, and consequently could impact the
value of Shares of the Fund.
Risks
Associated with MLP Structure
Holders of MLP units are subject to certain risks inherent in
the structure of MLPs, including (i) tax risks (described
further below), (ii) the limited ability to elect or remove
management or the general partner or managing member
(iii) limited voting rights, except with respect to
extraordinary transactions, and (iv) conflicts of interest
between the general partner or managing member and its
affiliates, on the one hand, and the limited partners or
members, on the other hand, including those arising from
incentive distribution payments or corporate opportunities.
The benefit the Fund will derive from its investment in MLPs is
largely dependent on the MLPs being treated as partnerships for
U.S. federal income tax purposes. As a partnership, an MLP
has no U.S. federal income tax liability at the entity
level. If, as a result of a change in current law or a change in
an MLPs business, an MLP were to be treated as a
corporation for U.S. federal income tax purposes, it would
be subject to U.S. federal income tax on its income at the
graduated tax rates applicable to corporations (currently a
maximum rate of 35%). In addition, if an MLP were to be
classified as a corporation for U.S. federal income tax
purposes, the amount of cash available for distribution by it
would be reduced and distributions received by the Fund from it
would be taxed under U.S. federal income tax laws
applicable to corporate distributions (as dividend income,
return of capital, or capital gain). Therefore, treatment of
MLPs as corporations for U.S. federal income tax purposes
would result in a reduction in the after-tax return to the Fund,
likely causing a reduction in the value of the Funds
common shares. MLP subordinated units are not typically listed
on an exchange or publicly traded. Holders of MLP subordinated
units are entitled to receive a distribution only after the
minimum quarterly distribution (the MQD) has been
paid to holders of common units, but prior to payment of
incentive distributions to the general partner or managing
member. MLP subordinated units generally do not provide
arrearage rights.
General partner and managing member interests are not publicly
traded, though they may be owned by publicly traded entities
such as general partners of MLPs. A holder of general partner or
managing member interests can be liable in certain circumstances
for amounts greater than the amount of the holders
investment. In addition, while a general partner or managing
members incentive distribution rights can mean that
general partners and managing members have higher distribution
growth prospects than their underlying MLPs, these incentive
distribution payments would decline at a greater rate than the
decline rate in quarterly distributions to common or
subordinated unitholders in the event of a reduction in the
MLPs quarterly distribution. A general partner or
51
managing member interest can be redeemed by the MLP if the MLP
unitholders choose to remove the general partner, typically by a
supermajority vote of the limited partners or members.
Risks
Associated with an Investment in IPOs
Securities purchased in IPOs are often subject to the general
risks associated with investments in companies with small market
capitalizations, and typically to a heightened degree.
Securities issued in IPOs have no trading history, and
information about the companies may be available for very
limited periods. In addition, the prices of securities sold in
an IPO may be highly volatile. At any particular time or from
time to time, the Fund may not be able to invest in IPOs, or to
invest to the extent desired, because, for example, only a small
portion (if any) of the securities being offered in an IPO may
be available to the Fund. In addition, under certain market
conditions, a relatively small number of companies may issue
securities in IPOs. The investment performance of the Fund
during periods when it is unable to invest significantly or at
all in IPOs may be lower than during periods when it is able to
do so. IPO securities may be volatile, and the Fund cannot
predict whether investments in IPOs will be successful. As the
Fund grows in size, the positive effect of IPO investments on
the Fund may decrease.
Risks
Associated with an Investment in PIPE Transactions
PIPE investors purchase securities directly from a publicly
traded company in a private placement transaction, typically at
a discount to the market price of the companys common
stock. Because the sale of the securities is not registered
under the Securities Act, the securities are
restricted and cannot be immediately resold by the
investors into the public markets. Accordingly, the company
typically agrees as part of the PIPE deal to register the
restricted securities with the SEC. PIPE securities may be
deemed illiquid.
Privately
Held Company Risk
Investing in privately held companies involves risk. For
example, privately held companies are not subject to SEC
reporting requirements, are not required to maintain their
accounting records in accordance with generally accepted
accounting principles, and are not required to maintain
effective internal controls over financial reporting. As a
result, the Investment Adviser may not have timely or accurate
information about the business, financial condition and results
of operations of the privately held companies in which the Fund
invests. In addition, the securities of privately held companies
are generally illiquid, and entail the risks described under
Liquidity Risk below.
Liquidity
Risk
The investments made by the Fund, including investments in
Energy Companies, may be illiquid and consequently the Fund may
not be able to sell such investments at prices that reflect the
Investment Advisers assessment of their value, the amount
paid for such investments by the Fund or at prices approximating
the value at which the Fund is carrying the securities on its
books. Furthermore, the nature of the Funds investments
may require a long holding period prior to profitability.
Although the equity securities of the Energy Companies in which
the Fund invests generally trade on major stock exchanges,
certain securities may trade less frequently, particularly those
with smaller capitalizations. Securities with limited trading
volumes may display volatile or erratic price movements.
Investment of the Funds capital in securities that are
less actively traded or over time experience decreased trading
volume may restrict the Funds ability to take advantage of
other market opportunities.
The Fund also expects to invest in unregistered or otherwise
restricted securities. Unregistered securities are securities
that cannot be sold publicly in the United States without
registration under the Securities Act, unless an exemption from
such registration is available. Restricted securities may be
more difficult to value and the Fund may have difficulty
disposing of such assets either in a timely manner or for a
reasonable price. In order to dispose of an unregistered
security, the Fund, where it has contractual rights to do so,
may have to cause such security to be registered. A considerable
period may elapse between the time the decision is made to sell
the security and the time the security is registered so that the
Fund could sell it. Contractual restrictions on the resale of
securities vary in length and scope and are generally the result
of a negotiation between the issuer and acquiror of the
securities. The
52
Fund would, in either case, bear the risks of any downward price
fluctuation during that period. The difficulties and delays
associated with selling restricted securities could result in
the Funds inability to realize a favorable price upon
disposition of such securities, and at times might make
disposition of such securities impossible.
Tax
Risks
In addition to other risk considerations, an investment in the
Funds common shares will involve certain tax risks,
including, but not limited to, the risks summarized below and
discussed in more detail elsewhere in this Prospectus. Tax
matters are complicated, and the foreign and U.S. federal,
state and local tax consequences of the purchase and ownership
of the Funds common shares will depend on the facts of
each investors situation. Prospective investors are
encouraged to consult their own tax advisors regarding the
specific tax consequences that may affect such investors. See
Certain U.S. Federal Income Tax Considerations.
C Corporation Structure Tax Risks. The Fund
will be treated as a regular corporation, or C
corporation, for U.S. federal income tax purposes. Because
of the Funds concentration in MLP and Energy Trust
investments, the Fund will not be eligible for passthrough-like
tax treatment as a regulated investment company under the Code.
Accordingly, the Fund generally will be subject to
U.S. federal income tax on its taxable income at the
graduated rates applicable to corporations (currently a maximum
rate of 35%) and will be subject to state and local income tax
by reason of its investments in equity securities of MLPs and
Energy Trusts.
U.S. Royalty Trust Tax
Risks. U.S. Royalty Trusts are generally not
subject to U.S. federal corporate income taxation at the
trust or entity level. Instead, each unitholder of the
U.S. Royalty Trust is required to take into account its
share of all items of the U.S. Royalty Trusts income,
gain, loss, deduction and expense. It is possible that the
Funds share of taxable income from a U.S. Royalty
Trust may exceed the cash actually distributed to it from the
U.S. Royalty Trust in a given year. In such a case, the
Fund will have less after-tax cash available for distribution to
shareholders.
MLP Tax Risks. As a limited partner or member
in the MLPs in which the Fund will invest, the Fund will be
required to include in its taxable income its allocable share of
income, gains, losses, deductions, and credits from those MLPs,
regardless of whether they distribute any cash to the Fund.
Historically, a significant portion of the distributions on MLPs
equity securities has been offset by tax deductions. As the
holder of an MLP equity security, the Fund will incur a current
tax liability on its allocable share of an MLPs income and
gains that is not offset by tax deductions, losses and credits,
or the Funds net operating loss carryforwards, if any. The
portion, if any, of a distribution received by the Fund as the
holder of an MLP equity security that is offset by the
MLPs tax deductions or losses generally will be treated as
a return of capital. However, those distributions will reduce
the Funds adjusted tax basis in the equity securities of
the MLP, which will result in an increase in the amount of
income or gain (or decrease in the amount of loss) that will be
recognized by the Fund for tax purposes upon the sale of any
such equity securities or upon subsequent distributions in
respect of such equity securities. The percentage of an
MLPs income and gains that is offset by tax deductions,
losses and credits will fluctuate over time for various reasons.
A significant slowdown in acquisition activity or capital
spending by MLPs held in the Funds portfolio could result
in a reduction of accelerated depreciation generated by new
acquisitions, which may result in increased current tax
liability for the Fund. The final portion of the distributions
received by the Fund that are considered return of capital will
not be known until the Funds receives a
schedule K-1
with respect to each of its MLP investments. The Funds tax
liability will not be known until the Fund completes its annual
tax return. The Funds tax estimates could vary
substantially from the actual liability and therefore the
determination of the Funds actual tax liability may have a
material impact on the Funds net asset value. The payment
of corporate income taxes imposed on the Fund will decrease cash
available for distribution to Shareholders.
Deferred Tax Risks. Because the Fund is
treated as a regular corporation, or C corporation,
for U.S. federal income tax purposes, the Fund will incur
tax expenses. In calculating the Funds net asset value in
accordance with generally accepted accounting principles, the
Fund will, among other things, account for its deferred tax
liability
and/or asset
balances.
The Fund will accrue a deferred income tax liability balance, at
the currently effective statutory U.S. federal income tax
rate (currently 35%) plus an estimated state and local income
tax rate, for its future tax liability associated with the
capital appreciation of its investments and the distributions
received by the Fund on equity
53
securities of MLPs considered to be return of capital and for
any net operating gains. Any deferred tax liability balance will
reduce the Funds net asset value. The portion, if any, of
a distribution on an MLP equity security received by the Fund
that is offset by the MLPs tax deductions or losses will
be treated as a return of capital. However, those distributions
will reduce the Funds adjusted tax basis in the equity
securities of the MLP, which will result in an increase in the
amount of income or gain (or a decrease in the amount of loss)
that will be recognized on the sale of the equity security in
the MLP by the Fund. Upon the Funds sale of a portfolio
security, the Fund will be liable for previously deferred taxes.
If the Fund is required to sell portfolio securities to meet
redemption requests, the Fund may recognize gains for
U.S. federal, state and local income tax purposes, which
will result in corporate income taxes imposed on the Fund. No
assurance can be given that such taxes will not exceed the
Funds deferred tax liability assumptions for purposes of
computing the Funds net asset value per share, which would
result in an immediate reduction of the Funds net asset
value per share, which could be material.
The Fund will accrue a deferred tax asset balance which reflects
an estimate of the Funds future tax benefit associated
with net operating losses and unrealized losses. Any deferred
tax asset balance will increase the Funds net asset value.
A deferred tax asset may be used to reduce a subsequent
periods income tax expense, subject to certain
limitations. To the extent the Fund has a deferred tax asset
balance, the Fund will assess whether a valuation allowance,
which would offset some or all of the value of the Funds
deferred tax asset balance, is required, considering all
positive and negative evidence related to the realization of the
Funds deferred tax asset. The Fund will assess whether a
valuation allowance is required to offset some or all of any
deferred tax asset balance based on estimates of the Fund in
connection with the calculation of the Funds net asset
value per share each day; however, to the extent the final
valuation allowance differs from the estimates of the Fund used
in calculating the Funds net asset value, the application
of such final valuation allowance could have a material impact
on the Funds net asset value.
The Funds deferred tax liability
and/or asset
balances are estimated using estimates of effective tax rates
expected to apply to taxable income in the years such balances
are realized. The Fund will rely to some extent on information
provided by MLPs regarding the tax characterization of the
distributions made by such MLPs, which may not be provided to
the Fund on a timely basis, to estimate the Funds deferred
tax liability
and/or asset
balances for purposes of financial statement reporting and
determining its net asset value. The Funds estimates
regarding its deferred tax liability
and/or asset
balances are made in good faith; however, the estimate of the
Funds deferred tax liability
and/or asset
balances used to calculate the Funds net asset value could
vary dramatically from the Funds actual tax liability,
and, as a result, the determination of the Funds actual
tax liability may have a material impact on the Funds net
asset value. From time to time, the Fund may modify its
estimates or assumptions regarding its deferred tax liability
and/or asset
balances as new information becomes available. Modifications of
the Funds estimates or assumptions regarding its deferred
tax liability
and/or asset
balances and any applicable valuation allowance, changes in
generally accepted accounting principles or related guidance or
interpretations thereof, limitations imposed on net operating
losses (if any) and changes in applicable tax law could result
in increases or decreases in the Funds net asset value per
share, which could be material.
The investment strategy of investing primarily in Energy Trusts
and MLPs and electing to be taxed as a regular corporation, or
C corporation, rather than as a regulated investment
company for U.S. federal income tax purposes, involves
complicated and in some cases unsettled accounting, tax and net
asset and share valuation aspects that cause the Fund to differ
significantly from most other registered investment companies.
This may result in unexpected and potentially significant
accounting, tax and valuation consequences for the Fund and for
its shareholders. In addition, accounting, tax and valuation
practices in this area are still developing, and there may not
always be a clear consensus among industry participants as to
the most appropriate approach. This may result in changes over
time in the practices applied by the Fund, which, in turn, could
have material adverse consequences on the Fund and its
shareholders.
Tax Law Changes Risk. Changes in tax laws,
regulations or interpretations of those laws or regulations in
the future could adversely affect the Fund or the Energy
Companies in which the Fund will invest. Any such changes could
negatively impact the Funds common shareholders.
Legislation could also negatively impact the amount and tax
characterization of dividends received by the Funds common
shareholders. Federal legislation has reduced the
U.S. federal income tax rate on qualified dividend income
to the rate applicable to long-term capital gains, which is
generally 15% for individuals, provided a holding period
requirement and certain other requirements are met. This
54
reduced rate of tax on dividends is currently scheduled to
revert to ordinary income tax rates for taxable years beginning
after December 31, 2012, and the 15% federal income tax
rate for long-term capital gains is scheduled to revert to 20%
for such taxable years.
Equity
Securities Risk
Equity securities of Energy Companies can be affected by
macroeconomic, political, global and other factors affecting the
stock market in general, expectations of interest rates,
investor sentiment towards the energy sector, changes in a
particular companys financial condition, or the
unfavorable or unanticipated poor performance of a particular
Energy Company (which, in the case of an Energy Trust or MLP, is
generally measured in terms of distributable cash flow). Prices
of equity securities of individual Energy Companies can also be
affected by fundamentals unique to the company, including
earnings power and coverage ratios.
Small-Cap
and Mid-Cap Company Risk
Certain of the Energy Companies in which the Fund may invest may
have small or medium-sized market capitalizations
(small-cap and mid-cap companies,
respectively). Investing in the securities of small-cap or
mid-cap Energy Companies presents some particular investment
risks. These Energy Companies may have limited product lines and
markets, as well as shorter operating histories, less
experienced management and more limited financial resources than
larger Energy Companies, and may be more vulnerable to adverse
general market or economic developments. Stocks of these Energy
Companies may be less liquid than those of larger Energy
Companies, and may experience greater price fluctuations than
larger Energy Companies. In addition, small-cap or mid-cap
company securities may not be widely followed by investors,
which may result in reduced demand.
Canadian
Risk
The Canadian economy is very dependent on the demand for, and
supply and price of, natural resources. The Canadian market is
relatively concentrated in issuers involved in the production
and distribution of natural resources. There is a risk that any
changes in these sectors could have an adverse impact on the
Canadian economy. The Canadian economy is dependent on the
economy of the United States as a key trading partner. Reduction
in spending on Canadian products and services or changes in the
U.S. economy may cause an impact in the Canadian economy.
The Canadian economy may be significantly affected by the
U.S. economy, given that the United States is Canadas
largest trading partner and foreign investor. Since the
implementation of the North American Free Trade Agreement
(NAFTA) in 1994, total two-way merchandise trade between the
United States and Canada has more than doubled. To further this
relationship, all three NAFTA countries entered into The
Security and Prosperity Partnership of North America in March
2005, which addressed economic and security related issues.
These agreements may further affect Canadas dependency on
the U.S. economy. Past periodic demands by the Province of
Quebec for sovereignty have significantly affected equity
valuations and foreign currency movements in the Canadian market.
Interest
Rate Risk
The costs associated with any leverage used by the Fund are
likely to increase when interest rates rise. Accordingly, the
market price of the Funds common shares may decline when
interest rates rise.
Interest
Rate Hedging Risk
The Fund may from time to time hedge against interest rate risk
resulting from the Funds portfolio holdings and any
financial leverage it may incur. Interest rate transactions the
Fund may use for hedging purposes will expose the Fund to
certain risks that differ from the risks associated with its
portfolio holdings. There are economic costs of hedging
reflected in the price of interest rate swaps, caps and similar
techniques, the cost of which can be significant. In addition,
the Funds success in using hedging instruments is subject
to the Investment Advisers ability to correctly predict
changes in the relationships of such hedging instruments to the
Funds leverage risk, and there can be no assurance that
the Investment Advisers judgment in this respect will be
accurate. Depending on the state of interest rates in general,
the Funds use of interest rate hedging instruments could
enhance or decrease
55
investment company taxable income available to the holders of
its common shares. To the extent there is a decline in interest
rates, the value of interest rate swaps or caps could decline,
and result in a decline in the net asset value of the
Funds common shares. In addition, if the counterparty to
an interest rate swap or cap defaults, the Fund would not be
able to use the anticipated net receipts under the interest rate
swap or cap to offset its cost of financial leverage.
Arbitrage
Risk
A part of the Investment Advisers investment operations
may involve spread positions between two or more securities, or
derivatives positions including commodities hedging positions,
or a combination of the foregoing. The Investment Advisers
trading operations also may involve arbitraging between two
securities or commodities, between the security, commodity and
related options or derivatives markets, between spot and futures
or forward markets,
and/or any
combination of the above. To the extent the price relationships
between such positions remain constant, no gain or loss on the
positions will occur. These offsetting positions entail
substantial risk that the price differential could change
unfavorably, causing a loss to the position.
Leverage
Risk
The Fund may use leverage through the issuance of Indebtedness
or the issuance of preferred shares. The use of leverage
magnifies both the favorable and unfavorable effects of price
movements in the investments made by the Fund. Insofar as the
Fund employs leverage in its investment operations, the Fund
will be subject to increased risk of loss. In addition, the Fund
will pay (and the holders of common shares will bear) all costs
and expenses relating to the issuance and ongoing maintenance of
leverage, including higher advisory fees. Similarly, any decline
in the net asset value of the Funds investments will be
borne entirely by the holders of common shares. Therefore, if
the market value of the Funds portfolio declines, the
leverage will result in a greater decrease in net asset value to
the holders of common shares than if the Fund were not
leveraged. This greater net asset value decrease will also tend
to cause a greater decline in the market price for the common
shares.
Leverage creates a greater risk of loss, as well as potential
for more gain, for the Funds common shares than if
leverage is not used. Preferred shares or debt issued by the
Fund would have complete priority upon distribution of assets
over common shares. Depending on the type of leverage involved,
the Funds use of financial leverage may require the
approval of its Board of Trustees. The Fund expects to invest
the net proceeds derived from any leveraging according to the
investment objective and policies described in this Prospectus.
So long as the Funds portfolio is invested in securities
that provide a higher rate of return than the dividend rate or
interest rate of the Leverage Instrument or other borrowing
arrangements, after taking its related expenses into
consideration, the leverage will cause the Funds common
shareholders to receive a higher rate of income than if it were
not leveraged. There is no assurance that the Fund will continue
to utilize leverage or, if leverage is utilized, that it will be
successful in enhancing the level of the Funds current
income and capital appreciation. The net asset value of the
Funds common shares will be reduced by the fees and
issuance costs of any leverage.
Leverage creates risk for holders of the Funds common
shares, including the likelihood of greater volatility of net
asset value and market price of the shares. Risk of fluctuations
in dividend rates or interest rates on Leverage Instruments or
other borrowing arrangements may affect the return to the
holders of the Funds common shares. To the extent the
return on securities purchased with funds received from the use
of leverage exceeds the cost of leverage (including increased
expenses to the Fund), the Funds returns will be greater
than if leverage had not been used. Conversely, if the return
derived from such securities is less than the cost of leverage
(including increased expenses to the Fund), the Funds
returns will be less than if leverage had not been used, and
therefore, the amount available for distribution to the
Funds common shareholders will be reduced. In the latter
case, the Investment Adviser in its best judgment nevertheless
may determine to maintain the Funds leveraged position if
it expects that the benefits to the Funds common
shareholders of so doing will outweigh the current reduced
return. Under normal market conditions, the Fund anticipates
that it will be able to invest the proceeds from leverage at a
higher rate than the costs of leverage (including increased
expenses to the Fund), which would enhance returns to the
Funds common shareholders. The fees paid to the Investment
Adviser will be calculated on the basis of the Funds
Managed Assets, which include proceeds from Leverage Instruments
and other borrowings. During periods in which the Fund uses
financial leverage, the investment management fee payable to the
Investment Adviser will be higher than if the Fund did not use a
leveraged capital structure. Consequently, the Fund and the
Investment Adviser
56
may have differing interests in determining whether to leverage
the Funds assets. The Board of Trustees will monitor the
Funds use of leverage and this potential conflict.
Credit Facility. The Fund may enter into
definitive agreements with respect to a credit facility. The
Fund may negotiate with commercial banks to arrange a credit
facility pursuant to which the Fund would be entitled to borrow
an amount equal to approximately
331/3%
of the Funds Managed Assets (i.e. 50% of the
Funds net assets attributable to the Funds common
shares). Any such borrowings would constitute financial
leverage. Such a facility is not expected to be convertible into
any other securities of the Fund. Any outstanding amounts are
expected to be prepayable by the Fund prior to final maturity
without significant penalty, and there are not expected to be
any sinking fund or mandatory retirement provisions. Outstanding
amounts would be payable at maturity or such earlier times as
required by the agreement. The Fund may be required to prepay
outstanding amounts under a facility or incur a penalty rate of
interest in the event of the occurrence of certain events of
default. The Fund would be expected to indemnify the lenders
under the facility against liabilities they may incur in
connection with the facility. The Fund may be required to pay
commitment fees under the terms of any such facility. With the
use of borrowings, there is a risk that the interest rates paid
by the Fund on the amount it borrows will be higher than the
return on the Funds investments.
The Fund expects that such a credit facility would contain
covenants that, among other things, likely will limit the
Funds ability to: (i) pay dividends in certain
circumstances, (ii) incur additional debt and
(iii) change its fundamental investment policies and engage
in certain transactions, including mergers and consolidations.
In addition, it may contain a covenant requiring asset coverage
ratios in addition to those required by the 1940 Act. The Fund
may be required to pledge its assets and to maintain a portion
of its assets in cash or high-grade securities as a reserve
against interest or principal payments and expenses. The Fund
expects that any credit facility would have customary covenant,
negative covenant and default provisions. There can be no
assurance that the Fund will enter into an agreement for a
credit facility on terms and conditions representative of the
foregoing or that additional material terms will not apply. In
addition, if entered into, any such credit facility may in the
future be replaced or refinanced by one or more credit
facilities having substantially different terms or by the
issuance of preferred shares.
The Fund may enter into fully-collateralized borrowing
arrangements in which the collateral maintained in a segregated
account exceeds the amount borrowed. If the Fund is unable to
repay the loan, the lender may realize upon the collateral. Such
arrangements are also subject to interest rate risk.
Preferred Share Risk. Preferred share risk is
the risk associated with the issuance of the preferred shares to
leverage the common shares. If the Fund issues preferred shares,
the net asset value and market value of the common shares will
be more volatile, and the yield to the holders of common shares
will tend to fluctuate with changes in the shorter-term dividend
rates on the preferred shares. If the dividend rate on the
preferred shares approaches the net rate of return on the
Funds investment portfolio, the benefit of leverage to the
holders of the common shares would be reduced. If the dividend
rate on the preferred shares exceeds the net rate of return on
the Funds portfolio, the leverage will result in a lower
rate of return to the holders of common shares than if the Fund
had not issued preferred shares.
In addition, the Fund will pay (and the holders of common shares
will bear) all costs and expenses relating to the issuance and
ongoing maintenance of the preferred shares, including higher
advisory fees. Accordingly, the Fund cannot assure you that the
issuance of preferred shares will result in a higher yield or
return to the holders of the common shares. Costs of the
offering of preferred shares will be borne immediately by the
Funds common shareholders and result in a reduction of net
asset value of the common shares.
Similarly, any decline in the net asset value of the Funds
investments will be borne entirely by the holders of common
shares. Therefore, if the market value of the Funds
portfolio declines, the leverage will result in a greater
decrease in net asset value to the holders of common shares than
if the Fund were not leveraged. This greater net asset value
decrease will also tend to cause a greater decline in the market
price for the common shares. The Fund might be in danger of
failing to maintain the required asset coverage of the preferred
shares or of losing its ratings on the preferred shares or, in
an extreme case, the Funds current investment income might
not be sufficient to meet the dividend requirements on the
preferred shares. In order to counteract such an event, the Fund
might need to liquidate investments in order to fund a
redemption of some or all of the preferred shares. Liquidation
at times of low prices for the Funds portfolio securities
may result in capital loss and may reduce returns to the holders
of common shares.
57
Preferred Shareholders May Have Disproportionate Influence
over the Fund. If preferred shares are issued,
holders of preferred shares may have differing interests than
holders of common shares and holders of preferred shares may at
times have disproportionate influence over the Funds
affairs. If preferred shares are issued, holders of preferred
shares, voting separately as a single class, would have the
right to elect two members of the Board of Trustees at all
times. The remaining members of the Board of Trustees would be
elected by holders of common shares and preferred shares, voting
as a single class. The 1940 Act also requires that, in addition
to any approval by shareholders that might otherwise be
required, the approval of the holders of a majority of any
outstanding preferred shares, voting separately as a class,
would be required to (i) adopt any plan of reorganization
that would adversely affect the preferred shares and
(ii) take any action requiring a vote of security holders
under Section 13(a) of the 1940 Act, including, among other
things, changes in the Funds
sub-classification
as a closed-end fund or changes in its fundamental investment
restrictions.
Portfolio Guidelines of Rating
Agencies. Pursuant to the terms of any
Indebtedness or in connection with obtaining and maintaining a
rating issued with respect to Indebtedness or preferred shares,
the Fund may be required to comply with investment quality,
diversification and other guidelines established by a rating
agency rating then providing a rating to the Funds
Indebtedness or preferred shares. Such guidelines will likely be
more restrictive than the restrictions otherwise applicable to
the Fund as described in this Prospectus. The Fund does not
anticipate that such guidelines would have a material adverse
effect on the Funds holders of common shares or its
ability to achieve its investment objective. No minimum rating
is required for the issuance of preferred shares by the Fund.
Securities
Lending Risk
The Fund may lend its portfolio securities (up to a maximum of
one-third of its Managed Assets) to banks or dealers which meet
the creditworthiness standards established by the Board of
Trustees of the Fund. Securities lending is subject to the risk
that loaned securities may not be available to the Fund on a
timely basis and the Fund may, therefore, lose the opportunity
to sell the securities at a desirable price. Any loss in the
market price of securities loaned by the Fund that occurs during
the term of the loan would be borne by the Fund and would
adversely affect the Funds performance. In addition, there
may be delays in recovery, or no recovery, of securities loaned
or even a loss of rights in the collateral should the borrower
of the securities fail financially while the loan is
outstanding. These risks may be greater for
non-U.S. securities.
Non-Diversification
Risk
The Fund is a non-diversified, closed-end management investment
company under the 1940 Act and will not elect to be treated as a
regulated investment company under the Code. As a result, there
are no regulatory requirements under the 1940 Act or the Code
that limit the proportion of the Funds assets that may be
invested in securities of a single issuer. Accordingly, the Fund
may invest a greater portion of its assets in a more limited
number of issuers than a diversified fund. An investment in the
Fund may present greater risk to an investor than an investment
in a diversified portfolio because changes in the financial
condition or market assessment of a single issuer may cause
greater fluctuations in the value of the Funds shares.
Valuation
Risk
Market prices may not be readily available for certain of the
Funds investments, and the value of such investments will
ordinarily be determined based on fair valuations determined by
the Board of Trustees or its designee pursuant to procedures
adopted by the Board of Trustees. Restrictions on resale or the
absence of a liquid secondary market may adversely affect the
Funds ability to determine its net asset value. The sale
price of securities that are not readily marketable may be lower
or higher than the Funds most recent determination of
their fair value.
In addition, the value of these securities typically requires
more reliance on the judgment of the Investment Adviser than
that required for securities for which there is an active
trading market. Due to the difficulty in valuing these
securities and the absence of an active trading market for these
investments, the Fund may not be able to realize these
securities true value or may have to delay their sale in
order to do so.
When determining the fair value of an asset, the Investment
Adviser will seek to determine the price that the Fund might
reasonably expect to receive from the current sale of that asset
in an arms length transaction. Fair value
58
pricing, however, involves judgments that are inherently
subjective and inexact, since fair valuation procedures are used
only when it is not possible to be sure what value should be
attributed to a particular asset or when an event will affect
the market price of an asset and to what extent. As a result,
there can be no assurance that fair value pricing will reflect
actual market value, and it is possible that the fair value
determined for a security will be materially different from the
value that actually could be or is realized upon the sale of
that asset.
In calculating the Funds net asset value, the Fund will
account for deferred tax assets or liabilities, which reflect
taxes on unrealized gains or losses, which are attributable to
the temporary differences between fair market value and tax
basis of the Funds assets, the net tax effects of
temporary differences between the carrying amounts of the
Funds assets and liabilities for financial reporting
purposes relative to the amounts used for income tax purposes
and the net tax benefit of accumulated net operating losses and
capital losses. A deferred tax liability is recognized for
temporary differences that will result in taxable amounts in
future years. A deferred tax asset is recognized for temporary
differences that will result in deductible amounts in future
years and for carryforwards. A deferred tax asset may be used to
reduce a subsequent periods income tax expense, subject to
certain limitations. Estimates of deferred income taxes used to
calculate the Funds net asset value could vary
dramatically from the Funds actual tax liability. These
potential differences in the estimated deferred taxes versus
actual tax liability could have a material impact on the
Funds net asset value.
To the extent the Fund has a deferred tax asset, the Fund will
periodically assess whether a valuation allowance is required,
considering all positive and negative evidence related to the
realization of the deferred tax asset. The Fund is a new entity
and has no history of profits and therefore it may be necessary
for the Fund to apply a valuation allowance against a deferred
tax asset. The timing and the amount of the potential valuation
allowance will not be known until the completion of the
Funds annual audit and therefore could have a material
impact on the Funds net asset value.
In order to estimate taxable income allocable to the MLP units
held in the Funds portfolio and the associated deferred
tax asset or liability, the Fund may rely to some extent on
information provided by the MLPs in which the Fund invests,
which may not necessarily be timely. Such estimates are made in
good faith. From time to time, as new information becomes
available, the Fund may modify its estimates or assumptions
regarding a deferred tax asset or liability. Modifications of
such estimates or assumptions or changes in applicable tax law
could result in increases or decreases in the Funds net
asset value per share.
Portfolio
Turnover Risk
The Fund anticipates that its annual portfolio turnover rate
will be approximately 35%, but that rate may vary greatly from
year to year. Portfolio turnover rate is not considered a
limiting factor in the Investment Advisers execution of
investment decisions. A higher portfolio turnover rate results
in correspondingly greater brokerage commissions and other
transactional expenses that are borne by the Fund. High
portfolio turnover may result in an increased realization of net
short-term capital gains or capital losses by the Fund.
Strategic
Transactions Risk
The Funds use of Strategic Transactions may involve the
purchase and sale of derivative instruments. The Fund may
purchase and sell exchange-listed and
over-the-counter
put and call options on securities, indices and other
instruments, enter into forward contracts, purchase and sell
futures contracts and options thereon, enter into swap, cap,
floor or collar transactions, purchase structured investment
products and enter into transactions that combine multiple
derivative instruments. Strategic Transactions often have risks
similar to the securities underlying the Strategic Transactions.
However, the use of Strategic Transactions also involves risks
that are different from, and possibly greater than, the risks
associated with other portfolio investments. Strategic
Transactions may involve the use of highly specialized
instruments that require investment techniques and risk analyses
different from those associated with other portfolio
investments. The use of derivative instruments has risks,
including the imperfect correlation between the value of the
derivative instruments and the underlying assets, the possible
default of the counterparty to the transaction or illiquidity of
the derivative investments. Furthermore, the ability to
successfully use these techniques depends on the Investment
Advisers ability to predict pertinent market movements,
which cannot be assured. Thus, the use of Strategic Transactions
may result in losses greater than if they had not been used,
59
may require the Fund to sell or purchase portfolio securities at
inopportune times or for prices other than current market
values, may limit the amount of appreciation the Fund can
realize on an investment or may cause the Fund to hold a
security that it might otherwise sell. In addition, amounts paid
by the Fund as premiums and cash, or other assets held in margin
accounts with respect to Strategic Transactions, are not
otherwise available to the Fund for investment purposes. It is
possible that government regulation of various types of
derivative instruments, including regulations enacted pursuant
to the Dodd-Frank Wall Street Reform and Consumer Protection Act
(the
Dodd-Frank
Act), which was signed into law in July 2010, may impact
the availability, liquidity and cost of derivative instruments.
There can be no assurance that such regulation will not have a
material adverse effect on the Fund or will not impair the
ability of the Fund to implement certain Strategic Transactions
or to achieve its investment objective. Although the Investment
Adviser seeks to use Strategic Transactions to further the
Funds investment objective, no assurance can be given that
the use of Strategic Transactions will achieve this result. A
more complete discussion of Strategic Transactions and their
risks is included in the Funds Statement of Additional
Information under the heading Strategic Transactions.
Convertible
Instrument Risk
The Fund may invest in convertible instruments. A convertible
instrument is a bond, debenture, note, preferred stock or other
security that may be converted into or exchanged for a
prescribed amount of common shares of the same or a different
issuer within a particular period of time at a specified price
or formula. Convertible debt instruments have characteristics of
both fixed income and equity investments. Convertible
instruments are subject both to the stock market risk associated
with equity securities and to the credit and interest rate risks
associated with fixed-income securities. As the market price of
the equity security underlying a convertible instrument falls,
the convertible instrument tends to trade on the basis of its
yield and other fixed-income characteristics. As the market
price of such equity security rises, the convertible security
tends to trade on the basis of its equity conversion features.
The Fund may invest in convertible instruments that have varying
conversion values. Convertible instruments are typically issued
at prices that represent a premium to their conversion value.
Accordingly, the value of a convertible instrument increases (or
decreases) as the price of the underlying equity security
increases (or decreases). If a convertible instrument held by
the Fund is called for redemption, the Fund will be required to
permit the issuer to redeem the instrument, or convert it into
the underlying stock, and will hold the stock to the extent the
Investment Adviser determines that such equity investment is
consistent with the investment objective of the Fund.
Short
Sales Risk
Short selling involves selling securities which may or may not
be owned and borrowing the same securities for delivery to the
purchaser, with an obligation to replace the borrowed securities
at a later date. Short selling allows the short seller to profit
from declines in market prices to the extent such declines
exceed the transaction costs and the costs of borrowing the
securities. A naked short sale creates the risk of an unlimited
loss because the price of the underlying security could
theoretically increase without limit, thus increasing the cost
of buying those securities to cover the short position. There
can be no assurance that the securities necessary to cover a
short position will be available for purchase. Purchasing
securities to close out the short position can itself cause the
price of the securities to rise, further exacerbating the loss.
The Funds obligation to replace the borrowed security will
be secured by collateral deposited with the broker-dealer,
usually cash, U.S. government securities or other liquid
securities similar to those borrowed. The Fund also will be
required to segregate similar collateral to the extent, if any,
necessary so that the value of both collateral amounts in the
aggregate is at all times equal to at least 100% of the current
market value of the security sold short. Depending on
arrangements made with the broker-dealer from which the Fund
borrowed the security regarding repaying amounts received by the
Fund on such security, the Fund may not receive any payments
(including interest) on the Funds collateral deposited
with such broker-dealer.
Inflation
Risk
Inflation risk is the risk that the value of assets or income
from investment will be worth less in the future as inflation
decreases the value of money. As inflation increases, the real
value of the Funds common shares and dividends can decline.
60
Debt
Securities Risk
Debt securities are subject to many of the risks described
elsewhere in this section. In addition, they are subject to
credit risk, prepayment risk and, depending on their quality,
other special risks.
Credit Risk. An issuer of a debt security may
be unable to make interest payments and repay principal. The
Fund could lose money if the issuer of a debt obligation is, or
is perceived to be, unable or unwilling to make timely principal
and/or
interest payments, or to otherwise honor its obligations. The
downgrade of a security may further decrease its value.
Below Investment Grade and Unrated Debt Securities
Risk. The Fund may invest up to 10% of its
Managed Assets in debt rated below investment grade and unrated
debt securities. Below investment grade and unrated debt
securities generally pay a premium above the yields of
U.S. government securities or debt securities of investment
grade issuers because they are subject to greater risks than
these securities. These risks, which reflect their speculative
character, include the following: greater yield and price
volatility; greater credit risk and risk of default; potentially
greater sensitivity to general economic or industry conditions;
potential lack of attractive resale opportunities (illiquidity);
and additional expenses to seek recovery from issuers who
default. Debt securities rated below investment grade are
commonly known as junk bonds and are regarded as
predominantly speculative with respect to the issuers
capacity to pay interest and repay principal in accordance with
the terms of the obligations, and involve major risk exposure to
adverse conditions.
The prices of these below investment grade and unrated debt
securities are more sensitive to negative developments, such as
a decline in the issuers revenues, downturns in
profitability in the natural resources industry or a general
economic downturn, than are the prices of higher-grade
securities. Below investment grade and unrated debt securities
tend to be less liquid than investment grade securities and the
market for below investment grade and unrated debt securities
could contract further under adverse market or economic
conditions. In such a scenario, it may be more difficult for the
Fund to sell these securities in a timely manner or for as high
a price as could be realized if such securities were more widely
traded. The market value of below investment grade and unrated
debt securities may be more volatile than the market value of
investment grade securities and generally tends to reflect the
markets perception of the creditworthiness of the issuer
and short-term market developments to a greater extent than
investment grade securities, which primarily reflect
fluctuations in general levels of interest rates. In the event
of a default by a below investment grade or unrated debt
security held in the Funds portfolio in the payment of
principal or interest, the Fund may incur additional expense to
the extent the Fund is required to seek recovery of such
principal or interest. For a description of the ratings
categories of certain rating agencies, see Appendix A to
the SAI.
Reinvestment Risk. Certain debt instruments,
particularly below investment grade securities, may contain call
or redemption provisions which would allow the issuer of the
debt instrument to prepay principal prior to the debt
instruments stated maturity. This is also sometimes known
as prepayment risk. Prepayment risk is greater during a falling
interest rate environment as issuers can reduce their cost of
capital by refinancing higher yielding debt instruments with
lower yielding debt instruments. An issuer may also elect to
refinance its debt instruments with lower yielding debt
instruments if the credit standing of the issuer improves. To
the extent debt securities in the Funds portfolio are
called or redeemed, the Fund may be forced to reinvest in lower
yielding securities.
Other
Investment Companies Risk
The Fund may invest in securities of other investment companies,
including other closed-end or open-end investment companies
(including ETFs). The market value of their shares may differ
from the net asset value of the particular fund. To the extent
the Fund invests a portion of its assets in investment company
securities, those assets will be subject to the risks of the
purchased investment companys portfolio securities. In
addition, if the Fund invests in such investment companies or
investment funds, the Funds shareholders will bear not
only their proportionate share of the expenses of the Fund
(including operating expenses and the fees of the investment
adviser), but also will indirectly bear similar expenses of the
underlying investment company. In addition, the securities of
other investment companies may also be leveraged and will
therefore be subject to the same leverage risks described
herein. As described in the section entitled Principal
Risks of the Fund Leverage Risk, the net asset
value and market value of leveraged shares will be more volatile
and the yield to stockholders will tend to
61
fluctuate more than the yield generated by unleveraged shares.
Other investment companies may have investment policies that
differ from those of the Fund. In addition, to the extent the
Fund invests in other investment companies, the Fund will be
dependent upon the investment and research abilities of persons
other than the Investment Adviser.
ETN and
ETF Risk
An ETN or ETF that is based on a specific index may not be able
to replicate and maintain exactly the composition and relative
weighting of securities in the index. An ETN or ETF also incurs
certain expenses not incurred by its applicable index. The
market value of an ETN or ETF share may differ from its net
asset value; the share may trade at a premium or discount to its
net asset value, which may be due to, among other things,
differences in the supply and demand in the market for the share
and the supply and demand in the market for the underlying
assets of the ETN or ETF. In addition, certain securities that
are part of the index tracked by an ETN or ETF may, at times, be
unavailable, which may impede the ETNs or ETFs
ability to track its index. An ETF that uses leverage can, at
times, be relatively illiquid, which can affect whether its
share price approximates net asset value. As a result of using
leverage, an ETF is subject to the risk of failure in the
futures and options markets it uses to obtain leverage and the
risk that a counterparty will default on its obligations, which
can result in a loss to the Fund. If the Fund invests in ETFs,
the Funds shareholders will bear not only their
proportionate share of the expenses of the Fund, but also will
indirectly bear similar expenses of the underlying ETF. Although
an ETN is a debt security, it is unlike a typical bond, in that
there are no periodic interest payments and principal is not
protected.
Investment
Management Risk
The Funds portfolio is subject to investment management
risk because it will be actively managed. The Investment Adviser
will apply investment techniques and risk analyses in making
investment decisions for the Fund, but there can be no guarantee
that they will produce the desired results.
The decisions with respect to the management of the Fund are
made exclusively by the Investment Adviser, subject to the
oversight of the Board of Trustees. Investors have no right or
power to take part in the management of the Fund. The Investment
Adviser also is responsible for all of the trading and
investment decisions of the Fund. In the event of the withdrawal
or bankruptcy of the Investment Adviser, generally the affairs
of the Fund will be
wound-up and
its assets will be liquidated.
Dependence
on Key Personnel of the Investment Adviser
The Fund is dependent upon the Investment Advisers key
personnel for its future success and upon their access to
certain individuals and investments in the energy sector. In
particular, the Fund will depend on the diligence, skill and
network of business contacts of the personnel of the Investment
Adviser and its portfolio managers, who will evaluate,
negotiate, structure, close and monitor the Funds
investments. The portfolio managers do not have a long-term
employment contract with the Investment Adviser, although they
do have equity interests and other financial incentives to
remain with the firm. The Fund will also depend on the senior
management of the Investment Adviser, including particularly
Jerry V. Swank. The departure of Mr. Swank or another of
the Investment Advisers senior management could have a
material adverse effect on the Funds ability to achieve
its investment objective. In addition, the Fund can offer no
assurance that the Investment Adviser will remain its investment
adviser, or that the Fund will continue to have access to the
Investment Advisers industry contacts and deal flow.
Conflicts
of Interest with the Investment Adviser
Conflicts of interest may arise because the Investment Adviser
and its affiliates generally will be carrying on substantial
investment activities for other clients, including, but not
limited to, other client accounts and funds managed or advised
by the Investment Adviser, in which the Fund will have no
interest. The Investment Adviser or its affiliates may have
financial incentives to favor certain of such accounts over the
Fund. Any of their proprietary accounts and other customer
accounts may compete with the Fund for specific trades. The
Investment Adviser or its affiliates may buy or sell securities
for the Fund which differ from securities bought or sold for
other accounts and customers, even though their investment
objectives and policies may be similar to the Funds.
Situations may occur
62
when the Fund could be disadvantaged because of the investment
activities conducted by the Investment Adviser and its
affiliates for their other accounts. Such situations may be
based on, among other things, legal or internal restrictions on
the combined size of positions that may be taken for the Fund
and the other accounts, limiting the size of the Funds
position, or the difficulty of liquidating an investment for the
Fund and the other accounts where the market cannot absorb the
sale of the combined position. Notwithstanding these potential
conflicts of interest, the Funds Board of Trustees and
officers have a fiduciary obligation to act in the Funds
best interest.
The Funds investment opportunities may be limited by
affiliations of the Investment Adviser or its affiliates with
Energy Companies. In addition, to the extent that the Investment
Adviser sources and structures private investments in Energy
Companies, certain employees of the Investment Adviser may
become aware of actions planned by Energy Companies, such as
acquisitions that may not be announced to the public. It is
possible that the Fund could be precluded from investing in an
Energy Company about which the Investment Adviser has material
non-public information; however, it is the Investment
Advisers intention to ensure that any material non-public
information available to certain of the Investment
Advisers employees not be shared with those employees
responsible for the purchase and sale of publicly traded
securities of Energy Companies.
The Investment Adviser manages several other client accounts and
funds. Some of these other client accounts and funds have
investment objectives that are similar to or overlap with the
Fund. Furthermore, the Investment Adviser may at some time in
the future manage additional client accounts and investment
funds with the same investment objective as the Fund.
The Investment Adviser and its affiliates generally will be
carrying on substantial investment activities for other clients
accounts and funds in which the Fund will have no interest.
Investment decisions for the Fund are made independently from
those of such other clients; however, from time to time, the
same investment decision may be made for more than one fund or
account. When two or more clients advised by the Investment
Adviser or its affiliates seek to purchase or sell the same
publicly traded securities, the securities actually purchased or
sold will be allocated among the clients on a good faith
equitable basis by the Investment Adviser in its discretion in
accordance with the clients various investment objectives
and procedures adopted by the Investment Adviser and approved by
the Funds Board of Trustees. In some cases, this system
may adversely affect the price or size of the position the Fund
may obtain.
The Funds investment opportunities may be limited by
investment opportunities in the Energy Companies that the
Investment Adviser is evaluating for other clients
accounts and funds. To the extent a potential investment is
appropriate for the Fund and one or more of the Investment
Advisers other client accounts or funds, the Investment
Adviser will need to fairly allocate that investment to the Fund
or another client account or fund, or both, depending on its
allocation procedures and applicable law related to combined or
joint transactions. There may occur an attractive limited
investment opportunity suitable for the Fund in which the Fund
cannot invest under the particular allocation method being used
for that investment.
Under the 1940 Act, the Fund and such other client accounts or
funds managed or advised by the Investment Adviser may be
precluded from co-investing in certain private placements of
securities. Except as permitted by law or positions of the staff
of the SEC, the Investment Adviser will not co-invest its other
clients assets in private transactions in which the Fund
invests. To the extent the Fund is precluded from co-investing,
the Investment Adviser will allocate private investment
opportunities among its clients, including but not limited to
the Fund and its other client accounts and funds, based on
allocation policies that take into account several suitability
factors, including the size of the investment opportunity, the
amount each client has available for investment and the
clients investment objectives. These allocation policies
may result in the allocation of investment opportunities to
another client account or fund managed or advised by the
Investment Adviser rather than to the Fund.
The management fee payable to the Investment Adviser is based on
the value of the Funds Managed Assets, as periodically
determined. A significant percentage of the Funds Managed
Assets may be illiquid securities acquired in private
transactions for which market quotations will not be readily
available. Although the Fund will adopt valuation procedures
designed to determine valuations of illiquid securities in a
manner that reflects their fair value, there typically is a
range of possible prices that may be established for each
individual security. Senior management of the Investment
Adviser, the Funds Board of Trustees and its Valuation
Committee will participate in the valuation of its securities.
See Net Asset Value.
63
Skadden, Arps, Slate, Meagher & Flom LLP, counsel to
the Fund in this offering, also represents the Investment
Adviser. Such counsel does not purport to represent the separate
interests of the investors and has assumed no obligation to do
so. Accordingly, the investors have not had the benefit of
independent counsel in the structuring of the Fund or
determination of the relative interests, rights and obligations
of the Funds investment adviser and the investors.
Market
Discount From Net Asset Value
Shares of closed-end investment companies frequently trade at a
discount from their net asset value, which is a risk separate
and distinct from the risk that the Funds net asset value
could decrease as a result of its investment activities.
Although the value of the Funds net assets is generally
considered by market participants in determining whether to
purchase or sell common shares, whether investors will realize
gains or losses upon the sale of common shares will depend
entirely upon whether the market price of common shares at the
time of sale is above or below the investors purchase
price for common shares. Because the market price of common
shares will be determined by factors such as net asset value,
dividend and distribution levels (which are dependent, in part,
on expenses), supply of and demand for common shares, stability
of dividends or distributions, trading volume of common shares,
general market and economic conditions and other factors beyond
the control of the Fund, the Fund cannot predict whether common
shares will trade at, below or above net asset value or at,
below or above the initial public offering price. This risk may
be greater for investors expecting to sell their common shares
soon after the completion of the public offering, as the net
asset value of the common shares will be reduced immediately
following the offering as a result of the payment of certain
offering costs. Common shares of the Fund are designed primarily
for long-term investors; investors in common shares should not
view the Fund as a vehicle for trading purposes.
Recent
Economic Events
Global financial markets have experienced periods of
unprecedented turmoil. The debt and equity capital markets in
the United States have been negatively impacted by significant
write-offs in the financial services sector relating to subprime
mortgages and the re-pricing of credit risk in the broader
market, among other things. These events, along with the
deterioration of the housing market, the failure of major
financial institutions and the concerns that other financial
institutions as well as the global financial system were also
experiencing severe economic distress materially and adversely
impacted the broader financial and credit markets and reduced
the availability of debt and equity capital for the market as a
whole and financial firms in particular. These events
contributed to severe market volatility and caused severe
liquidity strains in the credit markets. Volatile financial
markets can expose the Fund to greater market and liquidity risk
and potential difficulty in valuing portfolio instruments held
by the Fund.
While the U.S. and global markets had experienced extreme
volatility and disruption for an extended period of time, some
recent fiscal periods have witnessed more stabilized economic
activity as expectations for an economic recovery increased,
although other recent periods have witnessed more economic
disruption and adverse economic conditions may persist. Risks to
a robust resumption of growth persist: a weak consumer weighed
down by too much debt and increasing and persistent joblessness,
the growing size of the federal budget deficit and national
debt, existing home sales plunging to their lowest levels in
15 years, and the threat of inflation. A return to
unfavorable economic conditions or sustained economic slowdown
may place downward pressure on oil and natural gas prices and
may adversely affect the ability of MLPs to sustain their
historical distribution levels, which in turn, may adversely
affect the Fund. MLPs that have historically relied heavily on
outside capital to fund their growth have been impacted by the
contraction in the capital markets. The continued recovery of
the MLP sector is dependent on several factors, including the
recovery of the financial sector, the general economy and the
commodity markets.
The current financial market situation, as well as various
social, political, and psychological tensions in the United
States and around the world, may continue to contribute to
increased market volatility, may have long-term effects on the
U.S. and worldwide financial markets; and may cause further
economic uncertainties or deterioration in the United States and
worldwide. Since 2010, several European Union (EU)
countries, including Greece, Ireland, Italy, Spain, and
Portugal, have faced budget issues, some of which may have
negative long-term effects for the economies of those countries
and other EU countries. There is continued concern about
national-level support for the euro and the accompanying
coordination of fiscal and wage policy among European Economic
and
64
Monetary Union member countries. The prolonged continuation or
further deterioration of the current U.S. and global
economic downturn could adversely impact the Funds
portfolio. The Investment Adviser does not know how long the
financial markets will continue to be affected by these events
and cannot predict the effects of these or similar events in the
future on the U.S. economy and securities markets or on the
Funds portfolio. The Investment Adviser intends to monitor
developments and seek to manage the Funds portfolio in a
manner consistent with achieving the Funds investment
objective, but there can be no assurance that it will be
successful in doing so and the Investment Adviser may not timely
anticipate or manage existing, new or additional risks,
contingencies or developments, including regulatory developments
and trends in new products and services, in the current or
future market environment. Given the risks described above, an
investment in common shares may not be appropriate for all
prospective investors. A prospective investor should carefully
consider his or her ability to assume these risks before making
an investment in the Fund.
Government
Intervention in Financial Markets
The instability in the financial markets discussed above has led
the United States government to take a number of unprecedented
actions designed to support certain financial institutions and
segments of the financial markets that have experienced extreme
volatility, and, in some cases, a lack of liquidity. Federal,
state, and other governments, their regulatory agencies, or self
regulatory organizations may take actions that affect the
regulation of the instruments in which the Fund invests, or the
issuers of such instruments. The Dodd-Frank Act, which was
signed into law in July 2010, is expected to result in a
significant revision of the U.S. financial regulatory
framework. The Dodd-Frank Act covers a broad range of topics,
including, among many others, a reorganization of federal
financial regulators; a process designed to ensure financial
system stability and the resolution of potentially insolvent
financial firms; new rules for derivatives trading; the creation
of a consumer financial protection watchdog; the registration
and regulation of managers of private funds; the regulation of
credit rating agencies; and new federal requirements for
residential mortgage loans. The regulation of various types of
derivative instruments pursuant to the Dodd-Frank Act may
adversely affect MLPs and other issuers in which the Fund
invests that utilize derivatives strategies for hedging or other
purposes. The ultimate impact of the Dodd-Frank Act, and any
resulting regulation, is not yet certain, and issuers in which
the Fund invests may also be affected by the new legislation and
regulation in ways that are currently unforeseeable. Governments
or their agencies may also acquire distressed assets from
financial institutions and acquire ownership interests in those
institutions. The long-term implications of government ownership
and disposition of these assets are unclear, and may have
positive or negative effects on the liquidity, valuation and
performance of the Funds portfolio holdings.
Legal and
Regulatory Risk
Legal, tax and regulatory changes could occur during the term of
the Fund that may adversely affect the Fund. The regulatory
environment for closed-end funds is evolving, and changes in the
regulation of closed-end funds may adversely affect the value of
investments held by the Fund and the ability of the Fund to
obtain the leverage it might otherwise obtain or to pursue its
trading strategy. In addition, the securities and futures
markets are subject to comprehensive statutes, regulations and
margin requirements. The SEC, other regulators and
self-regulatory organizations and exchanges are authorized to
take extraordinary actions in the event of market emergencies.
The regulation of derivatives transactions and funds that engage
in such transactions is an evolving area of law and is subject
to modification by governmental and judicial action. The effect
of any future regulatory change on the Fund could be substantial
and adverse.
Terrorism
and Market Disruption Risk
As a result of the terrorist attacks on the World Trade Center
and the Pentagon on September 11, 2001, some of the
U.S. securities markets were closed for a
four-day
period. These terrorist attacks, the wars in Iraq and
Afghanistan and their aftermaths and other geopolitical events
have led to, and these and other similar events may in the
future lead to, increased short-term market volatility of, and
may have long-term effects on, U.S. and world economies and
markets. Global political and economic instability could affect
the operations of Energy Companies in unpredictable ways,
including through disruptions of natural resources supplies and
markets and the resulting volatility in commodity prices. The
U.S. government has issued warnings that natural resources
assets, specifically
65
pipeline infrastructure and production, transmission and
distribution facilities, may be future targets of terrorist
activities. In addition, changes in the insurance markets have
made certain types of insurance more difficult, if not
impossible, to obtain and have generally resulted in increased
premium costs.
MANAGEMENT
OF THE FUND
Trustees
and Officers
The Board of Trustees of the Fund provides broad oversight over
the operations and affairs of the Fund and protects the
interests of shareholders. The Board of Trustees has overall
responsibility to manage and control the business affairs of the
Fund, including the complete and exclusive authority to
establish policies regarding the management, conduct and
operation of the Funds business. The Funds officers,
who are all officers or employees of the Investment Adviser or
its affiliates, are responsible for the
day-to-day
management and administration of the Funds operations. The
names and ages of the Trustees and officers of the Fund, the
year each was first elected or appointed to office, their
principal business occupations during the last five years, the
number of funds overseen by each Trustee and other directorships
or trusteeships during the last five years are set forth under
Management of the Fund in the SAI.
The
Investment Adviser
Subject to the overall supervision of the Board of Trustees, the
Fund is managed by
Cushing®
MLP Asset Management, LP. The Investment Adviser is an
SEC-registered investment adviser headquartered in Dallas,
Texas. The Investment Adviser serves as investment adviser to
registered and unregistered funds, which invest primarily in
securities of MLPs and other natural resource companies. The
Investment Adviser is also the sponsor of The
Cushing®
30 MLP Index which is a fundamentally based MLP index, comprised
of 30 equally weighted publicly traded energy infrastructure
MLPs and The
Cushing®
MLP High Income Index, which tracks the performance of
30 publicly traded MLP securities with an emphasis on
current yield. The Investment Adviser continues to seek to
expand its platform of MLP-related investment products,
leveraging extensive industry contacts and significant research
depth to drive both passive and actively managed investment
opportunities for individual and institutional investors. The
Investment Adviser seeks to identify and exploit investment
niches it believes are generally less understood and less
followed by the broader investor community. The Investment
Advisers principal business address is 8117 Preston Road,
Suite 440, Dallas, Texas 75225. The Investment Adviser is
indirectly controlled by Jerry V. Swank.
The Investment Adviser considers itself one of the principal
professional institutional investors in the energy sector based
on the following:
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An investment team with extensive experience in analysis,
investment, portfolio management, risk management, and private
securities transactions in MLPs and MLP-related securities.
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Focus on
bottom-up,
fundamental analysis performed by its experienced investment
team is core to the Investment Advisers investment process.
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The investment teams wide range of professional
backgrounds, market knowledge, industry relationships, and
experience in the analysis, financing, and structuring of energy
sector investments give the Investment Adviser insight into, and
the ability to identify and capitalize on, investment
opportunities in MLPs and related issuers in the energy sector.
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Its central location in Dallas, Texas and proximity to major
players and assets in the MLP-related space.
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The Investment Adviser acts as the investment adviser to the
Fund pursuant to an investment management agreement (the
Investment Management Agreement). Pursuant to the
Investment Management Agreement, the Fund has agreed to pay the
Investment Adviser a fee, payable at the end of each calendar
month, at an annual rate equal to 1.50% of the average weekly
value of the Funds Managed Assets during such month (the
Management Fee) for the services and facilities
provided by the Investment Adviser to the Fund. The Investment
Adviser has agreed to waive 0.25% of its management fee from the
date the Fund commences operations through at least
February 28, 2013. Managed Assets means the
total assets of the Fund, minus all accrued expenses incurred in
the normal course of
66
operations other than liabilities or obligations attributable to
investment leverage, including, without limitation, investment
leverage obtained through (i) indebtedness of any type
(including, without limitation, borrowing through a credit
facility or the issuance of debt securities), (ii) the
issuance of shares of preferred stock or other similar
preference securities
and/or
(iii) the reinvestment of collateral received for
securities loaned in accordance with the Funds investment
objective and policies.
Because the Management Fee is based upon a percentage of the
Funds Managed Assets, the Management Fee will be higher if
the Fund employs leverage. Therefore, the Investment Adviser
will have a financial incentive to use leverage, which may
create a conflict of interest between the Investment Adviser and
the Funds common shareholders.
Pursuant to the Investment Management Agreement, the Investment
Adviser is responsible for managing the portfolio of the Fund in
accordance with its stated investment objective and policies,
makes investment decisions for the Fund, placing orders to
purchase and sell securities on behalf of the Fund and managing
the other business and affairs of the Fund, all subject to the
supervision and direction of the Funds Board of Trustees.
In addition, the Investment Adviser furnishes offices, necessary
facilities and equipment on behalf of the Fund; provides
personnel, including certain officers required for the
Funds administrative management; and pays the compensation
of all officers and Trustees of the Fund who are its affiliates.
In addition to the Management Fee, the Fund pays all other costs
and expenses of its operations, including the compensation of
its Trustees (other than those affiliated with the Investment
Adviser); the fees and expenses of the Funds
administrator, the custodian and transfer and dividend
disbursing agent; legal fees; leverage expenses (if any); rating
agency fees (if any); listing fees and expenses; fees of
independent auditors; expenses of repurchasing shares; expenses
of preparing, printing and distributing shareholder reports,
notices, proxy statements and reports to governmental agencies;
and taxes, if any.
A discussion regarding the basis for the approval of the
Investment Management Agreement by the Board of Trustees will be
available in the Funds initial annual report to
shareholders, for the period ending.
Portfolio
Management
Jerry V. Swank, Founder and Managing Partner of the Investment
Adviser, Daniel L. Spears, Partner and Portfolio Manager of the
Investment Adviser, and Judd B. Cryer, Senior Vice
President and Senior Research Analyst of the Investment Adviser,
are primarily responsible for the
day-to-day
management of the Funds portfolio.
Jerry V. Swank. Mr. Swank formed Swank
Capital, LLC in 2000 to provide proprietary energy research to a
select group of institutional investors, emphasizing in-depth
independent research. Prior to forming Swank Capital, LLC,
Mr. Swank spent five years with John S. Herold, Inc.
(Herold). Herold is an independent oil &
gas research and consulting company. He joined Herold in 1995
and served as Managing Director heading up its sales and new
product development team until May 1998, when he assumed the
position of President. During this period, Mr. Swank
developed an in-depth knowledge of the worldwide energy
industry, sector profitability, global growth prospects and
supply/demand dynamics. Prior to joining Herold, Mr. Swank
spent 14 years with Credit Suisse First Boston Corporation
in Institutional Equity and Fixed Income Sales in its Dallas
office from 1980 to 1995. From 1985 to 1995 he was a Credit
Suisse First Boston Corporation Director and Southwestern
Regional Sales Manager. Prior to Credit Suisse First Boston
Corporation, Mr. Swank worked from 1976 to 1980 on the buy
side as an analyst and portfolio manager with Mercantile Texas
Corp. Mr. Swank received a B.A. from the University of
Missouri (Economics) and an M.B.A. from the University of North
Texas. Mr. Swank has served on the Board of Directors of
John S. Herold, Inc., Matador Petroleum Corporation and
Advantage Acceptance, Inc. and currently serves on the board of
directors of
E-T Energy
Ltd., Central Energy, LP and The Dalrymple Global Resources
Offshore Fund, Ltd. Mr. Swank is also Chairman of the
Board, CEO, President, and Portfolio Manager for the
Cushing®
MLP Total Return Fund and the
Cushing®
MLP Premier Fund.
Daniel L. Spears. Mr. Spears joined Swank
Capital, LLC in 2006. Mr. Spears is a Partner of Swank
Capital and Executive Vice President, Secretary and Portfolio
Manager of The
Cushing®
MLP Total Return Fund and the
Cushing®
MLP Premier Fund. Prior to joining Swank Capital in 2006,
Mr. Spears was an investment banker in the
67
Natural Resources Group at Banc of America Securities LLC for
eight years. Prior to that, Mr. Spears was in the Global
Energy and Power Investment Banking Group at Salomon Smith
Barney. Mr. Spears received his B.S. in Economics from the
Wharton School of the University of Pennsylvania.
Mr. Spears currently serves on the Board of Directors for
Lonestar Midstream, L.P., PostRock Energy Corporation and
Central Energy, LP.
Judd B. Cryer. Mr. Cryer joined Swank
Capital, LLC in 2005. He is a Senior Vice President and Senior
Research Analyst of the Investment Adviser and has six years of
experience in investment management and research analysis, and
seven years of direct engineering and project management
experience in various sectors of the energy industry. Prior to
joining the Investment Adviser, Mr. Cryer was a consulting
engineer at Utility Engineering Corp. for three years, and
served three years as a project manager with Koch John Zink
Company. Mr. Cryer received his B.S. in Mechanical
Engineering from Oklahoma State University and an M.B.A. in
Finance from Southern Methodist University.
The SAI provides additional information about the portfolio
managers compensation, other accounts managed by the
portfolio managers and the portfolio managers ownership of
securities of the Fund.
NET ASSET
VALUE
The Fund will determine the net asset value of its common shares
as of the close of regular session trading on the New York Stock
Exchange (normally 4:00 p.m. eastern time) no less
frequently than weekly on Wednesday of each week and the last
business day in each of November and May. The Fund calculates
net asset value per common share by subtracting liabilities
(including accrued expenses or dividends and the Funds
deferred tax liability, if any) from the total assets of the
Fund (the value of the securities plus cash or other assets,
including interest accrued but not yet received and the
Funds deferred tax asset, if any) and dividing the result
by the total number of outstanding common shares of the Fund.
The Fund will use the following valuation methods to determine
either current market value for investments for which market
quotations are available, or if not available, the fair value,
as determined in good faith pursuant to such policies and
procedures as may be approved by the Board of Trustees from time
to time. The valuation of the portfolio securities of the Fund
currently includes the following processes:
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The market value of each security listed or traded on any
recognized securities exchange or automated quotation system
will be the last reported sale price at the relevant valuation
date on the composite tape or on the principal exchange on which
such security is traded. If no sale is reported on that date,
the Investment Adviser utilizes, when available, pricing
quotations from principal market makers. Such quotations may be
obtained from third-party pricing services or directly from
investment brokers and dealers in the secondary market.
Generally, the Funds loan and bond positions are not
traded on exchanges and consequently are valued based on market
prices received from third-party pricing services or
broker-dealer sources.
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Dividends declared but not yet received, and rights in respect
of securities which are quoted ex-dividend or ex-rights, will be
recorded at the fair value of those dividends or rights, as
determined by the Investment Adviser, which may (but need not)
be the value so determined on the day such securities are first
quoted ex-dividend or ex-rights.
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Listed options, or
over-the-counter
options for which representative brokers quotations are
available, will be valued in the same manner as listed or
over-the-counter
securities. Premiums for the sale of such options written by the
Fund will be included in the assets of the Fund, and the market
value of such options will be included as a liability.
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The Funds non-marketable investments will generally be
valued in such manner as the Investment Adviser determines in
good faith to reflect their fair values under procedures
established by, and under the general supervision and
responsibility of, the Board of Trustees. The pricing of all
assets that are fair valued in this manner will be subsequently
reported to and ratified by the Board of Trustees.
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When determining the fair value of an asset, the Investment
Adviser will seek to determine the price that the Fund might
reasonably expect to receive from the current sale of that asset
in an arms length transaction. Fair value determinations
will be based upon all available factors that the Investment
Adviser deems relevant.
68
Trading in securities on many foreign securities exchanges and
over-the-counter
markets is normally completed before the close of business on
each U.S. business day. In addition, securities trading in
a particular country or countries may not take place on all
U.S. business days or may take place on days which are not
U.S. business days. If events occur between the time when a
securitys price was last determined on a securities
exchange or market and the time when the Funds net asset
value is last calculated that the Investment Adviser deems
materially affect the price of such security (for example,
(i) movements in certain U.S. securities indices which
demonstrate strong correlation to movements in certain foreign
securities markets, (ii) a foreign securities market closes
because of a natural disaster or some other reason, (iii) a
halt in trading of the securities of an issuer on an exchange
during the trading day or (iv) a significant event
affecting an issuer occurs), such securities may be valued at
their fair value as determined in good faith in accordance with
procedures established by the Board of Trustees, an effect of
which may be to foreclose opportunities available to market
timers or short-term traders. For purposes of calculating net
asset value per share, all assets and liabilities initially
expressed in foreign currencies will be converted into
U.S. dollars at the mean of the bid price and asked price
of such currencies against the U.S. dollar as quoted by a
major bank.
Any derivative transaction that the Fund enters into may,
depending on the applicable market environment, have a positive
or negative value for purposes of calculating net asset value.
In addition, accrued payments to the Fund under such
transactions will be assets of the Fund and accrued payments by
the Fund will be liabilities of the Fund.
Because the Fund is treated as a regular corporation, or
C corporation, for U.S. federal income tax
purposes, the Fund will incur tax expenses. In calculating the
Funds net asset value, the Fund will, among other things,
account for its deferred tax liability
and/or asset
balances.
The Fund will accrue, in accordance with generally accepted
accounting principles, a deferred income tax liability balance
at the currently effective statutory U.S. federal income
tax rate (currently 35%) plus an assumed state and local income
tax rate, for its future tax liability associated with the
capital appreciation of its investments and the distributions
received by the Fund on equity securities of MLPs considered to
be return of capital and for any net operating gains. Any
deferred tax liability balance will reduce the Funds net
asset value.
The Fund will accrue, in accordance with generally accepted
accounting principles, a deferred tax asset balance which
reflects an estimate of the Funds future tax benefit
associated with net operating losses and unrealized losses. Any
deferred tax asset balance will increase the Funds net
asset value. To the extent the Fund has a deferred tax asset
balance, the Fund will assess, in accordance with generally
accepted accounting principles, whether a valuation allowance,
which would offset the value of some or all of the Funds
deferred tax asset balance, is required. Pursuant to Financial
Accounting Standards Board Accounting Standards Codification 740
(FASB ASC 740), the Fund will assess a valuation allowance
to reduce some or all of the deferred tax asset balance if,
based on the weight of all available evidence, both negative and
positive, it is more likely than not that some or all of the
deferred tax asset will not be realized. The Fund will use
judgment in considering the relative impact of negative and
positive evidence. The weight given to the potential effect of
negative and positive evidence will be commensurate with the
extent to which such evidence can be objectively verified. The
Funds assessment considers, among other matters, the
nature, frequency and severity of current and cumulative losses,
forecasts of future profitability (which are dependent on, among
other factors, future Energy Trust and MLP cash distributions),
the duration of statutory carryforward periods and the
associated risk that operating loss carryforwards may be limited
or expire unused. However, this assessment generally may not
consider the potential for market value increases with respect
to the Funds investments in equity securities of Energy
Trusts, MLPs or any other securities or assets. Significant
weight is given to the Funds forecast of future taxable
income, which is based on, among other factors, the expected
continuation of Energy Trust and MLP cash distributions at or
near current levels. Consideration is also given to the effects
of the potential of additional future realized and unrealized
gains or losses on investments and the period over which
deferred tax assets can be realized, as the expiration dates for
the federal tax net operating loss carryforwards range from
seventeen to twenty years and federal capital loss carryforwards
expire in five years. Recovery of a deferred tax asset is
dependent on continued payment of the Energy Trust and MLP cash
distributions at or near current levels in the future and the
resultant generation of taxable income. The Fund will assess
whether a valuation allowance is required to offset some or all
of any deferred tax asset in connection with the calculation of
the Funds net asset value per share each day; however, to
the extent the final valuation allowance differs from the
69
estimates of the Fund used in calculating the Funds net
asset value, the application of such final valuation allowance
could have a material impact on the Funds net asset value.
The Funds deferred tax liability
and/or asset
balances are estimated using estimates of effective tax rates
expected to apply to taxable income in the years such balances
are realized. The Fund will rely to some extent on information
provided by Energy Trusts and MLPs regarding the tax
characterization of the distributions made by such entities,
which may not be provided to the Fund on a timely basis, to
estimate the Funds deferred tax liability
and/or asset
balances for purposes of financial statement reporting and
determining its net asset value. If such information is not
received from such entities on a timely basis, the Fund will
estimate the tax characterization of the distributions received
by the Fund based on average historical tax characterization of
distributions made by Energy Trusts and MLPs. The Funds
estimates regarding its deferred tax liability
and/or asset
balances are made in good faith; however, the estimate of the
Funds deferred tax liability
and/or asset
balances used to calculate the Funds net asset value could
vary dramatically from the Funds actual tax liability and,
as a result, the determination of the Funds actual tax
liability may have a material impact on the Funds net
asset value. The Funds net asset value calculation will be
based on then current estimates and assumptions regarding the
Funds deferred tax liability
and/or asset
balances and any applicable valuation allowance, based on all
information available to the Fund at such time. From time to
time, the Fund may modify its estimates or assumptions regarding
its deferred tax liability
and/or asset
balances and any applicable valuation allowance as new
information becomes available. Modifications of the Funds
estimates or assumptions regarding its deferred tax liability
and/or asset
balances and any applicable valuation allowance, changes in
generally accepted accounting principles or related guidance or
interpretations thereof, limitations imposed on net operating
losses (if any) and changes in applicable tax law could result
in increases or decreases in the Funds net asset value per
share, which could be material.
The investment strategy of investing primarily in Energy Trusts
and MLPs and electing to be taxed as a regular corporation, or
C corporation, rather than as a regulated investment
company for U.S. federal income tax purposes, involves
complicated and in some cases unsettled accounting, tax and net
asset and share valuation aspects that cause the Fund to differ
significantly from most other registered investment companies.
This may result in unexpected and potentially significant
accounting, tax and valuation consequences for the Fund and for
its shareholders. In addition, accounting, tax and valuation
practices in this area are still developing, and there may not
always be a clear consensus among industry participants as to
the most appropriate approach. This may result in changes over
time in the practices applied by the Fund, which, in turn, could
have material adverse consequences on the Fund and its
shareholders.
DISTRIBUTIONS
The Fund intends to make regular quarterly cash distributions of
all or a portion of its income to its common shareholders. The
Fund may pay capital gain distributions annually, if available.
The Fund anticipates that, due to the tax characterization of
cash distributions made by Energy Trusts and MLPs, a portion of
the Funds distributions to common shareholders will
consist of tax-advantaged return of capital for
U.S. federal income tax purposes. In general, a portion of
the distribution will constitute a return of capital to a common
shareholder, rather than a dividend, to the extent such
distribution exceeds the Funds current and accumulated
earnings and profits. The portion of any distribution treated as
a return of capital will not be subject to tax currently, but
will result in a corresponding reduction in a shareholders
basis in common shares of the Fund and in the shareholders
recognizing more gain or less loss (that is, will result in an
increase of a shareholders tax liability) when the
shareholder later sells common shares of the Fund. Dividends in
excess of a shareholders adjusted tax basis in its shares
are generally treated as capital gains. The Funds
distribution rate will vary based upon the distributions
received from underlying investments in Energy Trust and MLPs.
To permit it to maintain a more stable quarterly distribution
rate, the Fund may distribute less or more than the entire
amount of cash it receives from its investments in a particular
period. Any undistributed cash would be available to supplement
future distributions and, until distributed, would add to the
Funds net asset value. Correspondingly, such amounts, once
distributed, will be deducted from the Funds net asset
value. Shareholders will automatically have all distributions
reinvested in common shares issued by the Fund or common shares
of the Fund purchased on the open market in accordance with the
Funds dividend reinvestment plan unless an election is
made to receive cash. Common
70
shareholders who receive dividends in the form of additional
common shares will be subject to the same U.S. federal,
state and local tax consequences as common shareholders who
elect to receive their dividends in cash. See Dividend
Reinvestment Plan.
Initial distributions to common shareholders are expected to be
declared within 60 to 90 days, and paid within 90 to
120 days, after completion of the common share offering,
depending upon market conditions. Due to the timing of the
Funds offering of common shares and expected receipt of
initial distributions from Energy Trusts and MLPs in which the
Fund will invest, the Fund anticipates that a significant
portion of its first distribution to common shareholders will be
made from sources other than cash distributions from Energy
Trusts and MLPs and may consist of a return of capital.
Distributions by the Fund, whether paid in cash or in additional
common shares, will be taken into account in measuring the
performance of the Fund with respect to its investment objective.
Pursuant to the requirements of the 1940 Act, in the event the
Fund makes distributions from sources other than income, a
notice will accompany each quarterly distribution with respect
to the estimated source of the distribution made. Such notices
will describe the portion, if any, of the quarterly dividend
which, in the Funds good faith judgment, constitutes
long-term capital gain, short-term capital gain, investment
income or a return of capital. The actual character of such
dividend distributions for U.S. federal income tax
purposes, however, will only be determined finally by the Fund
at the close of its fiscal year, based on the Funds full
year performance and its actual net income and net capital gains
for the year, which may result in a recharacterization of
amounts distributed during such fiscal year from the
characterization in the quarterly estimates.
DIVIDEND
REINVESTMENT PLAN
Unless the registered owner of common shares elects to receive
cash by contacting the Plan Agent, all dividends declared for
your common shares of the Fund will be automatically reinvested
by U.S. Bancorp Fund Services, LLC. (together, the
Plan Agent), agent for shareholders in administering
the Funds Dividend Reinvestment Plan (the
Plan), in additional common shares of the Fund. If a
registered owner of common shares elects not to participate in
the Plan, you will receive all dividends in cash paid by check
mailed directly to you (or, if the shares are held in street or
other nominee name, then to such nominee) by the Plan Agent, as
dividend disbursing agent. You may elect not to participate in
the Plan and to receive all dividends in cash by sending written
instructions or by contacting the Plan Agent, as dividend
disbursing agent, at the address set out below. Participation in
the Plan is completely voluntary and may be terminated or
resumed at any time without penalty by contacting the Plan Agent
before the dividend record date; otherwise such termination or
resumption will be effective with respect to any subsequently
declared dividend or other distribution. Some brokers may
automatically elect to receive cash on your behalf and may
reinvest that cash in additional common shares of the Fund for
you.
Whenever the Fund declares a dividend or other distribution (for
purposes of this section, together, a dividend)
payable in cash, non-participants in the Plan will receive cash
and participants in the Plan will receive the equivalent in
common shares. The common shares will be acquired by the Plan
Agent for the participants accounts, depending upon the
circumstances described below, either (i) through receipt
of additional unissued but authorized common shares from the
Fund (newly-issued common shares) or (ii) by
purchase of outstanding common shares on the open market
(open-market purchases) on the New York Stock
Exchange or elsewhere.
If, on the payment date for any dividend, the market price per
common share plus estimated brokerage commissions is greater
than the net asset value per common share (such condition being
referred to in this Prospectus as market premium),
the Plan Agent will invest the dividend amount in newly-issued
common shares, including fractions, on behalf of the
participants. The number of newly-issued common shares to be
credited to each participants account will be determined
by dividing the dollar amount of the dividend by the net asset
value per common share on the payment date; provided that, if
the net asset value per common share is less than 95% of the
market price per common share on the payment date, the dollar
amount of the dividend will be divided by 95% of the market
price per common share on the payment date.
If, on the payment date for any dividend, the net asset value
per common share is greater than the market value per common
share plus estimated brokerage commissions (such condition being
referred to in this Prospectus as
71
market discount), the Plan Agent will invest the
dividend amount in common shares acquired on behalf of the
participants in open-market purchases.
In the event of a market discount on the payment date for any
dividend, the Plan Agent will have until the last business day
before the next date on which the common shares trade on an
ex-dividend basis or 120 days after the payment
date for such dividend, whichever is sooner (the last
purchase date), to invest the dividend amount in common
shares acquired in open-market purchases. It is contemplated
that the Fund will pay quarterly dividends. Therefore, the
period during which open-market purchases can be made will exist
only from the payment date of each dividend through the date
before the ex-dividend date of the third month of
the quarter. If, before the Plan Agent has completed its
open-market purchases, the market price of a common share
exceeds the net asset value per common share, the average per
common share purchase price paid by the Plan Agent may exceed
the net asset value of the common shares, resulting in the
acquisition of fewer common shares than if the dividend had been
paid in newly-issued common shares on the dividend payment date.
Because of the foregoing difficulty with respect to open market
purchases, if the Plan Agent is unable to invest the full
dividend amount in open market purchases during the purchase
period or if the market discount shifts to a market premium
during the purchase period, the Plan Agent may cease making
open-market purchases and may invest the uninvested portion of
the dividend amount in newly-issued common shares at the net
asset value per common share at the close of business on the
last purchase date; provided that, if the net asset value per
common share is less than 95% of the market price per common
share on the payment date, the dollar amount of the dividend
will be divided by 95% of the market price per common share on
the payment date.
The Plan Agent maintains all shareholders accounts in the
Plan and furnishes written confirmation of all transactions in
the accounts, including information needed by shareholders for
tax records. Common shares in the account of each Plan
participant will be held by the Plan Agent on behalf of the Plan
participant, and each shareholder proxy will include those
shares purchased or received pursuant to the Plan. The Plan
Agent or its designee will forward all proxy solicitation
materials to participants and vote proxies for shares held under
the Plan in accordance with the instructions of the participants.
In the case of shareholders such as banks, brokers or nominees
which hold shares for others who are the beneficial owners, the
Plan Agent will administer the Plan on the basis of the number
of common shares certified from time to time by the record
shareholders name and held for the account of beneficial
owners who participate in the Plan.
There will be no brokerage charges with respect to common shares
issued directly by the Fund. However, each participant will pay
a pro rata share of brokerage commissions incurred in connection
with open-market purchases. The automatic reinvestment of
dividends will not relieve participants of any federal, state or
local income tax that may be payable (or required to be
withheld) on such dividends. Accordingly, any taxable dividend
received by a participant that is reinvested in additional
common shares will be subject to federal (and possibly state and
local) income tax even though such participant will not receive
a corresponding amount of cash with which to pay such taxes. See
Certain U.S. Federal Income Tax Considerations.
The Fund reserves the right to amend or terminate the Plan.
There is no direct service charge to participants in the Plan;
however, the Fund reserves the right to amend the Plan to
include a service charge payable by the participants.
For more information about the Plan you may contact the Plan
Agent in writing at PO Box 708, Milwaukee,
WI 53201-0701,
or by calling the Plan Agent.
DESCRIPTION
OF SHARES
The following is a brief description of the terms of the common
shares and preferred shares which may be issued by the Fund.
This description does not purport to be complete and is
qualified by reference to the Funds Governing Documents.
The Fund is a statutory trust organized under the laws of
Delaware pursuant to a Certificate of Trust dated July 18,
2011, as filed with the State of Delaware on July 18, 2011
and as amended through the date hereof.
72
Common
Shares
The Fund is authorized to issue an unlimited number of common
shares of beneficial interest, par value $0.001 per share. Each
common share has one vote and, when issued and paid for in
accordance with the terms of this offering, will be fully paid
and non-assessable, except that the Board of Trustees will have
the power to cause shareholders to pay expenses of the Fund by
setting off charges due from shareholders from declared but
unpaid distributions owed the shareholders
and/or by
reducing the number of common shares owned by each respective
shareholder. The Fund currently is not aware of any expenses
that will be paid pursuant to this provision, except to the
extent fees payable under its Dividend Reinvestment Plan are
deemed to be paid pursuant to this provision.
The Fund intends to hold annual meetings of shareholders so long
as the common shares are listed on a national securities
exchange and such meetings are required as a condition to such
listing. All common shares are equal as to distributions, assets
and voting privileges and have no conversion, preemptive or
other subscription rights. The Fund will send annual and
semi-annual reports, including financial statements, to all
holders of its shares.
The Fund has no present intention of offering any additional
shares other than common shares issued under the Funds
Dividend Reinvestment Plan. Any additional offerings of shares
will require approval by the Board of Trustees. Any additional
offering of common shares will be subject to the requirements of
the 1940 Act, which provides that shares may not be issued at a
price below the then current net asset value, except in
connection with an offering to existing holders of common shares
or with the consent of a majority of the Funds common
shareholders.
The Funds common shares are expected to be listed on the
New York Stock Exchange under the symbol SRF.
Net asset value will be reduced immediately following the
offering of common shares by the amount of the sales load and
offering costs paid by the Fund. See Summary of
Fund Expenses.
Unlike open-end funds, closed-end funds like the Fund do not
continuously offer shares and do not provide daily redemptions.
Rather, if a shareholder determines to buy additional common
shares or sell shares already held, the shareholder may do so by
trading through a broker on the NYSE or otherwise. Shares of
closed-end funds frequently trade on an exchange at prices lower
than net asset value. Because the market value of the common
shares may be influenced by such factors as distribution levels
(which are in turn affected by expenses), distribution
stability, net asset value, relative demand for and supply of
such shares in the market, general market and economic
conditions and other factors beyond the control of the Fund, the
Fund cannot assure you that common shares will trade at a price
equal to or higher than net asset value in the future. The
common shares are designed primarily for long-term investors,
and you should not purchase the common shares if you intend to
sell them soon after purchase.
Preferred
Shares
The Funds Agreement and Declaration of Trust provides that
the Board of Trustees may authorize and issue preferred shares
with rights as determined by the Board of Trustees, by action of
the Board of Trustees without the approval of the holders of the
common shares. Holders of common shares have no preemptive right
to purchase any preferred shares that might be issued pursuant
to such provision. Whenever preferred shares are outstanding,
the holders of common shares will not be entitled to receive any
distributions from the Fund unless all accrued distributions on
preferred shares have been paid, unless asset coverage (as
defined in the 1940 Act) with respect to preferred shares would
be at least 200% after giving effect to the distributions and
unless certain other requirements imposed by any rating agencies
rating the preferred shares have been met. If the Board of
Trustees determines to proceed with such an offering, the terms
of the preferred shares may be the same as, or different from,
the terms described below, subject to applicable law and the
Agreement and Declaration of Trust. The Board of Trustees,
without the approval of the holders of common shares, may
authorize an offering of preferred shares or may determine not
to authorize such an offering and may fix the terms of the
preferred shares to be offered. As of the date of this
Prospectus, the Fund has not issued any preferred shares, and
the Board of Trustees has no present intention to issue
preferred shares.
Liquidation Preference. In the event of any
voluntary or involuntary liquidation, dissolution or winding up
of the Fund, the holders of preferred shares will be entitled to
receive a preferential liquidating distribution, which is
expected to equal the original purchase price per preferred
share plus accrued and unpaid distributions, whether or not
declared, before any distribution of assets is made to holders
of common shares. After payment of the full
73
amount of the liquidating distribution to which they are
entitled, the holders of preferred shares will not be entitled
to any further participation in any distribution of assets by
the Fund.
Voting Rights. The 1940 Act requires that the
holders of any preferred shares, voting separately as a single
class, have the right to elect at least two trustees at all
times. The remaining trustees will be elected by holders of
common shares and preferred shares, voting together as a single
class. In addition, subject to the prior rights, if any, of the
holders of any other class of senior securities outstanding, the
holders of any preferred shares have the right to elect a
majority of the trustees of the Fund at any time two years of
distributions on any preferred shares are unpaid. The 1940 Act
also requires that, in addition to any approval by shareholders
that might otherwise be required, the approval of the holders of
a majority of any outstanding preferred shares, voting
separately as a class, would be required to (i) adopt any
plan of reorganization that would adversely affect the preferred
shares, and (ii) take any action requiring a vote of
security holders under Section 13(a) of the 1940 Act,
including, among other things, changes in the Funds
subclassification as a closed-end fund or changes in its
fundamental investment restrictions. As a result of these voting
rights, the Funds ability to take any such actions may be
impeded to the extent that there are any preferred shares
outstanding. The Board of Trustees presently intends that,
except as otherwise indicated in this Prospectus and except as
otherwise required by applicable law, holders of preferred
shares will have equal voting rights with holders of common
shares (one vote per share, unless otherwise required by the
1940 Act) and will vote together with holders of common shares
as a single class.
The affirmative vote of the holders of a majority of the
outstanding preferred shares, voting as a separate class, will
be required to amend, alter or repeal any of the preferences,
rights or powers of holders of preferred shares so as to affect
materially and adversely such preferences, rights or powers, or
to increase or decrease the authorized number of preferred
shares. The class vote of holders of preferred shares described
above will in each case be in addition to any other vote
required to authorize the action in question.
Redemption, Purchase and Sale of Preferred Shares by the
Fund. The terms of any issued preferred shares
are expected to provide that (i) they are redeemable by the
Fund in whole or in part at the original purchase price per
share plus accrued distributions per share, (ii) the Fund
may tender for or purchase preferred shares and (iii) 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 the common shares,
while any resale of shares by the Fund will increase that
leverage.
Other
Shares
The Board of Trustees (subject to applicable law and the
Agreement and Declaration of Trust) may authorize an offering,
without the approval of the holders of either common shares or
preferred shares, of other classes of shares, or other classes
or series of shares, as they determine to be necessary,
desirable or appropriate, having such terms, rights,
preferences, privileges, limitations and restrictions as the
Board of Trustees deems appropriate. The Fund currently does not
expect to issue any other classes of shares, or series of
shares, except for the common shares.
ANTI-TAKEOVER
PROVISIONS IN THE AGREEMENT AND DECLARATION OF TRUST
The Agreement and Declaration of Trust includes provisions that
could have the effect of limiting the ability of other entities
or persons to acquire control of the Fund or to change the
composition of its Board of Trustees. This could have the effect
of depriving shareholders of an opportunity to sell their shares
at a premium over prevailing market prices by discouraging a
third party from seeking to obtain control over the Fund. Such
attempts could have the effect of increasing the expenses of the
Fund and disrupting the normal operation of the Fund. The Board
of Trustees is divided into two classes, with the terms of one
class expiring at each annual meeting of shareholders. At each
annual meeting, one class of Trustees is elected to a two-year
term. This provision could delay for up to two years the
replacement of a majority of the Board of Trustees. A Trustee
may be removed from office (with or without cause) by the action
of a majority of the remaining Trustees followed by a vote of
the holders of at least 75% of the shares then entitled to vote
for the election of the respective Trustee.
74
In addition, the Agreement and Declaration of Trust requires the
favorable vote of a majority of the Funds Board of
Trustees followed by the favorable vote of the holders of at
least 75% of the outstanding shares of each affected class or
series of the Fund, voting separately as a class or series, to
approve, adopt or authorize certain transactions with 5% or
greater holders of a class or series of shares and their
associates, unless the transaction has been approved by at least
75% of the Trustees, in which case a majority of the
outstanding voting securities (as defined in the 1940 Act)
of the Fund will be required. For purposes of these provisions,
a 5% or greater holder of a class or series of shares (a
Principal Shareholder) refers to any person who,
whether directly or indirectly and whether alone or together
with its affiliates and associates, beneficially owns 5% or more
of the outstanding shares of all outstanding classes or series
of shares of beneficial interest of the Fund.
The 5% holder transactions subject to these special approval
requirements are: the merger or consolidation of the Fund or any
subsidiary of the Fund with or into any Principal Shareholder;
the issuance of any securities of the Fund to any Principal
Shareholder for cash, except pursuant to any automatic dividend
reinvestment plan; the sale, lease or exchange of any 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 the sale, lease or exchange to the Fund
or any subsidiary of the Fund, 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 purposes of such computation all assets sold,
leased or exchanged in any series of similar transactions within
a twelve-month period.
The Funds Agreement and Declaration of Trust limits the
ability of persons to beneficially own (within the meaning of
Section 382 of the Code) more than 4.99% of the outstanding
common shares of the Fund and could have an anti-takeover effect
on the Fund, which could decrease the Funds market price
in certain circumstances or limit the ability of certain
shareholders to influence the management of the Fund. This
restriction is intended to reduce the risk of the Fund
undergoing an ownership change within the meaning of
Section 382 of the Code, which would limit the Funds
ability to use a net operating loss carryforward, a capital loss
carryforward and certain unrealized losses (if such tax
attributes exist). In general, an ownership change occurs if 5%
shareholders (and certain persons or groups treated as 5%
shareholders) of the Fund increase their ownership percentage in
the Fund by more than 50 percentage points in the aggregate
within any three-year period ending on certain defined testing
dates. If an ownership change were to occur, Section 382
would impose an annual limitation on the amount of
post-ownership change income that the Fund may offset with
pre-ownership change losses, and might impose restrictions on
the Funds ability to use certain unrealized losses
existing at the time of the ownership change. Such a limitation
arising under Section 382 could reduce the benefit of the
Funds then existing net operating loss carryforward,
capital loss carryforward or unrealized losses, if any.
To convert the Fund to an open-end investment company, the
Agreement and Declaration of Trust requires the favorable vote
of a majority of the board of the Trustees followed by the
favorable vote of the holders of at least 75% of the outstanding
shares of each affected class or series of shares of the Fund,
voting separately as a class or series, unless such amendment
has been approved by 75% of the Trustees, in which case a
majority of the outstanding voting securities (as defined
in the 1940 Act) of the Fund will be required. The foregoing
vote would satisfy a separate requirement in the 1940 Act that
any conversion of the Fund to an open-end investment company be
approved by the shareholders.
For the purposes of calculating a majority of the
outstanding voting securities under the Agreement and
Declaration of Trust, each class and series of the Fund will
vote together as a single class, except to the extent required
by the 1940 Act or the Agreement and Declaration of Trust, with
respect to any class or series of shares. If a separate class
vote is required, the applicable proportion of shares of the
class or series, voting as a separate class or series, also will
be required.
The Agreement and Declaration of Trust also provides that the
Fund may be dissolved and terminated upon the approval of 75% of
the Trustees by written notice to the shareholders.
The Board of Trustees has determined that provisions with
respect to the Board of Trustees and the shareholder voting
requirements described above, which voting requirements are
greater than the minimum requirements under Delaware law or the
1940 Act, are in the best interest of shareholders generally.
Reference should be made to the Agreement and Declaration of
Trust, on file with the SEC for the full text of these
provisions.
75
CERTAIN
PROVISIONS OF DELAWARE LAW, THE AGREEMENT
AND DECLARATION OF TRUST AND BYLAWS
Classified Board of Trustees. The Funds
Board of Trustees is divided into two classes of trustees
serving staggered two-year terms. Upon expiration of their
current terms, Trustees of each class will be elected to serve
for two-year terms and until their successors are duly elected
and qualified or the Fund terminates, and each year one class of
Trustees will be elected by the shareholders. A classified board
may render a change in control of the Fund or removal of the
Funds incumbent management more difficult. The Fund
believes, however, that the longer time required to elect a
majority of a classified Board of Trustees will help to ensure
the continuity and stability of its management and policies.
Election of Trustees. The Funds
Agreement and Declaration of Trust provides that the affirmative
vote of the holders of a plurality of the outstanding shares
entitled to vote in the election of Trustees will be required to
elect a Trustee.
Number of Trustees; Vacancies; Removal. The
Funds Agreement and Declaration of Trust provides that the
number of Trustees will be set by the Board of Trustees. The
Funds Agreement and Declaration of Trust provides that a
majority of the Funds Trustees then in office may at any
time increase or decrease the number of Trustees provided there
will be at least one Trustee. As soon as any such Trustee has
accepted his appointment in writing, the trust estate will vest
in the new Trustee, together with the continuing Trustees,
without any further act or conveyance, and he will be deemed a
Trustee thereunder. The Trustees power of appointment is
subject to Section 16(a) of the 1940 Act. Whenever a
vacancy in the number of Trustees will occur, until such vacancy
is filled as provided, the Trustees in office, regardless of
their number, will have all the powers granted to the Trustees
and will discharge all the duties imposed upon the Trustees by
the Declaration.
Action by Shareholders. Shareholder action can
be taken only at an annual or special meeting of shareholders or
by written consent in lieu of a meeting.
Advance Notice Provisions for Shareholder Nominations and
Shareholder Proposals. The Funds Bylaws
provide that with respect to an annual meeting of shareholders,
nominations of persons for election to the Board of Trustees and
the proposal of business to be considered by shareholders may be
made only (1) pursuant to the Funds notice of the
meeting, (2) by the Board of Trustees or (3) by a
shareholder of record both at the time of giving of notice and
at the time of the annual meeting who is entitled to vote at the
meeting and who has complied with the advance notice procedures
of the Bylaws. With respect to special meetings of shareholders,
only the business specified in the Funds notice of the
meeting may be brought before the meeting. Nominations of
persons for election to the Board of Trustees at a special
meeting may be made only (1) pursuant to the Funds
notice of the meeting, (2) by the Board of Trustees or
(3) provided that the Board of Trustees has determined that
Trustees will be elected at the meeting, by a shareholder of
record both at the time of giving of notice and at the time of
the annual meeting who is entitled to vote at the meeting and
who has complied with the advance notice provisions of the
Bylaws.
Calling of Special Meetings of
Shareholders. The Funds Bylaws provide that
special meetings of shareholders may be called at any time by
the Chairman, the President or the Trustees. By following
certain procedures, a special meeting of shareholders will also
be called by the Secretary of the Trust upon the written request
of the Shareholders entitled to cast not less than a majority of
all the votes entitled to be cast at such meeting.
CLOSED-END
FUND STRUCTURE
Closed-end funds differ from open-end management investment
companies (commonly referred to as mutual funds).
Closed-end funds generally list their shares for trading on a
securities exchange and do not redeem their shares at the option
of the shareholder. In contrast, mutual funds issue securities
redeemable at net asset value at the option of the shareholder
and typically engage in a continuous offering of their shares.
Although mutual funds are subject to continuous asset in-flows
and out-flows that can complicate portfolio management,
closed-end funds generally can stay more fully invested in
securities consistent with the closed-end funds investment
objective and policies. Accordingly, closed-end funds have
greater flexibility than open-end funds to make certain types of
investments, including investments in illiquid securities.
76
Shares of closed-end funds listed for trading on a securities
exchange frequently trade at discounts to their net asset value,
but in some cases trade at a premium. The market price may be
affected by net asset value, dividend or distribution levels
(which are dependent, in part, on expenses), supply of and
demand for the shares, stability of dividends or distributions,
trading volume of the shares, general market and economic
conditions and other factors beyond the control of the
closed-end fund. The foregoing factors may result in the market
price of the Funds common shares being greater than, less
than or equal to net asset value. The Board of Trustees has
reviewed the Funds structure in light of its investment
objective and policies and has determined that the closed-end
structure is in the best interests of the Funds
shareholders. However, the Board of Trustees may periodically
review the trading range and activity of the Funds shares
with respect to their net asset value and may take certain
actions to seek to reduce or eliminate any such discount. Such
actions may include open market repurchases or tender offers for
the Funds common shares at net asset value or the
Funds possible conversion to an open-end mutual fund.
There can be no assurance that the Board of Trustees will decide
to undertake any of these actions or that, if undertaken, such
actions would result in the Funds common shares trading at
a price equal to or close to net asset value per share of its
common shares.
To convert the Fund to an open-end investment company, the
Agreement and Declaration of Trust requires the favorable vote
of a majority of the board of the Trustees followed by the
favorable vote of the holders of at least 75% of the outstanding
shares of each affected class or series of shares of the Fund,
voting separately as a class or series, unless such amendment
has been approved by 75% of the Trustees, in which case a
majority of the outstanding voting securities (as defined
in the 1940 Act) of the Fund will be required. The foregoing
vote would satisfy a separate requirement in the 1940 Act that
any conversion of the Fund to an open-end investment company be
approved by the shareholders. Following any such conversion, it
is possible that certain of the Funds investment policies
and strategies would have to be modified to assure sufficient
portfolio liquidity. In the event of conversion, the Fund would
be required to redeem any preferred shares then outstanding
(requiring in turn that it liquidate a portion of its investment
portfolio) and the common shares would cease to be listed on the
New York Stock Exchange or other national securities exchanges
or market systems. Shareholders of an open-end investment
company may require the investment company to redeem their
shares at any time (except in certain circumstances as
authorized by or permitted under the 1940 Act) at their net
asset value, less such redemption charge, if any, as might be in
effect at the time of redemption. In order to avoid maintaining
large cash positions or liquidating favorable investments to
meet redemptions, open-end investment companies typically engage
in a continuous offering of their shares. Open-end investment
companies are thus subject to periodic asset in-flows and
out-flows that can complicate portfolio management. The
Funds Board of Trustees may at any time propose the
Funds conversion to open-end status, depending upon its
judgment regarding the advisability of such action in light of
circumstances then prevailing. However, based on the
determination of the Board of Trustees in connection with this
initial offering of the Funds common shares that the
closed-end structure is desirable in light of the Funds
investment objective and policies, it is highly unlikely that
the Board of Trustees would vote to convert the Fund to an
open-end investment company.
REPURCHASE
OF COMMON SHARES
In recognition of the possibility that the Funds common
shares might trade at a discount to net asset value and that any
such discount may not be in the interest of the Funds
common shareholders, the Board of Trustees, in consultation with
the Investment Adviser, from time to time may, but is not
required to, review possible actions to reduce any such
discount. The Board of Trustees also may, but is not required
to, consider from time to time open market repurchases of
and/or
tender offers for the Funds common shares, as well as
other potential actions, to seek to reduce any market discount
from net asset value that may develop. After any consideration
of potential actions to seek to reduce any significant market
discount, the Board of Trustees may, subject to its applicable
duties and compliance with applicable U.S. state and
federal laws, authorize the commencement of a share-repurchase
program or tender offer. The size and timing of any such share
repurchase program or tender offer will be determined by the
Board of Trustees in light of the market discount of the
Funds common shares, trading volume of the Funds
common shares, information presented to the Board of Trustees
regarding the potential impact of any such share repurchase
program or tender offer, general market and economic conditions
and applicable law. There can be no assurance that the Fund will
in fact effect repurchases of or tender offers for any of its
common shares. The Fund may, subject to its investment
limitation with respect to borrowings, incur debt to finance
such repurchases or a tender offer or for other valid purposes.
Interest on any such borrowings would increase the Funds
expenses and reduce its net income.
77
There can be no assurance that repurchases of the Funds
common shares or tender offers, if any, will cause its common
shares to trade at a price equal to or in excess of their net
asset value. Nevertheless, the possibility that a portion of the
Funds outstanding common shares may be the subject of
repurchases or tender offers may reduce the spread between
market price and net asset value that might otherwise exist.
Sellers may be less inclined to accept a significant discount in
the sale of their common shares if they have a reasonable
expectation of being able to receive a price of net asset value
for a portion of their common shares in conjunction with an
announced repurchase program or tender offer for the Funds
common shares.
Although the Board of Trustees believes that repurchases or
tender offers generally would have a favorable effect on the
market price of the Funds common shares, the acquisition
of common shares by the Fund will decrease its total assets and
therefore will have the effect of increasing its expense ratio
and decreasing the asset coverage with respect to any preferred
shares outstanding. Because of the nature of the Funds
investment objective, policies and portfolio, particularly its
investment in illiquid or otherwise restricted securities, it is
possible that repurchases of common shares or tender offers
could interfere with the Funds ability to manage its
investments in order to seek its investment objective. Further,
it is possible that the Fund could experience difficulty in
borrowing money or be required to dispose of portfolio
securities to consummate repurchases of or tender offers for
common shares.
CERTAIN
U.S. FEDERAL INCOME TAX CONSIDERATIONS
The following is a summary of the material U.S. federal
income tax considerations generally applicable to
U.S. Shareholders (as defined below) that acquire shares
and that hold such shares as capital assets (generally, for
investment). The discussion is based upon the Code, Treasury
Regulations, judicial authorities, published positions of the
Internal Revenue Service (the IRS) and other
applicable authorities, all as in effect on the date hereof and
all of which are subject to change or differing interpretations
(possibly with retroactive effect). This summary does not
address all of the potential U.S. federal income tax
consequences that may be applicable to the Fund or to all
categories of investors (for example,
non-U.S. investors),
some of which may be subject to special tax rules. No ruling has
been or will be sought from the IRS regarding any matter
discussed herein. No assurance can be given that the IRS would
not assert, or that a court would not sustain, a position
contrary to any of the tax aspects set forth below. This summary
of U.S. federal income tax consequences is for general
information only. Prospective investors must consult their
own tax advisors as to the U.S. federal income tax
consequences of acquiring, holding and disposing of shares, as
well as the effects of state, local and
non-U.S. tax
laws.
For purposes of this summary, the term
U.S. Shareholder means a beneficial owner of
shares of the Fund that, for U.S. federal income tax
purposes, is one of the following:
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an individual who is a citizen or resident of the United States;
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a corporation or other entity taxable as a corporation created
in or organized under the laws of the United States, any
state thereof or the District of Columbia;
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an estate the income of which is subject to U.S. federal
income taxation regardless of its source; or
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a trust (x) if a U.S. court is able to exercise
primary supervision over the administration of such trust and
one or more U.S. persons have the authority to control all
substantial decisions of such trust or (y) that has a valid
election in effect under applicable U.S. Treasury
regulations to be treated as a U.S. person.
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If a partnership (including any other entity treated as a
partnership for U.S. federal income tax purposes) holds
shares, the U.S. federal income tax treatment of a partner
in such partnership generally will depend upon the status of the
partner and the activities of the partnership. Partners of
partnerships that hold shares should consult their tax advisors.
The
Fund
The Fund will be treated as a regular corporation, or
C corporation, for U.S. federal income tax
purposes. Accordingly, the Fund generally will be subject to
U.S. federal income tax on its taxable income at the
graduated rates applicable to corporations (currently a maximum
rate of 35%). In addition, as a regular corporation, the Fund
will be subject to state and local income taxes by reason of its
investments in equity securities of U.S. royalty trusts and
MLPs. Therefore, the Fund may have state and local income tax
liabilities in multiple states, which will reduce
78
the Funds cash available to make distributions on the
shares. The Fund may be subject to a 20% alternative minimum tax
on its alternative minimum taxable income to the extent that the
alternative minimum tax exceeds the Funds regular income
tax liability. The extent to which the Fund is required to pay
U.S. corporate income tax or alternative minimum tax could
materially reduce the Funds cash available to make
distributions.
The Fund intends to invest a portion of its assets in MLPs,
which are generally treated as partnerships for
U.S. federal income tax purposes. To the extent that the
Fund invests in the equity securities of an MLP, the Fund will
be a partner in such MLP. Accordingly, the Fund will be required
to include in its taxable income the Funds allocable share
of the income, gains, losses, deductions and expenses recognized
by each such MLP, regardless of whether the MLP distributes cash
to the Fund. Based upon a review of the historic results of the
type of MLPs in which the Fund intends to invest, the Fund
expects that the cash distributions it will receive with respect
to its investments in equity securities of MLPs will exceed the
taxable income allocated to the Fund from such MLPs. No
assurance, however, can be given in this regard. If this
expectation is not realized, the Fund will have a larger
corporate income tax expense than expected, which will result in
less cash available for distribution to shareholders.
The Fund will recognize gain or loss on the sale, exchange or
other taxable disposition of an equity security of an MLP equal
to the difference between the amount realized by the Fund on the
sale, exchange or other taxable disposition and the Funds
adjusted tax basis in such equity security. Any such gain will
be subject to U.S. federal income tax at the regular
graduated corporate rates (currently a maximum rate of 35%),
regardless of how long the Fund has held such equity security.
The amount realized by the Fund generally will be the amount
paid by the purchaser of the equity security plus the
Funds allocable share, if any, of the MLPs debt that
will be allocated to the purchaser as a result of the sale,
exchange or other taxable disposition. The Funds tax basis
in its equity securities in an MLP generally will be equal to
the amount the Fund paid for the equity securities,
(x) increased by the Funds allocable share of the
MLPs net taxable income and certain MLP nonrecourse debt,
if any, and (y) decreased by the Funds allocable
share of the MLPs net losses and any distributions
received by the Fund from the MLP. Although any distribution by
an MLP to the Fund in excess of the Funds allocable share
of such MLPs net taxable income may create a temporary
economic benefit to the Fund, such distribution will decrease
the Funds tax basis in an equity security and, as a
result, increase the amount of gain (or decrease the amount of
loss) that will be recognized on the sale of the equity security
in the MLP by the Fund. If the Fund is required to sell equity
securities in the MLPs to meet redemption requests, the Fund
likely will recognize income
and/or gain
for U.S. federal, state and local income tax purposes,
which will result in corporate income taxes imposed on the Fund
and decrease cash available for distribution to shareholders. To
the extent that the Fund has a net capital loss in any tax year,
the net capital loss can be carried back three years and forward
five years to reduce the Funds current capital gains,
subject to certain limitations. In the event a capital loss
carryover cannot be utilized in the carryover periods, the
Funds U.S. federal income tax liability may be higher
than expected, which will result in less cash available to
distribute to shareholders.
The Fund also intends to invest in U.S. royalty trusts.
U.S. royalty trusts are generally not subject to
U.S. federal corporate income taxation at the trust or
entity level. Instead, each unitholder of the U.S. royalty
trust is required to take into account its share of all items of
the U.S. royalty trusts income, gain, loss, deduction
and expense. It is possible that the Funds share of
taxable income from a U.S. royalty trust may exceed the
cash actually distributed to it from the U.S. royalty trust
in a given year. In such a case, the Fund will have less
after-tax cash available for distribution to shareholders.
The Funds allocable share of certain percentage depletion
deductions and intangible drilling costs of the MLPs and
U.S. royalty trusts in which the Fund invests may be
treated as items of tax preference for purposes of calculating
the Funds alternative minimum taxable income. Such items
will increase the Funds alternative minimum taxable income
and increase the likelihood that the Fund may be subject to the
alternative minimum tax.
The Fund will not be eligible to elect to be treated as a
regulated investment company under the Code because a regulated
investment company cannot invest more than 25% of its assets in
certain types of publicly traded partnerships.
Certain of the Funds investment practices are subject to
special and complex U.S. federal income tax provisions that
may, among other things, (i) disallow, suspend or otherwise
limit the allowance of certain losses or deductions,
(ii) convert an ordinary loss or a deduction into a capital
loss (the deductibility of which is more limited),
(iii) cause the Fund to recognize income or gain without a
corresponding receipt of cash, (iv) adversely
79
affect the time as to when a purchase or sale of stock or
securities is deemed to occur, and (v) adversely alter the
characterization of certain complex financial transactions.
U.S.
Shareholders
Distributions. Distributions by the Fund of
cash or property in respect of the shares of the Fund will be
treated as dividends for U.S. federal income tax purposes
to the extent paid from the Funds current or accumulated
earnings and profits (as determined under U.S. federal
income tax principles). Any such dividend will be eligible for
the dividends received deduction if received by an otherwise
qualifying corporate U.S. Shareholder that meets the
holding period and other requirements for the dividends received
deduction. Dividends paid by the Fund to certain non-corporate
U.S. Shareholders (including individuals), with respect to
taxable years beginning on or before December 31, 2012, are
eligible for U.S. federal income taxation at the rates
generally applicable to long-term capital gains for individuals
(currently at a maximum tax rate of 15%), provided that the
U.S. Shareholder receiving the dividend satisfies
applicable holding period and other requirements. For taxable
years beginning after December 31, 2012, dividends paid by
the Fund to certain non-corporate U.S. Shareholders
(including individuals) will be fully taxable at ordinary income
(i.e., currently up to 39.6%) rates unless further Congressional
action is taken.
If the amount of a distribution by the Fund exceeds the
Funds current and accumulated earnings and profits, such
excess will be treated first as a return of capital to the
extent of the U.S. Shareholders tax basis in the
shares of the Fund, which will not be subject to tax, and
thereafter as capital gain. Any such capital gain will be
long-term capital gain if such U.S. Shareholder has held
the applicable shares of the Fund for more than one year.
The Funds earnings and profits are generally calculated by
making certain adjustments to the Funds taxable income.
Based upon the Funds review of the historic results of the
type of MLPs in which the Fund intends to invest, the Fund
currently expects that the cash distributions it will receive
with respect to its investments in equity securities of MLPs
will exceed the Funds current and accumulated earnings and
profits. Accordingly, the Fund expects that only a portion of
its distributions to its shareholders with respect to the shares
of the Fund will be treated as dividends for U.S. federal
income tax purposes. No assurance, however, can be given in this
regard.
Because the Fund will invest a substantial portion of its assets
in MLPs, special rules will apply to the calculation of the
Funds earnings and profits. For example, the Funds
earnings and profits will be calculated using the straight-line
depreciation method rather than the accelerated depreciation
method. This difference in treatment may, for example, result in
the Funds earnings and profits being higher than the
Funds taxable income in a particular year if the MLPs in
which the Fund invests calculate their income using accelerated
depreciation. Because of these differences, the Fund may make
distributions in a particular year out of earnings and profits
(treated as dividends) in excess of the amount of the
Funds taxable income for such year.
U.S. Shareholders that participate in the Funds Plan
will be treated for U.S. federal income tax purposes as
having (i) received a cash distribution equal to the
reinvested amount and (ii) reinvested such amount in shares
of the Fund.
Sales of Shares of the Fund. Upon the sale,
exchange or other taxable disposition of shares of the Fund, a
U.S. Shareholder generally will recognize capital gain or
loss equal to the difference between the amount realized on the
sale, exchange or other taxable disposition and the
U.S. Shareholders adjusted tax basis in the shares of
the Fund. Any such capital gain or loss will be a long-term
capital gain or loss if the U.S. Shareholder has held the
shares of the Fund for more than one year at the time of
disposition. Long-term capital gains of certain non-corporate
U.S. Shareholders (including individuals) are currently
subject to U.S. federal income taxation at a maximum rate
of 15% (scheduled to increase to 20% for taxable years beginning
after December 31, 2012). The deductibility of capital
losses is subject to limitations under the Code.
A U.S. Shareholders adjusted tax basis in its shares
of the Fund may be less than the price paid for the shares of
the Fund as a result of distributions by the Fund in excess of
the Funds earnings and profits (i.e., returns of capital).
80
UNDERWRITING
Stifel, Nicolaus & Company, Incorporated, RBC Capital
Markets, LLC and Oppenheimer & Co. Inc. are acting as
representatives of the underwriters named below. Subject to the
terms and conditions stated in the Funds underwriting
agreement
dated ,
2012, each underwriter named below has severally agreed to
purchase, and the Fund has agreed to sell to that underwriter,
the number of common shares set forth opposite the
underwriters name.
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Number of
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Underwriters
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Common Shares
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Stifel, Nicolaus & Company, Incorporated
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RBC Capital Markets, LLC
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Oppenheimer & Co. Inc.
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Robert W. Baird & Co. Incorporated
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BB&T Capital Markets, a division of Scott &
Stringfellow, LLC
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Janney Montgomery Scott LLC
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Ladenburg Thalmann & Co. Inc.
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Mitsubishi UFJ Securities (USA), Inc.
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Wunderlich Securities, Inc
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Boenning & Scattergood, Inc.
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Global Hunter Securities, LLC
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Knight Capital Americas, L.P.
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Maxim Group LLC
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National Securities Corporation
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Pershing LLC
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Southwest Securities, Inc.
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Total
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The underwriting agreement provides that the obligations of the
underwriters to purchase the common shares included in this
offering are subject to approval of legal matters by counsel and
to other conditions. The underwriters are obligated to purchase
all the common shares (other than those covered by the
over-allotment option described below) if they purchase any of
the common shares.
The underwriters propose to offer some of the common shares
directly to the public at the public offering price set forth on
the cover page of this Prospectus and some of the common shares
to dealers at the public offering price less a concession not to
exceed $ per share. The sales load
the Fund will pay of $1.125 per share is equal to 4.50% of the
initial offering price. The underwriters may allow, and such
dealers may reallow, a concession not to exceed
$ per share on sales to other
dealers. If all of the common shares are not sold at the initial
offering price, the representatives may change the public
offering price and other selling terms. Investors must pay for
any common shares purchased on or
before ,
2012. The representatives have advised the Fund that the
underwriters do not intend to confirm any sales to any accounts
over which they exercise discretionary authority.
The Fund has granted to the underwriters an option, exercisable
for 45 days from the date of this Prospectus, to purchase
up
to
additional common shares at the public offering price less the
sales load. The underwriters may exercise such option solely for
the purpose of covering over-allotments, if any, in connection
with this offering. To the extent such option is exercised, each
underwriter will be obligated, subject to certain conditions, to
purchase a number of additional common shares approximately
proportionate to such underwriters initial purchase
commitment.
81
We and all trustees and officers and the holders of all of our
outstanding stock have agreed that, without the prior written
consent of the representatives on behalf of the underwriters, we
and they will not, during the period ending 180 days after
the date of this Prospectus:
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offer, pledge, sell, contract to sell, sell any option or
contract to purchase, purchase any option or contract to sell,
grant any option, right or warrant to purchase, lend or
otherwise transfer or dispose of, directly or indirectly, any
common shares or any securities convertible into or exercisable
or exchangeable for common shares;
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file any registration statement with the Securities and Exchange
Commission relating to the offering of any common shares or any
securities convertible into or exercisable or exchangeable for
common shares; or
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enter into any swap or other arrangement that transfers to
another, in whole or in part, any of the economic consequences
of ownership of the common shares;
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whether any such transaction described above is to be settled by
delivery of common shares or such other securities, in cash or
otherwise. Notwithstanding the foregoing, if (i) during the
last 17 days of the
180-day
restricted period, we issue an earnings release or announce
material news or a material event relating to the Fund; or
(ii) prior to the expiration of the
180-day
restricted period, we announce that we will release earnings
results during the
16-day
period beginning on the last day of the
180-day
restricted period, the restrictions described above shall
continue to apply until the expiration of the
18-day
period beginning on the date of the earnings release or the
announcement of the material news or material event. These
lock-up
agreements will not apply to the common shares to be sold
pursuant to the underwriting agreement or any common shares
issued pursuant to our Dividend Reinvestment Plan or any
preferred share issuance, if any.
To meet the NYSE distribution requirements for trading, the
underwriters have undertaken to sell common shares in a manner
such that shares are held by a minimum of 400 beneficial owners
in lots of 100 or more, at least 1,100,000 common shares are
publicly held in the United States and the aggregate market
value of publicly held shares in the United States will be at
least $60 million. The minimum investment requirement is
100 common shares ($2,500 ). The Funds common shares are
expected to be listed on the NYSE, subject to notice of
issuance, under the trading or ticker symbol
SRF.
The following table shows the sales load that the Fund will pay
to the underwriters in connection with this offering. These
amounts are shown assuming both no exercise and full exercise of
the underwriters option to purchase additional common
shares.
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Paid by Fund
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No Exercise
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Full Exercise
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Per share
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$
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1.125
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$
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1.125
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Total
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$
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$
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The Fund and the Investment Adviser have agreed to indemnify the
underwriters against certain liabilities, including liabilities
under the Securities Act, or to contribute to payments the
underwriters may be required to make because of any of those
liabilities.
Certain underwriters may make a market in the common shares
after trading in the common shares has commenced on the NYSE. No
underwriter is, however, obligated to conduct market-making
activities and any such activities may be discontinued at any
time without notice, at the sole discretion of the underwriters.
No assurance can be given as to the liquidity of, or the trading
market for, the common shares as a result of any market-making
activities undertaken by any underwriter. This Prospectus is to
be used by any underwriter in connection with the offering and,
during the period in which a prospectus must be delivered, with
offers and sales of the common shares in market-making
transactions in the
over-the-counter
market at negotiated prices related to prevailing market prices
at the time of the sale.
In connection with the offering, each of Stifel, Nicolaus &
Company, Incorporated, RBC Capital Markets, LLC and Oppenheimer
& Co. Inc., on behalf of itself and the other underwriters,
may purchase and sell common shares in the open market. These
transactions may include short sales, syndicate covering
transactions and stabilizing transactions. Short sales involve
syndicate sales of common shares in excess of the number of
common shares to be
82
purchased by the underwriters in the offering, which creates a
syndicate short position. Covered short sales are
sales of common shares made in an amount up to the number of
common shares represented by the underwriters
over-allotment option. In determining the source of common
shares to close out the covered syndicate short position, the
underwriters will consider, among other things, the price of
common shares available for purchase in the open market as
compared to the price at which they may purchase common shares
through the over-allotment option.
Transactions to close out the covered syndicate short position
involve either purchases of common shares in the open market
after the distribution has been completed or the exercise of the
over-allotment option. The underwriters may also make
naked short sales of common shares in excess of the
over-allotment option. The underwriters must close out any naked
short position by purchasing common shares in the open market. A
naked short position is more likely to be created if the
underwriters are concerned that there may be downward pressure
on the price of common shares in the open market after pricing
that could adversely affect investors who purchase in the
offering. Stabilizing transactions consist of bids for or
purchases of common shares in the open market while the offering
is in progress.
The underwriters may impose a penalty bid. Penalty bids permit
the underwriting syndicate to reclaim selling concessions
allowed to an underwriter or a dealer for distributing common
shares in this offering if the syndicate repurchases common
shares to cover syndicate short positions or to stabilize the
purchase price of the common shares.
Any of these activities may have the effect of preventing or
retarding a decline in the market price of common shares. They
may also cause the price of common shares to be higher than the
price that would otherwise exist in the open market in the
absence of these transactions. The underwriters may conduct
these transactions on the NYSE or in the
over-the-counter
market, or otherwise. If the underwriters commence any of these
transactions, they may discontinue them at any time.
A Prospectus in electronic format may be available on the
websites maintained by one or more of the underwriters. Other
than this Prospectus in electronic format, the information on
any such underwriters website is not part of this
Prospectus. The representatives may agree to allocate a number
of common shares to the underwriters for sale to their online
brokerage account holders. The representatives will allocate
common shares to the underwriters that may make internet
distributions on the same basis as other allocations. In
addition, common shares may be sold by the underwriters to
securities dealers who resell common shares to online brokerage
account holders.
The Fund estimates that its portion of the total expenses of
this offering, excluding the underwriting discounts, will be
approximately $ .
Prior to the initial public offering of common shares, the
Investment Adviser purchased common shares from the Fund in an
amount satisfying the net worth requirements of
Section 14(a) of the 1940 Act. Prior to this offering,
there has been no public or private market for the common shares
or any other securities of the Fund. Consequently, the offering
price for the common shares was determined by negotiation among
the Fund, the Investment Adviser and the representatives. There
can be no assurance, however, that the price at which the common
shares trade after this offering will not be lower than the
price at which they are sold by the underwriters or that an
active trading market in the common shares will develop and
continue after this offering.
No action has been taken in any jurisdiction (except in the
United States) that would permit a public offering of the common
shares, or the possession, circulation or distribution of this
Prospectus or any other material relating to us or the common
shares in any jurisdiction where action for that purposes is
required. Accordingly, the common shares may not be offered or
sold, directly or indirectly, and neither this Prospectus nor
any other offering material or advertisements in connection with
the common shares may be distributed or published, in or from
any country or jurisdiction except in compliance with the
applicable rules and regulations of any such country or
jurisdiction.
Certain of the underwriters and their respective affiliates are
full service financial institutions engaged in various
activities, which may include securities trading, commercial and
investment banking, financial advisory, investment management,
principal investment, hedging, financing and brokerage
activities. Certain of the underwriters and their respective
affiliates have engaged in, and may in the future engage in,
investment banking and other commercial dealings in the ordinary
course of business with the Fund or our affiliates for which
they received or will receive customary fees and expenses.
83
The Investment Adviser has entered into agreements with certain
registered broker/dealers who are not underwriters. These
broker/dealers will provide marketing support to the Investment
Adviser during the course of the offering. Compensation payable
to such broker/dealers will be paid by the Investment Adviser
(and not the Fund).
Pursuant to an engagement letter between the Investment Adviser
and Stifel, Nicolaus & Company, Incorporated, the
Investment Adviser has agreed to provide Stifel a right of first
refusal to act as the Funds lead managing underwriter,
exclusive placement agent, exclusive financial advisor or in any
other similar capacity, with respect to any registered,
underwritten public offering of the Funds securities,
private placement of the Funds securities, merger,
acquisition of another company or business, change of control,
sale of substantially all assets or other similar transaction,
at any time during the term of the engagement letter or within
12 months after the expiration or termination of the
engagement letter.
The principal business address of Stifel, Nicolaus &
Company, Incorporated is 237 Park Avenue, 8th Floor, New York,
NY 10017. The principal business address of RBC Capital Markets,
LLC is One Beacon St., 24th Floor, Boston, MA 02108. The
principal business address of Oppenheimer & Co. Inc. is 85
Broad Street, 23rd Floor, New York, NY 10004.
Additional
Compensation to Underwriters
The Investment Adviser (and not the Fund) has agreed to pay to
Stifel, Nicolaus & Company, Incorporated from its own
assets, a structuring fee for advice relating to the structure,
design and organization of the Fund as well as for services
related to the sale and distribution of the Funds common
shares in the amount of $ . The
structuring fee paid to Stifel, Nicolaus & Company,
Incorporated will not exceed 1.15% of the gross offering
proceeds, including the common shares subject to the
over-allotment option. These services are unrelated to the
Investment Advisers function of advising us as to its
investment in securities or use of investment strategies and
investment techniques.
The Investment Adviser (and not the Fund) has agreed to pay,
from its own assets, a sales incentive fee or additional
compensation in connection with the offering to certain
qualifying underwriters. The total amounts of these payments
paid to any such qualifying underwriters will not exceed 0.50%
of the total price of the common shares sold in the offering
(including those common shares subject to the over-allotment
option). The incentive fees are payable based on the dollar
volume of common shares purchased by such qualifying
underwriter, without taking into account the underwriting
discount.
Total underwriting compensation determined in accordance with
FINRA rules is summarized as follows. The sales load that we
will pay of $1.125 per share is equal to 4.50% of gross
proceeds. We have agreed to reimburse the underwriters the
reasonable fees and disbursements of counsel to the underwriters
in connection with the review by FINRA of the terms of the sale
of the common shares and the filing fees incident to the filling
of marketing materials with FINRA. We have also agreed to
reimburse the underwriters due diligence expenses, in an
amount not to exceed $75,000, and the transportation and other
expenses incurred by the underwriters in connection with
presentations to prospective purchasers of common shares, which
amount will not exceed $25,000. Our Adviser (and not us) will
pay sales incentive or additional compensation and structuring
fees as described above. Total compensation to the underwriters
will not exceed 8.0% of gross proceeds.
OTHER
SERVICE PROVIDERS
U.S. Bancorp Fund Services, LLC, located at 615 East Michigan
Street, Milwaukee, WI 53202, has entered into a transfer agent
servicing agreement with the Fund. Under this agreement,
U.S. Bancorp Fund Services, LLC serves as the
Funds transfer agent registrar, and dividend disbursing
agent.
U.S. Bank, National Association, which is located at
1555 N. Riveright Dr., Suite 302, Milwaukee, WI
53212, acts as custodian of the Funds securities and other
assets.
U.S. Bancorp Fund Services, LLC, the Administrator,
which is located at 615 East Michigan Street, Milwaukee, WI
53202, serves as the Funds administrator pursuant to a
fund administration servicing agreement. Pursuant to this
agreement, the Administrator provides the Fund with, among other
things, compliance oversight,
84
financial reporting oversight and tax reporting. The
Administrator also serves as the Funds fund accountant.
The Administrator will assist in the calculation of the
Funds net asset value. The Administrator will also
maintain and keep current the accounts, books, records and other
documents relating to the Funds financial and portfolio
transactions.
LEGAL
MATTERS
Certain legal matters will be passed on for the Fund by Skadden,
Arps, Slate, Meagher & Flom LLP, New York, New York,
and for the underwriters by Andrews Kurth LLP, New York, New
York in connection with the offering of the common shares.
INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM
Ernst & Young LLP, Dallas, Texas, is the independent
registered public accounting firm of the Fund and is expected to
render an opinion annually on the financial statements of the
Fund.
ADDITIONAL
INFORMATION
The Fund is subject to the informational requirements of the
Securities Exchange Act of 1934 and the 1940 Act and in
accordance with those requirements is required to file reports,
proxy statements and other information with the Securities and
Exchange Commission. Any such reports and other information,
including the Fund and Investment Advisers code of ethics,
can be inspected and copied at the Securities and Exchange
Commissions Public Reference Room, Washington, D.C.
20549-0102.
Information on the operation of such public reference facilities
may be obtained by calling the Securities and Exchange
Commission at
(202) 551-8090.
Copies of such materials can be obtained from the Securities and
Exchange Commissions Public Reference Room, at prescribed
rates, or by electronic request at publicinfo@sec.gov.
The Securities and Exchange Commission maintains a website at
www.sec.gov containing reports and information statements
and other information regarding registrants, including the Fund,
that file electronically with the Securities and Exchange
Commission. Reports, proxy statements and other information
concerning the Fund can also be inspected at the offices of the
New York Stock Exchange, 20 Broad Street, New York, New
York 10005. Copies of the Funds annual and semi-annual
reports may be obtained, without charge, upon request mailed to
The
Cushing®
Royalty & Income Fund,
c/o Cushing®
MLP Asset Management, LP, 8117 Preston Road, Suite 440,
Dallas, Texas 75225 or by calling toll free at
(800) 662-7232
and also are made available on the Funds website at
www.cushingcef.com. You may also call this toll-free
telephone number to request other information about the Fund or
to make shareholder inquiries. Information on, or accessible
through, the Funds website is not a part of, and is not
incorporated into, this Prospectus.
Additional information regarding the Fund is contained in the
registration statement on
Form N-2,
including the SAI and amendments, exhibits and schedules to the
registration statement relating to such shares filed by the Fund
with the Securities and Exchange Commission in
Washington, D.C. This Prospectus does not contain all of
the information set out in the registration statement, including
the SAI and any amendments, exhibits and schedules to the
registration statement. For further information with respect to
the Fund and the common shares offered hereby, reference is made
to the registration statement and the SAI. Statements contained
in this Prospectus as to the contents of any contract or other
document referred to are not necessarily complete and in each
instance reference is made to the copy of such contract or other
document filed as an exhibit to the registration statement, each
such statement being qualified in all respects by such
reference. A copy of the registration statement and the SAI may
be inspected without charge at the Securities and Exchange
Commissions principal office in Washington, D.C., and
copies of all or any part of the registration statement may be
obtained from the Securities and Exchange Commission upon the
payment of certain fees prescribed by the Securities and
Exchange Commission.
You may request a free copy of the Statement of Additional
Information, the table of contents of which is on page 87
of this Prospectus, by calling toll-free at
(800) 662-7232,
or you may obtain a copy (and other information regarding the
Fund) from the SECs web site
(http://www.sec.gov).
The SAI is incorporated by reference in its entirety into this
Prospectus.
85
PRIVACY
POLICY
In order to conduct its business, the Fund collects and
maintains certain nonpublic personal information about its
shareholders with respect to their transactions in shares of the
Fund. This information includes:
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information the Fund receives from you on or in applications or
other forms, correspondence, or conversations, including, but
not limited to, your name, address, phone number, social
security number, assets, income and date of birth; and
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information about your transactions with the Fund, our
affiliates or others, including, but not limited to, your
account number and balance, payment history, parties to
transactions, cost basis information and other financial
information.
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The Fund does not disclose any nonpublic personal information
about you, the Funds other shareholders or the Funds
former shareholders to third parties unless necessary to process
a transaction, service an account, or as otherwise permitted by
law. To protect your personal information internally, the Fund
restricts access to nonpublic personal information about the
Funds shareholders to those employees who need to know
that information to provide services to our shareholders. The
Fund also maintains certain other safeguards to protect your
nonpublic personal information.
In the event that you hold shares of the Fund through a
financial intermediary, including, but not limited to, a
broker-dealer, bank or trust company, the privacy policy of your
financial intermediary would govern how your non-public personal
information would be shared with nonaffiliated third parties.
86
TABLE OF
CONTENTS OF THE STATEMENT OF ADDITIONAL INFORMATION
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THE FUND
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S-2
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INVESTMENT STRATEGIES AND RISKS
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S-2
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STRATEGIC TRANSACTIONS
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S-4
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INVESTMENT RESTRICTIONS
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S-14
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MANAGEMENT OF THE FUND
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PORTFOLIO TRANSACTIONS AND BROKERAGE
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CERTAIN U.S. FEDERAL INCOME TAX CONSIDERATIONS
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SERVICE PROVIDERS
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S-27
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GENERAL INFORMATION
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S-27
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
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FS-1
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FINANCIAL STATEMENTS FOR THE FUND
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FS-2
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APPENDIX A: DESCRIPTION OF SECURITIES RATINGS
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A-1
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APPENDIX B: PROXY VOTING POLICIES AND PROCEDURES
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B-1
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PART C OTHER INFORMATION
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C-1
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87
Until (25 days after the date of this Prospectus), all
dealers that buy, sell or trade the common shares, whether or
not participating in this offering, may be required to deliver a
prospectus. This is in addition to the dealers obligation
to deliver a prospectus when acting as underwriters and with
respect to their unsold allotments or subscriptions.
Shares
The
Cushing®
Royalty & Income Fund
Common Shares
$25.00 per Share
PROSPECTUS
Subject
to Completion, dated February 23, 2012
The information in this Statement of Additional Information is not complete and may be changed.
The Fund may not sell these securities until the registration statement filed with the Securities
and Exchange Commission is effective. This Statement of Additional Information is not an offer to
sell these securities and is not soliciting an offer to buy these securities in any state where the
offer or sale is not permitted.
The Cushing® Royalty & Income Fund
Statement of Additional Information
The Cushing® Royalty & Income Fund (the Fund) is organized as a Delaware statutory trust
and is a newly organized non-diversified, closed-end management investment company. The Funds
investment objective is to seek a high total return, with an emphasis on current income. No
assurance can be given that the Funds investment objective will be achieved.
This Statement of Additional Information (SAI) is not a prospectus, but should be read in
conjunction with the prospectus for the Fund dated , 2012. Investors should obtain and read
the Prospectus prior to purchasing common shares. A copy of the Prospectus may be obtained,
without charge, by calling the Fund at (800) 662-7232.
The Prospectus and this SAI omit certain of the information contained in the registration
statement filed with the Securities and Exchange Commission (SEC). The registration statement
may be obtained from the Securities and Exchange Commission upon payment of the fee prescribed, or
inspected at the Securities and Exchange Commissions office or via its website (www.sec.gov) at no
charge. Capitalized terms used but not defined herein have the meanings ascribed to them in the
Prospectus.
The Fund is managed by Cushing® MLP Asset Management, LP (the Investment Adviser).
TABLE OF CONTENTS
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S-14 |
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S-15 |
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S-23 |
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S-24 |
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S-27 |
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FS-1 |
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FS-2 |
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A-1 |
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B-1 |
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This Statement of Additional Information is dated , 2012.
S-1
THE FUND
The Fund is a newly organized, non-diversified, closed-end management investment company
organized under the laws of the State of Delaware. The Funds common shares of beneficial
interest, par value $.001 (the common shares), are expected to be listed on the New York Stock
Exchange (the NYSE), subject to notice of issuance, under
the symbol SRF.
INVESTMENT STRATEGIES AND RISKS
The sections below describe, in greater detail than in the Prospectus, some of the different
types of investments that may be made by the Fund and the investment practices in which the Fund
may engage. The Fund may make the following investments, among others, some of which are part of
its principal investment strategies and some of which are not. The principal risks of the Funds
principal investment strategies are discussed in the Prospectus. The Fund may not buy all of the
types of securities or use all of the investment techniques that are described.
Repurchase Agreements
The Fund may engage in repurchase agreements with broker-dealers, banks and other financial
institutions to earn a return on temporarily available cash. A repurchase agreement is a short-term
investment in which the purchaser (i.e., the Fund) acquires ownership of a security and the seller
agrees to repurchase the obligation at a future time and set price, thereby determining the yield
during the holding period. Repurchase agreements involve certain risks in the event of default by
the other party. The Fund may enter into repurchase agreements with broker-dealers, banks and other
financial institutions deemed to be creditworthy by the Investment Adviser under guidelines
approved by the Board of Trustees. The Fund does not bear the risk of a decline in the value of the
underlying security unless the seller defaults under its repurchase obligation. In the event of the
bankruptcy or other default of a seller of a repurchase agreement, the Fund could experience both
delays in liquidating the underlying securities and losses including: (a) possible decline in the
value of the underlying security during the period while the Fund seeks to enforce its rights
thereto; (b) possible lack of access to income on the underlying security during this period; and
(c) expenses of enforcing its rights.
Repurchase agreements are fully collateralized by the underlying securities and are considered
to be loans under the 1940 Act. The Fund pays for such securities only upon physical delivery or
evidence of book entry transfer to the account of a custodian or bank acting as agent. The seller
under a repurchase agreement will be required to maintain the value of the underlying securities
marked-to-market daily at not less than the repurchase price. The underlying securities (normally
securities of the U.S. government, its agencies or instrumentalities) may have maturity dates
exceeding one year.
Reverse Repurchase Agreements
A reverse repurchase agreement involves the sale of a portfolio-eligible security by the Fund,
coupled with its agreement to repurchase the instrument at a specified time and price. Under a
reverse repurchase agreement, the Fund continues to receive any principal and interest payments on
the underlying security during the term of the agreement. The Fund typically will segregate cash
and/or liquid securities equal (on a daily mark-to-market basis) to its obligations under reverse
repurchase agreements. However, reverse repurchase agreements involve the risk that the market
value of securities retained by the Fund may decline below the repurchase price of the securities
sold by the Fund which it is obligated to repurchase. To the extent that positions in reverse
repurchase agreements are not covered through the segregation of cash and/or liquid securities at
least equal to the amount of any purchase commitment, such transactions would be subject to the
Funds limitations on borrowings.
Rights and Warrants
The Fund may invest in rights and warrants. Warrants are in effect longer-term call options.
They give the holder the right to purchase a given number of shares of a particular company at
specified prices within certain periods of time. Rights are similar to warrants except that they
have a substantially shorter term. The purchaser of a warrant expects that the market price of the
security will exceed the purchase price of the warrant plus the exercise price of the warrant, thus
producing a profit. Of course, since the market price may never exceed the exercise price
S-2
before the expiration date of the warrant, the purchaser of the warrant risks the loss of the
entire purchase price of the warrant. Warrants generally trade in the open market and may be sold
rather than exercised.
Warrants are sometimes sold in unit form with other securities of an issuer. Units of warrants
and common stock may be employed in financing young, unseasoned companies. The purchase price of a
warrant varies with the exercise price of the warrant, the current market value of the underlying
security, the life of the warrant and various other investment factors. Rights and warrants may be
considered more speculative and less liquid than certain other types of investments in that they do
not entitle a holder to dividends or voting rights with respect to the underlying securities nor do
they represent any rights in the assets of the issuing company and may lack a secondary market.
When-Issued and Delayed Delivery Transactions
The Fund may purchase and sell portfolio securities on a when-issued and delayed delivery
basis. No income accrues to the Fund on securities in connection with such purchase transactions
prior to the date the Fund actually takes delivery of such securities. These transactions are
subject to market fluctuation; the value of the securities at delivery may be more or less than
their purchase price, and yields generally available on comparable securities when delivery occurs
may be higher or lower than yields on the securities obtained pursuant to such transactions.
Because the Fund relies on the buyer or seller, as the case may be, to consummate the transaction,
failure by the other party to complete the transaction may result in the Fund missing the
opportunity of obtaining a price or yield considered to be advantageous. When the Fund is the buyer
in such a transaction, however, it will segregate cash and/or liquid securities having an aggregate
value at least equal to the amount of such purchase commitments until payment is made. The Fund
will make commitments to purchase securities on such basis only with the intention of actually
acquiring these securities, but the Fund may sell such securities prior to the settlement date if
such sale is considered to be advisable. To the extent the Fund engages in when-issued and delayed
delivery transactions, it will do so for the purpose of acquiring securities for the Funds
portfolio consistent with the Funds investment objectives and policies and not for the purpose of
investment leverage.
Since the market value of both the securities or currency subject to the commitment and the
securities or currency held as segregated assets may fluctuate, the use of commitments may magnify
the impact of interest rate changes on the Funds net asset value. A commitment sale is covered if
the Fund owns or has the right to acquire the underlying securities or currency subject to the
commitment. A commitment sale is for cross-hedging purposes if it is not covered, but is designed
to provide a hedge against a decline in value of a security or currency which the Fund owns or has
the right to acquire. By entering into a commitment sale transaction, the Fund foregoes or reduces
the potential for both gain and loss in the security which is being hedged by the commitment sale.
Short Sales Against the Box
The Fund may from time to time make short sales of securities it owns or has the right to
acquire. A short sale is against the box to the extent that the Fund contemporaneously owns or
has the right to obtain at no added cost securities identical to those sold short. In a short sale,
the Fund does not immediately deliver the securities sold and does not receive the proceeds from
the sale. The Fund is required to recognize gain from the short sale for federal income tax
purposes at the time it enters into the short sale, even though it does not receive the sales
proceeds until it delivers the securities. The Fund is said to have a short position in the
securities sold until it delivers such securities at which time it receives the proceeds of the
sale. The Fund may close out a short position by purchasing and delivering an equal amount of the
securities sold short, rather than by delivering securities already held by the Fund, because the
Fund may want to continue to receive interest and dividend payments on securities in its portfolio.
Preferred Stocks
The Fund may invest in preferred stock. Preferred stock generally has a preference as to
dividends and upon liquidation over an issuers common stock but ranks junior to other income
securities in an issuers capital structure. Preferred stock generally pays dividends in cash (or
additional shares of preferred stock) at a defined rate but, unlike interest payments on other
income securities, preferred stock dividends are payable only if declared by the issuers board of
directors. Dividends on preferred stock may be cumulative, meaning that, in the event the issuer
fails to make one or more dividend payments on the preferred stock, no dividends may be paid on the
issuers common stock until all unpaid preferred stock dividends have been paid. Preferred stock
also may provide that, in
S-3
the event the issuer fails to make a specified number of dividend payments, the holders of the
preferred stock will have the right to elect a specified number of directors to the issuers board.
Preferred stock also may be subject to optional or mandatory redemption provisions.
STRATEGIC TRANSACTIONS
The Fund may, but is not required to, use various investment strategies as described below
(Strategic Transactions). Strategic Transactions may be used for a variety of purposes including
hedging, risk management, portfolio management or to earn income. Any or all of the investment
techniques described herein may be used at any time and there is no particular strategy that
dictates the use of one technique rather than another, as the use of any Strategic Transaction by
the Fund is a function of numerous variables including market conditions. The Fund complies with
applicable regulatory requirements when implementing Strategic Transactions, including the
segregation of liquid assets when mandated by SEC rules or SEC staff positions. Although the
Investment Adviser seeks to use Strategic Transactions to further the Funds investment objective,
no assurance can be given that the use of Strategic Transactions will achieve this result.
General Risks of Derivatives
Strategic Transactions may involve the purchase and sale of derivative instruments. A
derivative is a financial instrument the value of which depends upon (or derives from) the value of
another asset, security, interest rate, or index. Derivatives may relate to a wide variety of
underlying instruments, including equity and debt securities, indexes, interest rates, currencies
and other assets. Certain derivative instruments which the Fund may use and the risks of those
instruments are described in further detail below. The Fund may in the future also utilize
derivatives techniques, instruments and strategies that may be newly developed or permitted as a
result of regulatory changes, consistent with the Funds investment objective and policies. Such
newly developed techniques, instruments and strategies may involve
risks different from or in
addition to those described herein. No assurance can be given that any derivatives strategy
employed by the Fund will be successful.
The risks associated with the use of derivatives are different from, and possibly greater
than, the risks associated with investing directly in the instruments underlying such derivatives.
Derivatives are highly specialized instruments that require investment techniques and risk analyses
different from other portfolio investments. The use of derivative instruments requires an
understanding not only of the underlying instrument but also of the derivative itself. Certain risk
factors generally applicable to derivative transactions are described below.
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Derivatives are subject to the risk that the market value of the derivative
itself or the market value of underlying instruments will change in a way adverse
to the Funds interests. The Fund bears the risk that the Investment Adviser may
incorrectly forecast future market trends and other financial or economic factors
or the value of the underlying security, index, interest rate or currency when
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Derivatives may be subject to pricing or basis risk, which exists when a
derivative becomes extraordinarily expensive (or inexpensive) relative to
historical prices or corresponding instruments. Under such market conditions, it
may not be economically feasible to initiate a transaction or liquidate a position
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Many derivatives are complex and often valued subjectively. Improper valuations
can result in increased payment requirements to counterparties or a loss of value
to the Fund. |
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Using derivatives as a hedge against a portfolio investment presents the risk
that the derivative will have imperfect correlation with the portfolio investment,
which could result in the Fund incurring substantial losses. This correlation risk
may be greater in the case of derivatives based on an index or other basket of
securities, as the portfolio securities being hedged may not duplicate the
components of the underlying index or the basket may not be of exactly the same
type of obligation as those underlying the derivative. The use of derivatives for
cross hedging purposes (using a derivative based on one instrument as a hedge on
a different instrument) may also involve greater correlation risks. |
S-4
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While using derivatives for hedging purposes can reduce the Funds risk of loss,
it may also limit the Funds opportunity for gains or result in losses by
offsetting or limiting the Funds ability to participate in favorable price
movements in portfolio investments. |
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Derivatives transactions for non-hedging purposes involve greater risks and may
result in losses which would not be offset by increases in the value of portfolio
securities or declines in the cost of securities to be acquired. In the event that
the Fund enters into a derivatives transaction as an alternative to purchasing or
selling the underlying instrument or in order to obtain desired exposure to an
index or market, the Fund will be exposed to the same risks as are incurred in
purchasing or selling the underlying instruments directly. |
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The use of certain derivatives transactions involves the risk of loss resulting
from the insolvency or bankruptcy of the other party to the contract (the
counterparty) or the failure by the counterparty to make required payments or
otherwise comply with the terms of the contract. In the event of default by a
counterparty, the Fund may have contractual remedies pursuant to the agreements
related to the transaction. |
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Liquidity risk exists when a particular derivative is difficult to purchase or
sell. If a derivative transaction is particularly large or if the relevant market
is illiquid, the Fund may be unable to initiate a transaction or liquidate a
position at an advantageous time or price. |
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Certain derivatives transactions, including OTC options, swaps, forward
contracts, certain options on foreign currencies and other OTC derivatives, are not
entered into or traded on exchanges or in markets regulated by the CFTC or the SEC.
Instead, such OTC derivatives are entered into directly by the counterparties and
may be traded only through financial institutions acting as market makers. OTC
derivatives transactions can only be entered into with a willing counterparty.
Where no such counterparty is available, the Fund will be unable to enter into a
desired transaction. There also may be greater risk that no liquid secondary market
in the trading of OTC derivatives will exist, in which case the Fund may be
required to hold such instruments until exercise, expiration or maturity. Many of
the protections afforded to exchange participants will not be available to
participants in OTC derivatives transactions. OTC derivatives transactions are not
subject to the guarantee of an exchange or clearinghouse and as a result the Fund
would bear greater risk of default by the counterparties to such transactions. |
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The Fund may be required to make physical delivery of portfolio securities
underlying a derivative in order to close out a derivatives position or to sell
portfolio securities at a time or price at which it may be disadvantageous to do so
in order to obtain cash to close out or to maintain a derivatives position. |
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As a result of the structure of certain derivatives, adverse changes in the
value of the underlying instrument can result in losses substantially greater
than the amount invested in the derivative itself. Certain derivatives have the
potential for unlimited loss, regardless of the size of the initial investment. |
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Certain derivatives, including certain OTC options and swap agreements, may be
considered illiquid. |
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Certain derivative transactions may give rise to a form of leverage. Leverage
associated with derivative transactions may cause the Fund to sell portfolio
securities when it may not be advantageous to do so to satisfy its obligations or
to meet segregation requirements, pursuant to applicable SEC rules and regulations,
or may cause the Fund to be more volatile than if the Fund had not been leveraged. |
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Derivatives transactions conducted outside the United States may not be
conducted in the same manner as those entered into on U.S. exchanges, and may be
subject to different margin, exercise, settlement or expiration procedures. Many of
the risks of OTC derivatives transactions are also
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applicable to derivatives transactions conducted outside the United States.
Derivatives transactions conducted outside the United States are subject to the risk
of governmental action affecting the trading in, or the prices of, foreign
securities, currencies and other instruments The value of such positions could be
adversely affected by foreign political and economic factors; lesser availability of
data on which to make trading decisions; delays the Funds ability to act upon
economic events occurring in foreign markets; and less liquidity than U.S. markets. |
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Currency derivatives are subject to additional risks. Currency derivatives
transactions may be negatively affected by government exchange controls, blockages,
and manipulations. Currency exchange rates may be influenced by factors extrinsic
to a countrys economy. There is no systematic reporting of last sale information
with respect to foreign currencies. As a result, the available information on which
trading in currency derivatives will be based may not be as complete as comparable
data for other transactions. Events could occur in the foreign currency market
which will not be reflected in currency derivatives until the following day, making
it more difficult for the Fund to respond to such events in a timely manner. |
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Legislation regarding regulation of the financial sector, including the
Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act),
which was signed into law in July 2010, could change the way in which derivative
instruments are regulated and/or traded. Such regulation may impact the
availability, liquidity and cost of derivative instruments. While many provisions
of the Dodd-Frank Act must be implemented through future rulemaking, and any
regulatory or legislative activity may not necessarily have a direct, immediate
effect upon the Fund, it is possible that, upon implementation of these measures or
any future measures, they could potentially limit or completely restrict the
ability of the Fund to use certain derivative instruments as a part of its
investment strategy, increase the costs of using these instruments or make them
less effective. Limits or restrictions applicable to the counterparties with which
a Fund engages in derivative transactions could also prevent a Fund from using
these instruments or affect the pricing or other factors relating to these
instruments, or may change availability of certain investments. There can be no
assurance that such legislation or regulation will not have a material adverse
effect on the Fund or will not impair the ability of the Fund to utilize certain
derivatives transactions or achieve its investment objective. |
Options
An option is a contract that gives the holder of the option the right, but not the obligation,
to buy from (in the case of a call option) or sell to (in the case of a put option) the seller of
the option (the option writer) the underlying security at a specified fixed price (the exercise
price) prior to a specified date (the expiration date). The buyer of the option pays to the
option writer the option premium, which represents the purchase price of the option.
Exchange traded options are issued by a regulated intermediary such as the Options Clearing
Corporation (OCC), which guarantees the performance of the obligations of the parties to such
option. OTC options are purchased from or sold to counterparties through direct bilateral agreement
between the counterparties. Certain options, such as options on individual securities, are settled
through physical delivery of the underlying security, whereas other options, such as index options,
are settled in cash in an amount based on the value of the underlying instrument multiplied by a
specified multiplier.
Writing Options. The Fund may write call and put options. As the writer of a call option, the
Fund receives the premium from the purchaser of the option and has the obligation, upon exercise of
the option, to deliver the underlying security upon payment of the exercise price. If the option
expires without being exercised the Fund is not required to deliver the underlying security but
retains the premium received.
The Fund may write call options that are covered. A call option on a security is covered if
(a) the Fund owns the security underlying the call or has an absolute and immediate right to
acquire that security without additional cash consideration (or, if additional cash consideration
is required, such amount is maintained by the Fund in segregated liquid assets) upon conversion or
exchange of other securities held by the Fund; or (b) the Fund has purchased a call on the
underlying security, the exercise price of which is (i) equal to or less than the exercise
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price of the call written, or (ii) greater than the exercise price of the call written,
provided the difference is maintained by the Fund in segregated liquid assets.
Selling call options involves the risk that the Fund may be required to sell the underlying
security at a disadvantageous price, below the market price of such security, at the time the
option is exercised. As the writer of a covered call option, the Fund gives up the opportunity
during the options life to profit from increases in the market value of the security covering the
call option above the sum of the premium and the strike price of the call, but the Fund retains the
risk of loss should the price of the underlying security decline.
The Fund may also write uncovered call options (i.e., where the Fund does not own the
underlying security or index). Similar to a naked short sale, writing an uncovered call creates the
risk of an unlimited loss, in that the price of the underlying security could theoretically
increase without limit, thus increasing the cost of buying those securities to cover the call
option if it is exercised before it expires. There can be no assurance that the securities
necessary to cover the call option will be available for purchase. Purchasing securities to cover
an uncovered call option can itself cause the price of the securities to rise, further exacerbating
the loss.
The Fund may write put options. As the writer of a put option, the Fund receives the premium
from the purchaser of the option and has the obligation, upon exercise of the option, to pay the
exercise price and receive delivery of the underlying security. If the option expires without being
exercised, the Fund is not required to receive the underlying security in exchange for the exercise
price but retains the option premium.
The Fund may write put options that are covered. A put option on a security is covered if
(a) the Fund segregates liquid assets equal to the exercise price; or (b) the Fund has purchased a
put on the same security as the put written, the exercise price of which is (i) equal to or greater
than the exercise price of the put written, or (ii) less than the exercise price of the put
written, provided the difference is maintained by the Fund in segregated liquid assets.
Selling put options involves the risk that the Fund may be required to buy the underlying
security at a disadvantageous price, above the market price of such security, at the time the
option is exercised. While the Funds potential gain in writing a covered put option is limited to
the premium received plus the interest earned on the liquid assets covering the put option, the
Funds risk of loss is equal to the entire value of the underlying security, offset only by the
amount of the premium received.
The Fund may also write uncovered put options. The seller of an uncovered put option
theoretically could lose an amount equal to the entire aggregate exercise price of the option if
the underlying security were to become valueless.
The Fund may close out an options position which it has written through a closing purchase
transaction. The Fund would execute a closing purchase transaction with respect to a call option
written by purchasing a call option on the same underlying security and having the same exercise
price and expiration date as the call option written by the Fund. The Fund would execute a closing
purchase transaction with respect to a put option written by purchasing a put option on the same
underlying security and having the same exercise price and expiration date as the put option
written by the Fund. A closing purchase transaction may or may not result in a profit to the Fund.
The Fund could close out its position as an option writer only if a liquid secondary market exists
for options of that series and there is no assurance that such a market will exist with respect to
any particular option.
The writer of an option generally has no control over the time when the option is exercised
and the option writer is required to deliver or acquire the underlying security. Once an option
writer has received an exercise notice, it cannot effect a closing purchase transaction in order to
terminate its obligation under the option. Thus, the use of options may require the Fund to buy or
sell portfolio securities at inopportune times or for prices other than the current market values
of such securities, may limit the amount of appreciation the Fund can realize on an investment, or
may cause the Fund to hold a security that it might otherwise sell.
Purchasing Options. The Fund may purchase call and put options. As the buyer of a call
option, the Fund pays the premium to the option writer and has the right to purchase the underlying
security from the option writer at the exercise price. If the market price of the underlying
security rises above the exercise price, the Fund could exercise the option and acquire the
underlying security at a below market price, which could result in a gain to the
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Fund, minus the premium paid. As the buyer of a put option, the Fund pays the premium to the
option writer and has the right to sell the underlying security to the option writer at the
exercise price. If the market price of the underlying security declines below the exercise price,
the Fund could exercise the option and sell the underlying security at an above market price, which
could result in a gain to the Fund, minus the premium paid. The Fund may buy call and put options
whether or not it holds the underlying securities.
As a buyer of a call or put option, the Fund may sell put or call options that it has
purchased at any time prior to such options expiration date through a closing sale transaction.
The principal factors affecting the market value of a put or a call option include supply and
demand, interest rates, the current market price of the underlying security in relation to the
exercise price of the option, the volatility of the underlying security, the underlying securitys
dividend policy, and the time remaining until the expiration date. A closing sale transaction may
or may not result in a profit to the Fund. The Funds ability to initiate a closing sale
transaction is dependent upon the liquidity of the options market and there is no assurance that
such a market will exist with respect to any particular option. If the Fund does not exercise or
sell an option prior to its expiration date, the option expires and becomes worthless.
OTC Options. Unlike exchange-traded options, which are standardized with respect to the
underlying instrument, expiration date, contract size and strike price, the terms of OTC options
generally are established through negotiation between the parties to the options contract. This
type of arrangement allows the purchaser and writer greater flexibility to tailor the option to
their needs. OTC options are available for a greater variety of securities or baskets of
securities, and in a wider range of expiration dates and exercise prices than exchange traded
options. However, unlike exchange traded options, which are issued and guaranteed by a regulated
intermediary, such as the OCC, OTC options are entered into directly with the counterparty. Unless
the counterparties provide for it, there is no central clearing or guaranty function for an OTC
option. Therefore, OTC options are subject to the risk of default or non-performance by the
counterparty. Accordingly, the Investment Adviser must assess the creditworthiness of the
counterparty to determine the likelihood that the terms of the option will be satisfied. There can
be no assurance that a continuous liquid secondary market will exist for any particular OTC option
at any specific time. As a result, the Fund may be unable to enter into closing sale transactions
with respect to OTC options.
Index Options. Call and put options on indices operate similarly to options on securities.
Rather than the right to buy or sell a single security at a specified price, options on an index
give the holder the right to receive, upon exercise of the option, an amount of cash determined by
reference to the value of the underlying index. The underlying index may be a broad-based index or
a narrower market index. Unlike options on securities, all settlements are in cash. The settlement
amount, which the writer of an index option must pay to the holder of the option upon exercise, is
generally equal to the difference between the fixed exercise price of the option and the value of
the underlying index, multiplied by a specified multiplier. The multiplier determines the size of
the investment position the option represents. Gain or loss to the Fund on index options
transactions will depend on price movements in the underlying securities market generally or in a
particular segment of the market rather than price movements of individual securities. As with
other options, the Fund may close out its position in index options through closing purchase
transactions and closing sale transactions provided that a liquid secondary market exists for such
options.
Index options written by the Fund may be covered in a manner similar to the covering of other
types of options, by holding an offsetting financial position and/or segregating liquid assets. The
Fund may cover call options written on an index by owning securities whose price changes, in the
opinion of the Investment Adviser, are expected to correlate to those of the underlying index.
Foreign Currency Options. Options on foreign currencies operate similarly to options on
securities. Rather than the right to buy or sell a single security at a specified price, options on
foreign currencies give the holder the right to buy or sell foreign currency for a fixed amount in
U.S. dollars. Options on foreign currencies are traded primarily in the OTC market, but may also be
traded on United States and foreign exchanges. The value of a foreign currency option is dependent
upon the value of the underlying foreign currency relative to the U.S. dollar. The price of the
option may vary with changes in the value of either or both currencies and has no relationship to
the investment merits of a foreign security. Options on foreign currencies are affected by all of
those factors which influence foreign exchange rates and foreign investment generally. As with
other options, the Fund may close out its position in foreign currency options through closing
purchase transactions and closing sale transactions provided that a liquid secondary market exists
for such options. Foreign currency options written by the Fund may be
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covered in a manner similar to the covering of other types of options, by holding an
offsetting financial position and/or segregating liquid assets.
Additional Risks of Options Transactions. The risks associated with options transactions are
different from, and possibly greater than, the risks associated with investing directly in the
underlying instruments. Options are highly specialized instruments that require investment
techniques and risk analyses different from those associated with other portfolio investments. The
use of options requires an understanding not only of the underlying instrument but also of the
option itself. Options may be subject to the risk factors generally applicable to derivatives
transactions described herein, and may also be subject to certain additional risk factors,
including:
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The exercise of options written or purchased by the Fund could cause the Fund to
sell portfolio securities, thus increasing the Funds portfolio turnover. |
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The Fund pays brokerage commissions each time it writes or purchases an option
or buys or sells an underlying security in connection with the exercise of an
option. Such brokerage commissions could be higher relative to the commissions for
direct purchases of sales of the underlying securities. |
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The Funds options transactions may be limited by limitations on options
positions established by the exchanges on which such options are traded. |
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The hours of trading for exchange listed options may not coincide with the hours
during which the underlying securities are traded. To the extent that the options
markets close before the markets for the underlying securities, significant price
and rate movements can take place in the underlying securities that cannot be
reflected in the options markets. |
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Index options based upon a narrower index of securities may present greater
risks than options based on broad market indexes, as narrower indexes are more
susceptible to rapid and extreme fluctuations as a result of changes in the values
of a small number of securities. |
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The Fund is subject to the risk of market movements between the time that an
option is exercised and the time of performance thereunder, which could increase
the extent of any losses suffered by the Fund in connection with options
transactions. |
Futures Contracts
A futures contract is a standardized agreement between two parties to buy or sell a specific
quantity of an underlying instrument at a specific price at a specific future time (the settlement
date). Futures contracts may be based on a specified equity security (securities futures), a
specified debt security or reference rate (interest rate futures), the value of a specified
securities index (index futures) or the value of a foreign currency (forward contracts and currency
futures). The value of a futures contract tends to increase and decrease in tandem with the value
of the underlying instrument. The buyer of a futures contract agrees to purchase the underlying
instrument on the settlement date and is said to be long the contract. The seller of a futures
contract agrees to sell the underlying instrument on the settlement date and is said to be short
the contract. Futures contracts differ from options in that they are bilateral agreements, with
both the purchaser and the seller equally obligated to complete the transaction. Futures contracts
call for settlement only on the expiration date and cannot be exercised at any other time during
their term.
Depending on the terms of the particular contract, futures contracts are settled through
either physical delivery of the underlying instrument on the settlement date (such as in the case
of securities futures and interest rate futures based on a specified debt security) or by payment
of a cash settlement amount on the settlement date (such as in the case of futures contracts
relating to interest rates, foreign currencies and broad-based securities indexes). In the case of
cash settled futures contracts, the settlement amount is equal to the difference between the
reference instruments price on the last trading day of the contract and the reference instruments
price at the time the contract was entered into. Most futures contracts, particularly futures
contracts requiring physical delivery, are not held until the settlement date, but instead are
offset before the settlement date through the establishment of an opposite and equal futures
position (buying a contract that had been sold, or selling a contract that had been purchased). All
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futures transactions (except currency forward contracts) are effected through a clearinghouse
associated with the exchange on which the futures are traded.
The buyer and seller of a futures contract are not required to deliver or pay for the
underlying commodity unless the contract is held until the settlement date. However, both the buyer
and seller are required to deposit initial margin with a futures commodities merchant when the
futures contract is entered into. Initial margin deposits are typically calculated as a percentage
of the contracts market value. If the value of either partys position declines, the party will be
required to make additional variation margin payments to settle the change in value on a daily
basis. The process is known as marking-to-market. Upon the closing of a futures position through
the establishment of an offsetting position, a final determination of variation margin will be
made and additional cash will be paid by or released to the Fund.
In addition, the Fund may be required to maintain segregated liquid assets in order to cover
futures transactions. The Fund will segregate liquid assets in an amount equal to the difference
between the market value of a futures contract entered into by the Fund and the aggregate value of
the initial and variation margin payments made by the Fund with respect to such contract.
Currency Forward Contracts and Currency Futures. A foreign currency forward contract is a
negotiated agreement between two parties to exchange specified amounts of two or more currencies at
a specified future time at a specified rate. The rate specified by the forward contract can be
higher or lower than the spot rate between the currencies that are the subject of the contract.
Settlement of a foreign currency forward contract for the purchase of most currencies typically
must occur at a bank based in the issuing nation. Currency futures are similar to currency forward
contracts, except that they are traded on an exchange and standardized as to contract size and
delivery date. Most currency futures call for payment or delivery in U.S. dollars. Unanticipated
changes in currency prices may result in losses to the Fund and poorer overall performance for the
Fund than if it had not entered into forward contracts.
Options on Futures Contracts. Options on futures contracts are similar to options on
securities except that options on futures contracts give the purchasers the right, in return for
the premium paid, to assume a position in a futures contract (a long position in the case of a call
option and a short position in the case of a put option) at a specified exercise price at any time
prior to the expiration of the option. Upon exercise of the option, the parties will be subject to
all of the risks associated with futures transactions and subject to margin requirements. As the
writer of options on futures contracts, the Fund would also be subject to initial and variation
margin requirements on the option position.
Options on futures contracts written by the Fund may be covered in a manner similar to the
covering of other types of options, by holding an offsetting financial position and/or segregating
liquid assets. The Fund may cover an option on a futures contract by purchasing or selling the
underlying futures contract. In such instances the exercise of the option will serve to close out
the Funds futures position.
Additional Risk of Futures Transactions. The risks associated with futures contract
transactions are different from, and possibly greater than, the risks associated with investing
directly in the underlying instruments. Futures are highly specialized instruments that require
investment techniques and risk analyses different from those associated with other portfolio
investments. The use of futures requires an understanding not only of the underlying instrument but
also of the futures contract itself. Futures may be subject to the risk factors generally
applicable to derivatives transactions described herein, and may also be subject to certain
additional risk factors, including:
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The risk of loss in buying and selling futures contracts can be substantial.
Small price movements in the commodity underlying a futures position may result in
immediate and substantial loss (or gain) to the Fund. |
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Buying and selling futures contracts may result in losses in excess of the
amount invested in the position in the form of initial margin. In the event of
adverse price movements in the underlying commodity, security, index, currency or
instrument, the Fund would be required to make daily cash payments to maintain its
required margin. The Fund may be required to sell portfolio securities in order to
meet daily margin requirements at a time when it may be disadvantageous to do so.
The Fund could lose margin payments deposited with a futures commodities merchant
if the
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futures commodities merchant breaches its agreement with the Fund, becomes insolvent
or declares bankruptcy. |
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Most exchanges limit the amount of fluctuation permitted in futures contract
prices during any single trading day. Once the daily limit has been reached in a
particular futures contract, no trades may be made on that day at prices beyond
that limit. If futures contract prices were to move to the daily limit for several
trading days with little or no trading, the Fund could be prevented from prompt
liquidation of a futures position and subject to substantial losses. The daily
limit governs only price movements during a single trading day and therefore does
not limit the Funds potential losses. |
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Index futures based upon a narrower index of securities may present greater
risks than futures based on broad market indexes, as narrower indexes are more
susceptible to rapid and extreme fluctuations as a result of changes in value of a
small number of securities. |
Swap Contracts and Related Derivative Instruments
A swap contract is an agreement between two parties pursuant to which the parties exchange
payments at specified dates on the basis of a specified notional amount, with the payments
calculated by reference to specified securities, indexes, reference rates, currencies or other
instruments. Most swap agreements provide that when the period payment dates for both parties are
the same, the payments are made on a net basis (i.e., the two payment streams are netted out, with
only the net amount paid by one party to the other). The Funds obligations or rights under a swap
contract entered into on a net basis will generally be equal only to the net amount to be paid or
received under the agreement, based on the relative values of the positions held by each
counterparty. Swap agreements are not entered into or traded on exchanges and there is no central
clearing or guaranty function for swaps. Therefore, swaps are subject to the risk of default or
non-performance by the counterparty. Accordingly, the Investment Adviser must assess the
creditworthiness of the counterparty to determine the likelihood that the terms of the swap will be
satisfied.
Swap agreements allow for a wide variety of transactions. For example, fixed rate payments may
be exchanged for floating rate payments, U.S. dollar denominated payments may be exchanged for
payments denominated in foreign currencies, and payments tied to the price of one security, index,
reference rate, currency or other instrument may be exchanged for payments tied to the price of a
different security, index, reference rate, currency or other instrument. Swap contracts are
typically individually negotiated and structured to provide exposure to a variety of particular
types of investments or market factors. Swap contracts can take many different forms and are known
by a variety of names. To the extent consistent with the Funds investment objectives and policies,
the Fund is not limited to any particular form or variety of swap contract. The Fund may utilize
swaps to increase or decrease their exposure to the underlying instrument, reference rate, foreign
currency, market index or other asset. The Fund may also enter into related derivative instruments
including caps, floors and collars.
The Fund may be required to cover swap transactions. Obligations under swap agreements entered
into on a net basis are generally accrued daily and any accrued but unpaid amounts owed by the Fund
to the swap counterparty will be covered by segregating liquid assets. If the Fund enters into a
swap agreement on other than a net basis, the Fund will segregate liquid assets with a value equal
to the full amount of the Funds accrued obligations under the agreement.
Interest Rate Swaps, Caps, Floors and Collars. Interest rate swaps consist of an agreement
between two parties to exchange their respective commitments to pay or receive interest (e.g., an
exchange of floating rate payments for fixed rate payments). Interest rate swaps are generally
entered into on a net basis.
The Fund may also buy or sell interest rate caps, floors and collars. 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 specified notional amount from
the party selling the 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 specified notional amount from the party selling the interest
rate floor. A collar is a combination of a cap and a floor that preserves a certain return within a
predetermined range of interest rate values. Caps, floors and collars may be less liquid that
other types of swaps. If the Fund sells caps, floors and collars,
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it will segregate liquid assets with a value equal to the full amount, accrued daily, of the
Funds net obligations with respect to the caps, floors or collars.
Index Swaps. An index swap consists of an agreement between two parties in which a party
exchanges a cash flow based on a notional amount of a reference index for a cash flow based on a
different index or on another specified instrument or reference rate. Index swaps are generally
entered into on a net basis.
Currency Swaps. A currency swap consists of an agreement between two parties to exchange cash
flows on a notional amount of two or more currencies based on the relative value differential among
them, such as exchanging a right to receive a payment in foreign currency for the right to receive
U.S. dollars. Currency swap agreements may be entered into on a net basis or may involve the
delivery of the entire principal value of one designated currency in exchange for the entire
principal value of another designated currency. In such cases, the entire principal value of a
currency swap is subject to the risk that the counterparty will default on its contractual delivery
obligations.
Credit Default Swaps. The Fund may enter into credit default swap contracts and options
thereon. A credit default swap consists of an agreement between two parties in which the buyer
agrees to pay to the seller a periodic stream of payments over the term of the contract and the
seller agrees to pay the buyer the par value (or other agreed-upon value ) of a referenced debt
obligation upon the occurrence of a credit event with respect to the issuer of the referenced debt
obligation. Generally, a credit event means bankruptcy, failure to pay, obligation acceleration or
modified restructuring. The Fund may be either the buyer or seller in a credit default swap. As the
buyer in a credit default swap, the Fund would pay to the counterparty the periodic stream of
payments. If no default occurs, the Fund would receive no benefit from the contract. As the seller
in a credit default swap, the Fund would receive the stream of payments but would be subject to
exposure on the notional amount of the swap, which it would be required to pay in the event of
default. The Fund will generally segregate liquid assets to cover any potential obligation under a
credit default swap sold by it. The use of credit default swaps could result in losses to the Fund
if the Investment Adviser fails to correctly evaluate the creditworthiness of the issuer of the
referenced debt obligation.
Inflation Swaps. Inflation swap agreements are contracts in which one party agrees to pay the
cumulative percentage increase in a price index, such as the Consumer Price Index, over the term of
the swap (with some lag on the referenced inflation index), and the other party pays a compounded
fixed rate. Inflation swap agreements may be used to protect the net asset value of the Fund
against an unexpected change in the rate of inflation measured by an inflation index. The value of
inflation swap agreements is expected to change in response to changes in real interest rates. Real
interest rates are tied to the relationship between nominal interest rates and the rate of
inflation. If nominal interest rates increase at a faster rate than inflation, real interest rates
may rise, leading to a decrease in value of an inflation swap agreement.
Swaptions. An option on a swap agreement, also called a swaption, is an option that gives
the buyer the right, but not the obligation, to enter into a swap on a future date in exchange for
paying a market based premium. A receiver swaption gives the owner the right to receive the total
return of a specified asset, reference rate, or index. A payer swaption gives the owner the right
to pay the total return of a specified asset, reference rate, or index. Swaptions also include
options that allow an existing swap to be terminated or extended by one of the counterparties.
General Risks of Swaps. The risks associated with swap transactions are different from, and
possibly greater than, the risks associated with investing directly in the underlying instruments.
Swaps are highly specialized instruments that require investment techniques and risk analyses
different from those associated with other portfolio investments. The use of swaps requires an
understanding not only of the underlying instrument but also of the swap contract itself. Swap
transactions may be subject to the risk factors generally applicable to derivatives transactions
described above, and may also be subject to certain additional risk factors, including:
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Swap agreements are not traded on exchanges and not subject to government
regulation like exchange traded derivatives. As a result, parties to a swap
agreement are not protected by such government regulations as participants in
transactions in derivatives traded on organized exchanges. |
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In addition to the risk of default by the counterparty, if the creditworthiness
of a counterparty to a swap agreement declines, the value of the swap agreement
would be likely to decline, potentially resulting in losses. |
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The swaps market is a relatively new market and is largely unregulated. It is
possible that further developments in the swaps market, including potential
governmental regulation, could adversely affect the Funds ability to utilize
swaps, terminate existing swap agreements or realize amounts to be received under
such agreements. |
Structured Products
The Fund also may invest a portion of its assets in structured notes and other types of
structured investments (referred to collectively as structured products). A structured note is a
derivative security for which the amount of principal repayment and/or interest payments is based
on the movement of one or more factors. These factors include, but are not limited to, currency
exchange rates, interest rates (such as the prime lending rate or LIBOR), referenced bonds and
stock indices. The cash flow or rate of return on a structured note may be determined by applying a
multiplier to the rate of total return on the referenced factor. Application of a multiplier is
comparable to the use of financial leverage, a speculative technique. Leverage magnifies the
potential for gain and the risk of loss. As a result, a relatively small decline in the value of
the referenced factor could result in a relatively large loss in the value of a structured note.
Investments in structured notes involve risks including interest rate risk, credit risk and
market risk. Where the Funds investments in structured notes are based upon the movement of one or
more factors, including currency exchange rates, interest rates, referenced bonds and stock
indices, depending on the factor used and the use of multipliers or deflators, changes in interest
rates and movement of the factor may cause significant price
fluctuations. In addition, changes in
the reference factor may cause the interest rate on the structured note to be reduced to zero and
any further changes in the reference factor may then reduce the principal amount payable on
maturity. Structured notes may be less liquid than other types of securities and more volatile than
the reference factor underlying the note.
Generally, structured investments are interests in entities organized and operated for the
purpose of restructuring the investment characteristics of underlying investment interests or
securities. These investment entities may be structured as trusts or other types of pooled
investment vehicles. This type of restructuring generally involves the deposit with or purchase by
an entity of the underlying investments and the issuance by that entity of one or more classes of
securities backed by, or representing interests in, the underlying investments. The cash flow or
rate of return on the underlying investments may be apportioned among the newly issued securities
to create different investment characteristics, such as varying maturities, credit quality, payment
priorities and interest rate provisions. The Fund may have the right to receive payments to which
it is entitled only from the structured investment, and generally does not have direct rights
against the issuer. Holders of structured investments bear risks of the underlying investment and
are subject to counterparty risk. While certain structured investment vehicles enable the investor
to acquire interests in a pool of securities without the brokerage and other expenses associated
with directly holding the same securities, investors in structured investment vehicles generally
pay their share of the investment vehicles administrative and other expenses.
Certain structured products may be thinly traded or have a limited trading market and may have
the effect of increasing the Funds illiquidity to the extent that the Fund, at a particular point
in time, may be unable to find qualified buyers for these securities.
Combined Transactions
Combined transactions involve entering into multiple derivatives transactions (such as
multiple options transactions, including purchasing and writing options in combination with each
other; multiple futures transactions; and combinations of options, futures, forward and swap
transactions) instead of a single derivatives transaction in order to customize the risk and return
characteristics of the overall position. Combined transactions typically contain elements of risk
that are present in each of the component transactions. The Fund may enter into a combined
transaction instead of a single derivatives transaction when, in the opinion of the Investment
Adviser, it is in the best
S-13
interest of the Fund to do so. Because combined transactions involve multiple transactions,
they may result in higher transaction costs and may be more difficult to close out.
Regulatory Matters
As described herein, the Fund may be required to cover its potential economic exposure to
certain derivatives transactions by holding an offsetting financial position and/or segregating or
earmarking liquid assets equal in value to the Funds potential economic exposure under the
transaction. The Fund will cover such transactions as described herein or in such other manner as
may be in accordance with applicable laws and regulations. Assets used to cover derivatives
transactions cannot be sold while the derivatives position is open, unless they are replaced by
other appropriate assets. Segregated or earmarked liquid assets and assets held in margin accounts
are not otherwise available to the Fund for investment purposes. If a large portion of the Funds
assets are used to cover derivatives transactions or are otherwise segregated, it could affect
portfolio management or other current obligations. With respect to derivatives which are
cash-settled (i.e., have no physical delivery requirement), the Fund is permitted to segregate or
earmark cash and/or liquid securities in an amount equal to the Funds daily marked-to-market net
obligations (i.e., the daily net liability) under the derivative, if any, rather than the
derivatives full notional value or the market value of the instrument underlying the derivative,
as applicable. By segregating or earmarking cash and/or liquid securities equal to only its net
obligations under cash-settled derivatives, the Fund will have the ability to employ a form of
leverage through the use of certain derivative transactions to a greater extent than if the Fund
were required to segregate assets equal to the full notional amount of the derivative or the market
value of the underlying instrument, as applicable.
Each
of the exchanges and other trading facilities on which options are traded has
established limitations on the maximum number of put or call options on a given underlying security
that may be written by a single investor or group of investors acting in concert, regardless
whether the options are written on different exchanges or through one or more brokers. These
position limits may restrict the number of listed options which the Fund may write. Option
positions of all investment companies advised by the Investment Adviser are combined for purposes
of these limits. An exchange may order the liquidation of positions found to be in excess of these
limits and may impose certain other sanctions or restrictions.
INVESTMENT RESTRICTIONS
The Fund operates under the following restrictions that constitute fundamental policies that,
except as otherwise noted, cannot be changed without the affirmative vote of the holders of a
majority of the outstanding voting securities of the Fund voting together as a single class, which
is defined by the 1940 Act as the lesser of (i) 67% or more of the Funds voting securities present
at a meeting, if the holders of more than 50% of the Funds outstanding voting securities are
present or represented by proxy; or (ii) more than 50% of the Funds outstanding voting securities.
Except as otherwise noted, all percentage limitations set forth below apply immediately after a
purchase or initial investment and any subsequent change in any applicable percentage resulting
from market fluctuations does not require any action. These restrictions provide that the Fund
shall not:
1. Issue senior securities nor borrow money, except the Fund may issue senior securities or
borrow money to the extent permitted by (i) the 1940 Act, as amended from time to time, (ii) the
rules and regulations promulgated by the SEC under the 1940 Act, as amended from time to time, or
(iii) an exemption or other relief applicable to the Fund from the provisions of the 1940 Act, as
amended from time to time.
2. Act as an underwriter of securities issued by others, except to the extent that, in
connection with the disposition of portfolio securities, it may be deemed to be an underwriter
under applicable securities laws.
3. Invest in any security if, as a result, 25% or more of the value of the Funds total
assets, taken at market value at the time of each investment, are in the securities of issuers in
any particular industry, except as otherwise provided by (i) the 1940 Act, as amended from time to
time, (ii) the rules and regulations promulgated by the SEC under the 1940 Act, as amended from
time to time, or (iii) an exemption or other relief applicable to the Fund from the provisions of
the 1940 Act, as amended from time to time; provided, however, that the Fund will, in normal
circumstances, invest more than 25% of its assets in the industry or group of industries that
constitute the energy sector and may invest to an unlimited degree in securities issued or
guaranteed by the U.S. government and
S-14
its agencies and instrumentalities or tax-exempt securities of state and municipal governments
or their political subdivisions.
4. Purchase or sell real estate except that the Fund may: (a) acquire or lease office space
for its own use, (b) invest in securities of issuers that invest in real estate or interests
therein or that are engaged in or operate in the real estate industry, (c) invest in securities
that are secured by real estate or interests therein, (d) purchase and sell mortgage-related
securities, (e) hold and sell real estate acquired by the Fund as a result of the ownership of
securities and (f) as otherwise permitted by (i) the 1940 Act, as amended from time to time, (ii)
the rules and regulations promulgated by the SEC under the 1940 Act, as amended from time to time,
or (iii) an exemption or other relief applicable to the Fund from the provisions of the 1940 Act,
as amended from time to time.
5. Purchase or sell physical commodities unless acquired as a result of ownership of
securities or other instruments; provided that this restriction shall not prohibit the Fund from
purchasing or selling options, futures contracts and related options thereon, forward contracts,
swaps, caps, floors, collars and any other financial instruments or from investing in securities or
other instruments backed by physical commodities or as otherwise permitted by (i) the 1940 Act, as
amended from time to time, (ii) the rules and regulations promulgated by the SEC under the 1940
Act, as amended from time to time, or (iii) an exemption or other relief applicable to the Fund
from the provisions of the 1940 Act, as amended from time to time.
6. Make loans of money or property to any person, except (a) to the extent that securities or
interests in which the respective Fund may invest are considered to be loans, (b) through the loan
of portfolio securities, (c) by engaging in repurchase agreements or (d) as may otherwise be
permitted by (i) the 1940 Act, as amended from time to time, (ii) the rules and regulations
promulgated by the SEC under the 1940 Act, as amended from time to time, or (iii) an exemption or
other relief applicable to the respective Fund from the provisions of the 1940 Act, as amended from
time to time.
The rest of the Funds investment policies, including the Funds investment objective and
percentage parameters described in the Funds Prospectus, are not fundamental policies of the Fund
and may be changed without shareholder approval.
MANAGEMENT OF THE FUND
Board of Trustees
The Board of Trustees of the Fund provides broad oversight over the operations and affairs of
the Fund and protects the interests of shareholders. The Board of Trustees has overall
responsibility to manage and control the business affairs of the Fund, including the complete and
exclusive authority to establish policies regarding the management, conduct and operation of the
Funds business. The names and ages of the Trustees and officers of the Fund, the year each was
first elected or appointed to office, their principal business occupations during the last five
years, the number of funds overseen by each Trustee and other directorships or trusteeships during
the last five years are shown below. The business address of the Fund, its Trustees and officers is
8117 Preston Road, Suite 440, Dallas, Texas 75225.
S-15
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Principal |
|
Number of Portfolios |
|
Other Directorships |
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|
Term of Office and |
|
Occupation |
|
in Fund |
|
Held by Trustee |
Name and Year |
|
Position Held |
|
Length of Time |
|
During Past |
|
Complex(2) |
|
During Past Five |
of Birth |
|
with the Fund |
|
Served(1) |
|
Five Years |
|
Overseen by Trustee |
|
Years |
NON-INTERESTED TRUSTEES: |
|
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|
Brian R. Bruce
(1955)
|
|
Trustee and
Chairman of the
Audit Committee
|
|
Trustee since 2011
|
|
Chief Executive
Officer, Hillcrest
Asset Management,
LLC (2008 to
present)
(registered
investment adviser); Director of
Southern Methodist
Universitys Encap
Investment & LCM
Group Alternative
Asset Management
Center (2006 to
2010); and Chief
Investment Officer
of Panagora Asset
Management, Inc.
(1999 to 2007)
(investment
management
company).
|
|
3 |
|
|
|
CM Advisers Family
of Funds (2 series)
and Dreman
Contrarian Funds (2
series) |
|
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|
|
|
|
|
|
|
|
|
Edward N. McMillan
(1947)
|
|
Lead Independent
Trustee
|
|
Trustee since 2011
|
|
Retired. Over 35
years of
experience in asset
management, banking
and general
business matters.
|
|
3 |
|
|
|
None |
|
|
|
|
|
|
|
|
|
|
|
|
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Ronald P. Trout
(1939)
|
|
Trustee and
Chairman of the
Nominating,
Corporate
Governance and
Compensation
Committee
|
|
Trustee since 2011
|
|
Retired. A founding
partner and Senior
Vice President of
Hourglass Capital
Management, Inc.
(1989 to 2002)
(investment
management
company).
|
|
3 |
|
|
|
Dorchester Minerals
LP (acquisition,
ownership and
administration of
natural gas and
crude oil royalty,
net profits and
leasehold interests
in the U.S.). |
|
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|
|
|
|
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|
|
INTERESTED TRUSTEE: |
|
|
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Jerry V. Swank
(1951)
|
|
Trustee, Chairman
of the Board, Chief
Executive Officer
and President
|
|
Trustee since 2011
|
|
Managing Partner of
the Investment
Adviser and founder
of Swank Capital,
LLC (2000 to
present).
|
|
3 |
|
|
|
E-T Energy Ltd.
(2008 to present);
Central Energy LP
(2011 to present) |
|
|
|
(1) |
|
After a Trustees initial term, each Trustee is expected to serve a two year term
concurrent with the class of Trustees for which he serves. |
|
|
|
Messrs. Bruce and Trout, as Class I Trustees, are expected to stand for re-election at
the Funds 2013 annual meeting of shareholders. |
|
|
|
Messrs. Swank and McMillan, as Class II Trustees, are expected to stand for re-election
at the Funds 2012 annual meeting of shareholders. |
|
(2) |
|
The Fund Complex includes each other registered investment company for which the Investment
Adviser serves as investment adviser. As of the date of this SAI, there are three funds
(including the Fund) in the Fund Complex. |
S-16
|
|
|
* |
|
Mr. Swank is an interested person of the Fund, as defined under the 1940 Act, by virtue of
his position as Managing Partner of the Investment Adviser. |
Trustee Qualifications
The Board of Trustees has determined that each Trustee should serve as such based on several
factors (none of which alone is decisive). Among the factors the Board of Trustees considered when
concluding that an individual should serve as a Trustee were the following: (i) availability and
commitment to attend meetings and perform the responsibilities of a Trustee, (ii) personal and
professional background, (iii) educational background, (iv) financial expertise, and (v) ability,
judgment, attributes and expertise. In respect of each Trustee, the individuals professional
accomplishments and prior experience, including, in some cases, in fields related to the operations
of the Fund, were a significant factor in the determination that the individual should serve as a
Trustee of the Fund.
Following is a summary of various qualifications, experiences and skills of each Trustee (in
addition to business experience during the past five years as set forth in the table above) that
contributed to the Board of Trustees conclusion that an individual should serve on the Board of
Trustees. References to the qualifications, attributes and skills of Trustees do not constitute the
holding out of any Trustee as being an expert under Section 7 of the Securities Act or the rules
and regulations of the SEC.
Brian R. Bruce. Mr. Bruce has served as a Trustee of the Fund since the Funds inception,
and has served as a trustee of the Cushing® MLP Premier Fund (Premier) since 2010 and as a trustee
of the Cushing® MLP Total Return Fund (SRV) since 2007. Through his experience as a trustee of and
chairman of the Audit Committee of the Fund, Premier, SRV and certain other registered investment
companies, as a professor at Southern Methodist Universitys Cox School of Business and Director of
the ENCAP Investments & LCM Group Alternative Asset Management Center and as a chief executive
officer, and formerly chief investment officer, of investment management firms, Mr. Bruce is
experienced in financial, accounting, regulatory and investment matters.
Edward N. McMillan. Mr. McMillan has served as a Trustee of the Fund since the Funds inception, and has served as a trustee of Premier since 2010 and as a trustee of SRV since 2007. Through
his experience as lead independent trustee of the Fund, Premier and SRV, 35 years of investment
management experience, including as president of a small cap equity management firm, and prior
service as chairman of the board of four registered investment companies, Mr. McMillan is
experienced in financial, regulatory and investment matters.
Ronald P. Trout. Mr. Trout has served as a Trustee of the Fund since the Funds inception,
and has served as a trustee of Premier since 2010 and as a trustee of SRV since 2007. Through his
experience as a trustee of the Fund, Premier and SRV, as founding partner and senior vice president
of an investment management firm and his service on the board of a publicly traded natural
resources company, Mr. Trout is experienced in financial, regulatory and investment matters.
Jerry V. Swank. Mr. Swank has served as a Trustee of the Fund since the Funds inception,
and has served as a trustee of Premier since 2010 and as a trustee of SRV since 2007. Through his
experience as a trustee and chairman of the board of trustees of the Fund, Premier and SRV,
managing partner of the Investment Adviser and founder of Swank Capital, LLC and his extensive
professional experience with investment firms and as an oil and gas research consultant, Mr. Swank
is experienced in financial, regulatory and investment matters.
Board Leadership Structure
The primary responsibility of the Board of Trustees is to represent the interests of the Fund
and to provide oversight of the management of the Fund. The Funds day-to-day operations are
managed by the Investment Adviser and other service providers who have been approved by the Board
of Trustees. The Board of Trustees is currently comprised of four Trustees, three of whom are
classified under the 1940 Act as non-interested persons of the Fund (Independent Trustees) and
one of whom is classified as an interested person of the Fund (Interested Trustee). Generally,
the Board of Trustees acts by majority vote of all the Trustees, including a majority vote of the
Independent Trustees if required by applicable law.
An Interested Trustee, Mr. Jerry V. Swank, currently serves as Chairman of the Board of
Trustees. The Chairman of the Board of Trustees presides at meetings of the Board of Trustees and
acts as a liaison with service providers, officers, attorneys and other Trustees generally between meetings, and performs
such other functions as may be requested by the Board of Trustees from time to time.
S-17
The Independent Trustees have selected Mr. McMillan as lead Independent Trustee. The lead
Independent Trustee participates in the planning of Board of Trustee meetings, seeks to encourage
open dialogue and independent inquiry among the trustees and management, and performs such other
functions as may be requested by the Independent Trustees from time to time.
The Board of Trustees will meet regularly four times each year to discuss and consider matters
concerning the Fund, and will also holds special meetings to address matters arising between
regular meetings. Regular meetings generally take place in-person; other meetings may take place
in-person or by telephone. The Independent Trustees are advised by independent legal counsel and
intend to regularly meet outside the presence of Fund management.
The Trustees have determined that the efficient conduct of the Trustees affairs makes it
desirable to delegate responsibility for certain specific matters to committees of the Board of
Trustees. The committees will meet as often as necessary, either in conjunction with regular
meetings of the Board of Trustees or otherwise. The committees of the Board of Trustees are the
Audit Committee and the Nominating, Corporate Governance and Compensation Committee. The
functions and role of each Committee are described below under Board Committees. The membership
of each Committee consists of all of the Independent Trustees, which the Board of Trustees believes
allows them to participate in the full range of the Board of Trustees oversight duties.
The Board of Trustees has determined that this leadership structure, including a Chairman of
the Board of Trustees who is an Interested Trustee, a Lead Independent Trustee, a supermajority of
Independent Trustees and Committee membership limited to Independent Trustees, is appropriate in
light of the characteristics and circumstances of the Fund. In reaching this conclusion, the Board
of Trustees considered, among other things, the role of the Investment Adviser in the day-to-day
management of Fund affairs, the extent to which the work of the Board of Trustees will be conducted
through the Committees, the projected net assets of the Fund and the management, distribution and
other service arrangements of the Fund. The Board of Trustees also believes that its structure,
including the presence of one Trustee who is an executive officer of the Investment Adviser,
facilitates an efficient flow of information concerning the management of the Fund to the
Independent Trustees.
Board Committees
Nominating, Corporate Governance and Compensation Committee. Messrs. Bruce, McMillan and
Trout, who are not interested persons of the Fund, as defined in the 1940 Act, serve on the
Funds Nominating, Corporate Governance and Compensation Committee. Mr. Trout serves as chairman of the Nominating,
Corporate Governance and Compensation Committee. As part of its duties, the Nominating, Corporate
Governance and Compensation Committee makes recommendations on the composition of the Board of
Trustees, develops and makes recommendations to the Board of Trustees regarding corporate
governance matters and practices, and reviews and makes recommendations to the Board of Trustees
with respect to any compensation to be paid to certain persons including the chief compliance
officer of the Fund and the Independent Trustees. The committee will consider nominees recommended
by shareholders under the terms of the Agreement and Declaration of Trust and the Bylaws. Such
recommendations should be forwarded to the Secretary of the Fund. In considering candidates
submitted by shareholders, the Nominating, Corporate Governance and Compensation Committee will
take into consideration the needs of the Board of Trustees and the qualifications of the candidate.
Audit Committee. Messrs. Bruce, McMillan and Trout, who are not interested persons of the
Fund, as defined in the 1940 Act, serve on the Funds Audit Committee. Mr. Bruce serves as
chairman of the Audit Committee. The Audit Committee is generally responsible for reviewing and
evaluating issues related to the accounting and financial reporting policies and internal controls
of the Fund and, as appropriate, the internal controls of certain service providers, overseeing the
quality and objectivity of the Funds financial statements and the audit thereof and acting as a
liaison between the Board of Trustees and the Funds independent registered public accounting firm.
S-18
Boards Role in Risk Oversight
The Fund has retained the Investment Adviser to provide investment advisory services and
certain administrative services. The Investment Adviser is primarily responsible for the
management of risks that may arise from Fund investments and operations. Certain employees of the
Investment Adviser serve as the Funds officers, including the Funds President, Chief Executive
Officer and Chief Financial Officer. The Board of Trustees oversees the performance of these
functions by the Investment Adviser, both directly and through the Committee structure the Board of
Trustees has established. The Board of Trustees will receive from the Investment Adviser reports
on a regular and as-needed basis relating to the Funds investment activities and to the actual and
potential risks of the Fund, including reports on investment risks, compliance with applicable
laws, and the Funds financial accounting and reporting. In addition, the Board of Trustees will
meet periodically with the portfolio managers of the Fund to receive reports regarding the
portfolio management of the Fund and its performance and investment risks.
In addition, the Board of Trustees has appointed a Chief Compliance Officer (CCO). The CCO
oversees the development of compliance policies and procedures of the Fund that are reasonably
designed to minimize the risk of violations of the federal securities laws (Compliance Policies).
The CCO reports directly to the Independent Trustees, and will provide presentations to the Board
of Trustees at its quarterly meetings and an annual report on the application of the Compliance
Policies. The Board of Trustees will discuss relevant risks affecting the Fund with the CCO at
these meetings. The Board of Trustees has approved the Compliance Policies and will review the
CCOs reports. Furthermore, the Board of Trustees will annually review the sufficiency of the
Compliance Policies, as well as the appointment and compensation of the CCO.
Executive Officers
The following information relates to the executive officers of the Funds who are not Trustees.
The officers of the Fund were appointed by the Board of Trustees on July 27, 2011 and will serve
until their respective successors are chosen and qualified.
|
|
|
|
|
|
|
|
|
Principal Occupation |
Name and Year of Birth |
|
Position |
|
During the Past Five Years |
John H. Alban (1963)
|
|
Chief Financial Officer
and Treasurer
|
|
Chief Operating Officer
(COO) and Chief
Financial Officer (CFO)
of the Investment Adviser
(2010 Present); Chief
Administrative Officer of
NGP Energy Capital
Management (2007
2009); Chief Operating
Officer of Spinnerhawk
Capital Management, L.P.
(2005 2007). |
|
|
|
|
|
Barry Y. Greenberg (1963)
|
|
Chief Compliance Officer
|
|
General Counsel and Chief
Compliance Officer of the
Investment Adviser (2010
Present); Partner,
Akin Gump Strauss Hauer &
Feld LLP (2005 2010);
Vice President, Legal,
Compliance and
Administration, American
Beacon Advisors, Inc.
(1995 2005); Attorney
and Branch Chief, U.S.
Securities and Exchange
Commission (1988
1995). |
|
|
|
|
|
Daniel L. Spears
(1972)
|
|
Executive Vice
President and Secretary
|
|
Partner and portfolio
manager of the Investment
Adviser (2006
present). Executive Vice
President and Secretary
of other funds in the
Fund Complex.
Previously, investment
banker at Banc of America
Securities, LLC (1998 to
2006). |
S-19
|
|
|
|
|
|
|
|
|
Principal Occupation |
Name and Year of Birth |
|
Position |
|
During the Past Five Years |
Judd B. Cryer
(1973)
|
|
Vice President
|
|
Senior Vice President and
Research Analyst of the
Investment Adviser (2005
present). Previously,
a consulting engineer at
Utility Engineering Corp.
(1999-2003) and a project
manager with Koch John
Zink Company
(1996-1998). |
Shareholder Communications
Shareholders may send communications to the Funds Board of Trustees. Shareholders should send
communications intended for the Funds Board of Trustees by addressing the communications directly
to the Board of Trustees (or individual Board member(s)) and/or otherwise clearly indicating in the
salutation that the communication is for the Board of Trustees (or individual Board members) and by
sending the communication to either the Funds office or directly to such Board member(s) at the
address specified above for each Trustee. Other shareholder communications received by the Fund not
directly addressed and sent to the Board of Trustees will be reviewed and generally responded to by
management and will be forwarded to the Board of Trustees only at managements discretion based on
the matters contained in those communications.
Remuneration of Trustees and Officers
Each Trustee who is not an interested person, as defined by the 1940 Act, of the Fund is
paid: (i) an annual retainer of $25,000 ; (ii) a fee of $2,000 for each in-person meeting of the Board of
Trustees attended; (iii) a fee of $1,000 for each Audit Committee meeting attended; and (iv) a fee of $500
for each telephonic meeting of the Board of Trustees attended. Because the Fund is newly
organized, it has not paid any compensation to its Trustees during any prior fiscal years. The
table below shows the estimated compensation that is contemplated to be paid to Trustees for the
Funds fiscal year ended November 30, 2012, assuming a full fiscal year of operations. Officers of the
Fund, all of whom are members, officers, or employees of the Investment Adviser, or their
affiliates, receive no compensation from the Fund.
|
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|
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|
|
|
|
|
|
|
|
|
|
Total Compensation |
|
|
|
|
|
|
|
Pension or Retirement |
|
|
|
|
|
|
from the Fund and |
|
|
|
Aggregate Estimated |
|
|
Benefits Accrued as Part |
|
|
Estimated Annual |
|
|
Fund |
|
|
|
Compensation |
|
|
of |
|
|
Benefits Upon |
|
|
Complex(2) |
|
|
|
from the Fund |
|
|
Fund Expenses(1) |
|
|
Retirement(1) |
|
|
Paid to Trustee |
|
NON-INTERESTED TRUSTEES: |
|
|
|
|
|
|
|
|
|
|
|
|
Brian R. Bruce |
|
$ |
35,000 |
|
|
None |
|
None |
|
$ |
68,000 |
|
Edward N. McMillan |
|
$ |
35,000 |
|
|
None |
|
None |
|
$ |
68,000 |
|
Ronald P. Trout |
|
$ |
35,000 |
|
|
None |
|
None |
|
$ |
68,000 |
|
INTERESTED TRUSTEE: |
Jerry V. Swank |
|
|
None |
|
|
None |
|
None |
|
|
None |
|
|
|
|
(1) |
|
The Fund does not accrue or pay retirement or pension benefits to Trustees as of the date of
this SAI. |
|
(2) |
|
The Fund Complex includes the Fund and each other registered investment company for which
the Investment Adviser serves as investment adviser. As of the date of this SAI, there are
three funds (including the Fund) in the Fund Complex. |
Trustee Share Ownership
As of December 31, 2011, each Trustee of the Fund beneficially owned equity securities of
the Fund and all of the registered investment companies in the family of investment companies
overseen by the Trustee in the dollar range amounts specified below.
S-20
|
|
|
|
|
|
|
|
|
Aggregate Dollar Range of Equity |
|
|
|
|
Securities in All Registered Investment |
|
|
Dollar Range of |
|
Companies Overseen by Trustee in |
|
|
Equity Securities in the Fund |
|
Family of Investment Companies(1) |
NON-INTERESTED
TRUSTEES: Brian R. Bruce |
|
None |
|
$10,001 - $50,000 |
Edward N. McMillan |
|
None |
|
$50,001 - $100,000 |
Ronald P. Trout |
|
None |
|
$10,001 - $50,000 |
|
|
|
|
|
INTERESTED TRUSTEE: |
|
|
|
|
Jerry V. Swank (2) |
|
Over $100,000(2) |
|
Over $100,000(2) |
|
|
|
(1) |
|
The Family of Investment Companies includes the Fund and each other registered investment
company for which the Investment Adviser serves as investment adviser. As of the date of this
SAI, there are three funds (including the Fund) in the Family of Investment Companies. |
|
(2) |
|
The Investment Adviser has purchased common shares of the Fund in order to provide the Fund
with over $100,000 of net capital as required by the 1940 Act. By virtue of his control of
the Investment Adviser, Mr. Swank may be deemed to beneficially own the common shares of the
Fund held by the Investment Adviser. |
Portfolio Management
Jerry V. Swank, Daniel L. Spears and Judd B. Cryer (the portfolio managers) are primarily
responsible for the day-to-day management of the Funds portfolio. The following section discusses
the accounts managed by the portfolio managers, the structure and method of their compensation and
potential conflicts of interest.
Other Accounts Managed by the Portfolio Managers. The following table reflects information
regarding accounts for which the portfolio managers have day-to-day management responsibilities
(other than the Fund). Accounts are grouped into three categories: (a) registered investment
companies, (b) other pooled investment accounts, and (c) other accounts. To the extent that any of
these accounts pay advisory fees that are based on account performance, this information will be
reflected in a separate table below. Asset amounts are approximate and have been rounded.
As of November 30, 2011, Mr. Swank managed or was a member of the management team for the
following client accounts:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of Accounts |
|
|
|
|
|
|
Number of |
|
|
|
|
|
|
Subject to a |
|
|
Assets Subject to a |
|
|
|
Accounts |
|
|
Assets of Accounts |
|
|
Performance Fee |
|
|
Performance Fee |
|
Registered Investment Companies |
|
|
2 |
|
|
$ |
415,212,602 |
|
|
|
0 |
|
|
$ |
0 |
|
Pooled Investment Vehicles Other
Than Registered Investment
Companies |
|
|
5 |
|
|
$ |
676,195,443 |
|
|
|
5 |
|
|
$ |
676,195,443 |
|
Other Accounts |
|
|
0 |
|
|
$ |
0 |
|
|
|
0 |
|
|
$ |
0 |
|
As of November 30, 2011, Mr. Spears managed or was a member of the management team for the
following client accounts:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of Accounts |
|
|
|
|
|
|
Number of |
|
|
|
|
|
|
Subject to a |
|
|
Assets Subject to a |
|
|
|
Accounts |
|
|
Assets of Accounts |
|
|
Performance Fee |
|
|
Performance Fee |
|
Registered Investment Companies |
|
|
2 |
|
|
$ |
415,212,602 |
|
|
|
0 |
|
|
$ |
0 |
|
Pooled Investment Vehicles Other
Than Registered Investment
Companies |
|
|
1 |
|
|
$ |
108,402,525 |
|
|
|
1 |
|
|
$ |
108,402,525 |
|
Other Accounts |
|
|
0 |
|
|
$ |
0 |
|
|
|
0 |
|
|
$ |
0 |
|
As of November 30, 2011, Mr. Cryer managed or was a member of the management team for the
following client accounts:
S-21
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of |
|
|
Assets Subject |
|
|
|
|
|
|
|
|
|
|
|
Accounts |
|
|
to a |
|
|
|
Number of |
|
|
Assets of |
|
|
Subject to a |
|
|
Performance |
|
|
|
Accounts |
|
|
Accounts |
|
|
Performance Fee |
|
|
Fee |
|
Registered Investment Companies |
|
|
2 |
|
|
$ |
415,212,602 |
|
|
|
0 |
|
|
$ |
0 |
|
Pooled Investment Vehicles Other
Than Registered Investment
Companies |
|
|
1 |
|
|
$ |
12,147,628 |
|
|
|
0 |
|
|
$ |
0 |
|
Other Accounts |
|
|
2 |
|
|
$ |
139,184,549 |
|
|
|
0 |
|
|
$ |
0 |
|
Compensation and Potential Conflicts of Interest. Messrs. Swank, Spears and Cryer are
compensated by the Investment Adviser. Messrs. Swank and Spears are principals of the Investment
Adviser and are compensated through partnership distributions that are based primarily on the
profits and losses of the Investment Adviser. The partnership distributions are affected by the
amount of assets the Investment Adviser manages and the appreciation of those assets, particularly
over the long-term, but are not determined with specific reference to any particular performance
benchmark or time period. Some of the other accounts managed by Messrs. Swank, Spears and Cryer
have investment strategies that are similar to the Funds investment strategy. However, the
Investment Adviser manages potential material conflicts of interest by allocating investment
opportunities in accordance with its allocation policies and procedures. See Principal Risks of
the Fund Conflicts of Interest with the Investment Adviser in the Funds Prospectus.
Securities Ownership of the Portfolio Managers.
Jerry V. Swank. Over $100,000. The Investment Adviser has purchased common shares of
the Fund in order to provide the Fund with over $100,000 of net capital as required by the 1940
Act. By virtue of his control of the Investment Adviser, Mr. Swank may be deemed to beneficially
own the common shares of the Fund held by the Investment Adviser.
Daniel L. Spears and Judd B. Cryer. None.
Advisory Agreement
Cushing® MLP Asset Management, LP acts as the investment adviser to the Fund. The Investment
Advisers principal business address is 8117 Preston Road, Suite 440, Dallas, Texas 75225.
The Investment Adviser provides investment advisory services to the Fund pursuant to the terms
of an Investment Advisory Agreement (the Investment Management Agreement), dated July 27, 2011
between the Investment Adviser and the Fund. The Investment Management Agreement has an initial
term expiring two years after the date of its execution, and may be continued in effect from year
to year thereafter subject to the approval thereof by (1) the Board of Trustees or (2) vote of a
majority (as defined by the 1940 Act) of the outstanding voting securities of the Fund, provided
that in either event the continuance must also be approved by a majority of the Independent
Trustees, by vote cast in person at a meeting called for the purpose of voting on such approval.
The Investment Management Agreement may be terminated at any time, without the payment of any
penalty, upon 60 days written notice by either party. The Fund may terminate by action of the
Board of Trustees or by a vote of a majority of the Funds outstanding voting securities
(accompanied by appropriate notice), and the Investment Management Agreement will terminate
automatically upon its assignment (as defined in the 1940 act and the rules thereunder). The
Investment Management Agreement may also be terminated, at any time, without payment of any
penalty, by the Board of Trustees or by vote of a majority of outstanding voting securities, in the
event that it is established by a court of competent jurisdiction that the Investment Adviser or
any principal, officer or employee of the Investment Adviser has taken any action that results in a
breach of the covenants of the Investment Adviser set out in the Investment Management Agreement.
The Investment Management Agreement will provide that the Investment Adviser will not be liable for
any loss sustained by reason of the purchase, sale or retention of any security, whether or not
such purchase, sale or retention will have been based upon the investigation and research made by
any other individual, firm or corporation, if such recommendation will have been selected with due
care and in good faith, except loss resulting from willful misfeasance, bad faith or gross
negligence on the
S-22
part of the Investment Adviser in performance of its obligations and duties, or by reason of
its reckless disregard of its obligations and duties under the Investment Management Agreement.
Pursuant to the Investment Management Agreement, the Investment Adviser is responsible for
managing the portfolio of the Fund in accordance with its stated investment objective and policies,
makes investment decisions for the Fund, placing orders to purchase and sell securities on behalf
of the Fund and managing the other business and affairs of the Fund, all subject to the supervision
and direction of the Funds Board of Trustees. Although the Investment Adviser intends to devote
such time and effort to the business of the Fund as is reasonably necessary to perform its duties
to the Fund, the services of the Investment Adviser are not exclusive, and the Investment Adviser
provides similar services to other clients and may engage in other activities.
Pursuant to the Investment Management Agreement, the Fund has agreed to pay the Investment
Adviser a fee, payable at the end of each calendar month, at an annual rate equal to 1.50% of the
average weekly value of the Funds Managed Assets during such month (the Management Fee) for the
services and facilities provided by the Investment Adviser to the Fund. Because the Management Fee
is based upon a percentage of the Funds Managed Assets, the Management Fee will be higher if the
Fund employs leverage. Therefore, the Investment Adviser will have a financial incentive to use
leverage, which may create a conflict of interest between the Investment Adviser and the Funds
common shareholders.
The Investment Adviser also provides such additional administrative services as the Fund may
require beyond those furnished by the Administrator and furnishes, at its own expense, such office
space, facilities, equipment, clerical help, and other personnel and services as may reasonably be
necessary in connection with the operations of the Fund. In addition, the Investment Adviser pays
the salaries of officers of the Fund who are employees of the Investment Adviser and any fees and
expenses of Trustees of the Fund who are also officers, directors, or employees of the Investment
Adviser or who are officers or employees of any company affiliated with the Investment Adviser.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Subject to the oversight of the Board of Trustees, the Investment Adviser is responsible for
decisions to buy and sell securities for the Fund, the negotiation of the commissions to be paid on
brokerage transactions, the prices for principal trades in securities, and the allocation of
portfolio brokerage and principal business. It is the policy of the Investment Adviser to seek the
best execution at the best security price available with respect to each transaction in light of
the overall quality of brokerage and research services provided to the Investment Adviser. In
selecting broker/dealers and in negotiating commissions, the Investment Adviser will consider,
among other things, the firms reliability, the quality of its execution services on a continuing
basis and its financial condition.
Section 28(e) of the Securities Exchange Act of 1934, as amended (the 1934 Act), permits an
investment adviser, under certain circumstances, to cause an account to pay a broker or dealer who
supplies brokerage and research services a commission for effecting a transaction in excess of the
amount of commission another broker or dealer would have charged for effecting the transaction.
Brokerage and research services include (a) furnishing advice as to the value of securities, the
advisability of investing, purchasing or selling securities, and the availability of securities or
purchasers or sellers of securities; (b) furnishing analyses and reports concerning issuers,
industries, securities, economic factors and trends, portfolio strategy, and the performance of
accounts; and (c) effecting securities transactions and performing functions incidental to those
transactions (such as clearance, settlement, and custody).
In light of the above, in selecting brokers, the Investment Adviser may consider investment
and market information and other research, such as economic, securities and performance measurement
research, provided by such brokers, and the quality and reliability of brokerage services,
including execution capability, performance, and financial responsibility. Accordingly, the
commissions charged by any such broker may be greater than the amount another firm might charge if
the Investment Adviser determines in good faith that the amount of such commissions is reasonable
in relation to the value of the research information and brokerage services provided by such broker
to the Investment Adviser or to the Fund. The Investment Adviser believes that the research
information received in this manner provides the Fund with benefits by supplementing the research
otherwise available to the Investment Adviser.
S-23
The Investment Adviser seeks to allocate portfolio transactions equitably whenever concurrent
decisions are made to purchase or sell securities on behalf of the Fund and another advisory
account. In some cases, this procedure could have an adverse effect on the price or the amount of
securities available to the Fund. In making such allocations between the Fund and other advisory
accounts, the main factors considered by the Investment Adviser are the investment objective, the
relative size of portfolio holding of the same or comparable securities, the availability of cash
for investment and the size of investment commitments generally held, and the views of the persons
responsible for recommending investments to the Fund and such other accounts and funds.
CERTAIN U.S. FEDERAL INCOME TAX CONSIDERATIONS
This section and the discussion in the Prospectus (see Certain U.S. Federal Income Tax
Considerations) provide a summary of the material U.S. federal income tax considerations generally
applicable to U.S. Shareholders (as defined in the Prospectus) that hold shares of the Fund as
capital assets (generally, for investment). The discussion is based upon the Internal Revenue Code
of 1986, as amended (the Code), Treasury Regulations, judicial authorities, published positions
of the Internal Revenue Service (the IRS) and other applicable authorities, all as in effect on
the date hereof and all of which are subject to change or differing interpretations (possibly with
retroactive effect). This summary does not address all of the potential U.S. federal income tax
consequences that may be applicable to the Fund or to all categories of investors (for example,
non-U.S. investors), some of which may be subject to special tax rules. No ruling has been or will
be sought from the IRS regarding any matter discussed herein. No assurance can be given that the
IRS would not assert, or that a court would not sustain, a position contrary to any of the tax
aspects set forth below. Prospective investors must consult their own tax advisors as to the U.S.
federal income tax consequences of acquiring, holding and disposing of shares of the Fund, as well
as the effects of state, local and non-U.S. tax laws.
The Fund
The Fund will be treated as a regular, or C corporation, for U.S. federal income tax
purposes. Accordingly, the Fund will be subject to U.S. federal income tax on its taxable income
at the graduated rates applicable to corporations (currently a maximum rate of 35%). In addition,
as a C corporation, the Fund will be subject to state and local income taxation by reason of its
investments in equity securities of Energy Trusts and MLPs. Therefore, the Fund may have state and
local income tax liabilities in multiple states, which will reduce the Funds cash available to
make distributions on the shares of the Fund. The Fund may be subject to a 20% alternative minimum
tax on its alternative minimum taxable income to the extent that the alternative minimum tax
exceeds the Funds regular income tax liability. The extent to which the Fund is required to pay
U.S. corporate income tax or alternative minimum tax could materially reduce the Funds cash
available to make distributions on the shares of the Fund. The Fund will not be eligible to elect
to be treated as a regulated investment company because the Fund intends to invest more than 25% of
its assets in the equity securities of Energy Trusts and MLPs.
Certain Fund Investments
Energy Trust Securities. The Fund intends to invest in U.S. royalty trusts. U.S. royalty
trusts are generally not subject to U.S. federal corporate income taxation at the trust or entity
level. Instead, each unitholder of the U.S. royalty trust is required to take into account its
share of all items of the U.S. royalty trusts income, gain, loss, deduction and expense. It is
possible that the Funds share of taxable income from a U.S. royalty trust may exceed the cash
actually distributed to it from the U.S. royalty trust in a given year. In such a case, the Fund
will have less after-tax cash available for distribution to shareholders.
The Funds allocable share of certain percentage depletion deductions and intangible drilling
costs of the U.S. royalty trusts in which the Fund invests may be treated as items of tax
preference for purposes of calculating the Funds alternative minimum taxable income. Such items
will increase the Funds alternative minimum taxable income and increase the likelihood that the
Fund may be subject to the alternative minimum tax.
MLP Equity Securities. MLPs are similar to corporations in many respects, but differ in
others, especially in the way they are treated for U.S. federal income tax purposes. A corporation
is required to pay U.S. federal income tax on its income, and, to the extent the corporation
distributes its income to its shareholders in the form of dividends from earnings and profits, its
shareholders are required to pay U.S. federal income tax on such dividends.
S-24
For this reason, it is said that corporate income is taxed at two levels. Unlike a
corporation, an MLP is treated for U.S. federal income tax purposes as a partnership, which means
that no U.S. federal income tax is paid at the entity level. A partnerships net income and net
gains are considered earned by all of its partners and are generally allocated among all the
partners in proportion to their interests in the partnership. Each partner pays tax on its share
of the partnerships net income and net gains regardless of whether the partnership distributes
cash to the partners. All the other items (such as losses, deductions and expenses) that go into
determining taxable income and tax owed are passed through to the partners as well. Partnership
income is thus said to be taxed only at one levelat the partner level.
The Code generally requires all publicly-traded partnerships to be treated as corporations for
U.S. federal income tax purposes. If, however, a publicly-traded partnership satisfies certain
requirements, the publicly-traded partnership will be treated as a partnership for U.S. federal
income tax purposes. Such publicly-traded partnerships are referred to herein as MLPs. Under
these requirements, an MLP is required to receive 90 percent of its income from qualifying sources,
such as interest, dividends, real estate rents, gain from the sale or disposition of real property,
income and gain from mineral or natural resources activities, income and gain from the
transportation or storage of certain fuels, gain from the sale or disposition of a capital asset
held for the production of income described in the foregoing, and, in certain circumstances, income
and gain from commodities or futures, forwards and options with respect to commodities. Mineral or
natural resources activities include exploration, development, production, mining, refining,
marketing and transportation (including pipelines), of oil and gas, minerals, geothermal energy,
fertilizers, timber or carbon dioxide. Many MLPs today are in energy, timber or real estate
related (including mortgage securities) businesses.
Although distributions from MLPs resemble corporate dividends, they are treated differently
for U.S. federal income tax purposes. A distribution from an MLP is not itself taxable (since
income of the MLP is taxable to its investors even if not distributed) to the extent of the
investors basis in its MLP interest and is treated as income or gain to the extent the
distribution exceeds the investors basis (see description below as to how an MLP investors basis
is calculated) in the MLP.
To the extent that the Fund invests in the equity securities of an MLP, the Fund will be a
partner in such MLP. Accordingly, the Fund will be required to include in its taxable income the
Funds allocable share of the income, gains, losses, deductions and expenses recognized by each
such MLP, regardless of whether the MLP distributes cash to the Fund. Based upon a review of the
historic results of the type of MLPs in which the Fund intends to invest, the Fund expects that the
cash distributions it will receive with respect to its investments in equity securities of MLPs
will exceed the taxable income allocated to the Fund from such MLPs. No assurance, however, can be
given in this regard. If this expectation is not realized, the Fund will have a larger corporate
income tax expense than expected, which will result in less cash available to distribute to
shareholders.
The Fund will recognize gain or loss on the sale, exchange or other taxable disposition of an
equity security of an MLP equal to the difference between the amount realized by the Fund on the
sale, exchange or other taxable disposition and the Funds adjusted tax basis in such equity
security. Any such gain will be subject to U.S. federal income tax at the regular graduated
corporate rates (currently a maximum rate of 35%), regardless of how long the Fund has held such
equity security. The amount realized by the Fund generally will be the amount paid by the
purchaser of the equity security plus the Funds allocable share, if any, of the MLPs debt that
will be allocated to the purchaser as a result of the sale, exchange or other taxable disposition.
The Funds tax basis in its equity securities in an MLP generally will be equal to the amount the
Fund paid for the equity securities, (x) increased by the Funds allocable share of the MLPs net
taxable income and certain MLP nonrecourse debt, if any, and (y) decreased by the Funds allocable
share of the MLPs net losses and any distributions received by the Fund from the MLP. Although
any distribution by an MLP to the Fund in excess of the Funds allocable share of such MLPs net
taxable income may create a temporary economic benefit to the Fund, such distribution will increase
the amount of income or gain (or decrease the amount of loss) that will be recognized on the sale
of an equity security in the MLP by the Fund. If the Fund is required to sell equity securities in
the MLPs to meet redemption requests, the Fund likely will recognize income and/or gain for U.S.
federal, state and local income tax purposes, which will result in corporate income taxes imposed
on the Fund and decrease cash available for distribution to shareholders.
Any capital losses that the Fund recognizes on a disposition of an equity security of an MLP
can only be used to offset capital gains that the Fund recognizes. Any capital losses that the
Fund is unable to use may be carried back for a period of three years and forward for a period of
five taxable years. Because (i) the period for
S-25
which capital losses may be carried forward is limited to five taxable years and (ii) the
disposition of an equity security of an MLP may be treated, in significant part, as ordinary
income, capital losses incurred by the Fund may expire without being utilized.
The Funds allocable share of certain percentage depletion deductions and intangible drilling
costs of the MLPs in which the Fund invests may be treated as items of tax preference for purposes
of calculating the Funds alternative minimum taxable income. Such items will increase the Funds
alternative minimum taxable income and increase the likelihood that the Fund may be subject to the
alternative minimum tax.
Other Investments. The Funds transactions in foreign currencies, forward contracts, options
and futures contracts (including options and futures contracts on foreign currencies), to the
extent permitted, will be subject to special provisions of the Code (including provisions relating
to hedging transactions and straddles) that, among other things, may affect the character of
gains and losses recognized by the Fund (i.e., may affect whether gains or losses are ordinary
versus capital or short-term versus long-term), accelerate recognition of income to the Fund and
defer Fund losses. These provisions also (a) will require the Fund to mark-to-market certain types
of the positions in its portfolio (i.e., treat them as if they were closed out at the end of each
year) and (b) may cause the Fund to recognize income without receiving the corresponding amount
cash.
If the Fund invests in debt obligations having original issue discount, the Fund may recognize
taxable income from such investments in advance of any cash received therefrom.
Foreign Investments. Dividends or other income (including, in some cases, capital gains)
received by the Fund from investments in foreign securities may be subject to withholding and other
taxes imposed by foreign countries. Tax conventions between certain countries and the United
States may reduce or eliminate such taxes in some cases. Foreign taxes paid by the Fund will
reduce the return from the Funds investments. Shareholders will not be entitled to claim credits
or deductions on their own tax returns for foreign taxes paid by the Fund.
U.S. Shareholders
Distributions. Distributions by the Fund of cash or property in respect of the shares of the
Fund will be treated as dividends for U.S. federal income tax purposes to the extent paid from the
Funds current or accumulated earnings and profits (as determined under U.S. federal income tax
principles) and will be includible in gross income by a U.S. Shareholder upon receipt. Any such
dividend will be eligible for the dividends received deduction if received by an otherwise
qualifying corporate U.S. Shareholder that meets the holding period and other requirements for the
dividends received deduction. Dividends paid by the Fund to certain non-corporate U.S.
Shareholders (including individuals), with respect to taxable years beginning on or before December
31, 2012, are eligible for U.S. federal income taxation at the rates generally applicable to
long-term capital gains for individuals (currently at a maximum tax rate of 15%), provided that the
U.S. Shareholder receiving the dividend satisfies applicable holding period and other requirements.
Thereafter, dividends paid by the Fund to certain non-corporate U.S. Shareholders (including
individuals) will be fully taxable at ordinary income rates (i.e., currently up to 39.6%) unless further
Congressional action is taken.
If the amount of a Fund distribution exceeds the Funds current and accumulated earnings and
profits, such excess will be treated first as a return of capital to the extent of the
U.S. Shareholders tax basis in the shares of the Fund, which will not be subject of tax, and thereafter as capital gain. Any such
capital gain will be long-term capital gain if such U.S. Shareholder has held the applicable shares
of the Fund for more than one year.
U.S. Shareholders that participate in the Funds Plan will be treated for U.S. federal income
tax purposes as having (i) received a cash distribution equal to the reinvested amount and (ii)
reinvested such amount in shares of the Fund.
Sales of Shares of the Fund. Upon the sale or other taxable disposition of shares of the
Fund, a U.S. Shareholder generally will recognize capital gain or loss equal to the difference
between the amount realized on such disposition and the U.S. Shareholders adjusted tax basis in
the shares of the Fund. Any such capital gain or loss will be long-term capital gain or loss if
the U.S. Shareholder has held the shares of the Fund for more than one year at the time of
disposition. Long-term capital gains of certain non-corporate U.S. Shareholders (including
individuals) are currently subject to U.S. federal income taxation at a maximum rate of 15%
(scheduled to increase to 20% for
S-26
taxable years beginning after December 31, 2012). The deductibility of capital losses is
subject to limitations under the Code.
A U.S. Shareholders adjusted tax basis in its shares of the Fund may be less than the price
paid for the shares of the Fund as a result of distributions by the Fund in excess of the Funds
earnings and profits (i.e., returns of capital).
UBTI. Under current law, an investment in shares of the Fund will not generate unrelated
business taxable income (UBTI) for tax-exempt U.S. Shareholders, provided that the tax-exempt
U.S. Shareholder does not incur acquisition indebtedness (as defined for U.S. federal income tax
purposes) with respect to the shares of the Fund. A tax-exempt U.S. Shareholder would recognize
UBTI by reason of its investment in the Fund if the shares of the Fund constitute debt-financed
property in the hands of the tax-exempt U.S. Shareholder.
SERVICE PROVIDERS
Administrator
U.S. Bancorp Fund Services, LLC, the Administrator, which is located at 615 East Michigan Street, Milwaukee, WI 53202,
serves as the Funds administrator pursuant to a fund administration
servicing agreement. Pursuant to this agreement, the Administrator provides the Fund with, among
other things, compliance oversight, financial reporting oversight and tax reporting. The Fund pays
the Administrator a monthly fee computed at an annual rate of 0.09% of the first $100 million
of Managed Assets, 0.07% on the next $200 million of Managed Assets and 0.04% on the
balance of Managed Assets, subject to a minimum annual fee of $70,000. The Fund will also pay for the
Administrators out-of-pocket expenses. The Administrator also serves as fund accountant pursuant
to a fund accounting servicing agreement.
Custodian
U.S. Bank, National Association (the Custodian), Custody Operations, 1555 N. RiverCenter
Drive, Suite 302, Milwaukee, WI 53212, serves as custodian for the Fund pursuant to the Custodian
Agreement with the Trust (the Custodian Agreement). The Custodian and the Administrator are
affiliates of each other. Under the Custodian Agreement, the Custodian will be responsible for,
among other things, receipt of and disbursement of funds from the Funds accounts, establishment of
segregated accounts as necessary, and transfer, exchange and delivery of Fund portfolio securities.
Transfer Agent
U.S.
Bancorp Fund Services, LLC,
located at 615 East Michigan Street, Milwaukee, WI 53202, has entered into a transfer agent servicing
agreement with the Fund. Under this agreement, U.S. Bancorp Fund
Services, LLC, serves as the
Funds transfer agent, registrar and dividend disbursing agent.
GENERAL INFORMATION
Additional Information
The Prospectus and this SAI constitute part of a Registration Statement filed by the Fund
with the SEC under the Securities Act, and the 1940 Act. The Prospectus and this SAI omit certain
of the information contained in the Registration Statement, and reference is hereby made to the
Registration Statement and related exhibits for further information with respect to the Fund and
the common shares offered hereby. Any statements contained in the Prospectus and herein concerning
the provisions of any document are not necessarily complete, and, in each instance, reference is
made to the copy of such document filed as an exhibit to the Registration Statement or otherwise
filed with the SEC. Each such statement is qualified in its entirety by such reference. The
complete Registration Statement may be obtained from the SEC upon payment of the fee prescribed by
its rules and regulations or free of charge through the SECs
web site (http://www.sec.gov).
S-27
Control Persons and Principal Holders
Prior to the public offering of the common shares, the Investment Adviser purchased Common
Shares from the Fund in an amount satisfying the net worth requirements of Section 14(a) of the
1940 Act, which requires the Trust to have a net worth of at least $100,000 prior to making a
public offering. As of the date of this SAI, the Investment Adviser owned 100% of the Trusts
outstanding common shares and therefore may be deemed to control the Trust until such time as it
owns less than 25% of the Trusts outstanding common shares, which is expected to occur as of the
completion of the offering of the common shares. By virtue of his control of the Investment
Adviser, Mr. Swank may be deemed to beneficially own the common shares of the Fund held by the
Investment Adviser and therefore may be deemed to be a control person of the Fund.
Counsel and Independent Registered Public Accounting Firm
Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York, is special counsel to the Fund
in connection with the issuance of the common shares.
Ernst & Young LLP, Dallas, Texas, serves as the independent registered public accounting firm of the Fund and will annually
render an opinion on the financial statements of the Fund.
Proxy Voting Policy and Procedures and Proxy Voting Record
The Fund has delegated authority to vote proxies to the Investment Adviser, subject to the
supervision of the Board of Trustees. Attached hereto as Appendix B is the Proxy Voting Policy
which is currently in effect as of the date of this Statement of Additional Information.
The Proxy Voting Policy is subject to change over time and investors seeking the most current
copy of the Proxy Voting Policy should go to the Funds web site at www.cushingfunds.com. The
Funds most recent proxy voting record for the twelve-month period ended June 30 which has been
filed with the SEC will also available without charge on the Funds web site at www.cushingcef.com.
The Funds proxy voting record is also available without charge on the SECs web site at
www.sec.gov.
Trustee and Officer Liability
Under the Funds Agreement and Declaration of Trust and its Bylaws, and under Delaware law,
the Trustees, officers, employees, and certain agents of the Fund are entitled to indemnification
under certain circumstances against liabilities, claims, and expenses arising from any threatened,
pending, or completed action, suit, or proceeding to which they are made parties by reason of the
fact that they are or were such Trustees, officers, employees, or agents of the Fund, subject to
the limitations of the 1940 Act that prohibit indemnification that would protect such persons
against liabilities to the Fund or its shareholders to which they would otherwise be subject by
reason of their own bad faith, willful misfeasance, gross negligence, or reckless disregard of
duties.
Shareholder Reports
Semiannual statements are furnished to shareholders, and annually such statements are audited
by the Funds independent registered public accounting firm.
Code of Ethics
The Fund and the Investment Adviser have adopted a code of ethics under Rule 17j-1 of the 1940
Act. This code permits personnel subject to the code to invest in securities, including securities
that may be purchased or held by the Fund. This code of ethics can be reviewed and copied at the
SECs Public Reference Room in Washington, D.C. Information on the operation of the Public
Reference Room may be obtained by calling the SEC at 1-202-551-8090. The code of ethics is
available on the EDGAR Database on the SECs web site (http://www.sec.gov), and copies of this code
may be obtained, after paying a duplicating fee, by electronic request at the following e-mail
address: publicinfo@sec.gov, or by writing the SECs Public Reference Section, Washington, D.C.
20549-0102.
S-28
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Shareholders and Board of Trustees of
Cushing Royalty & Income Fund:
We have audited the accompanying statement of assets and liabilities, of the Cushing Royalty &
Income Fund (the Fund) as of September 26, 2011. This statement of assets and liabilities is the
responsibility of the Funds management. Our responsibility is to express an opinion on the
statement of assets and liabilities based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the statement of assets and liabilities is free of material
misstatement. We were not engaged to perform an audit of the Funds internal control over financial
reporting. Our audit included consideration of internal control over financial reporting as a basis
for designing audit procedures that are appropriate in the circumstances, but not for the purpose
of expressing an opinion on the effectiveness of the Funds internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test
basis, evidence supporting the amounts and disclosures in the statement of assets and liabilities,
assessing the accounting principles used and significant estimates made by management, and
evaluating the overall statement of assets and liabilities presentation. We believe that our audit
provides a reasonable basis for our opinion.
In our opinion, the statement of assets and liabilities referred to above present fairly, in all
material respects, the financial position of the Cushing Royalty & Income Fund at September 26,
2011, in conformity with U.S. generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
Dallas, Texas
October 25, 2011
FS-1
FINANCIAL STATEMENTS FOR THE FUND
The Cushing Royalty & Income Fund
STATEMENT OF ASSETS & LIABILITIES
September 26, 2011
|
|
|
|
|
Assets |
|
|
|
|
Cash |
|
$ |
100,000 |
|
Receivable from Adviser for organizational costs |
|
|
51,353 |
|
Deferred offering costs |
|
|
32,663 |
|
|
|
|
|
Total assets |
|
|
184,016 |
|
|
|
|
|
|
Liabilities |
|
|
|
|
Payable for organizational costs |
|
|
51,353 |
|
Accrued offering costs |
|
|
32,663 |
|
|
|
|
|
Total
liabilities |
|
|
84,016 |
|
|
|
|
|
Net assets applicable to common stockholders |
|
$ |
100,000 |
|
|
|
|
|
|
Net Assets Applicable to Common Stockholders Consist of: |
|
|
|
|
Capital
stock, $0.001 par value; 4,188 shares issued and outstanding (unlimited shares authorized) |
|
$ |
4 |
|
Additional paid-in capital |
|
|
99,996 |
|
|
|
|
|
Net assets applicable to common stockholders |
|
$ |
100,000 |
|
|
|
|
|
|
Net Asset
Value per common share outstanding (net assets applicable to common
shares divided by common shares outstanding) |
|
$ |
23.88 |
|
See the accompanying Notes to Statement of Assets and Liabilities
FS-2
The Cushing Royalty & Income Fund
Notes to Statement of Assets and Liabilities
September 26, 2011
The Cushing Royalty & Income Fund (the Fund) was formed as a Delaware statutory trust on
July 18, 2011, and plans to register as a non-diversified, closed-end management investment company
under the Investment Company Act of 1940, as amended. The Fund is managed by Cushing MLP Asset
Management, LP (Adviser). The Funds investment objective is to seek a high total return with an
emphasis on current income. As of September 26, 2011, the Fund has not yet commenced investment
operations. The only transaction of the Fund has been the initial sale on September 26, 2011 of
4,188 shares of the Fund to the Adviser, which represented the initial capital at $23.88 per share.
2. Significant Accounting Policies
A. Use of Estimates
The preparation of financial statements in conformity with accounting principles generally
accepted in the United States of America requires management to make estimates and assumptions that
affect the reported amount of assets and liabilities, recognition of distribution income and
disclosure of contingent assets and liabilities at the date of the financial statements. Actual
results could differ from those estimates.
B. Organizational Expenses and Offering Costs
The Adviser has agreed to pay the costs related to the Funds formation, which amounted to
$51,353 as of September 26, 2011.
Deferred offering costs paid by the Fund will be charged as a reduction of additional paid-in
capital at the completion of the Funds initial public offering (IPO). As of September 26, 2011,
the amount of deferred offering costs owed by the Fund was $32,663. The Adviser has also agreed to
pay certain offering costs to the extent they exceed an amount per share to be determined based on
the number of shares sold in the IPO. The Fund will not pay offering costs in excess of $0.05 per
share sold in the IPO.
C. Federal Income Taxes
The Fund, which is taxed as a corporation, is obligated to pay federal and state income tax on
its taxable income. The Funds tax expense or benefit will be included in the Statement of
Operations based on the component of income or gains (losses) to which such expense or benefit
relates. No tax expense or benefit was accrued as of September 26, 2011.
3. Agreements and Related Party Transactions
The Fund has entered into an Investment Management Agreement (the Agreement) with the
Adviser. Pursuant to the Agreement, the Fund has agreed to pay the Adviser a fee payable at the end
of each calendar month, at an annual rate equal to 1.50% of the average weekly value of the Funds
managed assets during such month. The Adviser has agreed to waive 0.25% of the management fee until
at least November 1, 2012. Such waiver may be modified or terminated by the Adviser at any time
after November 1, 2012. No fees have been paid to or are due to the Adviser as of September 26,
2011.
4. Subsequent Events
Management has evaluated subsequent events through the date the statement of assets and liabilities
was issued and has determined that there are no material events that would require disclosure in
the Funds financial statements through this date.
FS-3
APPENDIX A: DESCRIPTION OF SECURITIES RATINGS
Standard & Poors
A brief description of the applicable Standard & Poors rating symbols and their meanings (as
published by Standard & Poors) follows:
A S&P issue credit rating is a current opinion of the creditworthiness of an obligor with respect
to a specific financial obligation, a specific class of financial obligations, or a specific
financial program (including ratings on medium-term note programs and commercial paper programs).
It takes into consideration the creditworthiness of guarantors, insurers, or other forms of credit
enhancement on the obligation and takes into account the currency in which the obligation is
denominated. The opinion evaluates the obligors capacity and willingness to meet its financial
commitments as they come due, and may assess terms, such as collateral security and subordination,
which could affect ultimate payment in the event of default. The issue credit rating is not a
statement of fact or recommendation to purchase, sell, or hold a financial obligation or make any
investment decisions. Nor is it a comment regarding an issues market price or suitability for a
particular investor.
Issue credit ratings are based on current information furnished by the obligors or obtained by
Standard & Poors from other sources it considers reliable. S&P does not perform an audit in
connection with any credit rating and may, on occasion, rely on unaudited financial information.
Credit ratings may be changed, suspended, or withdrawn as a result of changes in, or unavailability
of, such information, or based on other circumstances.
Issue credit ratings can be either long term or short term. Short-term ratings are generally
assigned to those obligations considered short-term in the relevant market. In the U.S., for
example, that means obligations with an original maturity of no more than 365 daysincluding
commercial paper. Short-term ratings are also used to indicate the creditworthiness of an obligor
with respect to put features on long-term obligations. The result is a dual rating, in which the
short-term rating addresses the put feature, in addition to the usual long-term rating. Medium-term
notes are assigned long-term ratings.
Long-Term Issue Credit Ratings
Issue credit ratings are based, in varying degrees, on the following considerations:
|
|
Likelihood of paymentcapacity and willingness of the obligor to meet its financial
commitment on an obligation in accordance with the terms of the obligation; |
|
|
|
Nature of and provisions of the obligation; |
|
|
|
Protection afforded by, and relative position of, the obligation in the event of
bankruptcy, reorganization, or other arrangement under the laws of bankruptcy and other laws
affecting creditors rights. |
Issue ratings are an assessment of default risk, but may incorporate an assessment of relative
seniority or ultimate recovery in the event of default. Junior obligations are typically rated
lower than senior obligations, to reflect the lower priority in bankruptcy, as noted above. (Such
differentiation may apply when an entity has both senior and subordinated obligations, secured and
unsecured obligations, or operating company and holding company obligations.)
AAA
An obligation rated AAA has the highest rating assigned by Standard & Poors. The obligors
capacity to meet its financial commitment on the obligation is extremely strong.
AA
An obligation rated AA differs from the highest-rated obligations only to a small degree. The
obligors capacity to meet its financial commitment on the obligation is very strong.
A
An obligation rated A is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than obligations in higher-rated categories. However, the
obligors capacity to meet its financial commitment on the obligation is still strong.
A-1
BBB
An obligation rated BBB exhibits adequate protection parameters. However, adverse economic
conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor
to meet its financial commitment on the obligation.
BB, B, CCC, CC, and C
Obligations rated BB, B, CC , CC, and C are regarded as having significant speculative
characteristics. BB indicates the least degree of speculation and C the highest. While such
obligations will likely have some quality and protective characteristics, these may be outweighed
by large uncertainties or major exposures to adverse conditions.
BB
An obligation rated BB is less vulnerable to nonpayment than other speculative issues. However,
it faces major ongoing uncertainties or exposure to adverse business, financial, or economic
conditions which could lead to the obligors inadequate capacity to meet its financial commitment
on the obligation.
B
An obligation rated B is more vulnerable to nonpayment than obligations rated BB, but the
obligor currently has the capacity to meet its financial commitment on the obligation. Adverse
business, financial, or economic conditions will likely impair the obligors capacity or
willingness to meet its financial commitment on the obligation.
CCC
An obligation rated CCC is currently vulnerable to nonpayment, and is dependent upon favorable
business, financial, and economic conditions for the obligor to meet its financial commitment on
the obligation. In the event of adverse business, financial, or economic conditions, the obligor
is not likely to have the capacity to meet its financial commitment on the obligation.
CC
An obligation rated CC is currently highly vulnerable to nonpayment.
C
A C rating is assigned to obligations that are currently highly vulnerable to nonpayment,
obligations that have payment arrearages allowed by the terms of the documents, or obligations of
an issuer that is the subject of a bankruptcy petition or similar action which have not experienced
a payment default. Among others, the C rating may be assigned to subordinated debt, preferred
stock or other obligations on which cash payments have been suspended in accordance with the
instruments terms or when preferred stock is the subject of a distressed exchange offer, whereby
some or all of the issue is either repurchased for an amount of cash or replaced by other
instruments having a total value that is less than par.
D
An obligation rated D is in payment default. The D rating category is used when payments on an
obligation are not made on the date due even if the applicable grace period has not expired, unless
S&P believes that such payments will be made during such grace period. The D rating also will be
used upon the filing of a bankruptcy petition or the taking of similar action if payments on an
obligation are jeopardized. An obligations rating is lowered to D upon completion of a
distressed exchange offer, whereby some or all of the issue is either repurchased for an amount of
cash or replaced by other instruments having a total value that is less than par.
Moodys Investors Service Inc.
A brief description of the applicable Moodys Investors Service, Inc. (Moodys) rating symbols
and their meanings (as published by Moodys) follows:
Long-Term Obligation Ratings
Moodys long-term obligation ratings are opinions of the relative credit risk of fixed-income
obligations with an original maturity of one year or more. They address the possibility that a
financial obligation will not be honored as promised. Such ratings reflect both the likelihood of
default and any financial loss suffered in the event of default.
A-2
Moodys Long-Term Rating Definitions:
|
|
|
Aaa
|
|
Obligations rated Aaa are judged to be of the highest quality, with minimal credit risk. |
|
|
|
Aa
|
|
Obligations rated Aa are judged to be of high quality and are subject to very low credit risk. |
|
|
|
A
|
|
Obligations rated A are considered upper-medium grade and are subject to low credit risk. |
|
|
|
Baa
|
|
Obligations rated Baa are subject to moderate credit risk. They are considered medium-grade and as such may possess
certain speculative characteristics. |
|
|
|
Ba
|
|
Obligations rated Ba are judged to have speculative elements and are subject to substantial credit risk. |
|
|
|
B
|
|
Obligations rated B are considered speculative and are subject to high credit risk. |
|
|
|
Caa
|
|
Obligations rated Caa are judged to be of poor standing and are subject to very high credit risk. |
|
|
|
Ca
|
|
Obligations rated Ca are highly speculative and are likely in, or very near, default, with some prospect of recovery of
principal and interest. C Obligations rated C are the lowest rated class of bonds and are typically in default, with
little prospect for recovery of principal or interest. |
|
|
|
Note:
|
|
Moodys appends numerical modifiers 1, 2, and 3 to each generic rating classification from Aa through Caa. The modifier
1 indicates that the obligation ranks in the higher end of its generic rating category; the modifier 2 indicates a
mid-range ranking; and the modifier 3 indicates a ranking in the lower end of that generic rating category. |
Medium-Term Note Ratings
Moodys assigns long-term ratings to individual debt securities issued from medium-term note (MTN)
programs, in addition to indicating ratings to MTN programs themselves. Notes issued under MTN
programs with such indicated ratings are rated at issuance at the rating applicable to all pari
passu notes issued under the same program, at the programs relevant indicated rating, provided
such notes do not exhibit any of the characteristics listed below:
|
|
Notes containing features that link interest or principal to the credit performance of any
third party or parties (i.e., credit-linked notes); |
|
|
|
Notes allowing for negative coupons, or negative principal; |
|
|
|
Notes containing any provision that could obligate the investor to make any additional
payments; |
|
|
|
Notes containing provisions that subordinate the claim. |
For notes with any of these characteristics, the rating of the individual note may differ from the
indicated rating of the program.
Short-Term Ratings
Moodys short-term ratings are opinions of the ability of issuers to honor short-term financial
obligations. Ratings may be assigned to issuers, short-term programs or to individual short-term
debt instruments. Such obligations generally have an original maturity not exceeding thirteen
months, unless explicitly noted.
Moodys employs the following designations to indicate the relative repayment ability of
rated issuers:
|
|
|
P-1
|
|
Issuers (or supporting institutions) rated Prime-1 have a superior ability to repay short-term debt obligations. |
|
|
|
P-2
|
|
Issuers (or supporting institutions) rated Prime-2 have a strong ability to repay short-term debt obligations. |
|
|
|
P-3
|
|
Issuers (or supporting institutions) rated Prime-3 have an acceptable ability to repay short-term obligations. |
|
|
|
NP
|
|
Issuers (or supporting institutions) rated Not Prime do not fall within any of the Prime rating categories. |
A-3
|
|
|
Note:
|
|
Canadian issuers rated P-1 or P-2 have their short-term ratings enhanced by the senior-most long-term rating of the
issuer, its guarantor or support-provider. |
A-4
APPENDIX B: PROXY VOTING POLICIES AND PROCEDURES
Proxy Voting Policy
Cushing MLP Asset Management, L.P. (the Investment Manager) serves as the
investment adviser and general partner, respectively, of certain the investment accounts and
pooled investment (each a Client and collectively, the Clients). Through these relationships
the Investment Manager is sometimes delegated the right to vote, on behalf of the Clients,
proxies received from companies, the securities of which are owned by the Clients.
Purpose
The Investment Manager follows this proxy voting policy (the Policy) to ensure that
proxies the Investment Manager votes, on behalf of each Client, are voted to further the best
interest of that Client. The Policy establishes a mechanism to address any conflicts of interests
between the Investment Manager and the Client. Further, the Policy establishes how Clients may
obtain information on how the proxies have been voted.
Determination of Vote
The Investment Manager determines how to vote after studying the proxy materials and
any other materials that may be necessary or beneficial to voting. The Investment Manager votes
in a manner that the Investment Manager believes reasonably furthers the best interests of the
Client and is consistent with the Clients investment philosophy as set forth in the relevant
investment management documents.
The major proxy-related issues generally fall within five categories: corporate
governance, takeover defenses, compensation plans, capital structure, and social responsibility.
The Investment Manager will cast votes for these matters on a case-by-case basis. The
Investment Manager will generally vote in favor of matters which follow an agreeable corporate
strategic direction, support an ownership structure that enhances shareholder value without
diluting managements accountability to shareholders and/or present compensation plans that are
commensurate with enhanced manager performance and market practices.
Resolution of any Conflicts of Interest
If a proxy vote creates a material conflict between the interests of the Investment
Manager and a Client, the Investment Manager will resolve the conflict before voting the
proxies. The Investment Manager will either disclose the conflict to the Client and obtain a
consent or take other steps designed to ensure that a decision to vote the proxy was based on the
Investment Manager's determination of the Client's best interest and was not the product of the
conflict.
Records
The Investment Manager maintains records of (i) all proxy statements and materials the
Investment Manager receives on behalf of Clients; (ii) all proxy votes that are made on behalf of
the Clients; (iii) all documents that were material to a proxy vote; (iv) all written requests from
Clients regarding voting history; and (v) all responses (written and oral) to Clients requests.
Such records are available to the Clients (and owners of a Client that is an investment vehicle)
upon request.
Questions and Requests
This document is a summary of the proxy voting process. Clients may obtain, free of
charge, a full copy of the policies and procedures and/or a record of proxy votes. Any questions
or requests should be directed to Barry Greenberg at:
8117 Preston Rd.
Suite 440
Dallas, Texas 75225
Telephone: (214) 692-6334
Facsimile: (214) 219-2353
B-1
PART C
OTHER INFORMATION
Item 25. Financial Statements And Exhibits
|
|
The Registrant has not conducted any business as of the date of this filing, other than in
connection with its organization. Financial statements indicating that the Registrant has
met the net worth requirements of Section 14(a) of the 1940 Act will be filed by
Pre-Effective Amendment to the Registration Statement. |
|
(2) |
|
Exhibits |
|
(a)(i) |
|
Certificate of Trust (1) |
|
|
(a)(ii) |
|
Agreement and Declaration of Trust of Registrant (1) |
|
|
(a)(iii) |
|
Amended and Restated Agreement and Declaration of Trust of Registrant (1) |
|
|
(b) |
|
Bylaws of Registrant (1) |
|
|
(c) |
|
Not applicable |
|
|
(d) |
|
Not applicable |
|
|
(e) |
|
Dividend Reinvestment Plan of Registrant (1) |
|
|
(f) |
|
Not applicable |
|
|
(g) |
|
Form of Investment Management Agreement between Registrant and Cushing® MLP Asset Management, LP (1) |
|
|
|
(h) |
|
Form of Underwriting Agreement (2) |
|
|
|
(i) |
|
Not applicable |
|
|
|
(j) (i) |
|
Form of Custody Agreement (2) |
|
|
|
|
(j) (ii) |
|
First Amendment to the Custody Agreement (2) |
|
|
|
|
(k)(i) |
|
Form of Transfer Agent Servicing Agreement (2) |
|
|
|
|
(ii) |
|
Form of Fund Administration Servicing Agreement (2) |
|
|
|
|
(iii) |
|
Form of Fund Accounting Servicing Agreement (2) |
|
|
|
|
(l) |
|
Opinion and Consent of Skadden, Arps, Slate, Meagher &
Flom LLP (2) |
|
|
|
(m) |
|
Not applicable |
|
|
(n) |
|
Consent of Independent Registered Public Accounting Firm (2) |
|
|
(o) |
|
Not applicable |
|
|
(p) |
|
Form of Initial Subscription Agreement (1) |
|
|
(q) |
|
Not applicable |
|
|
|
(r) |
|
Code of Ethics of the Registrant and the Investment Adviser (2) |
|
C-1
|
(s) |
|
Power of Attorney (1) |
|
|
|
(1) |
|
Incorporated by reference to the corresponding exhibit number to the Registrants Registration Statement under the Securities Act of 1933, as amended, and the Investment Company Act of 1940, as amended, (333-175925 and 811-22593), on Form N-2, filed on August 1, 2011. |
|
(2) |
|
Filed herewith. |
|
|
Item 26. Marketing Arrangements
|
|
Reference is made to Exhibit 2(h) to this Registration Statement to be filed by further
amendment. |
Item 27. Other Expenses of Issuance and Distribution
|
|
|
The following table sets forth the estimated expenses to be incurred in connection with the
offering described in this Registration Statement: |
|
|
|
|
SEC Fees |
|
$22,920 |
FINRA Fees |
|
19,900 |
Printing/Engraving Expenses |
|
300,000 |
Marketing Expenses |
|
400,000 |
Legal Fees |
|
300,000 |
NYSE Listing Fees |
|
20,000 |
Audit Fees |
|
42,000 |
Total (1) |
|
$1,104,820 |
|
|
|
|
(1) |
|
The Fund will bear $300,000 of the total estimated expenses. |
|
Item 28. Persons Controlled by or Under Common Control with Registrant
Item 29. Number of Holders of Securities
|
|
|
|
|
|
|
Number of Record Shareholders |
Title Class |
|
as
of February 21, 2012 |
Common shares of beneficial interest, par value $0.001 per share |
|
One |
Item 30. Indemnification
Article IV of the Registrants Amended and Restated Agreement and Declaration of Trust provides as follows: |
Section 2. Limitation of Liability. All persons contracting with or having any claim
against the Trust or a particular Series shall look only to the assets of the Trust or, as applicable,
all Series or such particular Series for payment under such contract or claim; and neither the
Trustees nor, when acting in such capacity, any of the Trusts officers, employees or agents,
whether past, present or future, shall be personally liable therefor. Every written instrument or
obligation on behalf of the Trust or any Series shall contain a statement to the foregoing effect,
but the absence of such statement shall not operate to make any Trustee or officer of the Trust
liable thereunder. Provided they have exercised reasonable care and have acted under the
reasonable belief that their actions are in the best interest of the Trust, the Trustees and officers
of the Trust shall not be responsible or liable for any act or omission or for neglect or
wrongdoing of them or any officer, agent, employee, investment adviser or independent
contractor of the Trust, but nothing contained in this Declaration or in the Delaware Act shall
protect any Trustee or officer of the Trust against liability to the Trust or to Shareholders 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.
Section 3. Indemnification.
(a) Subject to the exceptions and limitations contained in subsection (b) below:
(i) every person who is, or has been, a Trustee or an officer, employee
or agent of the Trust (including any individual who serves at its request as director,
officer, partner, employee, trustee, agent or the like of another organization in which it
has any interest as a shareholder, creditor or otherwise) ("Covered Person") shall be
indemnified by the Trust or the appropriate Series to the fullest extent permitted by law
against liability and against all expenses reasonably incurred or paid by him in
connection with any claim, action, suit or proceeding in which he becomes involved as a
party or otherwise by virtue of his being or having been a Covered Person and against
amounts paid or incurred by him in the settlement thereof; and
C-2
(ii) as used herein, the words claim, action, suit, or proceeding
shall apply to all claims, actions, suits or proceedings (civil, criminal, administrative,
investigative, arbitration or other, including appeals), actual or threatened, and the words
liability and expenses shall include, without limitation, attorneys fees, costs,
judgments, amounts paid in settlement, fines, penalties and other liabilities.
(b) No indemnification shall be provided hereunder to a Covered Person:
(i) who shall have been adjudicated by a court or body before which
the proceeding was brought (A) to be liable to the Trust or its Shareholders by reason of
willful misfeasance, bad faith, gross negligence or reckless disregard of the duties
involved in the conduct of his office, or (B) not to have acted in good faith and in a
manner the person reasonably believed to be in or not opposed to the best interests of the Trust; or
(ii) in the event of a settlement, unless there has been a determination
that such Covered Person did not engage in willful misfeasance, bad faith, gross
negligence or reckless disregard of the duties involved in the conduct of his office; (A) by
the court or other body approving the settlement; (B) by at least a majority of those
Trustees who are neither Interested Persons of the Trust nor are parties to the matter
based upon a review of readily available facts (as opposed to a full trial-type inquiry); (C)
by written opinion of independent legal counsel based upon a review of readily available
facts (as opposed to a full trial-type inquiry) or (D) by a vote of a majority of the
Outstanding Shares entitled to vote (excluding any Outstanding Shares owned of record
or beneficially by such individual).
(c) The rights of indemnification herein provided may be insured against by
policies maintained by the Trust, shall be severable, shall not be exclusive of or affect any other
rights to which any Covered Person may now or hereafter be entitled, and shall inure to the
benefit of the heirs, executors and administrators of a Covered Person.
(d) To the maximum extent permitted by applicable law, expenses in
connection with the preparation and presentation of a defense to any claim, action, suit or
proceeding of the character described in subsection (a) of this Section may be paid by the Trust
or applicable Series from time to time prior to final disposition thereof upon receipt of an
undertaking by or on behalf of such Covered Person that such amount will be paid over by him
to the Trust or applicable Series if it is ultimately determined that he is not entitled to
indemnification under this Section; provided, however, that either (i) such Covered Person shall
have provided appropriate security for such undertaking, (ii) the Trust is insured against losses
arising out of any such advance payments or (iii) either a majority of a quorum of the Trustees
who are neither Interested Persons of the Trust nor parties to the matter, or independent legal
counsel in a written opinion, shall have determined, based upon a review of readily available
facts (as opposed to a full trial-type inquiry) that there is reason to believe that such Covered
Person will not be disqualified from indemnification under this Section. Independent counsel
retained for the purpose of rendering an opinion regarding advancement of expenses and/or a
majority of a quorum of the Trustees who are neither Interested Persons of the Trust nor parties
to the matter, may proceed under a rebuttable presumption that the Covered Person has not
engaged in willful misfeasance, bad faith, gross negligence or reckless disregard of the Covered
Persons duties to the Trust and were based on the Covered Persons determination that those
actions were in the best interests of the Trust and its Shareholders; provided that the Covered
Person is not an Interested Person (or is an Interested Person solely by reason of being an officer
of the Trust).
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(e) Any repeal or modification of this Article IV by the Shareholders, or
adoption or modification of any other provision of the Declaration or By-Laws inconsistent with
this Article, shall be prospective only, to the extent that such repeal, or modification would, if
applied retrospectively, adversely affect any limitation on the liability of any Covered Person or
indemnification available to any Covered Person with respect to any act or omission which
occurred prior to such repeal, modification or adoption. Any such repeal or modification by the
Shareholders shall require a vote of at least two-thirds of the Outstanding Shares entitled to vote
and present in person or by proxy at any meeting of the Shareholders.
Section 4. Indemnification of Shareholders.
(a) If any Shareholder or former Shareholder of the Trust (as opposed to a
Shareholder or former Shareholder of any Series) shall be held personally liable solely by reason
of his being or having been a Shareholder and not because of his acts or omissions or for some
other reason, the Shareholder or former Shareholder (or his heirs, executors, administrators or
other legal representatives or in the case of any entity, its general successor) shall be entitled out
of the assets belonging to the Trust to be held harmless from and indemnified against all loss and
expense arising from such liability. The Trust shall, upon request by such Shareholder, assume
the defense of any claim made against such Shareholder for any act or obligation of the Trust and
satisfy any judgment thereon from the assets of the Series.
(b) If any Shareholder or former Shareholder of any Series shall be held
personally liable solely by reason of his being or having been a Shareholder and not because of
his acts or omissions or for some other reason, the Shareholder or former Shareholder (or his
heirs, executors, administrators or other legal representatives or in the case of any entity, its
general successor) shall be entitled out of the assets belonging to the applicable Series to be held
harmless from and indemnified against all loss and expense arising from such liability. The
Trust, on behalf of the affected Series, shall, upon request by such Shareholder, assume the
defense of any claim made against such Shareholder for any act or obligation of the Series and
satisfy any judgment thereon from the assets of the Series.
Section 5. No Bond Required of Trustees. No Trustee shall be obligated to give any
bond or other security for the performance of any of his duties hereunder.
Section 6. No Duty of Investigation; Notice in Trust Instruments, Etc. No purchaser,
lender, transfer agent or other Person dealing with the Trustees or any officer, employee or agent
of the Trust or a Series thereof shall be bound to make any inquiry concerning the validity of any
transaction purporting to be made by the Trustees or by said officer, employee or agent or be
liable for the application of money or property paid, loaned, or delivered to or on the order of the
Trustees or of said officer, employee or agent. Every obligation, contract, instrument, certificate,
Share, other security of the Trust or a Series thereof or undertaking, and every other act or thing
whatsoever executed in connection with the Trust shall be conclusively presumed to have been
executed or done by the executors thereof only in their capacity as Trustees under this
Declaration or in their capacity as officers, employees or agents of the Trust or a Series thereof.
Every written obligation, contract, instrument, certificate, Share, other security of the Trust or a
Series thereof or undertaking made or issued by the Trustees may recite that the same is executed
or made by them not individually, but as Trustees under the Declaration, and that the obligations
of the Trust or a Series thereof under any such instrument are not binding upon any of the
Trustees or Shareholders individually, but bind only the Trust Property or the Trust Property of
the applicable Series, and may contain any further recital which they may deem appropriate, but
the omission of such recital shall not operate to bind the Trustees individually. The Trustees
may maintain insurance for the protection of the Trust Property or the Trust Property of the
applicable Series, its Shareholders, Trustees, officers, employees and agents in such amount as
the Trustees shall deem adequate to cover possible tort liability, and such other insurance as the
Trustees in their sole judgment shall deem advisable.
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Section 7. Reliance on Experts, Etc. Each Trustee, officer or employee of the Trust
or a Series thereof shall, in the performance of his duties, powers and discretions hereunder be
fully and completely justified and protected with regard to any act or any failure to act resulting
from reliance in good faith upon the books of account or other records of the Trust or a Series
thereof, upon an opinion of counsel, or upon reports made to the Trust or a Series thereof by any
of its officers or employees or by the Investment Adviser, the Administrator, the Distributor, the
Principal Underwriter, Transfer Agent, selected dealers, accountants, appraisers or other experts
or consultants selected with reasonable care by the Trustees, officers or employees of the Trust,
regardless of whether such counsel or expert may also be a Trustee.
Section 18 of the Investment Management Agreement between Registrant and Cushing MLP
Asset Management, LP provides as follows:
18. Limitation of Liability of the Fund and the Shareholders
None of the Trustees, officers, agents or shareholders of the Fund will be personally liable
under this Agreement. The name The Cushing Royalty & Income Fund is the designation of
the Fund for the time being under the Amended and Restated Agreement and Declaration of
Trust and all persons dealing with the Fund must look solely to the property of the Fund for the
enforcement of any claims against the Fund, as none of the Trustees, officers, agents or
shareholders assume any personal liability for obligations entered into on behalf of the Fund.
Section 8 of the form of Underwriting Agreement between Registrant and the various
underwriters provides as follows:
8. (a) The Fund and the Investment Adviser, jointly and severally, agree to
indemnify and hold harmless each Underwriter, each person, if any, who controls any
Underwriter within the meaning of Section 15 of the Securities Act or Section 20(a) of the
Exchange Act, each affiliate of any Underwriter within the meaning of Rule 405 under the
Securities Act who has, or who is alleged to have, participated in the distribution of the Shares as
an underwriter, and each agent of any Underwriter from and against any and all losses, liabilities,
claims, damages and expenses whatsoever as incurred (including without limitation, reasonable
attorneys' fees and any and all reasonable expenses whatsoever incurred in investigating,
preparing or defending against any litigation, commenced or threatened, or any claim whatsoever,
and any and all amounts paid in settlement of any claim or litigation), joint or several, to which
they or any of them may become subject under the Securities Act, the Exchange Act, the
Investment Company Act or otherwise, insofar as such losses, liabilities, claims, damages or
expenses (or actions in respect thereof) arise out of or are based upon any untrue statement or
alleged untrue statement of a material fact contained in the Initial Registration Statement, as
originally filed or any amendment thereof, the Registration Statement, or any post-effective
amendment thereof, any Preliminary Prospectus, the Pricing Prospectus, the Prospectus, any
Omitting Prospectus or in any supplement thereto or amendment thereof, or arise out of or are
based upon the omission or alleged omission to state therein a material fact required to be stated
therein or necessary to make the statements therein not misleading (in the case of any Omitting
Prospectus, preliminary prospectus, the Pricing Prospectus or the Prospectus, in light of the
circumstances in which they were made); provided, however, that the Fund and the Investment
Adviser will not be liable in any such case to the extent that any such loss, liability, claim,
damage or expense arises out of or is based upon any such untrue statement or alleged untrue
statement or omission or alleged omission made in the Initial Registration Statement, as
originally filed or any amendment thereof, the Registration Statement, or any post-effective
amendment thereof, any Preliminary Prospectus, the Pricing Prospectus, the Prospectus, any
Omitting Prospectus or in any supplement thereto or amendment thereof in reliance upon and in
strict conformity with written information furnished to the Fund by or on behalf of any
Underwriter through Stifel Nicolaus expressly for use therein, it being understood and agreed
that the only such information furnished by any Underwriter is the information described as such
in Section 8(b) below.
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(b) Each Underwriter severally, and not jointly, agrees to indemnify and hold
harmless the Fund, the Investment Adviser, each of the trustees of the Fund and the Investment
Adviser, each of the officers of the Fund who shall have signed the Registration Statement, and
each other person, if any, who controls the Fund or the Investment Adviser within the meaning
of Section 15 of the Securities Act or Section 20(a) of the Exchange Act, against any losses,
liabilities, claims, damages and expenses whatsoever as incurred (including without limitation,
reasonable attorneys fees and any and all reasonable expenses whatsoever incurred in
investigating, preparing or defending against any litigation, commenced or threatened, or any
claim whatsoever, and any and all amounts paid in settlement of any claim or litigation), joint or
several, to which they or any of them may become subject under the Securities Act, the
Exchange Act, the Investment Company Act or otherwise, insofar as such losses, liabilities,
claims, damages or expenses (or actions in respect thereof) arise out of or are based upon any
untrue statement or alleged untrue statement of a material fact contained in the Initial
Registration Statement, as originally filed or any amendment thereof, the Registration Statement,
or any post-effective amendment thereof, or any Preliminary Prospectus, the Pricing Prospectus,
the Prospectus, any Omitting Prospectus or in any supplement thereto or amendment thereof, or
arise out of or are based upon the omission or alleged omission to state therein a material fact
required to be stated therein or necessary to make the statements therein not misleading, in each
case to the extent, but only to the extent, that any such loss, liability, claim, damage or expense
arises out of or is based upon any such untrue statement or alleged untrue statement or omission
or alleged omission made therein in reliance upon and in strict conformity with written
information furnished to the Fund by or on behalf of such Underwriter through Stifel Nicolaus
expressly for use therein, it being understood and agreed that the only such information furnished
by any Underwriter consists of the following information in the Pricing Prospectus and the
Prospectus furnished on behalf of each Underwriter: the concession and reallowance figures
appearing in the third paragraph under the caption Underwriting and the information contained
in the ninth and tenth paragraphs under the caption Underwriting.
(c) Promptly after receipt by an indemnified party under Section 8(a) or 8(b)
of notice of the commencement of any action, such indemnified party shall, if a claim in respect
thereof is to be made against the indemnifying party under such Section, notify each party
against whom indemnification is to be sought in writing of the commencement thereof (but the
failure so to notify an indemnifying party shall not relieve it from any liability which it may have
under this Section 8). In case any such action is brought against any indemnified party, and it
notifies an indemnifying party of the commencement thereof, the indemnifying party will be
entitled to participate therein, and jointly with any other indemnifying party similarly notified, to
the extent it may elect by written notice delivered to the indemnified party promptly after
receiving the aforesaid notice from such indemnified party, to assume the defense thereof with
counsel reasonably satisfactory to such indemnified party (who shall not, except with the consent
of the indemnified party, be counsel to the indemnified party). Notwithstanding the foregoing,
the indemnified party or parties shall have the right to employ its or their own counsel in any
such case, but the fees and expenses of such counsel shall be at the expense of such indemnified
party or parties unless (i) the employment of such counsel shall have been authorized in writing
by one of the indemnifying parties in connection with the defense of such action, (ii) the
indemnifying parties shall not have employed counsel to have charge of the defense of such
action within a reasonable time after notice of commencement of the action, or (iii) such
indemnified party or parties shall have reasonably concluded that there may be defenses
available to it or them which are different from or additional to those available to one or all of
the indemnifying parties (in which case the indemnifying parties shall not have the right to direct
the defense of such action on behalf of the indemnified party or parties), in any of which events
such fees and expenses shall be borne by the indemnifying parties. In no event shall the
indemnifying parties be liable for fees and expenses of more than one counsel (in addition to any
local counsel) separate from their own counsel for all indemnified parties in connection with any
one action or separate but similar or related actions in the same jurisdiction arising out of the
same general allegations or circumstances, which counsel, in the event of indemnified parties
under Section 8(a), shall be selected by Stifel Nicolaus. The indemnifying party shall not be
liable for any settlement of any proceeding effected without its written consent (which may not
be unreasonably withheld), but if settled with such consent or if there be a final judgment for the
plaintiff, the indemnifying party agrees to indemnify the indemnified party from and against any
loss or liability by reason of such settlement or judgment. Notwithstanding the foregoing
sentence, if at any time an indemnified party shall have requested an indemnifying party to
reimburse the indemnified party for fees and expenses of counsel as contemplated by the third
and fourth sentences of this paragraph, the indemnifying party agrees that it shall be liable for
any settlement of any proceeding effected without its written consent if (i) such settlement is
entered into more than 60 days after receipt by such indemnifying party of the aforesaid request,
(ii) such indemnifying party shall not have reimbursed the indemnified party in accordance with
such request prior to the date of such settlement and (iii) such indemnified party shall have given
the indemnifying party at least 30 days prior written notice of its intention to settle. No
indemnifying party shall, without the written consent of the indemnified party, effect the
settlement or compromise of, or consent to the entry of any judgment with respect to, any
pending or threatened action or claim in respect of which indemnification or contribution may be
sought hereunder (whether or not the indemnified party is an actual or potential party to such
action or claim) unless such settlement, compromise or judgment (i) includes an unconditional
release of the indemnified party from all liability arising out of such action or claim and (ii) does
not include a statement as to or an admission of fault, culpability or a failure to act, by or on
behalf of any indemnified party.
C-6
(d) If the indemnification provided for in this Section 8 is unavailable to or
insufficient to hold harmless an indemnified party under Section 8(a) or 8(c) in respect of any
losses, liabilities, claims, damages or expenses (or actions in respect thereof) referred to therein,
then each indemnifying party shall contribute to the amount paid or payable by such indemnified
party as a result of such losses, liabilities, claims, damages or expenses (or actions in respect
thereof) in such proportion as is appropriate to reflect the relative benefits received by the Fund
and the Investment Adviser on the one hand and the Underwriters on the other from the offering
of the Shares. If, however, the allocation provided by the immediately preceding sentence is not
permitted by applicable law, then each indemnifying party shall contribute to such amount paid
or payable by such indemnified party in such proportion as is appropriate to reflect not only such
relative benefits but also the relative fault of the Fund and the Investment Adviser on the one
hand and the Underwriters on the other in connection with the statements or omissions which
resulted in such losses, liabilities, claims, damages or expenses (or actions in respect thereof), as
well as any other relevant equitable considerations. The relative benefits received by the Fund
and the Investment Adviser on the one hand and the Underwriters on the other from the offering
of the Shares shall be deemed to be in the same proportion as the total net proceeds from the
offering (before deducting expenses) received by the Fund and the Investment Adviser bear to
the total underwriting discounts and commissions received by the Underwriters, in each case as
set forth in the table on the cover page of the Prospectus. The relative fault shall be determined
by reference to, among other things, whether the untrue or alleged untrue statement of a material
fact or the omission or alleged omission to state a material fact relates to information supplied by
the Fund or the Investment Adviser on the one hand or the Underwriters on the other and the
parties relative intent, knowledge, access to information and opportunity to correct or prevent
such statement or omission.
The Fund, the Investment Adviser and the Underwriters agree that it would not be
just and equitable if contributions pursuant to this Section 8(d) were determined by pro rata
allocation (even if the Underwriters were treated as one entity for such purpose) or by any other
method of allocation which does not take account of the equitable considerations referred to
above in this Section 8(d). The amount paid or payable by an indemnified party as a result of the
losses, liabilities, claims, damages or expenses (or actions in respect thereof) referred to above in
this Section 8(d) shall be deemed to include any legal or other expenses reasonably incurred by
such indemnified party in connection with investigating or defending any such action or claim.
Notwithstanding the provisions of this Section 8(d), no Underwriter shall be required to
contribute any amount in excess of the amount by which the total price at which the Shares
underwritten by it and distributed to the public were offered to the public exceeds the amount of
any damages which such Underwriter has otherwise been required to pay by reason of such
untrue or alleged untrue statement or omission or alleged omission.
No person guilty of fraudulent misrepresentation (within the meaning of Section
11(f) of the Securities Act) shall be entitled to contribution from any person who was not guilty
of such fraudulent misrepresentation. The Underwriters obligations in this Section 8(d) to
contribute are several in proportion to their respective underwriting obligations and not joint.
(e) The obligations of the parties to this Agreements contained in this Section
8 are not exclusive and shall not limit any rights or remedies which may otherwise be available
to any indemnified party at law or in equity.
(f) Notwithstanding any other provisions in this Section 8, no party shall be
entitled to indemnification or contribution under this Agreement in violation of Section 17(j) of
the Investment Company Act.
Item 31. Business and Other Connections of the Adviser
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The Investment Adviser is not engaged in any other business, profession, vocation or
employment of a substantial nature. A description of any other business, profession,
vocation or employment of a substantial nature in which each limited partner or executive
officer of the Investment Adviser is or has been during the past two fiscal years engaged in
for his or her own account or in his or her capacity as trustee, officer, or portfolio
manager of the Fund, is set forth in Part A and Part B of this Registration Statement in the
sections entitled Management of the Fund or in the Investment Advisers Form ADV, as filed
with the SEC (SEC File No. 801-63255), and which Form ADV is incorporated herein by
reference. |
Item 32. Location of Accounts and Records
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The accounts, books or other documents required to be maintained by Section 31(a) of the
1940 Act, and the rules promulgated under the 1940 Act, are kept by the Registrant or its
custodian, transfer agent, administrator and fund accountant. The Registrant is located at
the following address: The Cushing® Royalty & Income Fund, 8117 Preston Road, Suite 440,
Dallas, Texas 75225. The Funds custodian is located at the following address: U.S. Bank,
National Association, 1555 N. Riveright Dr., Suite 302, Milwaukee, WI |
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53212. The Funds transfer agent, registrar, dividend disbursing agent, fund accountant and administrator is located at the following
address: U.S. Bancorp Fund Services, LLC, 615 East Michigan Street Milwaukee, WI 53202.
Item 33. Management Services
Item 34. Undertakings
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1. |
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Registrant undertakes to suspend the offering of common shares until the
prospectus is amended, if subsequent to the effective date of this registration
statement, its net asset value declines more than ten percent from its net asset value,
as of the effective date of the registration statement or its net asset value increases
to an amount greater than its net proceeds as stated in the prospectus. |
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5. |
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Registrant undertakes that, for the purpose of determining any liability under
the Securities Act of 1933, the information omitted from the form of prospectus filed
as part of the Registration Statement in reliance upon Rule 430A and contained in the
form of prospectus filed by the Registrant pursuant to Rule 497(h) will be deemed to be
a part of the Registration Statement as of the time it was declared effective. |
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Registrant undertakes that, for the purpose of determining any liability under the
Securities Act of 1933, each post-effective amendment that contains a form of
prospectus will be deemed to be a new Registration Statement relating to the
securities offered therein, and the offering of such securities at that time will be
deemed to be the initial bona fide offering thereof. |
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6. |
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Registrant undertakes to send by first class mail or other means designed to
ensure equally prompt delivery, within two business days of receipt of a written or
oral request, any Statement of Additional Information constituting Part B of this
Registration Statement. |
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Signatures
As required by the Securities Act of 1933, as amended, and the Investment Company Act of 1940,
as amended, this Registrants Registration Statement has been signed on behalf of the Registrant,
in the City of Dallas, State of Texas, on the 23rd day of February, 2012.
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THE CUSHING® ROYALTY & INCOME FUND
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By: |
/s/ Jerry V. Swank
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Name: |
Jerry V. Swank |
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Title: |
Trustee, Chairman of the Board,
Chief
Executive Officer and President |
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As required by the
Securities Act of 1933, as amended, this Registration Statement has been
signed below by the following persons in the capacities set forth
below on the 23rd day of February, 2012.
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NAME |
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DATE |
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TITLE |
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/s/ Jerry V. Swank
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February 23, 2012
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Trustee, Chairman of the Board,
Chief Executive Officer and President |
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Jerry V. Swank |
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/s/ John Alban
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February 23, 2012
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Chief Financial Officer and Treasurer |
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John Alban |
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*
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February 23, 2012
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Trustee |
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Brian R. Bruce |
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*
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February 23, 2012
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Trustee |
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Edward N. McMillan |
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*
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February 23, 2012
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Trustee |
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Ronald P. Trout |
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* By: |
/s/ Jerry V. Swank
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Jerry V. Swank |
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As
Attorney-In-Fact February 23, 2012 |
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C-9
EXHIBIT INDEX
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Exhibit |
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Document |
EX. 99(H)
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Form of Underwriting Agreement* |
EX. 99(J)(1) |
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Form of Custody Agreement* |
EX. 99(J)(2) |
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First Amendment to the Custody
Agreement* |
EX. 99(K)(1)
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Form of Transfer Agent Servicing Agreement* |
EX. 99(K)(2)
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Form of Fund Administration
Servicing Agreement* |
EX. 99(K)(3)
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Form of Fund Accounting Servicing Agreement* |
EX. 99(L)
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Opinion and Consent of Skadden,
Arps, Slate, Meagher & Flom LLP* |
EX. 99(N)
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Independent Registered Public Accounting Firm Consent* |
EX. 99(R)
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Code of Ethics of the Registrant and the Investment Adviser* |
* Filed herewith.
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