As filed with the Securities and Exchange Commission on July 10, 2001
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1933 Act File No.
1940 Act File No. 811-10379
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form N-2
[X] REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
[_] Pre-Effective Amendment No. ___
[_] Post-Effective Amendment No. [_______]
and
[X] REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
[X] Amendment No. 6
PIMCO California Municipal Income Fund
(Exact Name of Registrant as Specified in Declaration of Trust)
c/o PIMCO Advisory Services
1345 Avenue of the Americas
New York, New York 10105
(Address of Principal Executive Offices)
(Number, Street, City, State, Zip Code)
(212) 739-3502
(Registrant's Telephone Number, including Area Code)
Stephen J. Treadway
c/o PIMCO Funds Distributors LLC
2187 Atlantic Street
Stamford, Connecticut 06902
(Name and Address (Number, Street, City, State, Zip Code) of Agent for Service)
Copies of Communications to:
Joseph B. Kittredge, Jr., Esq. Thomas A. Hale, Esq.
Ropes & Gray Skadden, Arps, Slate, Meagher & Flom (Illinois)
One International Place 333 West Wacker Drive
Boston, Massachusetts 02110 Chicago, Illinois 60606
Approximate Date of Proposed Public Offering:
As soon as practicable after the effective date of this Registration Statement
___________________________
If any of the securities being registered on this form will be offered on a
delayed or continuous basis in reliance on Rule 415 under the Securities Act of
1933, other than securities offered in connection with a dividend reinvestment
plan, check the following box. [_]
It is proposed that this filing will become effective (check appropriate
box)
[ ] when declared effective pursuant to section 8(c)
___________________________
CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933
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Proposed Proposed
Maximum Maximum
Title of Securities Being Amount Being Offering Price Aggregate Amount of
Registered Registered Per Unit Offering Price/1/ Registration Fee
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Preferred Shares, no par value 10 Shares $25,0000 $250,000 $62.50
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/1/ Estimated solely for the purpose of calculating the registration fee.
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 this Registration Statement
shall thereafter become effective in accordance with Section 8(a) of the
Securities Act of 1933 or until the Registration Statement shall become
effective on such dates as the Commission, acting pursuant to said Section 8(a),
may determine.
PIMCO CALIFORNIA MUNICIPAL INCOME FUND
Cross Reference Sheet Pursuant to Rule 495(a)
Under the Securities Act of 1933
PARTS A AND B OF PROSPECTUS*
Part A
Item No. Item Caption Prospectus Caption
------- ------------ -------------------
1. Outside Front Cover....................................... Outside Front Cover
2. Cover Pages; Other Offering Information................... Inside Front and Outside Back Cover Page;
Underwriting
3. Fee Table and Synopsis.................................... Prospectus Summary
4. Financial Highlights...................................... Not applicable
5. Plan of Distribution...................................... Underwriting
6. Selling Shareholders...................................... Not Applicable
7. Use of Proceeds........................................... Use of Proceeds
8. General Description of Registrant......................... Prospectus Summary; Management of the Fund;
The Fund; The Fund's Investments; Risks;
Description of Capital Structure
9. Management................................................. Management of the Fund; Custodian and
Transfer Agents
10. Capital Stock, Long-Term Debt,
and Other Securities....................................... Description of APS; Description of Preferred
Shares; Taxes; Certain Provisions of the
Declaration of Trust
11. Defaults and Arrears on Senior Securities.................. Not Applicable
12. Legal Proceedings.......................................... Not Applicable
13. Table of Contents of Statement of Additional Information... Table of Contents for the Statement of
Additional Information
Part B Statement of Additional
Item No. Item Caption Information Caption
-------- ------------ -------------------
14. Cover Page....................................... Cover Page
15. Table of Contents................................ Table of Contents
16. General Information and History.................. Not Applicable
17. Investment Objective and Policies................ Investment Objective and Policies
18. Management....................................... Management of the Fund; Trustees and Officers;
Investment Manager and Portfolio Manager
19. Control Persons and Principal
Holders of Securities............................ Other Information
20. Investment Advisory and Other Services........... Management of the Fund; Investment Manager and
Portfolio Manager
21. Brokerage Allocation and Other Practices......... Portfolio Transactions
22. Tax Status....................................... Tax Matters
23. Financial Statements............................. Financial Statements
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Part C
The information required to be included in Part C is set forth under
the appropriate item, so numbered, in Part C to this Registration Statement.
Preliminary Prospectus Subject to Completion [____], 2001
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 IT IS NOT SOLICITING AN OFFER TO BUY THESE
SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
[LOGO]
$[_______________]
PIMCO CALIFORNIA MUNICIPAL INCOME FUND
[______] Shares Series A
[______] Shares Series B
Auction Preferred Shares
Liquidation Preference $25,000 Per Share
INVESTMENT OBJECTIVE. The Fund is a recently organized, non-diversified,
closed-end management investment company. The Fund's investment objective is to
provide current income exempt from federal and California income tax. In
pursuing this objective, the portfolio manager also seeks to preserve and
enhance the value of the Fund's holdings relative to the municipal bond market
generally, using proprietary analytical models that test and evaluate the
sensitivity of those holdings to changes in interest rates and yield
relationships.
PORTFOLIO CONTENTS. Under normal market conditions, the Fund will invest
substantially all (at least 90%) of its total assets in municipal bonds which
pay interest that, in the opinion of bond counsel to the issuer (or on the basis
of other authority believed by the Fund's portfolio manager to be reliable), is
exempt from federal and California income taxes. The Fund will seek to avoid
bonds generating interest potentially subjecting individuals to the alternative
minimum tax. The Fund will invest at least 80% of its net assets in investment
grade quality municipal bonds, including bonds that are unrated but judged to be
of investment grade quality by the Fund's portfolio manager. The Fund may invest
up to 20% of its net assets in municipal bonds that are rated Ba/BB or B or that
are unrated but judged to be of comparable quality by the Fund's portfolio
manager. The Fund cannot assure you that it will achieve its investment
objective.
Certain capitalized terms used in this Prospectus are defined in the Glossary
that appears at the end of this Prospectus.
BEFORE BUYING ANY PREFERRED SHARES YOU SHOULD READ THE DISCUSSION OF THE
MATERIAL RISKS OF INVESTING IN THE FUND IN "RISKS" BEGINNING ON PAGE [__].
THESE RISKS ARE SUMMARIZED IN "SPECIAL RISK CONSIDERATIONS" BEGINNING ON PAGE
[__].
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.
Proceeds
Price to Public Sales Load to Fund(1)
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Per Share $ 25,000 $ $
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Total $ $ $
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(1) Plus accumulated dividends, if any, from the date the preferred shares are
issued.
UBS Warburg
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1
The auction preferred shares ("APS") are being offered by the underwriters
subject to certain conditions. The underwriters reserve the right to withdraw,
cancel or modify the offering in whole or in part. It is expected that the APS
will be delivered to the nominee of The Depository Trust Company on or about
[_____], 2001.
Investors in APS will be entitled to receive cash dividends at an annual rate
that may vary for the successive dividend periods for such shares. The dividend
rate on the Series A APS for the initial period from and including the date of
issue to, but excluding, [_____], 2001 will be [____]% per year. The dividend
rate on the Series B APS for the initial period from and including the date of
issue to, but excluding, [_____], 2001 will be [____]% per year. For each
subsequent period, the auction agent will determine the dividend rate for a
particular period by an auction conducted in accordance with the procedures
described in this Prospectus and, in further detail, in Appendix D to the
Statement of Additional Information (an "Auction").
APS will not be listed on an exchange. Broker-dealers may maintain a secondary
trading market in the APS outside of Auctions; however, they have no obligation
to do so, and there can be no assurance that a secondary market for the APS will
develop or, if it does develop, that it will provide holders with a liquid
trading market (i.e., trading will depend on the presence of willing buyers and
sellers and the trading price is subject to variables to be determined at the
time of the trade by such broker-dealers). The APS will not be registered on any
stock exchange or on any automated quotation system. A general increase in the
level of interest rates likely will have an adverse effect on the secondary
market price of the APS, and a selling shareholder may sell APS between Auctions
at a price per share of less than $25,000. The Fund may redeem APS as described
under "Description of APS--Redemption."
The Fund is required to allocate net capital gains and other taxable income, if
any, proportionately among its common shares and the Series A APS and the Series
B APS. The Fund will give notice of the amount of any taxable income to be
included in a dividend on APS in the related Auction, as described herein, or
include such income in a dividend on the APS without giving advance notice
thereof if it increases the dividend by an amount sufficient to offset
substantially the tax effect thereof. Where the Fund makes (or is required to
make) an allocation of such income retroactively, solely as a result of a
redemption of the APS or the liquidation of the Fund, the Fund is required pay a
Gross-up Dividend in an amount sufficient to offset substantially the effect
thereof. The amount of taxable income otherwise allocable to the APS will
depend upon the amount of such income realized by the Fund and other factors but
generally is not expected to be significant. See "Taxes."
The APS will be senior in liquidation and distribution rights to the Fund's
outstanding common shares. The Fund's common shares are traded on the New York
Stock Exchange under the symbol "PCQ." This offering is conditioned upon the
APS receiving a rating of "aaa" from Moody's Investors Service, Inc.
You should read this Prospectus, which contains important information about the
Fund, before deciding whether to invest and retain it for future reference. A
Statement of Additional Information, dated [________], 2001, containing
additional information about the Fund, has been filed with the Securities and
Exchange Commission and is incorporated by reference in its entirety into this
Prospectus, which means that it is part of the Prospectus for legal purposes.
You can review the table of contents of the Statement of Additional Information
on page [__] of this Prospectus. You may request a free copy of the Statement of
Additional Information by calling (877) 819-2224 or by writing to the Fund, or
obtain a copy (and other information regarding the Fund) from the Securities and
Exchange Commission web site (http://www.sec.gov).
The APS do not represent a deposit or obligation of, and are not guaranteed or
endorsed by, any bank or other insured depository institution, and are not
federally insured by the Federal Deposit Insurance Corporation, the Federal
Reserve Board or any other government agency.
You should rely only on the information contained or incorporated by reference
in this Prospectus. The Fund has not, and the underwriters have not, authorized
anyone to provide you with different information. If anyone provides you with
different or inconsistent information, you should not rely on it. The Fund is
not, and the underwriters are not, making an offer of the APS in any state where
the offer is not permitted. You should not assume that the information contained
in this Prospectus is accurate as of any date other than the date on the front
of this Prospectus. The Fund's business, financial condition, results of
operations and prospects may have changed since that date.
Until [________], 2001 (25 days after the date of this Prospectus), all dealers
that buy, sell or trade the APS, whether or not participating in this offering,
may be required to deliver a prospectus. This is in addition to the dealers'
obligation to deliver a prospectus when acting as underwriters and with respect
to their unsold allotments or subscriptions.
2
TABLE OF CONTENTS
Prospectus Summary.................................
The Fund...........................................
Use of proceeds....................................
Capitalization ....................................
Portfolio Composition..............................
The Fund's investments.............................
Preferred shares and related leverage..............
Risks..............................................
How the Fund manages risk..........................
Rating agency guidelines ..........................
Description of APS.................................
Management of the Fund.............................
Net asset value....................................
Taxes..............................................
Description of capital structure...................
Certain provisions in the Declaration
of Trust.........................................
Repurchase of Fund shares; conversion to
open-end fund....................................
Underwriting ......................................
Custodian and transfer agents......................
Legal matters......................................
Table of contents for the Statement of
Additional Information...........................
Glossary...........................................
-i-
PROSPECTUS SUMMARY
This is only a summary. You should review the more detailed information
contained in this Prospectus. Certain capitalized terms used in this Prospectus
are defined in the Glossary that appears at the end of this Prospectus.
THE FUND
PIMCO California Municipal Income Fund (the "Fund") is a recently organized,
non-diversified, closed-end management investment company registered under the
Investment Company Act of 1940, as amended (the "1940 Act"). The Fund is
designed to provide tax benefits to investors who are residents of California.
See "The Fund." The Fund's common shares ("Common Shares") are traded on the
New York Stock Exchange under the symbol "PCQ." As of [________], 2001, the
Fund had [________] Common Shares outstanding and net assets of [____].
THE OFFERING
The Fund is offering an aggregate of [__] Series A APS and [___] Series B APS,
each at a purchase price of $25,000 per share plus accumulated dividends, if
any, from the date of original issue. The APS are being offered through a group
of underwriters led by UBS Warburg LLC (collectively, the "Underwriters"). See
"Underwriting."
The APS will entitle their holders to receive cash dividends at an annual rate
that may vary for successive Dividend Periods. In general, except as described
under "Description of APS--Dividends," each Dividend Period will be seven days.
The Auction Agent will determine the Applicable Rate for a particular period by
an Auction conducted on the Business Day immediately prior to the start of that
Dividend Period.
The APS are not listed on an exchange. Instead, investors may buy or sell APS
at an auction that normally is held weekly, by submitting orders to Broker-
Dealers that have entered into an agreement with the Auction Agent and the Fund
or to certain other Broker-Dealers. [_________], the Auction Agent, reviews
orders from Broker-Dealers on behalf of Existing Holders that wish to sell, or
hold at the auction rate, or hold only at a specified Applicable Rate, and on
behalf of Potential Holders that wish to buy, APS. The Auction Agent then
determines the lowest Applicable Rate that will result in all of the outstanding
APS continuing to be held. The first Auction Date for Series A APS will be
[____], 2001 and the first Auction Date for Series B APS will be [_______],
2001, each being the Business Day before the Dividend Payment Date for the
Initial Dividend Period for the relevant series of APS ([_______], 2001 for
Series A and [_________], 2001 for Series B). The auction day for Series A APS
will be [Tuesday] and for Series B APS will be [Thursday], unless the then
current Dividend Period is a Special Dividend Period, or the day that normally
would be the Auction Date or the first day of the subsequent Dividend Period is
not a Business Day.
INVESTMENT OBJECTIVE
The Fund's investment objective is to provide current income exempt from federal
and California income tax. In pursuing this objective, the portfolio manager
also seeks to preserve and enhance the value of the Fund's holdings relative to
the municipal bond market generally, using proprietary analytical models that
test and evaluate the sensitivity of those holdings to changes in interest rates
and yield relationships. Under normal market conditions, the Fund will invest
substantially all (at least 90%) of its total assets in municipal bonds which
pay interest that, in the opinion of bond counsel to the issuer (or on the basis
of other authority believed by the Fund's portfolio manager to be reliable) is
exempt from federal and California income taxes ("California Municipal Bonds").
The Fund will seek to avoid bonds generating interest potentially subjecting
individuals to the alternative minimum tax. The Fund will invest at least 80% of
its net assets in municipal bonds that at the time of investment are investment
grade quality. Investment grade quality bonds are bonds rated within the four
highest grades (Baa or BBB or better by Moody's, S&P)or Fitch), or bonds that
are unrated but judged to be of comparable quality by the Fund's portfolio
manager. The Fund may invest up to 20% of its net assets in municipal bonds
that, at the time of investment, are rated Ba/BB or B by Moody's, S&P or Fitch
or that are unrated but judged to be of comparable quality by the Fund's
portfolio manager. Bonds of below investment grade quality are regarded as
having predominantly speculative characteristics with respect to capacity to pay
interest and repay principal, and are commonly referred to as "junk bonds".
Bonds in the lowest investment grade category may also be considered to possess
some speculative characteristics.
The Fund may invest in "structured" notes, which are privately negotiated debt
obligations where the principal and/or interest is determined by reference to
the performance of a benchmark asset or market, such as selected securities or
an index of securities, or the differential performance of two assets or
markets, such as indices reflecting taxable and tax-exempt bonds. The Fund
currently intends that any use of structured notes will be for the purpose of
reducing the interest rate sensitivity of the Fund's portfolio (and thereby
decreasing the Fund's exposure to interest rate risk) and, in any event, that
the interest income on the notes will normally be exempt from federal and
California income tax.
The Fund cannot assure you that it will attain its investment objective. See
"The Fund's investments."
1
INVESTMENT MANAGER
PIMCO Advisors L.P. ("PIMCO Advisors") serves as the investment manager of the
Fund. Subject to the supervision of the Board of Trustees, PIMCO Advisors is
responsible for managing, either directly or through others selected by it, the
investment activities of the Fund and the Fund's business affairs and other
administrative matters. PIMCO Advisors is located at 1345 Avenue of the
Americas, New York, New York 10105. Organized in 1987, PIMCO Advisors provides
investment management and advisory services to private accounts of institutional
and individual clients and to mutual funds. As of June 30, 2001, PIMCO Advisors
and its subsidiary partnerships had approximately $[___] billion in assets under
management.
PIMCO Advisors has retained its affiliate, Pacific Investment Management Company
LLC ("PIMCO"), as a sub-adviser to manage the Fund's portfolio investments. See
"Portfolio Manager" below.
PORTFOLIO MANAGER
PIMCO serves as the Fund's sub-adviser responsible for managing the Fund's
portfolio investments, and is sometimes referred to herein as the "portfolio
manager." Subject to the supervision of PIMCO Advisors, PIMCO has full
investment discretion and makes all determinations with respect to the
investment of the Fund's assets.
PIMCO is located at 840 Newport Center Drive, Newport Beach, California 92660.
Organized in 1971, PIMCO provides investment management and advisory services to
private accounts of institutional and individual clients and to mutual funds. As
of June 30, 2001, PIMCO had approximately $[____] billion in assets under
management.
LEVERAGE
The Fund utilizes financial leverage on an ongoing basis for investment
purposes. After completion of the offering of APS, the Fund anticipates its
total leverage from the issuance of APS will be approximately [___]%. This
amount may change, but total leverage will not exceed 50% of the Fund's total
assets.
The Fund generally will not utilize leverage if it anticipates that it would
result in a lower return to common shareholders over time. Use of financial
leverage creates an opportunity for increased income for common shareholders
but, at the same time, creates the possibility for greater loss (including the
likelihood of greater volatility of net asset value and market price of the
shares and of dividends), and there can be no assurance that a leveraging
strategy will be successful during any period in which it is employed. Because
the fees paid to PIMCO Advisors and PIMCO will be calculated on the basis of the
Fund's managed assets, the fees will be higher when leverage is utilized, giving
PIMCO Advisors and PIMCO an incentive to utilize leverage. See "Risks--Leverage
Risk."
SPECIAL RISK CONSIDERATIONS
Risks of investing in APS include:
Restrictions on Dividends
The Fund will not be permitted to declare dividends or other distributions with
respect to your APS unless the Fund meets certain asset coverage requirements.
Illiquidity of APS
If an Auction fails you may not be able to sell some or all of your APS and the
Fund is not obliged to redeem your APS if the Auction fails.
Risk of Loss
You could receive less than the price you paid for your APS if you sell them
outside of the Auction, especially when market interest rates are rising.
Rating Agency Risk
A Rating Agency could downgrade the APS, which could affect their liquidity and
value.
2
Risk of Redemption
The Fund may be forced to redeem your APS to meet regulatory or Rating Agency
requirements and may voluntarily redeem your APS.
Dividend Risk
In extraordinary circumstances, the Fund may not earn sufficient income from its
investments to pay dividends.
Interest Rate Risk
If long-term rates rise, the value of the Fund's investment portfolio may
decline, reducing asset coverage on the APS.
Default Risk
In an issuer of municipal bonds defaults, there may be a negative impact on the
Fund's income and asset coverage.
Risks of investing in a California fund:
Concentration Risk
The Fund's policy of investing substantially all of its assets in California
Municipal Bonds makes the Fund more susceptible to adverse economic, political
or regulatory occurrences affecting the issuers of such bonds.
Non-Diversification Risk
Because the Fund is classified as "non-diversified" under the 1940 Act, it can
invest a greater portion of its assets in obligations of a single issuer. As
a result, the Fund will be more susceptible than a more widely diversified
fund to any single corporate, economic, political or regulatory occurrence.
For additional risks of investing in the Fund, see "Risks" below.
DIVIDENDS ON APS
The APS will entitle their holders to receive cash dividends at a rate per annum
that may vary for the successive Dividend Periods for such shares. In general,
except as described below, each Dividend Period for each series of APS
subsequent to the Initial Dividend Period will be seven days in length. The
Applicable Rate for a particular Dividend Period will be determined by an
Auction conducted on the Business Day next preceding the start of such Dividend
Period.
Through their Broker-Dealers, Beneficial Owners and Potential Beneficial Owners
of APS may participate in Auctions therefor, although, except in the case of
certain Special Dividend Periods, Beneficial Owners desiring to continue to hold
all of their APS regardless of the Applicable Rate resulting from Auctions need
not participate. For an explanation of Auctions and the method of determining
the Applicable Rate, see "Description of APS--The Auction."
Except as described herein, investors in APS will not receive certificates
representing ownership of their shares. Ownership of APS will be maintained in
book-entry form by the Securities Depository or its nominee for the account of
the investor's Agent Member. The investor's Agent Member, in turn, will maintain
records of such investor's beneficial ownership of APS. Accordingly, references
herein to an investor's investment in or purchase, sale or ownership of APS are
to purchases, sales or ownership of those shares by Beneficial Owners.
After the Initial Dividend Period, each Subsequent Dividend period for each
series of APS will generally consist of seven days (a "7-day Dividend Period");
provided, however, that prior to any Auction, the Fund may elect, subject to
certain limitations described herein, upon giving notice to holders thereof, a
Special Dividend Period for either or both series. A Special Dividend Period is
a Dividend Period consisting of a specified number of days, evenly divisible by
seven and not fewer than fourteen nor more than 364 (a "Short Term Dividend
Period") or a Dividend Period consisting of a specified period of one whole year
or more but not greater than five years (a "Long Term Dividend Period").
Dividends on the APS offered hereby are cumulative from the Date of Original
Issue and are payable when, as and if declared by the Board of Trustees of the
Fund, out of funds legally available therefor, commencing on the Initial
Dividend Payment Date and, in the case of Dividend Periods that are not Special
Dividend Periods, dividends will be payable generally on each succeeding
3
Wednesday for Series A APS and on each succeeding Friday for Series B APS,
subject to certain exceptions.
Dividends for the APS will be paid through the Securities Depository on each
Dividend Payment Date. The Securities Depository's normal procedures provide for
it to distribute dividends in same-day funds to Agent Members, who are in turn
expected to distribute such dividends to the person for whom they are acting as
agent in accordance with the instructions of such person. See "Description of
APS--Dividends."
For each Subsequent Dividend Period, the cash dividend rate on each series of
the APS will be the Applicable Rate that the Auction Agent advises the Fund has
resulted from an Auction. See "Description of APS--Dividends." The first Auction
for each series of the APS is scheduled to be held on the ending date for the
Initial Dividend Period as set forth above.
The Amended By-Laws provide that until the Fund gives a Request for Special
Dividend Period and the related Notice of Special Dividend Period, only 7-Day
Dividend Periods will be applicable to each series of APS. While the Fund does
not currently intend to give a Request for Special Dividend Period with respect
to either series of APS, it may so elect in the future subject to, and on, the
conditions discussed under "Description of the APS--Dividends--Notification of
Dividend Period."
A Special Dividend Period will not be effective for a series of APS unless
Sufficient Clearing Bids exist at the Auction in respect of such Special
Dividend Period. If Sufficient Clearing Bids do not exist at such Auction for
the APS, the Dividend Period commencing on the Business Day succeeding such
Auction will be a 7-Day Dividend Period, and the holders of the APS outstanding
prior to such Auction will be required to continue to hold such shares for such
Dividend Period. In addition, the Fund may not give a Notice of Special Dividend
Period with respect to the APS, or if the Fund has given a Notice of Special
Dividend Period for the APS, the Fund will be required to give a Notice of
Revocation in respect thereof, if (i) either the 1940 Act APS Asset Coverage is
not satisfied or the Fund fails to maintain Moody's Eligible Assets with an
aggregate Discounted Value at least equal to the APS Basic Maintenance Amount,
in each case on each of the two Valuation Dates immediately preceding the
Business Day prior to the related Auction Date for the APS, (ii) sufficient
funds for the payment of dividends payable on the immediately succeeding
Dividend Payment Date have not been irrevocably deposited with the Auction Agent
by the close of business on the third Business Day preceding the related Auction
Date, or (iii) the Broker-Dealers have given the Fund notice that it is not
advisable to hold an Auction in respect of a Special Dividend Period. In such
event, the next succeeding Dividend Period will be a 7-Day Dividend Period.
ADVANCE NOTICE OF ALLOCATION OF TAXABLE INCOME; INCLUSION OF TAXABLE INCOME
IN DIVIDENDS
Dividends paid by the Fund, to the extent paid from tax-exempt income earned on
municipal bonds, will be exempt from federal income tax, although a portion of
those dividends may be a tax preference item for individuals for purposes of the
federal alternative minimum tax. In addition, for corporations, interest on all
tax-exempt obligations is taken into account in the computation of income
subject to the federal alternative minimum tax. Although the Fund will seek to
avoid portfolio investments that pay interest that is taxable to individuals
under the federal alternative minimum tax, the Fund may not succeed in this
regard. The Fund is required to allocate net capital gains and other income
subject to federal income tax, if any, proportionately among the Fund's Common
Shares and APS. Except as noted below and under "Description of APS--Auction
Procedures," whenever the Fund is aware that it will include any net capital
gains or other income subject to federal income tax ("Taxable Income") in any
dividend on the APS, the Fund will notify the Auction Agent prior to the Auction
establishing the Applicable Rate for such dividend. The Auction Agent in turn
will notify each Broker-Dealer whenever it receives any such notice from the
Fund, and each Broker-Dealer will notify its Beneficial Owners and Potential
Beneficial Owners, as provided in its Broker-Dealer Agreement. In the
alternative, the Fund also may include such Taxable Income in a dividend on the
APS without giving advance notice thereof if it increases the dividend by an
amount sufficient to offset substantially the tax effect thereof or, in certain
circumstances, makes a Gross-up Dividend, as described immediately below. The
amount of Taxable Income otherwise allocable to the APS will depend upon the
amount of such income realized by the Fund and other factors but generally is
not expected to be significant. See "Taxes" and "Description of APS- Auction
Procedures--Auction Date; Advance Notice of Allocation of Taxable Income;
Inclusion of Taxable Income in Dividends."
GROSS-UP DIVIDENDS
If the Fund retroactively allocates any net capital gains or other Taxable
Income to the APS without having given advance notice thereof as described
above, the Fund will make certain payments to holders of the APS to which such
allocation was made to offset substantially the tax effect thereof, when such
allocation is made as a result of the redemption of all or a portion of the
outstanding APS or the liquidation of the Fund. Otherwise, the Fund does not
expect to make payments to holders of the APS to offset the tax effect of any
reallocation of net capital gains or other taxable income. See "Description of
APS--Dividends--Gross-up Dividends" and "Taxes."
DETERMINATION OF MAXIMUM APPLICABLE RATES
Except during a Non-Payment Period, the Applicable Rate for any Dividend Period
for APS will not be more than the Maximum Applicable Rate applicable to such
4
shares. The Maximum Applicable Rate for each series of APS will depend on the
credit rating assigned to such shares and on the duration of the Dividend
Period. The Maximum Applicable Rate will be the Applicable Percentage of the
Reference Rate. The Reference Rate is (i) with respect to any 7-Day Dividend
Period or any Short Term Dividend Period having 28 or fewer days, the higher of
the applicable "AA" Composite Commercial Paper Rate and the Taxable Equivalent
of the Short-Term Municipal Obligation Rate, (ii) with respect to any Short Term
Dividend Period having more than 28 but fewer than 183 days, the applicable "AA"
Composite Commercial Paper Rate, (iii) with respect to any Short Term Dividend
Period having 183 or more but fewer than 364 days, the applicable U.S. Treasury
Bill Rate and (iv) with respect to any Long Term Dividend Period, the applicable
U.S. Treasury Note Rate. The Applicable Percentage will be determined based on
(i) the credit rating assigned on such date to the APS by Moody's (or, if
Moody's shall not make such rating available, the equivalent of such rating by a
Substitute Rating Agency) and (ii) whether the Fund has provided notification to
the Auction Agent prior to the Auction establishing the Applicable Rate for any
dividend that net capital gains or other taxable income will be included in such
dividend on the APS, as follows:
APPLICABLE APPLICABLE
PERCENTAGE OF PERCENTAGE OF
REFERENCE RATE--NO REFERENCE RATE--
MOODY'S CREDIT RATINGS ON APS NOTIFICATION NOTIFICATION
------------------------------------------ ------------ -------------
aa3 or higher............................. 110% 150%
a......................................... 125 160
baa....................................... 150 250
Below baa................................. 200 275
There is no minimum Applicable Rate in respect of any Dividend Period. The
Applicable Rate for any Dividend Period commencing during any Non-Payment
Period, and the rate used to calculate the late charge described under
"Description of APS--Dividends--Non-Payment Period; Late Charge," initially will
be 200% of the Reference Rate (or 275% of such rate if the Fund has provided
notification to the Auction Agent prior to the Auction establishing the
Applicable Rate for any dividend that net capital gains or other taxable income
will be included in such dividend on APS).
AUCTION PROCEDURES
Separate Auctions will be conducted for each series of APS. Unless otherwise
permitted by the Fund, Beneficial Owners and Potential Beneficial Owners of APS
may only participate in Auctions through their Broker-Dealers. Broker-Dealers
will submit the Orders of their respective customers who are Beneficial Owners
and Potential Beneficial Owners to the Auction Agent, designating themselves as
Existing Holders in respect of shares subject to Orders submitted or deemed
submitted to them by Beneficial Owners and as Potential Holders in respect of
shares subject to Orders submitted to them by Potential Beneficial Owners. On or
prior to each Auction Date for the APS (the Business Day next preceding the
first day of each Dividend Period), each Beneficial Owner may submit Orders to
its Broker-Dealer as follows:
-- Hold Order--indicating its desire to hold the APS without regard to the
Applicable Rate for the next Dividend Period for such shares.
-- Bid--indicating its desire to hold the APS, provided that the Applicable
Rate for the next Dividend Period for such shares is not less than the rate
per annum specified in such Bid.
-- Sell Order--indicating its desire to sell the APS without regard to the
Applicable Rate for the next Dividend Period for such shares.
A Beneficial Owner may submit different types of Orders to its Broker-Dealer
with respect to the APS then held by such Beneficial Owner, provided that the
total number of APS covered by such Orders does not exceed the number of APS
held by such Beneficial Owner. If, however, a Beneficial Owner offers through
its Broker-Dealer to purchase additional APS in such Auction, such Beneficial
Owner, for purposes of such offer to purchase additional shares, will be treated
as a Potential Beneficial Owner as described below. Bids by Beneficial Owners
through their Broker-Dealers with rates per annum higher than the Maximum
Applicable Rate will be treated as Sell Orders. A Hold Order (in the case of an
Auction relating to a Dividend Period of 91 days or less) or a Sell Order (in
the case of an Auction relating to a Special Dividend Period of longer than 91
days) shall be deemed to have been submitted on behalf of a Beneficial Owner if
an Order with respect to the APS then held by such Beneficial Owner is not
submitted on behalf of such Beneficial Owner for any reason, including the
failure of a Broker-Dealer to submit such Beneficial Owner's Order to the
Auction Agent.
Potential Beneficial Owners of APS may submit Bids through their Broker-Dealers
in which they offer to purchase APS, provided that the Applicable Rate for the
next Dividend Period for such shares is not less than the rate per annum
specified in such Bid. A Bid by a Potential Beneficial Owner with a rate per
annum higher than the Maximum Applicable Rate will not be considered.
Neither the Fund nor the Auction Agent will be responsible for a Broker-Dealer's
failure to act in accordance with the instructions of Beneficial Owners or
Potential Beneficial Owners or failure to comply with any of the foregoing.
5
A Broker-Dealer also may hold APS for its own account as a Beneficial Owner. A
Broker-Dealer thus may submit Orders to the Auction Agent as a Beneficial Owner
or a Potential Beneficial Owner and therefore participate in an Auction as an
Existing Holder or Potential Holder on behalf of both itself and its customers.
Any Order placed with the Auction Agent by a Broker-Dealer as or on behalf of a
Beneficial Owner or a Potential Beneficial Owner will be treated in the same
manner as an Order placed with a Broker-Dealer by a Beneficial Owner or a
Potential Beneficial Owner. Similarly, any failure by a Broker-Dealer to submit
to the Auction Agent an Order in respect of any APS held by it or its customers
who are Beneficial Owners will be treated in the same manner as a Beneficial
Owner's failure to submit to its Broker-Dealer an Order in respect of APS held
by it, as described above. Inasmuch as a Broker-Dealer participates in an
Auction as an Existing Holder or a Potential Holder only to represent the
interests of a Beneficial Owner or Potential Beneficial Owner, whether it be a
customer or itself, all discussion herein relating to the consequences of an
Auction for Existing Holders and Potential Holders also applies to the
underlying beneficial ownership interests represented thereby.
If Sufficient Clearing Bids exist in an Auction for a series of APS (that is, in
general, the number of APS subject to Bids by Potential Holders with rates equal
to or lower than the Maximum Applicable Rate is at least equal to the number of
APS subject to Sell Orders by Existing Holders), the Applicable Rate will be the
lowest rate per annum specified in the Submitted Bids which, taking into account
such rate per annum and all lower rates per annum bid by Existing Holders and
Potential Holders, would result in Existing Holders and Potential Holders owning
all of the APS available for purchase in the Auction. If Sufficient Clearing
Bids do not exist, the Dividend Period next following the Auction automatically
will be a 7-Day Dividend Period and the Applicable Rate will be the Maximum
Applicable Rate, and in such event, Existing Holders that have submitted Sell
Orders will not be able to sell in the Auction all, and may not be able to sell
any, APS subject to such Sell Orders. Thus, in certain circumstances, Existing
Holders and, thus, the Beneficial Owners they represent may not have liquidity
of investment. If all Existing Holders submit (or are deemed to have submitted)
Hold Orders in an Auction, the Dividend Period next following the Auction
automatically shall be the same length as the immediately preceding Dividend
Period, and the Applicable Rate will be 40% of the Reference Rate (as defined
under "Determination of Maximum Applicable Rates" above) in effect on the date
of the Auction (or 60% of such rate if the Fund has provided notification to the
Auction Agent prior to the Auction establishing the Applicable Rate for any
dividend that net capital gains or other taxable income will be included in such
dividend on APS).
The Auction Procedures include a pro rata allocation of shares for purchase and
sale, which may result in an Existing Holder selling or holding, or a Potential
Holder purchasing, a number of APS that is less than the number of APS specified
in its Order. To the extent the allocation has this result, a Broker-Dealer will
be required to make appropriate pro rata allocations among its customers and
itself.
A Sell Order by an Existing Holder will constitute an irrevocable offer to sell
the APS subject thereto, and a Bid placed by an Existing Holder also will
constitute an irrevocable offer to sell the APS subject thereto if the rate per
annum specified in the Bid is higher than the Applicable Rate determined in the
Auction, in each case at a price per share equal to $25,000. A Bid placed by a
Potential Holder will constitute an irrevocable offer to purchase the APS
subject thereto if the rate per annum specified in such Bid is less than or
equal to the Applicable Rate determined in the Auction. Settlement of purchases
and sales will be made on the next Business Day (also a Dividend Payment Date)
after the Auction Date through the Securities Depository. Purchasers will make
payment through their Agent Members in same-day funds to the Securities
Depository against delivery by book-entry to their Agent Members. The Securities
Depository will make payment to the sellers' Agent Members in accordance with
the Securities Depository's normal procedures, which now provide for payment in
same-day funds. See "Description of APS--The Auction."
ASSET MAINTENANCE
Under the Amended By-Laws, the Fund must maintain (i) Moody's Eligible Assets
having in the aggregate a Discounted Value at least equal to the APS Basic
Maintenance Amount and (ii) 1940 Act APS Asset Coverage of at least 200%. See
"Description of APS--Asset Maintenance."
The Fund estimates that, based on the composition of its portfolio at [____],
2001, 1940 Act APS Asset Coverage with respect to APS would be approximately
[___]% immediately after the issuance of the APS offered hereby in an amount
representing approximately [___]% of the Fund's capital (including the capital
attributable to the APS).
The Discount Factors and guidelines for calculating the Discounted Value of the
Fund's portfolio for purposes of determining whether the APS Basic Maintenance
Amount has been satisfied have been established by Moody's in connection with
the Fund's receipt of a rating of "aaa" on the APS on their Date of Original
Issue. See "Rating Agency Guidelines."
6
MANDATORY REDEMPTION
If the APS Basic Maintenance Amount or the 1940 Act APS Asset Coverage is not
maintained or restored as specified herein, the APS will be subject to mandatory
redemption, out of funds legally available therefor, at the Mandatory Redemption
Price of $25,000 per share plus an amount equal to dividends thereon (whether or
not earned or declared) accumulated but unpaid to the date fixed for redemption.
In addition, holders of APS may be entitled to receive Gross-up Dividends in the
event of redemption of such APS as described herein. See "Description of APS--
Dividends--Gross-up Dividends." Any such redemption will be limited to the
minimum number of APS necessary to restore the APS Basic Maintenance Amount or
the 1940 Act APS Asset Coverage, as the case may be. The Fund's ability to make
such a mandatory redemption may be restricted by the provisions of the
Investment Company Act of 1940, as amended (the "1940 Act"). See "Description of
APS--Redemption--Mandatory Redemption."
OPTIONAL REDEMPTION
The APS are redeemable at the option of the Fund, as a whole or in part, on any
Dividend Payment Date (except during the Initial Dividend Period or a Non-Call
Period) at the Optional Redemption Price of $25,000 per share, plus an amount
equal to dividends thereon (whether or not earned or declared) accumulated but
unpaid to the date fixed for redemption plus the premium, if any, resulting from
the designation of a Premium Call Period. See "Description of APS--Redemption--
Optional Redemption." In addition, holders of APS may be entitled to receive
Gross-up Dividends in the event of redemption of such APS as described herein.
See "Description of APS--Dividends--Gross-up Dividends."
LIQUIDATION PREFERENCE
The liquidation preference of the APS will be $25,000 per share, plus an amount
equal to accumulated but unpaid dividends (whether or not earned or declared).
See "Description of APS--Liquidation Rights." In addition, holders of APS may be
entitled to receive Gross-up Dividends in the event of the liquidation of the
Fund as provided herein. See "Description of APS--Dividends--Gross-up
Dividends."
RATING
It is a condition to their issuance that the APS be issued with a credit quality
rating of "aaa" from Moody's. The Fund may at some future time seek to have the
APS rated by an additional Rating Agency. See "Rating Agency Guidelines."
VOTING RIGHTS
The 1940 Act requires that the holders of APS and any other Preferred Shares,
voting as a class, have the right to elect at least two trustees at all times
and to elect a majority of the trustees at any time when two years' dividends on
the APS or any other Preferred Shares are unpaid. The holders of APS and any
other Preferred Shares will vote as a separate class on certain other matters as
required under the Fund's Agreement and Declaration of Trust and the 1940 Act.
See "Description of APS--Voting Rights," "Description of capital structure" and
"Certain provisions in the Declaration of Trust."
TAX CONSIDERATIONS
Interest on certain "private activity" municipal bonds is treated as a tax
preference item for individuals for purposes of the federal alternative minimum
tax. In addition, for corporations, interest on all tax-exempt obligations is
taken into account in the computation of income subject to the federal
alternative minimum tax. The Fund will seek to avoid portfolio investments that
pay interest that is taxable to individuals under the federal alternative
minimum tax. Nonetheless, the Fund may not be successful in this regard and if
you are, or as a result of an investment in the Fund would become, subject to
the federal alternative minimum tax, the Fund may not be a suitable investment
for you. Moreover, distributions of any taxable net investment income and net
short-term capital gain are taxable as ordinary income. See "Taxes."
The Fund
The Fund is a recently organized, non-diversified, closed-end management
investment company registered under the Investment Company Act of 1940 and the
rules and regulations thereunder, as amended (the "1940 Act"). The Fund was
organized as a Massachusetts business trust on May 10, 2001 pursuant to the
Declaration, which is governed by the laws of The Commonwealth of Massachusetts.
The Fund's principal office is located at 1345 Avenue of the Americas, New York,
New York 10105, and its telephone number is (212) 739-3369. The Fund is
designed to provide tax benefits to investors who are residents of California.
The Fund commenced operations on June 29, 2001 upon the closing of an initial
public offering of 15,200,000 of its Common Shares. The proceeds of such
offering were approximately $217,740,000 after the payment of organizational and
offering expenses. In connection with the initial public offering of the Fund's
Common Shares, the underwriters were granted an option to purchase up to an
additional 2,280,000 additional common shares to cover over-allotments. On
_____, 2001, the underwriters purchased, at a price of $_______ per Common
Share, an additional [____________] Common Shares of the Fund pursuant to the
over-allotment option.
7
Use of proceeds
The net proceeds of the offering of APS will be approximately $(___________)
after payment of the estimated offering costs (not expected to exceed
$[__________]). The Fund will invest the net proceeds of the offering in
accordance with the Fund's investment objective and policies discussed below
under "The Fund's investments." It is presently anticipated that the Fund will
be able to invest substantially all of the net proceeds in municipal bonds that
meet the investment objective and policies within three months after the
completion of the offering. Pending such investment, it is anticipated that the
proceeds will be invested in short-term, tax-exempt securities.
Capitalization
The following table sets forth the unaudited capitalization of the Fund as of
[___________], 2001 and as adjusted to give effect to the issuance of the APS
offered hereby (including estimated offering expenses and a sales load of
$[____________]).
As of [_________], 2001
-----------------------
Actual As Adjusted
--------------- ----------------
Shareholders' Equity
Auction Preferred Shares, no par value
(no shares issued; _______ shares issued, as
adjusted, at $25,000 per share liquidation preference)
Common Shares, no par value, [______] shares
outstanding.
Capital in excess of par value
Undistributed net investment income
Net realized gain (loss) from investment transactions
Net unrealized depreciation of investments
Net assets
Portfolio Composition
As of [_________], 2001, approximately [____]% of the market value of the Fund's
portfolio was invested in long-term municipal bonds and approximately [___%] of
the market value of the Fund's portfolio was invested in short-term municipal
bonds. The following table sets forth certain information with respect to the
composition of the Fund's investment portfolio as of [__________], 2001.
NUMBER OF VALUE
S&P* MOODY's* ISSUES (IN THOUSANDS) PERCENT
---- -------- --------- -------------- -------
AAA Aaa
AA Aa1, Aa
A A1
BBB Baa1
BB Ba1
NR+ NR+
Cash
Total
100.0%
-------- --------- --------------- -------
o Ratings: Using the higher of S&P's or Moody's ratings on the Fund's
municipal bonds. [See "Schedule of Investments."] S&P rating
categories may be modified further by a plus (+) or minus (-) in AA,
A, BBB, BB, B and C ratings. Moody's rating categories may be modified
further by a 1, 2, or 3 in Aa, A, Baa, Ba and B ratings.
o Securities that are not rated by S&P or Moody's. Such municipal bonds
may be rated by Rating Agencies other than S&P or Moody's, or may not
be rated by any such Rating Agency. With respect to the percentage of
the Fund's assets invested in such securities, PIMCO believes that
these are of comparable quality to municipal bonds rated investment
grade (that is, rated within the four highest grades by Moody's, S&P
or Fitch). This determination is based on PIMCO's own internal
evaluation and does not necessarily reflect how such securities would
be rated by S&P or Moody's if either were to rate the securities.
8
The Fund's investments
INVESTMENT OBJECTIVE AND POLICIES
The Fund's investment objective is to provide current income exempt from federal
and California income tax. In pursuing this objective, PIMCO also seeks to
preserve and enhance the value of the Fund's holdings relative to the municipal
bond market generally, using proprietary analytical models that test and
evaluate the sensitivity of those holdings to changes in interest rates and
yield relationships.
PIMCO may at times believe that bonds associated with a particular municipal
market sector (for example, electric utilities), issued by a particular
municipal issuer, or having particular structural characteristics, are
undervalued. PIMCO may purchase such a bond for the Fund's portfolio because it
represents a market sector or issuer that PIMCO considers undervalued, even if
the value of the particular bond appears to be consistent with the value of
similar bonds. Municipal bonds of particular types (e.g., hospital bonds,
industrial revenue bonds or bonds issued by a particular municipal issuer) may
be undervalued because there is a temporary excess of supply in that market
sector, or because of a general decline in the market price of municipal bonds
of the market sector for reasons that do not apply to the particular municipal
bonds that are considered undervalued. The Fund's investment in municipal bonds
may be based on PIMCO's belief that their yield and/or total return potential is
higher than that available on bonds bearing similar levels of interest rate
risk, credit risk and other forms of risk, or that their value relative to the
municipal bond market is less sensitive to these risks. The Fund attempts to
increase its portfolio value relative to the municipal bond market generally by
prudent selection of municipal bonds regardless of the direction the market may
move. Any capital appreciation realized by the Fund will generally result in
the distribution of taxable capital gains to holders of APS.
Under normal market conditions, the Fund will invest substantially all (at least
90%) of its total assets in California Municipal Bonds.
The Fund will seek to avoid bonds generating interest potentially subjecting
individuals to the alternative minimum tax. The Fund will invest at least 80% of
its net assets in investment grade quality municipal bonds. Investment grade
quality means that such bonds are rated, at the time of investment, within the
four highest grades (Baa or BBB or better by Moody's, S&P or Fitch) or are
unrated but judged to be of comparable quality by PIMCO. The Fund may invest up
to 20% of its net assets in municipal bonds that are rated, at the time of
investment, Ba/BB or B by Moody's, S&P or Fitch or that are unrated but judged
to be of comparable quality by PIMCO. Bonds of below investment grade quality
(Ba/BB or below) are commonly referred to as "junk bonds." Bonds of below
investment grade quality are regarded as having predominantly speculative
characteristics with respect to capacity to pay interest and repay principal.
Bonds in the lowest investment grade category may also be considered to possess
some speculative characteristics by certain rating agencies. The foregoing
credit quality policies 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
or PIMCO downgrades its assessment of the credit characteristics of a particular
issue. In determining whether to retain or sell such a security, PIMCO may
consider such factors as PIMCO's 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, assigned to such security by other rating agencies. A general
description of Moody's, S&P's and Fitch's ratings of municipal bonds is set
forth in Appendix A to the Statement of Additional Information. See "Municipal
Bonds" below for a general description of the economic and credit
characteristics of municipal issuers in California. The Fund may also invest in
securities of other open- or closed-end investment companies that invest
primarily in municipal bonds of the types in which the Fund may invest directly.
As a stockholder in an investment company, the Fund would bear its ratable share
of that investment company's expenses in addition to the Fund's own expenses.
See "--Other Investment Companies" below.
The Fund may purchase municipal bonds that are additionally secured by
insurance, bank credit agreements, or escrow accounts. The credit quality of
companies which provide such credit enhancements will affect the value of those
securities. Although the insurance feature reduces certain financial risks, the
premiums for insurance and the higher market price paid for insured obligations
may reduce the Fund's income. Insurance generally will be obtained from insurers
with a claims-paying ability rated Aaa by Moody's or AAA by S&P or Fitch. The
insurance feature does not guarantee the market value of the insured obligations
or the net asset value of the Common Shares.
Upon PIMCO's recommendation, temporarily or for defensive purposes and in order
to keep the Fund's cash fully invested, including the period during which the
net proceeds of this offering are being invested, the Fund may invest a
substantial portion of its net assets in short-term investments including high
quality, short-term securities that may be either tax-exempt or taxable. The
Fund intends to invest in taxable short-term investments only in the event that
suitable tax-exempt short-term investments are not available at reasonable
prices and yields. Investment in taxable short-term investments would result in
a portion of your dividends being subject to federal and California income
taxes. However, as discussed below under "Description of APS - Auction
Procedures - Auction Date; Advance Notice of Allocation of Taxable Income;
Inclusion of Taxable Income in Dividends," dividends on APS will generally
increase if Taxable Income is included in a dividend.
The Fund cannot change its investment objective without the approval of the
holders of a "majority of the outstanding" Common Shares and any Preferred
Shares (including the APS) voting together as a single class, and of the holders
of a "majority of the outstanding" Preferred Shares voting as a separate class.
A "majority of the outstanding" shares (whether voting together as a single
class or voting as a separate class) means (i) 67% or more of such shares
present at a meeting, if the holders of more than 50% of those shares are
9
present or represented by proxy, or (ii) more than 50% of such shares, whichever
is less. See "Description of APS--Voting Rights" in this Prospectus for
additional information with respect to the voting rights of holders of APS.
The Fund will seek to avoid portfolio investments that pay interest that is
taxable to individuals under the federal alternative minimum tax. Nonetheless,
the Fund may not be successful in this regard and if you are, or as a result of
an investment in the Fund would become, subject to the federal alternative
minimum tax, the APS may not be a suitable investment for you. Special
alternative minimum tax rules apply to corporate holders. In addition, capital
gain dividends will be subject to capital gains taxes. See "Taxes."
MUNICIPAL BONDS
Municipal bonds are either general obligation or revenue bonds and typically are
issued to finance public projects (such as roads or public buildings), to pay
general operating expenses, or to refinance outstanding debt. General obligation
bonds are backed by the full faith and credit, or taxing authority, of the
issuer and may be repaid from any revenue source; revenue bonds may be repaid
only from the revenues of a specific facility or source. The Fund also may
purchase municipal bonds that represent lease obligations. These carry special
risks because the issuer of the bonds may not be obligated to appropriate money
annually to make payments under the lease. In order to reduce this risk, the
Fund will only purchase municipal bonds representing lease obligations where
PIMCO believes the issuer has a strong incentive to continue making
appropriations until maturity.
The California Municipal Bonds in which the Fund will invest are generally
issued by the State of California, a city in California, or a political
subdivision, agency, authority or instrumentality of such state or city.
The yields on municipal bonds depend on a variety of factors, including
prevailing interest rates and the condition of the general money market and the
municipal bond market, the size of a particular offering, the maturity of the
obligation and the rating of the issue. The market value of municipal bonds will
vary with changes in interest rate levels and as a result of changing
evaluations of the ability of their issuers to meet interest and principal
payments.
The Fund will invest primarily in municipal bonds with long-term maturities in
order to maintain a weighted average maturity of 15-30 years, but the weighted
average maturity of obligations held by the Fund may be shortened, depending on
market conditions.
WHEN-ISSUED, DELAYED DELIVERY AND FORWARD COMMITMENT TRANSACTIONS
The Fund may buy and sell municipal bonds on a when-issued, delayed delivery or
forward commitment basis, making payment or taking delivery at a later date,
normally within 45 days of the trade date. This type of transaction may involve
an element of risk because no interest accrues on the bonds prior to settlement
and, since bonds are subject to market fluctuations, the value of the bonds at
time of delivery may be less (or more) than cost. When such purchases are
outstanding, the Fund will segregate until the settlement date assets determined
to be liquid by PIMCO in accordance with procedures established by the Board of
Trustees, in an amount sufficient to meet the purchase price.
STRUCTURED NOTES
The Fund may invest in "structured" notes, which are privately negotiated debt
obligations where the principal and/or interest is determined by reference to
the performance of a benchmark asset or market, such as selected securities or
an index of securities, or the differential performance of two assets or
markets, such as indices reflecting taxable and tax-exempt bonds. Depending on
the terms of the note, the Fund may forgo all or part of the interest and
principal that would be payable on a comparable conventional note. The rate of
return on structured notes may be determined by applying a multiplier to the
performance or differential performance of the referenced index(es) or other
asset(s). Application of a multiplier involves leverage which will serve to
magnify the potential for gain and the risk of loss.
The Fund currently intends that any use of structured notes will be for the
purpose of reducing the interest rate sensitivity of the Fund's portfolio (and
thereby decreasing the Fund's exposure to interest rate risk) and, in any event,
that the interest income on the notes will normally be exempt from federal and
California income tax. The Fund will only invest in structured notes if it has
received an opinion of counsel for the issuer (or the advice of another
authority believed by PIMCO to be reliable) that the interest income on the
notes will be exempt from federal income tax. Like other sophisticated
strategies, the Fund's use of structured notes may not work as intended; for
example, by reducing the duration of the Fund's portfolio, structured notes may
limit the Fund's return when having a longer duration would be beneficial (for
instance, when interest rates decline).
VARIABLE AND FLOATING RATE SECURITIES
Variable and floating rate securities provide for a periodic adjustment in the
interest rate paid on the obligations. The Fund may invest in floating rate debt
instruments ("floaters") and engage in credit spread trades. While floaters
10
provide a certain degree of protection against rises in interest rates, the Fund
will participate in any decline in interest rates as well, although this is no
guarantee that the interest rates earned by the Fund on its investments will be
greater than the dividend rate payable with respect to the APS. A credit spread
trade is an investment position relating to a difference in the prices or
interest rates of two bonds or other securities, where the value of the
investment position is determined by changes in the difference between such
prices or interest rates, as the case may be, of the respective securities.
RESIDUAL INTEREST MUNICIPAL BONDS (RIBS)
The Fund may also invest up to 10% of its assets in RIBS, whose interest rates
bear an inverse relationship to the interest rate on another security or the
value of an index. An investment in RIBS typically will involve greater risk
than an investment in a fixed rate bond. Because changes in the interest rate on
the other security or index inversely affect the residual interest paid on a
RIB, the value of a RIB is generally more volatile than that of a fixed rate
bond. RIBS have interest rate adjustment formulas which generally reduce or, in
the extreme, eliminate the interest paid to the Fund when short-term interest
rates rise, and increase the interest paid to the Fund when short-term interest
rates fall. RIBS have varying degrees of liquidity, and the market for these
securities is volatile. These securities generally will underperform the market
for fixed rate bonds in a rising interest rate environment, but tend to
outperform the market for fixed rate bonds when interest rates decline or remain
relatively stable. Although volatile, RIBS typically offer the potential for
yields exceeding the yields available on fixed rate bonds with comparable credit
quality, coupon, call provisions and maturity. The Fund may also invest in RIBS
for the purpose of increasing the Fund's leverage. Should short-term interest
rates rise, the combination of the Fund's investment in RIBS and its use of
other forms of leverage (including through the issuance of APS or the use of
other derivative instruments) likely will adversely affect the Fund's net asset
value. Trusts in which RIBS may be held could be terminated, in which case the
residual bond holder would take possession of the underlying bond on an
unleveraged basis.
OTHER INVESTMENT COMPANIES
The Fund may invest up to 10% of its net assets in securities of other open- or
closed-end investment companies that invest primarily in municipal bonds of the
types in which the Fund may invest directly. The Fund may invest in other
investment companies either during periods when it has large amounts of
uninvested cash, such as the period shortly after the Fund receives the proceeds
of the offering of its APS, during periods when there is a shortage of
attractive, high-yielding municipal bonds available in the market, or when PIMCO
believes share prices of other investment companies offer attractive values. The
Fund may invest in investment companies that are advised by PIMCO or its
affiliates to the extent permitted by applicable law and/or pursuant to
exemptive relief from the Securities and Exchange Commission. As a stockholder
in an investment company, the Fund will bear its ratable share of that
investment company's expenses, and would remain subject to payment of the Fund's
management fees and other expenses with respect to assets so invested. PIMCO
will take expenses into account when evaluating the investment merits of an
investment in an investment company relative to available municipal bond
investments. In addition, the securities of other investment companies may also
be leveraged and will therefore be subject to the risks associated with
leverage. The net asset value and market value of leveraged shares will be more
volatile and the yield to shareholders will tend to fluctuate more than the
yield generated by unleveraged shares.
Risks
Risk is inherent in all investing. Investing in any investment company security
involves risk, including the risk that you may receive little or no return on
your investment or even that you may lose part or all of your investment.
Therefore, before purchasing APS, you should consider carefully the following
risks that you assume when you invest in the Fund.
AUCTION RISK
You may not be able to sell your APS at an Auction if the Auction fails; that
is, if there are more APS offered for sale than there are buyers for those
shares. If Sufficient Clearing Bids do not exist in an Auction, the Applicable
Rate will be the Maximum Applicable Rate, and in such event, owners of APS
wishing to sell will not be able to sell all, and may not be able to sell any,
of such shares in the Auction. As a result, investors may not have liquidity of
investment. Neither the Broker-Dealers nor the Fund are obligated to purchase
APS in an Auction or otherwise nor is the Fund required to redeem APS in the
event of a failed Auction. Also, if you place bid orders (orders to retain APS)
at an Auction only at a specified rate, and that bid rate exceeds the Applicable
Rate set at the Auction, you will not retain your APS. Finally, if you elect to
retain APS without specifying a rate below which you would not wish to continue
to hold those APS, and the Auction sets a below-market rate, you may receive a
lower rate of return on your APS than the market rate. See "Description of APS--
The Auction" and "Description of APS--Auction Procedures."
RATINGS AND ASSET COVERAGE RISK
While Moody's has assigned a rating of "aaa" to the APS, the ratings do not
eliminate or necessarily mitigate the risks of investing in the APS. A Rating
Agency could downgrade the APS, which may make your shares less liquid at an
11
Auction or in the secondary market. If a Rating Agency downgrades APS, the Fund
has undertaken to alter its portfolio or redeem the APS. The Fund may
voluntarily redeem APS under certain circumstances. See "Rating Agency
Guidelines" for a description of the asset maintenance tests the Fund must meet.
SECONDARY MARKET RISK
The Broker-Dealers may maintain a secondary trading market in the APS outside of
Auctions; however, they have no obligation to do so and there can be no
assurance that a secondary market for the APS will develop or, if it does
develop, that it will provide holders with a liquid trading market (i.e.,
trading will depend on the presence of willing buyers and sellers and the
trading price is subject to variables to be determined at the time of the trade
by the Broker-Dealers). The APS will not be registered on any stock exchange or
on any automated quotation system. If you try to sell your APS between Auctions,
you may not be able to sell any or all of your shares, or you may not be able to
sell them for $25,000 per share. An increase in the level of interest rates,
particularly during any Long Term Dividend Period, likely will have an adverse
effect on the secondary market price of the APS .
NEWLY ORGANIZED
The Fund is a recently organized, non-diversified, closed-end management
investment company and has a limited operating history.
INTEREST RATE RISK
Interest rate risk is the risk that bonds (and the Fund's net assets) will
decline in value because of changes in interest rates. Generally, municipal
bonds will decrease in value when interest rates rise and increase in value when
interest rates decline. The value of the longer-term bonds in which the Fund
generally invests normally fluctuates more in response to changes in interest
rates than does the value of shorter-term bonds. Because the Fund will invest
primarily in long-term bonds, the Fund's net asset value will fluctuate more in
response to changes in market interest rates than if the Fund invested primarily
in shorter-term bonds. The Fund may invest up to 10% of its assets in RIBS.
Compared to similar fixed rate municipal obligations, the value of RIBS will
fluctuate to a greater extent in response to changes in prevailing long-term
interest rates. Moreover, the income earned on RIBS will fluctuate in response
to changes in prevailing short-term interest rates. Thus, when RIBS are held by
the Fund, an increase in short- or long-term market interest rates will
adversely affect the income received from such bonds or the net asset value of
the Fund's shares.
The APS pay dividends based on short-term interest rates. The Fund will use the
proceeds from the issuance of APS to buy municipal bonds, which generally pay
interest based on longer-term yields. Long-term municipal bond yields are
typically, although not always, higher than short-term interest rates. If
short-term interest rates rise, the dividend rate on the APS may rise so that
the amount of dividends paid to APS shareholders exceeds the income from the
portfolio securities purchased with the proceeds from the APS. Because income
from the Fund's entire investment portfolio (not just the portion of the
portfolio purchased with the proceeds of the APS offering) is available to pay
APS dividends, however, APS dividend rates would need to greatly exceed the
Fund's net portfolio income before the Fund's ability to pay APS dividends would
be jeopardized. If long-term rates rise, the value of the Fund's investment
portfolio will decline, reducing the amount of assets serving as asset coverage
for the APS.
The Fund may utilize certain strategies, including investments in structured
notes, for the purpose of reducing the interest rate sensitivity of the
portfolio and decreasing the Fund's exposure to interest rate risk, although
there is no assurance that it will do so or that such strategies will be
successful. See "How the Fund manages risk--Hedging and Related Strategies."
CREDIT RISK
Credit risk is the risk that an issuer of a municipal bond will become unable to
meet its obligation to make interest and principal payments. Because the
primary source of income for the Fund is the interest and principal payments on
the municipal bonds in which it invests, any default by an issuer of a municipal
bond could have a negative impact on the Fund's ability to pay dividends on the
APS and could result in the redemption of some or all of the APS. In general,
lower rated municipal bonds carry a greater degree of risk that the issuer will
lose its ability to make interest and principal payments, which could have a
negative impact on the Fund's net asset value or dividends. The Fund may invest
up to 20% of its net assets in municipal bonds that are rated Ba/BB or B by
Moody's, S&P or Fitch or that are unrated but judged to be of comparable quality
by PIMCO. Bonds rated Ba/BB or B are regarded as having predominantly
speculative characteristics with respect to capacity to pay interest and repay
principal, and these bonds are commonly referred to as "junk bonds." The prices
of these lower grade bonds are more sensitive to negative developments, such as
a decline in the issuer's revenues or a general economic downturn, than are the
prices of higher grade securities. Bonds in the lowest investment grade category
may also be considered to possess some speculative characteristics by certain
rating agencies.
12
CONCENTRATION RISK
As described above, except to the extent the Fund invests in temporary
investments, the Fund will invest substantially all of its net assets in
California Municipal Bonds. The Fund is therefore susceptible to political,
economic, regulatory and other factors affecting issuers of California Municipal
Bonds, their ability to meet their obligations and the economic condition of the
facility or specific revenue source from whose revenues payments of obligations
may be made. The ability of state, county, or local governments or other issuers
of California Municipal Bonds to meet their obligations will depend primarily on
the availability of tax and other revenues to those entities. The amounts of tax
and other revenues available to issuers of California Municipal Bonds may be
affected from time to time by economic, political and demographic conditions
that specifically impact California. In addition, there are constitutional and
statutory restrictions that limit the power of certain issuers to raise revenues
or increase taxes. The availability of federal, state and local aid to issuers
of California Municipal Bonds may also affect their ability to meet their
obligations. The creditworthiness of obligations issued by local California
issuers may be unrelated to the creditworthiness of obligations issued by the
State of California and there is no obligation on the part of the State to make
payment on such local obligations in the event of default. Any reduction in the
actual or perceived ability of an issuer of California Municipal Bonds to meet
its obligations (including a reduction in the rating of its outstanding
securities) would likely affect adversely the market value and marketability of
its obligations and could adversely affect the values of other California
Municipal Bonds as well. Moreover, in such circumstances, the value of the
Fund's shares may fluctuate more widely than the value of shares of a more
diversified fund which invests in a number of different states.
The foregoing information constitutes only a brief summary of some of the
general factors which may impact certain issuers of California Municipal Bonds
and does not purport to be a complete or exhaustive description of all adverse
conditions to which the issuers of such bonds held by the Fund are subject.
Additionally, many factors including national economic, social and environmental
policies and conditions, which are not within the control of the issuers of
California Municipal Bonds, could affect or could have an adverse impact on the
financial condition of the issuers. The Fund is unable to predict whether or to
what extent such factors or other factors may affect the issuers of California
Municipal Bonds, the market value or marketability of such bonds or the ability
of the respective issuers of the bonds acquired by the Fund to pay interest on
or principal of such bonds. This information has not been independently
verified.
For a more detailed description of these and other risks affecting investment in
California Municipal Bonds, see "Appendix B--Factors pertaining to California"
in the Statement of Additional Information.
MUNICIPAL BOND MARKET RISK
Investing in the municipal bond market involves certain risks. The amount of
public information available about the municipal bonds in the Fund's portfolio
is generally less than that for corporate equities or bonds, and the investment
performance of the Fund may therefore be more dependent on the analytical
abilities of PIMCO than would be a stock fund or taxable bond fund. The
secondary market for municipal bonds, particularly the below investment grade
bonds in which the Fund may invest, also tends to be less well-developed or
liquid than many other securities markets, which may adversely affect the Fund's
ability to sell its bonds at attractive prices.
The ability of municipal issuers to make timely payments of interest and
principal may be diminished during general economic downturns and as
governmental cost burdens are reallocated among federal, state and local
governments. In addition, laws enacted in the future by Congress or state
legislatures or referenda could extend the time for payment of principal and/or
interest, or impose other constraints on enforcement of such obligations, or on
the ability of municipal issuers to levy taxes. Issuers of municipal securities
might seek protection under the bankruptcy laws. In the event of bankruptcy of
such an issuer, the Fund could experience delays in collecting principal and
interest and the Fund may not, in all circumstances, be able to collect all
principal and interest to which it is entitled. To enforce its rights in the
event of a default in the payment of interest or repayment of principal, or
both, the Fund may take possession of and manage the assets securing the
issuer's obligations on such securities, which may increase the Fund's operating
expenses. Any income derived from the Fund's ownership or operation of such
assets may not be tax-exempt.
NON-DIVERSIFICATION RISK
Because the Fund is classified as "non-diversified" under the 1940 Act, it can
invest a greater portion of its assets in obligations of a single issuer. As a
result, to the extent the Fund invests a relatively high percentage of its
assets in obligations of a limited number of issuers, the Fund will be more
susceptible than a more widely diversified fund to any single corporate,
economic, political or regulatory occurrence. See "The Fund's investments."
The Fund must satisfy certain asset diversification rules in order to qualify as
a regulated investment company for federal income tax purposes.
REINVESTMENT RISK
Reinvestment risk is the risk that income from the Fund's bond portfolio will
decline if and when the Fund invests the proceeds from matured, traded or called
13
bonds at market interest rates that are below the portfolio's current earnings
rate. A decline in income could affect the Fund's net asset value.
INFLATION RISK
Inflation risk is the risk that the value of assets or income from an investment
will be worth less in the future as inflation decreases the value of money. As
inflation increases, the real value of the APS and distributions can decline.
However, during any periods of rising inflation, APS dividend rates would likely
increase, which would tend to offset this risk.
LEVERAGE RISK
The Fund utilizes financial leverage on an ongoing basis for investment
purposes. Leverage risk includes the risk associated with the issuance of APS
to leverage the Fund's Common Shares. If the dividend rate on the APS exceeds
the net rate of return on the Fund's portfolio, the leverage will result in a
lower net asset value than if the Fund were not leveraged, and the Fund's
ability to meet its asset coverage requirements on the APS would be reduced.
Because the long-term bonds included in the Fund's portfolio will typically pay
fixed rates of interest while the dividend rate on the APS will be adjusted
periodically, this could occur even when both long-term and short-term municipal
rates rise. Similarly, any decline in the net asset value of the Fund's
investments could result in the Fund being in danger of failing to meet its
asset coverage requirements or of losing its expected "aaa" rating on the APS
or, in an extreme case, the Fund's current investment income might not be
sufficient to meet the dividend requirements on the APS. 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 APS.
While the Fund may from time to time consider reducing leverage in response to
actual or anticipated changes in interest rates in an effort to mitigate the
increased volatility of current income and net asset value associated with
leverage, there can be no assurance that the Fund will actually reduce leverage
in the future or that any reduction, if undertaken, will be effective. Changes
in the future direction of interest rates are very difficult to predict
accurately. If the Fund were to reduce leverage based on a prediction about
future changes to interest rates, and that prediction turned out to be
incorrect, the reduction in leverage would likely operate to reduce the Fund's
net asset value relative to the circumstance where the Fund had not reduced
leverage. The Fund may decide that this risk outweighs the likelihood of
achieving the desired reduction to volatility in income and net asset value if
the prediction were to turn out to be correct, and determine not to reduce
leverage as described above.
The Fund may also invest up to 10% of its assets in RIBS and invest in other
derivative instruments, which may amplify the effects of leverage and, during
periods of rising short-term interest rates, may adversely affect the Fund's net
asset value. See "Residual Interest Municipal Bonds (RIBS)" under "The Fund's
investments" and the Statement of Additional Information under "Investment
objective and policies--Derivative Instruments."
Because the fees paid to PIMCO Advisors and PIMCO will be calculated on the
basis of the Fund's managed assets, the fees will be higher when leverage is
utilized, giving PIMCO Advisors and PIMCO an incentive to utilize leverage.
ANTI-TAKEOVER PROVISIONS
The Fund's 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 the Board of Trustees. See
"Certain provisions in the Declaration of Trust."
CERTAIN AFFILIATIONS
Certain broker-dealers may be considered to be affiliated persons of the Fund,
PIMCO Advisors and/or PIMCO due to their possible affiliations with Allianz AG,
the ultimate parent of PIMCO Advisors and PIMCO. Absent an exemption from the
Securities and Exchange Commission or other regulatory relief, the Fund is
generally precluded from effecting certain principal transactions with
affiliated brokers, and its ability to purchase securities being underwritten by
an affiliated broker or a syndicate including an affiliated broker or to utilize
affiliated brokers for agency transactions is subject to restrictions. This
could limit the Fund's ability to engage in securities transactions and take
advantage of market opportunities. Similar prohibitions apply to trades with
the Underwriters or their affiliates during the offering of APS.
How the Fund manages risk
INVESTMENT LIMITATIONS
The Fund has adopted certain investment limitations designed to limit investment
risk. These limitations (one of which is described below) are fundamental and
may not be changed without the approval of the holders of a majority of the
outstanding Common Shares and any Preferred Shares (including APS) voting
14
together as a single class, and the approval of the holders of a majority of any
Preferred Shares (including APS) voting as a separate class. Among other
restrictions, the Fund may not concentrate its investments in a particular
industry, as that term is used in the 1940 Act and as interpreted, modified, or
otherwise permitted by regulatory authority having jurisdiction from time to
time.
The Fund's industry concentration policy does not preclude it from focusing
investments in issuers in a group of related industries (such as different types
of utilities).
The Fund may become subject to guidelines which are more limiting than the
investment restrictions set forth above and in the Statement of Additional
Information in order to obtain and maintain a rating of "aaa" from Moody's on
the APS. The Fund does not anticipate that such guidelines would have a
material adverse effect on the Fund's ability to achieve its investment
objective. See "Investment objective and policies" and "Investment restrictions"
in the Statement of Additional Information for information about these
guidelines and a complete list of the fundamental investment policies of the
Fund.
QUALITY OF INVESTMENTS
The Fund will invest at least 80% of its net assets in bonds of investment grade
quality at the time of investment. Investment grade quality means that such
bonds are rated by Rating Agencies within the four highest grades (Baa or BBB or
better by Moody's, S&P or Fitch) or are unrated but judged to be of comparable
quality by PIMCO.
MANAGEMENT OF INVESTMENT PORTFOLIO AND CAPITAL STRUCTURE TO LIMIT LEVERAGE RISK
The Fund may take certain actions if short-term interest rates increase or
market conditions otherwise change (or the Fund anticipates such an increase or
change) and the Fund's leverage begins (or is expected) to adversely affect
Common Shareholders. In order to attempt to offset such a negative impact of
leverage on Common Shareholders, the Fund may shorten the average maturity or
duration of its investment portfolio (by investing in shorter-term, high quality
securities) or may extend the maturity of outstanding Preferred Shares. The Fund
may also attempt to reduce leverage by redeeming or otherwise purchasing
Preferred Shares (subject to any restrictions discussed under "Description of
APS - Redemption") or by reducing any holdings in RIBS or other instruments that
create leverage. The success of any such attempt to limit leverage risk depends
on PIMCO's ability to accurately predict interest rate or other market changes.
Because of the difficulty of making such predictions, the Fund may not be
successful in managing its interest rate exposure in the manner described above.
If market conditions suggest that additional leverage would be beneficial, the
Fund may issue additional Preferred Shares or utilize other forms of leverage,
such as RIBS or other derivative instruments.
HEDGING AND RELATED STRATEGIES
The Fund may use various investment strategies designed to limit the risk of
bond price fluctuations and to preserve capital. For instance, the Fund may
invest in structured notes for the purpose of reducing the interest rate
sensitivity of the Fund's portfolio and, thereby, decreasing the Fund's exposure
to interest rate risk. The Fund currently intends that the income on these notes
will normally be exempt from federal and California income tax. Other hedging
strategies that the Fund may use include: financial futures contracts; short
sales; swap agreements or options thereon; options on financial futures; and
options based on either an index of municipal securities or on taxable debt
securities whose prices, PIMCO believes, correlate with the prices of the Fund's
investments. Income earned by the Fund from many hedging activities will be
treated as capital gain and, if not offset by net realized capital loss, will be
distributed to shareholders in taxable distributions. If effectively used,
hedging strategies will offset in varying percentages losses incurred on the
Fund's investments due to adverse interest rate changes. There is no assurance
that these hedging strategies will be available at any time or that PIMCO will
determine to use them for the Fund.
Rating agency guidelines
The Fund is required under Moody's guidelines to maintain assets having in the
aggregate a Discounted Value at least equal to the APS Basic Maintenance Amount.
Moody's has established guidelines for determining Discounted Value. To the
extent any particular portfolio holding does not satisfy Moody's guidelines, all
or a portion of such holding's value will not be included in the calculation of
Discounted Value (as defined by Moody's). The Moody's guidelines do not impose
any limitations on the percentage of the Fund's assets that may be invested in
holdings not eligible for inclusion in the calculation of the Discounted Value
of the Fund's portfolio. The amount of such assets included in the portfolio at
any time may vary depending upon the rating, diversification and other
characteristics of the eligible assets included in the portfolio, although it is
not anticipated that in the normal course of business the value of such assets
would exceed 20% of the Fund's total assets.
The Fund is also required under the 1940 Act and Rating Agency guidelines to
maintain, with respect to shares of APS, asset coverage of at least 200% with
respect to senior securities which are shares, including APS (or such other
asset coverage as may in the future be specified in or under the 1940 Act as the
minimum asset coverage for senior securities which are shares of a closed-end
investment company as a condition of declaring dividends on its common shares)
("1940 Act APS Asset Coverage").
In the event the Fund does not timely cure a failure to maintain (a) a
Discounted Value of its portfolio equal to the APS Basic Maintenance Amount or
15
(b) the 1940 Act APS Asset Coverage, in each case in accordance with the
requirements of the Rating Agency or Agencies then rating the shares of APS, the
Fund will be required to redeem shares of APS as described under "Description of
APS--Redemption--Mandatory Redemption."
The Fund may, but is not required to, adopt any modifications to the guidelines
that may hereafter be established by Moody's. Failure to adopt any such
modifications, however, may result in a change in the ratings described above or
a withdrawal of ratings altogether. In addition, any Rating Agency providing a
rating for the APS may, at any time, change or withdraw any such rating. The
Board may, without shareholder approval, amend, alter or repeal any or all of
the definitions and related provisions which have been adopted by the Fund
pursuant to the Rating Agency guidelines in the event the Fund receives written
confirmation from Moody's that any such amendment, alteration or repeal would
not impair the ratings then assigned by Moody's to the APS.
As recently described by Moody's, a preferred stock rating is an assessment of
the capacity and willingness of an issuer to pay preferred stock obligations.
The ratings on the APS are not recommendations to purchase, hold or sell those
shares, inasmuch as the ratings do not comment as to market price or suitability
for a particular investor. The Rating Agency guidelines described above also do
not address the likelihood that an owner of shares of APS will be able to sell
such shares in an Auction or otherwise. The ratings are based on current
information furnished to Moody's by the Fund and/or PIMCO and information
obtained from other sources. The ratings may be changed, suspended or withdrawn
as a result of changes in, or the unavailability of, such information. The
Fund's Common Shares have not been rated by a Rating Agency
A Rating Agency's guidelines will apply to the APS only so long as such Rating
Agency is rating such shares. The Fund will pay certain fees to Moody's for
rating the APS.
Description of APS
Each series of APS will be Preferred Shares that entitle their holders to
receive dividends when, as and if declared by the Board of Trustees, out of
funds legally available therefor, at a rate per annum that may vary for the
successive Dividend Periods for each such series. After the Initial Dividend
Period, each Subsequent Dividend Period for each series of APS generally will be
a 7-Day Dividend Period; provided, however, that prior to any Auction, the Fund
may elect, subject to certain limitations described herein, upon giving notice
to holders thereof, a Special Dividend Period. The Applicable Rate for a
particular Dividend Period for a series of APS will be determined by an Auction
conducted on the Business Day before the start of such Dividend Period.
Beneficial Owners and Potential Beneficial Owners of APS may participate in
Auctions therefor, although, except in the case of certain Special Dividend
Periods, Beneficial Owners desiring to continue to hold all of their APS
regardless of the Applicable Rate resulting from Auctions need not participate.
For an explanation of Auctions and the method of determining the Applicable
Rate, see "--The Auction."
The nominee of the Securities Depository is expected to be the sole holder of
record of each series of APS. Accordingly, each purchaser of APS must rely on
(i) the procedures of the Securities Depository and, if such purchaser is not a
member of the Securities Depository, such purchaser's Agent Member, to receive
dividends, distributions and notices and to exercise voting rights (if and when
applicable) and (ii) the records of the Securities Depository and, if such
purchaser is not a member of the Securities Depository, such purchaser's Agent
Member, to evidence its beneficial ownership of the APS.
When issued and sold, the APS of each series will have a liquidation preference
of $25,000 per share plus an amount equal to accumulated but unpaid dividends
(whether or not earned or declared) and will be fully paid and, except as
discussed under "Certain provisions in the Declaration of Trust" below, non-
assessable. See "Description of APS--Liquidation Rights." The APS will not be
convertible into Common Shares or other shares of beneficial interest of the
Fund, and the holders thereof will have no preemptive rights. The APS will not
be subject to any sinking fund but will be subject to redemption at the option
of the Fund at the Optional Redemption Price on any Dividend Payment Date for
such series (except during the Initial Dividend Period and during a Non-Call
Period) and, in certain circumstances, will be subject to mandatory redemption
by the Fund at the Mandatory Redemption Price stated herein. See "--
Redemption."
In addition to serving as the Auction Agent in connection with the Auction
Procedures described below, [_______] will be the transfer agent, registrar,
dividend disbursing agent and redemption agent for each series of APS. The
Auction Agent, however, will serve merely as the agent of the Fund, acting in
accordance with the Fund's instructions, and will not be responsible for any
evaluation or verification of any matters certified to it.
Except in an Auction, the Fund will have the right (to the extent permitted by
applicable law) to purchase or otherwise acquire any APS so long as the Fund is
current in the payment of dividends on APS and on any other shares of beneficial
interest of the Fund ranking on a parity with the APS with respect to the
payment of dividends or upon liquidation.
The following is a brief description of the terms of the APS. This description
does not purport to be complete and is subject to and qualified in its entirety
by reference to the Fund's Declaration of Trust and Amended By-Laws, including
the provisions thereof establishing the APS. The Fund's Declaration of Trust and
the form of Amended By-Laws establishing the terms of the APS have been filed as
exhibits to the Registration Statement of which this Prospectus is a part.
16
THE AUCTION
GENERAL. Holders of the APS of each series will be entitled to receive
cumulative cash dividends on their shares when, as and if declared by the Board
of Trustees of the Fund, out of the funds legally available therefor, on the
Initial Dividend Payment Date with respect to the Initial Dividend Period for
each series and, thereafter, on each Dividend Payment Date with respect to a
Subsequent Dividend Period for each series (generally a period of seven days
subject to certain exceptions set forth under "--Dividends--General") at the
rate per annum equal to the Applicable Rate for each such Dividend Period.
The provisions of the Amended By-Laws establishing the terms of the APS offered
hereby will provide that the Applicable Rate for each Dividend Period after the
Initial Dividend Period for each series will be equal to the rate per annum that
the Auction Agent advises has resulted on the Business Day preceding the first
day of such Dividend Period due to implementation of the Auction Procedures set
forth in the Amended By-Laws in which persons determine to hold or offer to
purchase or sell the APS. The Auction Procedures are attached as Appendix D to
the Statement of Additional Information. Each periodic operation of such
procedures with respect to the APS is referred to herein as an "Auction." If,
however, the Fund should fail to pay or duly provide for the full amount of any
dividend on or the redemption price of the APS called for redemption, the
Applicable Rate for the APS will be determined as set forth under "Dividends--
Non-Payment Period; Late Charge."
AUCTION AGENT AGREEMENT. The Fund will enter into the Auction Agent Agreement
with the Auction Agent, which provides, among other things, that the Auction
Agent will follow the Auction Procedures for the purpose of determining the
Applicable Rate for each series of APS. The Fund will pay the Auction Agent
compensation for its services under the Auction Agent Agreement.
The Auction Agent will act as agent for the Fund in connection with Auctions. In
the absence of bad faith or negligence on its part, the Auction Agent will not
be liable for any action taken, suffered or omitted, or for any error of
judgment made, by it in the performance of its duties under the Auction Agent
Agreement, and will not be liable for any error of judgment made in good faith
unless the Auction Agent shall have been negligent in ascertaining the pertinent
facts. Pursuant to the Auction Agent Agreement, the Fund is required to
indemnify the Auction Agent for certain losses and liabilities incurred by the
Auction Agent without negligence or bad faith on its part in connection with the
performance of its duties under such agreement.
The Auction Agent may terminate the Auction Agent Agreement upon notice to the
Fund, which termination may be no earlier than 60 days following delivery of
such notice. If the Auction Agent resigns, the Fund will use its best efforts to
enter into an agreement with a successor Auction Agent containing substantially
the same terms and conditions as the Auction Agent Agreement. The Fund may
terminate the Auction Agent Agreement, provided that prior to such termination
the Fund shall have entered into such an agreement with respect thereto with a
successor Auction Agent.
BROKER-DEALER AGREEMENTS. The Auctions require the participation of one or more
broker-dealers. The Auction Agent will enter into agreements (collectively, the
"Broker-Dealer Agreements") with one or more broker-dealers, or other entities
permitted by law to perform the functions required of a Broker-Dealer in the
Auction Procedures (collectively, the "Broker-Dealers"), selected by the Fund,
which provide for the participation of such Broker-Dealers in Auctions. A
Broker--Dealer Agreement may be terminated by the Auction Agent or a Broker-
Dealer on five days' notice to the other party, provided that the Broker-Dealer
Agreement with UBS Warburg LLC may not be terminated without the prior written
consent of the Fund, which consent may not be unreasonably withheld.
SECURITIES DEPOSITORY. The Depository Trust Company initially will act as the
Securities Depository for the Agent Members with respect to the APS. All of the
shares of each series of APS initially will be registered in the name of Cede &
Co., as nominee of the Securities Depository. Such shares will be subject to the
provisions restricting transfers of the APS contained in the Amended By-Laws.
Cede & Co. initially will be the holder of record of all shares of APS, and
Beneficial Owners will not be entitled to receive certificates representing
their ownership interest in such shares. See Appendix D (Auction Procedures) to
the Statement of Additional Information. The Securities Depository will maintain
lists of its participants and will maintain the positions (ownership interests)
of the APS held by each Agent Member, whether as the Beneficial Owner thereof
for its own account or as nominee for the Beneficial Owner thereof. Payments
made by the Fund to holders of APS will be duly made by making payments to the
nominee of the Securities Depository.
AUCTION PROCEDURES.
The following is a brief summary of the procedures to be used in conducting
Auctions. This summary is qualified by reference to the Auction Procedures set
forth in Appendix D to the Statement of Additional Information. The Settlement
Procedures to be used with respect to Auctions are set forth in Appendix C to
the Statement of Additional Information.
AUCTION DATE; ADVANCE NOTICE OF ALLOCATION OF TAXABLE INCOME; INCLUSION OF
TAXABLE INCOME IN DIVIDENDS. An Auction to determine the Applicable Rate for
the APS offered hereby for each Dividend Period for such shares (other than the
Initial Dividend Period therefor) will be held on the last Business Day
preceding the first day of such Dividend Period, which first day is also the
Dividend Payment Date for the preceding Dividend Period (the date of each
Auction being referred to herein as an "Auction Date"). The initial Auction Date
will be [____], 2001 for Series A APS and [____], 2001 for Series B APS.
Auctions for the APS for Dividend Periods after the Initial Dividend Period
normally will be held every [Tuesday] after the preceding Dividend Payment Date
for Series A APS and every such [Thursday] for Series B APS; and each subsequent
Dividend Period normally will begin on the following [Wednesday] for Series A
17
APS and on the following [Friday] for Series B APS (also a Dividend Payment
Date). The Auction Date and the first day of the related Dividend Period for a
series of APS (both of which must be Business Days) need not be consecutive
calendar days. See "--Dividends" for information concerning the circumstances
under which a Dividend Payment Date may fall on a date other than the days
specified above, which may affect the Auction Date.
Except as noted below, whenever the Fund is aware that it will include any net
capital gain or other income subject to federal income tax in any dividend on
the APS, the Fund will notify the Auction Agent of the amount to be so included
at least five Business Days prior to the Auction Date on which the Applicable
Rate for such dividend is to be established. Whenever the Auction Agent receives
such notice from the Fund, in turn it will notify each Broker-Dealer, who, on or
prior to such Auction Date, in accordance with its Broker-Dealer Agreement, will
notify its customers who are Beneficial Owners and Potential Beneficial Owners
believed to be interested in submitting an Order in the Auction to be held on
such Auction Date. The Fund also may include such income in a dividend on the
APS without giving advance notice thereof if it increases the dividend by an
additional amount calculated as if such income were a Retroactive Taxable
Allocation and the additional amount were a Gross-up Dividend; provided that the
Fund will notify the Auction Agent of the additional amounts to be included in
such dividend at least five Business Days prior to the applicable Dividend
Payment Date. See "--Dividends--Gross-up Dividends."
ORDERS BY BENEFICIAL OWNERS, POTENTIAL BENEFICIAL OWNERS, EXISTING HOLDERS AND
POTENTIAL HOLDERS. On or prior to each Auction Date for a series of APS:
(a) each Beneficial Owner may submit to its Broker-Dealer by telephone a:
(i) Hold Order--indicating the number of outstanding APS, if any, such
Beneficial Owner desires to continue to hold without regard to Applicable
Rate for the next Dividend Period for such shares;
(ii) Bid--indicating the number of outstanding APS, if any, that
Beneficial Owner desires to continue to hold, provided that the Applicable
Rate for the next Dividend Period for such shares is not less than the rate
per annum then specified by such Beneficial Owner; and/or
(iii) Sell Order--indicating the number of outstanding APS, if any, that
such Beneficial Owner offers to sell without regard to the Applicable Rate
for the next Dividend Period for such shares; and
(b) Broker-Dealers will contact customers who are Potential Beneficial
Owners of APS to determine whether such Potential Beneficial Owners desire to
submit Bids indicating the number of APS which they offer to purchase provided
that the Applicable Rate for the next Dividend Period is not less than the rates
per annum specified in such Bids.
The communication by a Beneficial Owner or Potential Beneficial Owner to a
Broker-Dealer and the communication by a Broker-Dealer, whether or not acting
for its own account, to the Auction Agent of the foregoing information is
hereinafter referred to as an "Order" and collectively as "Orders." A Beneficial
Owner or a Potential Beneficial Owner placing an Order, including a Broker-
Dealer acting in such capacity for its own account, is hereinafter referred to
as a "Bidder" and collectively as "Bidders." Any Order submitted by a Beneficial
Owner or a Potential Beneficial Owner to its Broker-Dealer, or by a Broker-
Dealer to the Auction Agent, prior to the Submission Deadline on any Auction
Date shall be irrevocable.
In an Auction, a Beneficial Owner may submit different types of Orders with
respect to APS then held by such Beneficial Owner, as well as Bids for
additional APS. If, however, a Beneficial Owner offers through its Broker-Dealer
to purchase additional APS in such Auction, such Beneficial Owner, for purposes
of such offer to purchase additional shares, will be treated as a Potential
Beneficial Owner as described below. For information concerning the priority
given to different types of Orders placed by Beneficial Owners, see "--
Submission of Orders by Broker-Dealers to Auction Agent" below.
The Maximum Applicable Rate for a series of APS will be the Applicable
Percentage of the Reference Rate. The Auction Agent will round each applicable
Maximum Applicable Rate to the nearest one-thousandth (0.001) of one percent per
annum, with any such number ending in five ten-thousandths of one percent being
rounded upwards to the nearest one-thousandth (0.001) of one percent. The
Auction Agent will not round the applicable Reference Rate as part of its
calculation of the Maximum Applicable Rate.
The Maximum Applicable Rate for a series of APS will depend on the credit rating
or ratings assigned to such shares. The Applicable Percentage will be determined
based on (i) the credit rating assigned on such date to such shares by Moody's
(or if Moody's shall not make such rating available, the equivalent of such
rating by a Substitute Rating Agency), and (ii) whether the Fund has provided
notification to the Auction Agent prior to the Auction establishing the
Applicable Rate for any dividend that net capital gains or other taxable income
will be included in such dividend on the APS as follows:
18
APPLICABLE APPLICABLE
PERCENTAGE OF PERCENTAGE OF
REFERENCE RATE-- REFERENCE RATE--
MOODY'S CREDIT RATINGS ON APS NO NOTIFICATION NOTIFICATION
----------------------------------------- ----------------- -----------------
aa3 or higher............................ 110% 150%
a........................................ 125 160
baa...................................... 150 250
Below baa................................ 200 275
There is no minimum Applicable Rate in respect of any Dividend Period.
The Fund will take all reasonable action necessary to enable Moody's to provide
a rating for each series of APS. If Moody's shall not make such a rating
available, the Underwriters or their affiliates and successors, after
consultation with the Fund, will select another Rating Agency to act as a
Substitute Rating Agency.
Any Bid by a Beneficial Owner specifying a rate per annum higher than the
Maximum Applicable Rate will be treated as a Sell Order, and any Bid by a
Potential Beneficial Owner specifying a rate per annum higher than the Maximum
Applicable Rate will not be considered. See "--Determination of Sufficient
Clearing Bids, Winning Bid Rate and Applicable Rate" and "--Acceptance and
Rejection of Submitted Bids and Submitted Sell Orders and Allocation of Shares."
A Broker-Dealer also may hold APS in its own account as a Beneficial Owner. A
Broker-Dealer thus may submit Orders to the Auction Agent as a Beneficial Owner
or a Potential Beneficial Owner and therefore participate in an Auction as an
Existing Holder or Potential Holder on behalf of both itself and its customers.
Any Order placed with the Auction Agent by a Broker-Dealer as or on behalf of a
Beneficial Owner or a Potential Beneficial Owner will be treated in the same
manner as an Order placed with a Broker-Dealer by a Beneficial Owner or a
Potential Beneficial Owner. Similarly, any failure by a Broker-Dealer to submit
to the Auction Agent an Order in respect of any APS held by it or its customers
who are Beneficial Owners will be treated in the same manner as a Beneficial
Owner's failure to submit to its Broker-Dealer an Order in respect of APS held
by it, as described in the next paragraph. Inasmuch as a Broker-Dealer
participates in an Auction as an Existing Holder or a Potential Holder only to
represent the interests of a Beneficial Owner or Potential Beneficial Owner,
whether it be its customers or itself, all discussion herein relating to the
consequences of an Auction for Existing Holders and Potential Holders also
applies to the underlying beneficial ownership interests represented thereby.
For information concerning the priority given to different types of Orders
placed by Existing Holders, see "--Submission of Orders by Broker-Dealers to
Auction Agent." Each purchase or sale in an Auction will be settled on the
Business Day next succeeding the Auction Date at a price per share equal to
$25,000. See "--Notification of Results; Settlement."
If one or more Orders covering in the aggregate all of the outstanding APS held
by a Beneficial Owner are not submitted to the Auction Agent prior to the
Submission Deadline, either because a Broker-Dealer failed to contact such
Beneficial Owner or otherwise, the Auction Agent shall deem a Hold Order (in the
case of an Auction relating to a Dividend Period of 91 days or less) or a Sell
Order (in the case of an Auction relating to a Special Dividend Period of longer
than 91 days) to have been submitted on behalf of such Beneficial Owner covering
the number of outstanding APS held by such Beneficial Owner and not subject to
Orders submitted to the Auction Agent.
If all of the outstanding APS are subject to Submitted Hold Orders, the Dividend
Period next succeeding the Auction automatically shall be the same length as the
immediately preceding Dividend Period, and the Applicable Rate for the next
Dividend Period for all the APS will be 40% of the Reference Rate on the date of
the applicable Auction (or 60% of such rate if the Fund has provided
notification to the Auction Agent prior to the Auction establishing the
Applicable Rate for any dividend that net capital gains or other taxable income
will be included in such dividend on the APS).
For the purposes of an Auction, the APS for which the Fund shall have given
notice of redemption and deposited moneys therefor with the Auction Agent in
trust or segregated in an account at the Fund's custodian bank for the benefit
of the Auction Agent, as set forth under "--Redemption," will not be considered
as outstanding and will not be included in such Auction. Pursuant to the Amended
By-Laws of the Fund, the Fund will be prohibited from reissuing and its
affiliates (other than an Underwriter) will be prohibited from transferring
(other than to the Fund or pursuant to an Auction) any APS they may acquire.
Neither the Fund nor any affiliate of the Fund (other than an Underwriters) may
submit an Order in any Auction, except that an affiliate of the Fund that is a
Broker-Dealer may submit an Order. The restrictions in this paragraph shall in
no way limit the activities of any Auction Agent that is affiliated with the
Fund.
Neither the Fund nor the Auction Agent will be responsible for a Broker-Dealer's
failure to act in accordance with the instructions of Beneficial Owners or
Potential Beneficial Owners or failure to comply with the foregoing.
SUBMISSION OF ORDERS BY BROKER-DEALERS TO AUCTION AGENT. Prior to 1:00 p.m.,
New York City time, on each Auction Date, or such other time on the Auction Date
as may be specified by the Auction Agent (the "Submission Deadline"), each
Broker-Dealer will submit to the Auction Agent in writing all Orders obtained by
it for the Auction for a series of APS to be conducted on such Auction Date,
designating itself (unless otherwise permitted by the Fund) as the Existing
Holder or Potential Holder in respect of the APS subject to such Orders. Any
Order submitted by a Beneficial Owner or a Potential Beneficial Owner to its
Broker-Dealer, or by a Broker-Dealer to the Auction Agent, prior to the
Submission Deadline for any Auction Date, shall be irrevocable.
19
If the rate per annum specified in any Bid contains more than three figures to
the right of the decimal point, the Auction Agent will round such rate per annum
up to the next highest one-thousandth (.001) of 1%. If one or more Orders of an
Existing Holder are submitted to the Auction Agent and such Orders cover in the
aggregate more than the number of outstanding shares of APS held by such
Existing Holder, such Orders will be considered valid in the following order of
priority:
(i) any Hold Order will be considered valid up to and including the number
of outstanding APS held by such Existing Holder, provided that if more than one
Hold Order is submitted by such Existing Holder and the number of APS subject to
such Hold Orders exceeds the number of outstanding APS held by such Existing
Holder, the number of APS subject to each of such Hold Orders will be reduced
pro rata so that such Hold Orders, in the aggregate, will cover exactly the
number of outstanding APS held by such Existing Holder;
(ii) any Bids will be considered valid, in the ascending order of their
respective rates per annum if more than one Bid is submitted by such Existing
Holder, up to and including the excess of the number of outstanding APS held by
such Existing Holder over the number of outstanding APS subject to any Hold
Order referred to in clause (i) above (and if more than one Bid submitted by
such Existing Holder specifies the same rate per annum and together they cover
more than the remaining number of shares that can be the subject of valid Bids
after application of clause (i) above and of the foregoing portion of this
clause (ii) to any Bid or Bids specifying a lower rate or rates per annum, the
number of shares subject to each of such Bids will be reduced pro rata so that
such Bids, in the aggregate, cover exactly such remaining number of outstanding
shares); and the number of outstanding shares, if any, subject to Bids not valid
under this clause (ii) shall be treated as the subject of a Bid by a Potential
Holder; and
(iii) any Sell Order will be considered valid up to and including the excess
of the number of outstanding APS held by such Existing Holder over the sum of
the number of APS subject to Hold Orders referred to in clause (i) above and the
number of APS subject to valid Bids by such Existing Holder referred to in
clause (ii) above; provided that, if more than one Sell Order is submitted by
any Existing Holder and the number of APS subject to such Sell Orders is greater
than such excess, the number of APS subject to each of such Sell Orders will be
reduced pro rata so that such Sell Orders, in the aggregate, will cover exactly
the number of APS equal to such excess.
If more than one Bid of any Potential Holder is submitted in any Auction, each
Bid submitted in such Auction will be considered a separate Bid with the rate
per annum and number of APS therein specified.
DETERMINATION OF SUFFICIENT CLEARING BIDS, WINNING BID RATE AND APPLICABLE RATE.
Not earlier than the Submission Deadline for each Auction, the Auction Agent
will assemble all Orders submitted or deemed submitted to it by the Broker-
Dealers (each such "Hold Order," "Bid" or "Sell Order" as submitted or deemed
submitted by a Broker-Dealer hereinafter being referred to as a "Submitted Hold
Order," a "Submitted Bid" or a "Submitted Sell Order," as the case may be, or as
a "Submitted Order") and will determine the excess of the number of outstanding
APS over the number of outstanding APS subject to Submitted Hold Orders (such
excess being referred to as the "Available APS") and whether Sufficient Clearing
Bids have been made in such Auction. Sufficient Clearing Bids will have been
made if the number of outstanding APS that are the subject of Submitted Bids of
Potential Holders with rates per annum not higher than the Maximum Applicable
Rate equals or exceeds the number of outstanding shares that are the subject of
Submitted Sell Orders (including the number of shares subject to Bids of
Existing Holders specifying rates per annum higher than the Maximum Applicable
Rate). If Sufficient Clearing Bids have been made, the Auction Agent will
determine the lowest rate per annum specified in the Submitted Bids (the
"Winning Bid Rate") which would result in the number of shares subject to
Submitted Bids specifying such rate per annum or a lower rate per annum being at
least equal to the Available APS. If Sufficient Clearing Bids have been made,
the Winning Bid Rate will be the Applicable Rate for the next Dividend Period
for the APS then outstanding. If Sufficient Clearing Bids have not been made
(other than because all outstanding APS are the subject of Submitted Hold
Orders), the Dividend Period next following the Auction automatically will be a
7-Day Dividend Period, and the Applicable Rate for such Dividend Period will be
equal to the Maximum Applicable Rate.
If Sufficient Clearing Bids have not been made, Beneficial Owners that have
Submitted Sell Orders will not be able to sell in the Auction all, and may not
be able to sell any, of their APS subject to such Submitted Sell Orders. See "--
Acceptance and Rejection of Submitted Bids and Submitted Sell Orders and
Allocation of Shares." Thus, under some circumstances, Beneficial Owners may not
have liquidity of investment.
ACCEPTANCE AND REJECTION OF SUBMITTED BIDS AND SUBMITTED SELL ORDERS AND
ALLOCATION OF SHARES. Based on the determinations described under "--
Determination of Sufficient Clearing Bids, Winning Bid Rate and Applicable Rate"
and subject to the discretion of the Auction Agent to round as described below,
Submitted Bids and Submitted Sell Orders will be accepted or rejected in the
order of priority set forth in the Auction Procedures with the result that
Existing Holders and Potential Holders of a series of APS will sell, continue to
hold and/or purchase APS as set forth below. Existing Holders that submit or are
deemed to have submitted Hold Orders will continue to hold the APS subject to
such Hold Orders.
If Sufficient Clearing Bids have been made:
(a) each Existing Holder that placed a Submitted Bid specifying a rate
per annum higher than the Winning Bid Rate or a Submitted Sell Order will
sell the outstanding APS subject to such Submitted Bid or Submitted Sell
Order;
20
(b) each Existing Holder that placed a Submitted Bid specifying a rate
per annum lower than the Winning Bid Rate will continue to hold the
outstanding APS subject to such Submitted Bid;
(c) each Potential Holder that placed a Submitted Bid specifying a rate
per annum lower than the Winning Bid Rate will purchase the number of APS
subject to such Submitted Bid;
(d) each Existing Holder that placed a Submitted Bid specifying a rate
per annum equal to the Winning Bid Rate will continue to hold the outstanding
shares of APS subject to such Submitted Bids, unless the number of
outstanding APS subject to all such Submitted Bids of Existing Holders is
greater than the excess of the Available APS over the number of APS accounted
for in clauses (b) and (c) above, in which event each Existing Holder with
such a Submitted Bid will sell a number of outstanding APS determined on a
pro rata basis based on the number of outstanding APS subject to all such
Submitted Bids of such Existing Holders; and
(e) each Potential Holder that placed a Submitted Bid specifying a rate
per annum equal to the Winning Bid Rate will purchase any Available APS not
accounted for in clause (b), (c) or (d) above on a pro rata basis based on
the APS subject to all such Submitted Bids of Potential Holders.
If Sufficient Clearing Bids have not been made (other than because all
outstanding APS are the subject of Submitted Hold Orders):
(a) each Existing Holder that placed a Submitted Bid specifying a rate
per annum equal to or lower than the Maximum Applicable Rate will continue to
hold the outstanding APS subject to such Submitted Bid;
(b) each Potential Holder that placed a Submitted Bid specifying a rate
per annum equal to or lower than the Maximum Applicable Rate will purchase
the number of APS subject to such Submitted Bid; and
(c) each Existing Holder that placed a Submitted Bid specifying a rate per
annum higher than the Maximum Applicable Rate or a Submitted Sell Order
will sell a number of outstanding APS determined on a pro rata basis based
on the outstanding APS subject to all such Submitted Bids and Submitted
Sell Orders.
If as a result of the Auction Procedures described above any Existing Holder
would be entitled or required to sell, or any Potential Holder would be entitled
or required to purchase, a fraction of APS, the Auction Agent, in such manner
as, in its sole discretion, it shall determine, will round up or down the number
of APS being sold or purchased on such Auction Date so that each share sold or
purchased by each Existing Holder or Potential Holder will be a whole APS. If
any Potential Holder would be entitled or required to purchase less than a whole
APS, the Auction Agent, in such manner as, in its sole discretion, it shall
determine, will allocate APS for purchase among Potential Holders so that only
whole APS are purchased by any such Potential Holder, even if such allocation
results in one or more of such Potential Holders not purchasing any APS.
NOTIFICATION OF RESULTS; SETTLEMENT. The Auction Agent will advise each Broker-
Dealer who submitted a Bid or Sell Order in an Auction whether such Bid or Sell
Order was accepted or rejected in whole or in part and of the Applicable Rate
for the next Dividend Period for the related APS by telephone at approximately
3:00 p.m., New York City time, on the Auction Date for such Auction. Each such
Broker-Dealer that submitted an Order for the account of a customer then will
advise such customer whether such Bid or Sell Order was accepted or rejected,
will confirm purchases and sales with each customer purchasing or selling APS as
a result of the Auction and will advise each customer purchasing or selling APS
to give instructions to its Agent Member of the Securities Depository to pay the
purchase price against delivery of such shares or to deliver such shares against
payment therefor as appropriate. If a customer selling APS as a result of an
Auction shall fail to instruct its Agent Member to deliver such shares, the
Broker-Dealer that submitted such customer's Bid or Sell Order will instruct
such Agent Member to deliver such shares against payment therefor. Each Broker-
Dealer that submitted a Hold Order in an Auction on behalf of a customer also
will advise such customer of the Applicable Rate for the next Dividend Period
for the APS. The Auction Agent will record each transfer of APS on the record
book of Existing Holders to be maintained by the Auction Agent.
In accordance with the Securities Depository's normal procedures, on the day
after each Auction Date, the transactions described above will be executed
through the Securities Depository, and the accounts of the respective Agent
Members at the Securities Depository will be debited and credited as necessary
to effect the purchases and sales of APS as determined in such Auction.
Purchasers will make payment through their Agent Members in same-day funds to
the Securities Depository against delivery through their Agent Members; the
Securities Depository will make payment in accordance with its normal
procedures, which now provide for payment in same-day funds. If the procedures
of the Securities Depository applicable to APS shall be changed to provide for
payment in next-day funds, then purchasers may be required to make payment in
next-day funds. If the certificates for the APS are not held by the Securities
Depository or its nominee, payment will be made in same-day funds to the Auction
Agent against delivery of such certificates.
If any Existing Holder selling APS in an Auction fails to deliver such shares,
the Broker-Dealer of any person that was to have purchased APS in such Auction
may deliver to such person a number of whole APS that is less than the number of
shares that otherwise was to be purchased by such person. In such event, the
number of APS to be so delivered will be determined by such Broker-Dealer.
21
Delivery of such lesser number of shares will constitute good delivery. Each
Broker-Dealer Agreement also will provide that neither the Fund nor the Auction
Agent will have responsibility or liability with respect to the failure of a
Potential Beneficial Owner, Potential Beneficial Owner or their respective Agent
Members to deliver APS or to pay for APS purchased or sold pursuant to an
Auction or otherwise.
BROKER-DEALERS
The Auction Agent after each Auction will pay a service charge from funds
provided by the Fund to each Broker-Dealer on the basis of the purchase price of
APS placed by such Broker-Dealer at such Auction. The service charge (i) for any
7-Day Dividend Period shall be payable at the annual rate of 0.25% of the
purchase price of the APS placed by such Broker-Dealer in any such Auction and
(ii) for any Special Dividend Period shall be determined by mutual consent of
the Fund and any such Broker-Dealer or Broker-Dealers and shall be based upon a
selling concession that would be applicable to an underwriting of fixed or
variable rate preferred shares with a similar final maturity or variable rate
dividend period, respectively, at the commencement of the Dividend Period with
respect to such Auction. For the purposes of the preceding sentence, the APS
will be placed by a Broker-Dealer if such shares were (i) the subject of Hold
Orders deemed to have been made by Beneficial Owners that were acquired by such
Beneficial Owners through such Broker-Dealer or (ii) the subject of the
following Orders submitted by such Broker-Dealer: (A) a Submitted Bid of a
Beneficial Owner that resulted in such Beneficial Owner continuing to hold such
shares as a result of the Auction, (B) a Submitted Bid of a Potential Beneficial
Owner that resulted in such Potential Beneficial Owner purchasing such shares as
a result of the Auction or (C) a Submitted Hold Order.
The Broker-Dealer Agreements provide that a Broker-Dealer may submit Orders in
Auctions for its own account, unless the Fund notifies all Broker-Dealers that
they no longer may do so; provided that Broker-Dealers may continue to submit
Hold Orders and Sell Orders. If a Broker-Dealer submits an Order for its own
account in any Auction of APS, it may have knowledge of Orders placed through it
in that Auction and therefore have an advantage over other Bidders, but such
Broker-Dealer would not have knowledge of Orders submitted by other Broker-
Dealers in that Auction.
The Broker-Dealers may maintain a secondary trading market in the APS outside of
Auctions; however, they have no obligation to do so and there can be no
assurance that a secondary market for the APS will develop or, if it does
develop, that it will provide holders with a liquid trading market (i.e.,
trading will depend on the presence of willing buyers and sellers and the
trading price is subject to variables to be determined at the time of the trade
by the Broker-Dealers). The APS will not be registered on any stock exchange or
on any automated quotation system. An increase in the level of interest rates,
particularly during any Long Term Dividend Period for a series of APS, likely
will have an adverse effect on the secondary market price of such APS, and a
selling shareholder may sell APS between Auctions at a price per share of less
than $25,000.
DIVIDENDS
GENERAL. The holders of APS of each series will be entitled to receive, when,
as and if declared by the Board of Trustees, out of funds legally available
therefor, cumulative cash dividends on their shares, at the Applicable Rate
determined as set forth below under "--Determination of Dividend Rate," payable
on the dates set forth below. Dividends on the APS so declared and payable shall
be paid (i) in preference to and in priority over any dividends so declared and
payable on the Common Shares, and (ii) to the extent permitted under the Code
and to the extent available, out of net tax-exempt income earned on the Fund's
investments. Dividends on the APS, to the extent that they are derived from
Municipal Obligations, generally will be exempt from federal income tax,
although all of those dividends will be a tax preference item for corporate
taxpayers and a portion of those dividends may be a tax preference item for
purposes of the federal alternative minimum tax for individuals ("Preference
Item"). See "Taxes."
Dividends on each series of APS will accumulate from the date on which the Fund
originally issues the APS (the "Date of Original Issue") and will be payable on
the APS on the dates described below. Dividends on a series of APS with respect
to the Initial Dividend Period shall be payable on the Initial Dividend Payment
Date for that series. Following the Initial Dividend Payment Date, dividends on
each series of APS will be payable, at the option of the Fund, either (i) with
respect to any 7-Day Dividend Period and any Short Term Dividend Period of 35 or
fewer days, on the day next succeeding the last day thereof or (ii) with respect
to any Short Term Dividend Period of more than 35 days and with respect to any
Long Term Dividend Period, monthly on the first Business Day of each calendar
month during such Short Term Dividend Period or Long Term Dividend Period and on
the day next succeeding the last day thereof (each such date referred to in
clause (i) or (ii) being referred to herein as a "Normal Dividend Payment
Date"), except that if such Normal Dividend Payment Date is not a Business Day,
the Dividend Payment Date shall be the first Business Day next succeeding such
Normal Dividend Payment Date. Although any particular Dividend Payment Date may
not occur on the originally scheduled date because of the exceptions discussed
above, the next succeeding Dividend Payment Date, subject to such exceptions,
will nonetheless occur on the next following originally scheduled date. If for
any reason a Dividend Payment Date cannot be fixed as described above, then the
Board of Trustees shall fix the Dividend Payment Date. The Board of Trustees by
resolution prior to authorization of a dividend by the Board of Trustees may
change a Dividend Payment Date if such change does not adversely affect the
contract rights of the holders of APS set forth in the Declaration of Trust or
Amended By-Laws. The Initial Dividend Period, 7-Day Dividend Periods and Special
22
Dividend Periods are hereinafter sometimes referred to as "Dividend Periods."
Each dividend payment date determined as provided above is hereinafter referred
to as a "Dividend Payment Date."
Prior to each Dividend Payment Date, the Fund is required to deposit with the
Auction Agent sufficient funds for the payment of declared dividends. The Fund
does not intend to establish any reserves for the payment of dividends.
Each dividend will be paid to the record holder of the APS, which holder is
expected to be the nominee of the Securities Depository. See "--The Auction--
Securities Depository." The Securities Depository will credit the accounts of
the Agent Members of the Existing Holders in accordance with the Securities
Depository's normal procedures which provide for payment in same-day funds. The
Agent Member of an Existing Holder will be responsible for holding or disbursing
such payments on the applicable Dividend Payment Date to such Existing Holder in
accordance with the instructions of such Existing Holder. Dividends in arrears
for any past Dividend Period may be declared and paid at any time, without
reference to any regular Dividend Payment Date, to the nominee of the Securities
Depository. Any dividend payment made on the APS first shall be credited against
the earliest declared but unpaid dividends accumulated with respect to such
shares.
Holders of the APS will not be entitled to any dividends, whether payable in
cash, property or stock, in excess of full cumulative dividends except as
described under "--Gross-up Dividends" and "--Non-Payment Period; Late Charge"
below. No interest will be payable in respect of any dividend payment or
payments on the APS which may be in arrears.
The amount of cash dividends per share of APS of each series payable (if
declared) on the Initial Dividend Payment Date, each 7-Day Dividend Period and
each Dividend Payment Date of each Short Term Dividend Period shall be computed
by multiplying the Applicable Rate for such Dividend Period by a fraction, the
numerator of which will be the number of days in such Dividend Period or part
thereof that such share was outstanding and for which dividends are payable on
such Dividend Payment Date and the denominator of which will be 365, multiplying
the amount so obtained by $25,000, and rounding the amount so obtained to the
nearest cent. During any Long Term Dividend Period, the amount of cash dividends
per share of APS payable (if declared) on any Dividend Payment Date shall be
computed by multiplying the Applicable Rate for such Dividend Period by a
fraction, the numerator of which will be such number of days in such part of
such Dividend Period that such share was outstanding and for which dividends are
payable on such Dividend Payment Date and the denominator of which will be 360,
multiplying the amount so obtained by $25,000, and rounding the amount so
obtained to the nearest cent.
NOTIFICATION OF DIVIDEND PERIOD. With respect to each Dividend Period that is a
Special Dividend Period, the Fund, at its sole option and to the extent
permitted by law, by telephonic and written notice (a "Request for Special
Dividend Period") to the Auction Agent and to each Broker-Dealer, may request
that the next succeeding Dividend Period for a series of APS will be a number of
days (other than seven), evenly divisible by seven, and not fewer than seven nor
more than 364 in the case of a Short Term Dividend Period or one whole year or
more but not greater than five years in the case of a Long Term Dividend Period,
specified in such notice, provided that the Fund may not give a Request for
Special Dividend Period (and any such request shall be null and void) unless,
for any Auction occurring after the initial Auction, Sufficient Clearing Bids
were made in the last occurring Auction and unless full cumulative dividends,
any amounts due with respect to redemptions, and any Gross-up Dividends payable
prior to such date have been paid in full. Such Request for Special Dividend
Period, in the case of a Short Term Dividend Period, shall be given on or prior
to the second Business Day but not more than seven Business Days prior to an
Auction Date for the APS of that series and, in the case of a Long Term Dividend
Period, shall be given on or prior to the second Business Day but not more than
28 days prior to an Auction Date for the APS of that series. Upon receiving such
Request for Special Dividend Period, the Broker-Dealers jointly shall determine
whether, given the factors set forth below, it is advisable that the Fund issue
a Notice of Special Dividend Period as contemplated by such Request for Special
Dividend Period and the Optional Redemption Price of the APS of that series
during such Special Dividend Period and the Specific Redemption Provisions and
shall give the Fund and the Auction Agent written notice (a "Response") of such
determination by no later than the second Business Day prior to such Auction
Date. In making such determination, the Broker-Dealers will consider (i)
existing short-term and long-term market rates and indices of such short-term
and long-term rates, (ii) existing market supply and demand for short-term and
long-term securities, (iii) existing yield curves for short-term and long-term
securities comparable to the APS, (iv) industry and financial conditions which
may affect the APS of that series, (v) the investment objective of the Fund and
(vi) the Dividend Periods and dividend rates at which current and potential
beneficial holders of the APS would remain or become beneficial holders.
If the Broker-Dealers shall not give the Fund and the Auction Agent a Response
by such second Business Day or if the Response states that given the factors set
forth above it is not advisable that the Fund give a Notice of Special Dividend
Period for the APS of that series, the Fund may not give a Notice of Special
Dividend Period in respect of such Request for Special Dividend Period. In the
event the Response indicates that it is advisable that the Fund give a Notice of
Special Dividend Period for the APS of that series, the Fund, by no later than
the second Business Day prior to such Auction Date, may give a notice (a "Notice
of Special Dividend Period") to the Auction Agent, the Securities Depository and
each Broker-Dealer, which notice will specify (i) the duration of the Special
Dividend Period, (ii) the Optional Redemption Price, if any, as specified in the
related Response and (iii) the Specific Redemption Provisions, if any, as
specified in the related Response. The Fund also shall provide a copy of such
Notice of Special Dividend Period to Moody's. The Fund shall not give a Notice
of Special Dividend Period, and, if such Notice of Special Dividend Period shall
have been given already, shall give telephonic and written notice of its
23
revocation (a "Notice of Revocation") to the Auction Agent, each Broker-Dealer,
and the Securities Depository on or prior to the Business Day prior to the
relevant Auction Date if (x) either the 1940 Act APS Asset Coverage is not
satisfied or the Fund shall fail to maintain Moody's Eligible Assets with an
aggregate Discounted Value at least equal to the APS Basic Maintenance Amount,
on each of the two Valuation Dates immediately preceding the Business Day prior
to the relevant Auction Date on an actual basis and on a pro forma basis giving
effect to the proposed Special Dividend Period (using as a pro forma dividend
rate with respect to such Special Dividend Period the dividend rate which the
Broker-Dealers shall advise the Fund is an approximately equal rate for
securities similar to the APS with an equal dividend period), (y) sufficient
funds for the payment of dividends payable on the immediately succeeding
Dividend Payment Date have not been irrevocably deposited with the Auction Agent
by the close of business on the third Business Day preceding the related Auction
Date or (z) the Broker-Dealers jointly advise the Fund that, after consideration
of the factors listed above, they have concluded that it is advisable to give a
Notice of Revocation. The Fund also shall provide a copy of such Notice of
Revocation to Moody's. If the Fund is prohibited from giving a Notice of Special
Dividend Period as a result of the factors enumerated in clause (x), (y) or (z)
above or if the Fund gives a Notice of Revocation with respect to a Notice of
Special Dividend Period, the next succeeding Dividend Period for that series
will be a 7-Day Dividend Period. In addition, in the event Sufficient Clearing
Bids are not made in any Auction or an Auction is not held for any reason, the
next succeeding Dividend Period will be a 7-Day Dividend Period, and the Fund
may not again give a Notice of Special Dividend Period (and any such attempted
notice shall be null and void) until Sufficient Clearing Bids have been made in
an Auction with respect to a 7-Day Dividend Period.
DETERMINATION OF DIVIDEND RATE. The dividend rate on a series of APS during the
period from and including the Date of Original Issue for the APS to but
excluding the Initial Dividend Payment Date for that series of APS (the "Initial
Dividend Period") will be the rate per annum set forth on the inside cover page
hereof. Commencing on the Initial Dividend Payment Date for a series of APS, the
Applicable Rate on that series of APS for each Subsequent Dividend Period, which
Subsequent Dividend Period shall be a period commencing on and including a
Dividend Payment Date and ending on and including the calendar day prior to the
next Dividend Payment Date (or last Dividend Payment Date in a Dividend Period
if there is more than one Dividend Payment Date), shall be equal to the rate per
annum that results from the Auction with respect to such Subsequent Dividend
Period. Cash dividends shall be calculated as set forth above under "Dividends-
-General."
NON-PAYMENT PERIOD; LATE CHARGE. A "Non-Payment Period" for a series of APS
will commence if the Fund fails to (i) declare, prior to the close of business
on the second Business Day preceding any Dividend Payment Date, for payment on
or (to the extent permitted as described below) within three Business Days after
such Dividend Payment Date to the persons who held such shares as of 12:00 noon,
New York City time, on the Business Day preceding such Dividend Payment Date,
the full amount of any dividend on the APS payable on such Dividend Payment Date
or (ii) deposit, irrevocably in trust, in same-day funds, with the Auction Agent
by 12:00 noon, New York City time, (A) on such Dividend Payment Date the full
amount of any cash dividend on such shares (if declared) payable on such
Dividend Payment Date or (B) on any redemption date for the APS called for
redemption, the Mandatory Redemption Price per share of such APS or, in the case
of an optional redemption, the Optional Redemption Price per share. Such Non-
Payment Period will consist of the period commencing on and including the
aforementioned Dividend Payment Date or redemption date, as the case may be, and
ending on and including the Business Day on which, by 12:00 noon, New York City
time, all unpaid cash dividends and unpaid redemption prices shall have been so
deposited or otherwise shall have been made available to the applicable holders
in same-day funds, provided that a Non-Payment Period for the APS will not end
unless the Fund shall have given at least five days' but no more than 30 days'
written notice of such deposit or availability to the Auction Agent, the
Securities Depository and all holders of the APS of such series. Notwithstanding
the foregoing, the failure by the Fund to deposit funds as provided for by
clauses (ii) (A) or (ii) (B) above within three Business Days after any Dividend
Payment Date or redemption date, as the case may be, in each case to the extent
contemplated below, shall not constitute a "Non-Payment Period." The Applicable
Rate for each Dividend Period for the APS of any series, commencing during a
Non-Payment Period, will be equal to the Non-Payment Period Rate; and each
Dividend Period commencing after the first day of, and during, a Non-Payment
Period shall be a 7-Day Dividend Period. Any dividend on the APS due on any
Dividend Payment Date for such shares (if, prior to the close of business on the
second Business Day preceding such Dividend Payment Date, the Fund has declared
such dividend payable on such Dividend Payment Date to the persons who held such
shares as of 12:00 noon, New York City time, on the Business Day preceding such
Dividend Payment Date) or redemption price with respect to such shares not paid
to such persons when due may be paid to such persons in the same form of funds
by 12:00 noon, New York City time, on any of the first three Business Days after
such Dividend Payment Date or due date, as the case may be, provided that such
amount is accompanied by a late charge calculated for such period of non-payment
at the Non-Payment Period Rate applied to the amount of such non-payment based
on the actual number of days comprising such period divided by 365, and in such
case such period shall not constitute a Non-Payment Period. In the case of a
willful failure of the Fund to pay a dividend on a Dividend Payment Date or to
redeem any APS on the date set for such redemption, the preceding sentence shall
not apply and the Applicable Rate for the Dividend Period commencing during the
Non-Payment Period resulting from such failure shall be the Non-Payment Period
Rate. For the purposes of the foregoing, payment to a person in same-day funds
on any Business Day at any time will be considered equivalent to payment to that
person in New York Clearing House (next-day) funds at the same time on the
preceding Business Day, and any payment made after 12:00 noon, New York City
time, on any Business Day shall be considered to have been made instead in the
same form of funds and to the same person before 12:00 noon, New York City time,
on the next Business Day. The Non-Payment Period Rate initially will be 200% of
the applicable Reference Rate (or 275% of such rate if the Fund has provided
notification to the Auction Agent prior to the Auction establishing the
Applicable Rate for any dividend that net capital gains or other taxable income
will be included in such dividend on the APS), provided that the Board of
Trustees of the Fund shall have the authority to adjust, modify, alter or change
24
from time to time the initial Non-Payment Period Rate if the Board of Trustees
of the Fund determines and Moody's (or any Substitute Rating Agency in lieu of
Moody's in the event Moody's shall not rate the APS) advises the Fund in writing
that such adjustment, modification, alteration or change will not adversely
affect its then-current rating on the APS.
RESTRICTIONS ON DIVIDENDS AND OTHER PAYMENTS. Under the 1940 Act, the Fund may
not declare dividends or make other distributions on Common Shares or purchase
any such shares if, at the time of the declaration, distribution or purchase, as
applicable (and after giving effect thereto), asset coverage (as defined in the
1940 Act) with respect to the outstanding APS would be less than 200% (or such
other percentage as in the future may be required by law). The Fund estimates
that, based on the composition of its portfolio at [__], 2001, asset coverage
with respect to the APS would be approximately [__]% immediately after the
issuance of the APS offered hereby. The foregoing limitations on dividends,
other distributions and purchases in certain circumstances may impair the Fund's
ability to maintain its qualification as a regulated investment company under
the Code. See "Taxes." Upon any failure to pay dividends on the APS for two
years or more, the holders of the APS will acquire certain additional voting
rights. See "--Voting Rights" below.
For so long as any APS are outstanding, the Fund will not declare, pay or set
apart for payment any dividend or other distribution (other than a dividend or
distribution paid in shares of, or options, warrants or rights to subscribe for
or purchase, Common Shares or other shares, if any, ranking junior to the APS as
to dividends or upon liquidation) in respect of Common Shares or any other
shares of the Fund ranking junior to or on a parity with the APS as to dividends
or upon liquidation, or call for redemption, redeem, purchase or otherwise
acquire for consideration any Common Shares or shares of any other such junior
stock (except by conversion into or exchange for stock of the Fund ranking
junior to APS as to dividends and upon liquidation) or any such parity stock
(except by conversion into or exchange for stock of the Fund ranking junior to
or on a parity with APS as to dividends and upon liquidation), unless (A)
immediately after such transaction, the Fund would have Moody's Eligible Assets
with an aggregate Discounted Value equal to or greater than the APS Basic
Maintenance Amount, and the 1940 Act APS Asset Coverage (see "--Asset
Maintenance" and "--Redemption" below) would be satisfied, (B) full cumulative
dividends on the APS due on or prior to the date of the transaction have been
declared and paid or shall have been declared and sufficient funds for the
payment thereof deposited with the Auction Agent, (C) any Gross-up Dividend
required to be paid on or before the date of such declaration or payment has
been paid and (D) the Fund has redeemed the full number of APS required to be
redeemed by any provision for mandatory redemption contained in the Amended By-
Laws.
INCLUSION OF TAXABLE INCOME IN DIVIDENDS. Where the Fund is aware that it will
include any net capital gains or other taxable income in any dividend on APS,
the Fund will notify the Auction Agent of the amount to be so included prior to
the Auction Date on which the Applicable Rate for the dividend is to be
established. The Fund may also include such income in a dividend on shares of
APS without giving notice in advance of the Auction Date if it increases the
dividend by an additional amount calculated as if such income were a Retroactive
Taxable Allocation and the additional amount were a Gross-up Dividend and
notifies the Auction Agent of such inclusion at least five days prior to the
applicable Dividend Payment Date.
GROSS-UP DIVIDENDS. The Fund may retroactively allocate net capital gains or
other taxable income to the APS without giving advance notice thereof to the
Auction Agent as described above under "--The Auction--Auction Date; Advance
Notice of Allocation of Taxable Income; Inclusion of Taxable Income in
Dividends." If the Fund does so solely by reason of the fact that such
allocation is made as a result of the redemption of all or a portion of the
outstanding shares of APS or the liquidation of the Fund (a "Retroactive Taxable
Allocation"), the Fund, within 90 days (and generally within 60 days) after the
end of the Fund's fiscal year for which a Retroactive Taxable Allocation is
made, will provide notice thereof to the Auction Agent and to each holder of APS
(initially Cede & Co. as nominee of the Securities Depository) during such
fiscal year at such holder's address as the same appears or last appeared on the
stock books of the Fund. Within 30 days after such notice is given to the
Auction Agent, the Fund will pay to the Auction Agent (who then will distribute
to such holders of the APS), out of funds legally available therefor, an amount
equal to the aggregate Gross-up Dividend (as defined below) with respect to all
Retroactive Taxable Allocations made to such holders during the fiscal year in
question. The Fund will not otherwise compensate the holders of the APS for any
tax liability caused by the retroactive allocation of net capital gains or other
taxable income to the APS. See "Taxes."
A "Gross-up Dividend" means a payment to a present or former holder of the APS
of an amount which, when giving effect to the Retroactive Taxable Allocation
made to such holder with respect to the fiscal year in question, would cause
such holder's after-tax return (taking into account both the Retroactive Taxable
Allocation and the Gross-up Dividend) to be equal to the after-tax return the
holder would have received if there had been no Retroactive Taxable Allocation.
A Gross-up Dividend shall be calculated (i) without consideration being given to
the time value of money; (ii) assuming that none of the dividends received from
the Fund is a Preference Item; and (iii) assuming that each Retroactive Taxable
Allocation would be taxable to each holder of APS at the maximum marginal
federal income tax rate (including any surtax) applicable to the taxable
character of the distribution (i.e., ordinary income or net capital gain) in the
hands of an individual or a corporation, whichever is greater (disregarding the
effect of any state and local taxes and the phase out of, or provision limiting,
personal exemptions, itemized deductions, or the benefit of lower tax brackets).
The Fund generally intends to designate any Gross-up Dividend as an "exempt-
interest" dividend to the extent permitted by applicable law. However, a
portion or all of any Gross-up Dividend will be taxable to the recipient
25
thereof. See "Taxes--Tax Treatment of Gross-up Dividends." The Fund will not
pay a further Gross-up Dividend with respect to any taxable portion of a Gross-
up Dividend.
ASSET MAINTENANCE
The Fund will be required to satisfy two separate asset maintenance requirements
under the terms of the Amended By-Laws. These requirements are summarized below.
1940 ACT APS ASSET COVERAGE. The Fund will be required under the Amended By-
Laws to maintain, with respect to the APS, as of the last Business Day of each
month in which any APS are outstanding, asset coverage of at least 200% with
respect to senior securities which are beneficial interests in the Fund,
including the APS (or such other asset coverage as in the future may be
specified in or under the 1940 Act as the minimum asset coverage for senior
securities which are beneficial interests of a closed-end investment company as
a condition of paying dividends on its common stock) ("1940 Act APS Asset
Coverage"). If the Fund fails to maintain 1940 Act APS Asset Coverage and such
failure is not cured as of the last Business Day of the following month (the
"1940 Act Cure Date"), the Fund will be required under certain circumstances to
redeem certain of the APS. See "--Redemption" below.
The 1940 Act APS Asset Coverage immediately following the issuance of APS
offered hereby (after giving effect to the deduction of the sales load and
offering expenses for the APS) computed using the Fund's net assets as of [___],
2001 and assuming the APS had been issued as of such date will be as follows:
Value of Fund assets less liabilities not
constituting senior securities $[__________]
------------------------------------------------- ------------- = [____]
Senior securities representing indebtedness plus $[__________]
liquidation value of the shares of APS
APS BASIC MAINTENANCE AMOUNT. So long as the APS are outstanding, the Fund will
be required under the Amended By-Laws to maintain as of each Business Day (a
"Valuation Date") Moody's Eligible Assets having in the aggregate a Discounted
Value at least equal to the APS Basic Maintenance Amount. If the Fund fails to
meet such requirement as of any Valuation Date and such failure is not cured on
or before the sixth Business Day after such Valuation Date (the "APS Basic
Maintenance Cure Date"), the Fund will be required in certain circumstances to
redeem certain of the APS. Upon any failure to maintain the required Discounted
Value, the Fund will use its best efforts to alter the composition of its
portfolio to retain a Discounted Value at least equal to the APS Basic
Maintenance Amount on or prior to the APS Basic Maintenance Cure Date. See "--
Redemption."
The APS Basic Maintenance Amount as of any Valuation Date is defined as the
dollar amount equal to (i) the sum of (A) the product of the number of APS
outstanding on such Valuation Date multiplied by the sum of $25,000 and any
applicable redemption premium attributable to the designation of a Premium Call
Period; (B) the aggregate amount of cash dividends (whether or not earned or
declared) that will have accumulated for each APS outstanding to (but not
including) the end of the current Dividend Period that follows such Valuation
Date in the event the then-current Dividend Period will end within 49 calendar
days of such Valuation Date or through the 49th day after such Valuation Date in
the event the then-current Dividend Period for the APS will not end within 49
calendar days of such Valuation Date; (C) in the event the then-current Dividend
Period will end within 49 calendar days of such Valuation Date, the aggregate
amount of cash dividends that would accumulate at the Maximum Applicable Rate
applicable to a Dividend Period of 28 or fewer days on any APS outstanding from
the end of such Dividend Period through the 49th day after such Valuation Date,
multiplied by the Moody's Volatility Factor determined from time to time by
Moody's (except that if such Valuation Date occurs during a Non-Payment Period,
the cash dividend for purposes of calculation would accumulate at the then-
current Non-Payment Period Rate); (D) the amount of anticipated Fund expenses
for the 90 days subsequent to such Valuation Date; (E) the amount of the Fund's
Maximum Potential Gross-up Dividend Liability as of such Valuation Date; and (F)
any current liabilities as of such Valuation Date to the extent not reflected in
any of (i) (A) through (i) (E) (including, without limitation, and immediately
upon determination, any amounts due and payable by the Fund pursuant to
repurchase agreements and any amounts payable for municipal bonds purchased as
of such Valuation Date) less (ii) either (A) the Discounted Value of any Fund
assets, or (B) the face value of any of the Fund's assets if such assets mature
prior to or on the date of redemption of the APS or payment of a liability and
are either securities issued or guaranteed by the United States Government or
Deposit Securities, in both cases irrevocably deposited by the Fund for the
payment of the amount needed to redeem the APS subject to redemption or to
satisfy any of (i) (B) through (i) (F). For purposes of the foregoing, "Maximum
Potential Gross-up Dividend Liability," as of any Valuation Date, means the
aggregate amount of Gross-up Dividends that would be due if the Fund were to
make Retroactive Taxable Allocations, with respect to any fiscal year, estimated
based upon dividends paid and the amount of undistributed realized net capital
gains and other taxable income earned by the Fund, as of the end of the calendar
month immediately preceding such Valuation Date and assuming such Gross-up
Dividends are fully taxable.
The Discount Factors and guidelines for determining the market value of the
Fund's portfolio holdings have been based on criteria established in connection
with rating the APS. These factors include, but are not limited to, the
26
sensitivity of the market value of the relevant asset to changes in interest
rates, the liquidity and depth of the market for the relevant asset, the credit
quality of the relevant asset (for example, the lower the rating of a debt
obligation, the higher the related discount factor) and the frequency with which
the relevant asset is marked to market. In no event shall the Discounted Value
of any asset of the Fund exceed its unpaid principal balance or face amount as
of the date of calculation. The Discount Factor relating to any asset of the
Fund and the APS Basic Maintenance Amount, the assets eligible for inclusion in
the calculation of the Discounted Value of the Fund's portfolio and certain
definitions and methods of calculation relating thereto may be changed from time
to time by the Fund, without shareholder approval, but only in the event the
Fund receives written confirmation from Moody's, and any Substitute Rating
Agency that any such changes would not impair the ratings then assigned to the
APS by Moody's or any Substitute Rating Agency.
On or before the third Business Day after a Valuation Date on which the Fund
fails to maintain Moody's Eligible Assets with an aggregate Discounted Value
equal to or greater than the APS Basic Maintenance Amount, the Fund is required
to deliver to the Auction Agent and Moody's a report with respect to the
calculation of the APS Basic Maintenance Amount and the value of its portfolio
holdings as of the date of such failure (an "APS Basic Maintenance Report").
Additionally, on or before the third Business Day after the first day of a
Special Dividend Period, the Fund will deliver an APS Basic Maintenance Report
to Moody's and the Auction Agent. The Fund also will deliver an APS Basic
Maintenance Report as of the last Business Day of the last month of each fiscal
quarter of the Fund on or before the third Business Day after such day. Within
ten Business Days after delivery of such report relating to the last Business
Day of the last month of each fiscal quarter of the Fund, the Fund will deliver
a letter prepared by the Fund's independent accountants regarding the accuracy
of the calculations made by the Fund in its most recent APS Basic Maintenance
Report. Also, on or before 5:00 p.m., New York City time, on the first Business
Day after any Common Shares are repurchased by the Fund, the Fund will complete
and deliver to Moody's an APS Basic Maintenance Report as of the close of
business on such date that Common Shares are repurchased. If any such letter
prepared by the Fund's independent accountants shows that an error was made in
the most recent APS Basic Maintenance Report, the calculation or determination
made by the Fund's independent accountants will be conclusive and binding on the
Fund.
REDEMPTION
OPTIONAL REDEMPTION. To the extent permitted under the 1940 Act and under
Massachusetts law, upon giving a notice of redemption, as provided below, the
Fund, at its option, may redeem the APS, in whole or in part, out of funds
legally available therefor, at the Optional Redemption Price per share on any
Dividend Payment Date; provided that no APS may be redeemed at the option of the
Fund during (a) the Initial Dividend Period with respect to the APS or (b) a
Non-Call Period to which such share is subject. "Optional Redemption Price"
means $25,000 per share of APS plus an amount equal to accumulated but unpaid
dividends (whether or not earned or declared) to the date fixed for redemption
plus any applicable redemption premium, if any, attributable to the designation
of a Premium Call Period. In addition, holders of APS may be entitled to receive
Gross-up Dividends in the event of redemption of such APS to the extent provided
herein. See "--Dividends--Gross-up Dividends." The Fund has the authority to
redeem the APS for any reason and may redeem all or part of the outstanding APS
if it anticipates that the Fund's leveraged capital structure will result in a
lower rate of return to holders of Common Shares for any significant period of
time than that obtainable if the Common Shares were unleveraged.
MANDATORY REDEMPTION. The Fund will be required to redeem, out of funds legally
available therefor, at the Mandatory Redemption Price per share, the APS to the
extent permitted under the 1940 Act and Massachusetts law, on a date fixed by
the Board of Trustees, if the Fund fails to maintain Moody's Eligible Assets
with an aggregate Discounted Value equal to or greater than the APS Basic
Maintenance Amount or to satisfy the 1940 Act APS Asset Coverage and such
failure is not cured on or before the APS Basic Maintenance Cure Date or the
1940 Act Cure Date (herein collectively referred to as a "Cure Date"), as the
case may be. "Mandatory Redemption Price" for each series of APS means $25,000
per share plus an amount equal to accumulated but unpaid dividends (whether or
not earned or declared) to the date fixed for redemption. In addition, holders
of APS may be entitled to receive Gross-up Dividends in the event of redemption
of such APS to the extent provided herein. See "--Dividends--Gross-up
Dividends." The number of APS to be redeemed will be equal to the lesser of (a)
the minimum number of APS the redemption of which, if deemed to have occurred
immediately prior to the opening of business on the Cure Date, together with all
other Preferred Shares subject to redemption or retirement, would result in the
Fund having Moody's Eligible Assets with an aggregate Discounted Value equal to
or greater than the APS Basic Maintenance Amount or satisfaction of the 1940 Act
APS Asset Coverage, as the case may be, on such Cure Date (provided that, if
there is no such minimum number of shares the redemption of which would have
such result, all APS then outstanding will be redeemed), and (b) the maximum
number of APS, together with all other shares of Preferred Shares subject to
redemption or retirement, that can be redeemed out of funds expected to be
legally available therefor on such redemption date. In determining the number of
APS required to be redeemed in accordance with the foregoing, the Fund shall
allocate the number required to be redeemed which would result in the Fund
having Moody's Eligible Assets with an aggregate Discounted Value equal to or
greater than the APS Basic Maintenance Amount or satisfaction of the 1940 Act
APS Asset Coverage, as the case may be, pro rata among APS and other Preferred
Shares subject to redemption pursuant to provisions similar to those set forth
below; provided that, APS that may not be redeemed at the option of the Fund due
to the designation of a Non-Call Period applicable to such shares (A) will be
subject to mandatory redemption only to the extent that other shares are not
available to satisfy the number of shares required to be redeemed and (B) will
be selected for redemption in an ascending order of outstanding number of days
in the Non-Call Period (with shares with the lowest number of days to be
redeemed first) and by lot in the event of shares having an equal number of days
in such Non-Call Period. The Fund is required to effect such a mandatory
27
redemption not later than 35 days after such Cure Date, except that if the Fund
does not have funds legally available for the redemption of all of the required
number of APS which are subject to mandatory redemption or the Fund otherwise is
unable to effect such redemption on or prior to 35 days after such Cure Date,
the Fund will redeem those APS which it was unable to redeem on the earliest
practicable date on which it is able to effect such redemption.
GENERAL. If the APS are to be redeemed, a notice of redemption will be mailed
to each record holder of such APS (initially Cede & Co. as nominee of the
Securities Depository) and to the Auction Agent not less than 17 nor more than
30 days prior to the date fixed for the redemption thereof. Each notice of
redemption will include a statement setting forth: (i) the redemption date, (ii)
the aggregate number of APS to be redeemed, (iii) the redemption price, (iv) the
place or places where APS are to be surrendered for payment of the redemption
price, (v) a statement that dividends on the shares to be redeemed will cease to
accumulate on such redemption date (except that holders may be entitled to
Gross-up Dividends) and (vi) the provision of the Amended By-Laws pursuant to
which such shares are being redeemed. The notice also will be published in The
Wall Street Journal. No defect in the notice of redemption or in the mailing or
publication thereof will affect the validity of the redemption proceedings,
except as required by applicable law.
If less than all of the outstanding APS are to be redeemed, the shares to be
redeemed will be selected by lot or such other method as the Fund shall deem
fair and equitable, and the results thereof will be communicated to the Auction
Agent. The Auction Agent will give notice to the Securities Depository, whose
nominee will be the record holder of all APS, and the Securities Depository will
determine the number of shares to be redeemed from the account of the Agent
Member of each Existing Holder. Each Agent Member will determine the number of
shares to be redeemed from the account of each Existing Holder for which it acts
as agent. An Agent Member may select for redemption shares from the accounts of
some Existing Holders without selecting for redemption any shares from the
accounts of other Existing Holders. Notwithstanding the foregoing, if neither
the Securities Depository nor its nominee is the record holder of all of the APS
series, the particular shares to be redeemed shall be selected by the Fund by
lot or by such other method as the Fund shall deem fair and equitable.
If the Fund gives notice of redemption, and concurrently or thereafter deposits
in trust with the Auction Agent, or segregates in an account at the Fund's
custodian bank for the benefit of the Auction Agent, Deposit Securities (with a
right of substitution) having an aggregate Discounted Value (utilizing an
Moody's Exposure Period of 3 Business Days) equal to the redemption payment for
the APS as to which notice of redemption has been given, with irrevocable
instructions and authority to pay the redemption price to the record holders
thereof, then upon the date of such deposit or, if no such deposit is made, upon
such date fixed for redemption (unless the Fund shall default in making payment
of the redemption price), all rights of the holders of such shares called for
redemption will cease and terminate, except the right of such holders to receive
the redemption price thereof and any Gross-up Dividends, but without interest,
and such shares no longer will be deemed to be outstanding. The Fund will be
entitled to receive, from time to time, the interest, if any, earned on such
Deposit Securities deposited with the Auction Agent, and the holders of any
shares so redeemed will have no claim to any such interest. Any funds so
deposited which are unclaimed at the end of one year from such redemption date
will be repaid, upon demand, to the Fund, after which the holders of the APS of
such series so called for redemption may look only to the Fund for payment
thereof.
So long as any APS are held of record by the nominee of the Securities
Depository (initially Cede & Co.), the redemption price for such shares will be
paid on the redemption date to the nominee of the Securities Depository. The
Securities Depository's normal procedures now provide for it to distribute the
amount of the redemption price to Agent Members who, in turn, are expected to
distribute such funds to the persons for whom they are acting as agent.
Notwithstanding the provisions for redemption described above, no APS shall be
subject to optional redemption (i) unless all dividends in arrears on the
outstanding APS, and all capital stock of the Fund ranking on a parity with the
APS with respect to the payment of dividends or upon liquidation, have been or
are being contemporaneously paid or declared and set aside for payment and (ii)
if redemption thereof would result in the Fund's failure to maintain Moody's
Eligible Assets with an aggregate Discounted Value equal to or greater than the
APS Basic Maintenance Amount.
LIQUIDATION RIGHTS
Upon any liquidation, dissolution or winding up of the Fund, whether voluntary
or involuntary, the holders of APS of each series will be entitled to receive,
out of the assets of the Fund available for distribution to shareholders, before
any distribution or payment is made upon any Common Shares or any other shares
of beneficial interest of the Fund ranking junior in right of payment upon
liquidation of APS, $25,000 per share together with the amount of any dividends
accumulated but unpaid (whether or not earned or declared) thereon to the date
of distribution, and after such payment the holders of APS will be entitled to
no other payments except for any Gross-up Dividends. If such assets of the Fund
shall be insufficient to make the full liquidation payment on outstanding APS
and liquidation payments on any other outstanding class or series of Preferred
Shares of the Fund ranking on a parity with the APS as to payment upon
liquidation, then such assets will be distributed among the holders of APS and
the holders of shares of such other class or series ratably in proportion to the
respective preferential amounts to which they are entitled. After payment of the
full amount of liquidation distribution to which they are entitled, the holders
of APS will not be entitled to any further participation in any distribution of
assets by the Fund except for any Gross-up Dividends. A consolidation, merger or
28
share exchange of the Fund with or into any other entity or entities or a sale,
whether for cash, shares of stock, securities or properties, of all or
substantially all or any part of the assets of the Fund shall not be deemed or
construed to be a liquidation, dissolution or winding up of the Fund.
VOTING RIGHTS
Except as otherwise indicated in this Prospectus and except as otherwise
required by applicable law, holders of APS will be entitled to one vote per
share on each matter submitted to a vote of shareholders and will vote together
with holders of Common Shares and other Preferred Shares as a single class.
In connection with the election of the Fund's trustees, holders of the APS and
any other Preferred Shares, voting as a separate class, shall be entitled at all
times to elect two of the Fund's trustees, and the remaining trustees will be
elected by holders of Common Shares and APS and any other Preferred Shares,
voting together as a single class. In addition, if at any time dividends on
outstanding APS shall be unpaid in an amount equal to at least two full years'
dividends thereon or if at any time holders of any shares of Preferred Shares
are entitled, together with the holders of APS, to elect a majority of the
trustees of the Fund under the 1940 Act, then the number of trustees
constituting the Board of Trustees automatically shall be increased by the
smallest number that, when added to the two trustees elected exclusively by the
holders of APS and any other Preferred Shares as described above, would
constitute a majority of the Board of Trustees as so increased by such smallest
number, and at a special meeting of shareholders which will be called and held
as soon as practicable, and at all subsequent meetings at which trustees are to
be elected, the holders of the APS and any other Preferred Shares, voting as a
separate class, will be entitled to elect the smallest number of additional
trustees that, together with the two trustees which such holders in any event
will be entitled to elect, constitutes a majority of the total number of
trustees of the Fund as so increased. The terms of office of the persons who are
trustees at the time of that election will continue. If the Fund thereafter
shall pay, or declare and set apart for payment in full, all dividends payable
on all outstanding APS and any other Preferred Shares for all past Dividend
Periods, the additional voting rights of the holders of APS and any other
Preferred Shares as described above shall cease, and the terms of office of all
of the additional trustees elected by the holders of APS and any other Preferred
Shares (but not of the trustees with respect to whose election the holders of
Common Shares were entitled to vote or the two trustees the holders of APS and
any other Preferred Shares have the right to elect in any event) will terminate
automatically.
The affirmative vote of a majority of the votes entitled to be cast by holders
of outstanding APS and any other Preferred Shares, voting as a separate class,
will be required to (i) authorize, create or issue any class or series of stock
ranking prior to the APS or any other series of Preferred Shares with respect to
the payment of dividends or the distribution of assets on liquidation; provided,
however, that no vote is required to authorize the issuance of another class of
Preferred Shares which are substantially identical in all respects to the APS or
(ii) amend, alter or repeal the provisions of the Declaration of Trust or the
Amended By-Laws, whether by merger, consolidation or otherwise, so as to
adversely affect any of the contract rights expressly set forth in the
Declaration of Trust or the Amended By-Laws of holders of APS or any other
Preferred Shares. To the extent permitted under the 1940 Act, in the event
shares of more than one series of APS are outstanding, the Fund shall not
approve any of the actions set forth in clause (i) or (ii) which adversely
affects the contract rights expressly set forth in the Declaration of Trust or
the Amended By-Laws of a holder of shares of a series of APS differently than
those of a holder of shares of any other series of APS without the affirmative
vote of at least a majority of votes entitled to be cast by holders of the APS
of each series adversely affected and outstanding at such time (each such
adversely affected series voting separately as a class). The Board of Trustees,
however, without shareholder approval, may amend, alter or repeal any or all of
the various Rating Agency guidelines described herein in the event the Fund
receives confirmation from such Rating Agency that any such amendment,
alteration or repeal would not impair the rating then assigned to the APS.
Unless a higher percentage is provided for under "Certain provisions in the
Declaration of Trust," the affirmative vote of a majority of the votes entitled
to be cast by holders of outstanding APS and any other Preferred Shares, voting
as a separate class, will be required to approve any plan of reorganization
(including bankruptcy proceedings) adversely affecting such shares or any action
requiring a vote of security holders under Section 13(a) of the 1940 Act
including, among other things, changes in the investment restrictions described
as fundamental policies under "Investment Restrictions" in the Statement of
Additional Information. The class vote of holders of APS and any other
Preferred Shares described above in each case will be in addition to a separate
vote of the requisite percentage of Common Shares and APS and any other
Preferred Shares, voting together as a single class, necessary to authorize the
action in question.
The foregoing voting provisions will not apply to the APS if, at or prior to the
time when the act with respect to which such vote otherwise would be required
shall be effected, such shares shall have been (i) redeemed or (ii) called for
redemption and sufficient funds shall have been deposited in trust to effect
such redemption.
Management of the Fund
TRUSTEES AND OFFICERS
The Board of Trustees is responsible for the management of the Fund, including
supervision of the duties performed by PIMCO Advisors and PIMCO. There are
29
currently three Trustees of the Fund, one of whom is an "interested person" (as
defined in the 1940 Act) and two of whom are not "interested persons." The names
and business addresses of the Trustees and officers of the Fund and their
principal occupations and other affiliations during the past five years are set
forth under "Management of the Fund" in the Statement of Additional Information.
INVESTMENT MANAGER
PIMCO Advisors serves as the investment manager of the Fund. Subject to the
supervision of the Board of Trustees, PIMCO Advisors is responsible for
managing, either directly or through others selected by it, the investment
activities of the Fund and the Fund's business affairs and other administrative
matters. PIMCO Advisors is located at 1345 Avenue of the Americas, New York, New
York 10105.
Organized in 1987, PIMCO Advisors provides investment management and advisory
services to private accounts of institutional and individual clients and to
mutual funds. As of June 30, 2001, PIMCO Advisors and its subsidiary
partnerships had approximately $[____] billion in assets under management.
PIMCO Advisors has retained its affiliate, PIMCO, to manage the Fund's
investments. See "Portfolio Manager" below. PIMCO Advisors and PIMCO are each
majority-owned indirect subsidiaries of Allianz AG, a publicly traded German
insurance and financial services company.
PORTFOLIO MANAGER
PIMCO serves as the portfolio manager for the Fund. Subject to the supervision
of PIMCO Advisors, PIMCO has full investment discretion and makes all
determinations with respect to the investment of the Fund's assets.
PIMCO is located at 840 Newport Center Drive, Newport Beach, California 92660.
Organized in 1971, PIMCO provides investment management and advisory services to
private accounts of institutional and individual clients and to mutual funds. As
of June 30, 2001, PIMCO had approximately $[____] billion in assets under
management. PIMCO Advisors (and not the Fund) pays a portion of the fees it
receives to PIMCO in return for its services.
The following individual at PIMCO has primary responsibility for the day-to-day
portfolio management of the Fund.
Since Recent Professional Experience
Mark V. McCray 2001 (Inception) Executive Vice President, PIMCO. He
joined PIMCO as a Portfolio Manager
in 2000. Prior to that, he was a
bond trader from 1992-1999 at
Goldman Sachs & Co. where he was
appointed Vice President in 1996
and named co-head of municipal bond
trading in 1997 with responsibility
for the firm's proprietary account
and supervised municipal bond
traders.
Chris Dialynas, a Managing Director and senior member of PIMCO's investment
strategy group, oversees Mr. McCray regarding the management of the Fund.
INVESTMENT MANAGEMENT AGREEMENT
Pursuant to an investment management agreement between PIMCO Advisors and the
Fund, the Fund has agreed to pay PIMCO Advisors an annual management fee payable
on a monthly basis at the annual rate of 0.65% of the Fund's average daily net
assets (including net assets attributable to Preferred Shares) for the services
and facilities it provides.
In addition to the fees of PIMCO Advisors, the Fund pays all other costs and
expenses of its operations, including compensation of its trustees (other than
those affiliated with PIMCO Advisors), custodial expenses, shareholder servicing
expenses, transfer agency and dividend disbursing expenses, legal fees, expenses
of independent auditors, expenses of repurchasing shares, expenses of issuing
any Preferred Shares, expenses of preparing, printing and distributing
prospectuses, shareholder reports, notices, proxy statements and reports to
governmental agencies, and taxes, if any.
PIMCO Advisors has contractually agreed to waive a portion of the management
fees it is entitled to receive from the Fund in the amounts, and for the time
periods, set forth below (covering commencement of Fund operations through June
30, 2009):
Percentage Waived
(annual rate as a
percentage
of average daily net
Period Ending June 30, assets) (1)
2002 (2)............. 0.20%
2003................. 0.20%
2004................. 0.20%
30
2005................. 0.20%
2006................. 0.20%
2007................. 0.15%
2008................. 0.10%
2009................. 0.05%
----------------
(1) Including net assets attributable to Preferred Shares.
(2) From the commencement of the Fund's operations.
PIMCO Advisors has not agreed to waive any portion of its fees beyond June 30,
2009.
Because the fees received by PIMCO Advisors and PIMCO are based on the total net
assets of the Fund (including assets represented by APS and any leverage created
thereby), PIMCO Advisors and PIMCO each have a financial incentive for the Fund
to issue APS, which may create a conflict of interest between PIMCO Advisors
and/or PIMCO and the holders of the Fund's Common Shares.
Net asset value
The net asset value ("NAV") of the Fund equals the total value of the Fund's
portfolio investments and other assets, less any liabilities. For purposes of
calculating NAV, portfolio securities and other assets for which market quotes
are available are stated at market value. Market value is generally determined
on the basis of the last reported sales price, or if no sales are reported,
based on quotes obtained from a quotation reporting system, established market
makers, or pricing services. Certain securities or investments for which market
quotations are not readily available (which is usually the case for municipal
bonds) may be valued, pursuant to guidelines established by the Board of
Trustees, with reference to other securities or indices. For instance, a pricing
service may recommend a fair market value based on prices of comparable
municipal bonds. Short-term investments having a maturity of 60 days or less are
generally valued at amortized cost. Exchange traded options, futures and options
on futures are valued at the settlement price determined by the exchange. Other
securities for which market quotes are not readily available are valued at fair
value as determined in good faith by the Board of Trustees or persons acting at
their direction.
The NAV of the Fund will be determined as of the close of regular trading
(normally 4:00 p.m., Eastern time) (the "NYSE Close") on each day the New York
Stock Exchange is open. Domestic fixed income securities are normally priced
using data reflecting the earlier closing of the principal markets for those
securities. Information that becomes known to the Fund or its agent after the
NAV has been calculated on a particular day will not generally be used to
retroactively adjust the price of a security or the NAV determined earlier that
day.
In unusual circumstances, instead of valuing securities in the usual manner, the
Fund may value securities at fair value or estimate their value as determined in
good faith by the Board of Trustees, generally based upon recommendations
provided by PIMCO. Fair valuation may also be used if extraordinary events occur
after the close of the relevant market but prior to the NYSE Close.
Taxes
FEDERAL INCOME TAX MATTERS
The following federal income tax discussion is based on the advice of Ropes &
Gray, counsel to the Fund, and reflects provisions of the Internal Revenue Code
of 1986, as amended (the "Code"), existing treasury regulations, rulings
published by the IRS and other applicable authority, as of the date of this
Prospectus. These authorities are subject to change by legislative or
administrative action. The following discussion is only a summary of some of the
important tax considerations generally applicable to investments in the Fund.
For more detailed information regarding tax considerations, see the Statement of
Additional Information. There may be other tax considerations applicable to
particular investors. In addition, income earned through an investment in the
Fund may be subject to state and local taxes.
The Fund intends to qualify each year for taxation as a regulated investment
company eligible for treatment under the provisions of Subchapter M of the Code.
If the Fund so qualifies and satisfies certain distribution requirements, the
Fund will not be subject to federal income tax on income distributed in a timely
manner to its shareholders in the form of dividends or capital gain
distributions.
In order for any distributions to holders of APS to be eligible to be treated as
exempt interest dividends, the APS must be treated as equity for Federal income
tax purposes. Based in part on certain representations made by the Fund to
Ropes & Gray relating to the lack of any present intention to redeem or purchase
APS at any time in the future, it is the opinion of Ropes & Gray that the APS
will constitute equity for Federal income tax purposes. This opinion relies in
part on a published ruling of the IRS stating that certain auction rate
preferred stock similar in many material respects to the APS represents equity.
The opinion of Ropes & Gray represents only its best legal judgment and is not
binding on the IRS or the courts. If the IRS were successfully to assert that
variable rate preferred stock such as the APS should be treated as debt for
Federal income tax purposes, dividends on shares of the preferred would not be
31
increased by the Fund and holders of APS would not be entitled to any additional
distributions to offset the effect of paying Federal income tax on the Fund's
distributions so recharacterized as interest. Ropes & Gray has advised the Fund
that, should the IRS pursue in court the position that the APS should be treated
as debt for Federal income tax purposes, the IRS would be unlikely to prevail.
To satisfy the distribution requirement applicable to regulated investment
companies, amounts paid as dividends by the Fund to its shareholders, including
holders of its APS, must qualify for the dividends-paid deduction. In certain
circumstances, the IRS could take the position that dividends paid on the APS
constitute preferential dividends under Section 562(c) of the Code, and thus do
not qualify for the dividends-paid deduction.
If at any time when APS are outstanding the Fund does not meet applicable asset
coverage requirements, it will be required to suspend distributions to Common
Shareholders until the requisite asset coverage is restored. Any such suspension
may cause the Fund to pay a 4% federal excise tax (imposed on regulated
investment companies that fail to distribute for a given calendar year,
generally, at least 98% of their net investment income and capital gain net
income) and income tax on undistributed income or gains, and may, in certain
circumstances, prevent the Fund from qualifying for treatment as a regulated
investment company. The Fund may redeem APS in an effort to comply with the
distribution requirement applicable to regulated investment companies and to
avoid income and excise taxes.
The California Municipal Bonds in which the Fund will invest are generally
issued by the State of California, a city in California, or a political
subdivision, agency, authority or instrumentality of such state or city. Thus,
substantially all of the Fund's dividends to you will qualify as "exempt-
interest dividends," which are not generally subject to federal income tax. An
investment in the Fund may result in liability for federal alternative minimum
tax for corporate shareholders. The Fund will seek to avoid portfolio
investments that pay interest that is taxable to individuals under the federal
alternative minimum tax. Nonetheless, the Fund may not be successful in this
regard and if you are, or as a result of an investment in the Fund would become,
subject to the federal alternative minimum tax, the Fund may not be a suitable
investment for you.
The IRS has taken the position in a published ruling that the Fund is required
for each taxable year to allocate net capital gain and other income subject to
regular federal income tax, if any, proportionately among its common shares and
the Series A APS and Series B APS in accordance with the percentage of total
Fund distributions received by each such class of shares with respect to such
year. As described above in the section entitled "Description of APS--
Dividends--Gross-up Dividends," if the Fund retroactively allocates any net
capital gains or other taxable income to the APS, in certain circumstances, it
will pay Gross-up Dividends to the holders of the APS. There are other
circumstances where, even if it is determined after the payment of a dividend
that a portion of that dividend was subject to federal income tax, the Fund will
not be required to pay any additional amount to compensate for any tax payable
on the dividend.
The federal income tax consequences of Gross-up Dividends under existing law are
uncertain. For example, it is unclear how Gross-up Dividends will be treated
under the rules in Subchapter M of the Code applicable to dividends paid
following the close of a taxable year in respect of a prior year's income. The
Fund intends to treat such Gross-up Dividends as paid during such prior taxable
year for purposes of the rules governing the Fund's treatment of such dividends,
and to treat a holder as receiving a dividend distribution in the amount of any
Gross-up Dividend only as and when such Gross-up Dividend is paid.
Existing authorities do not specifically address whether dividends (including
possible Gross-up Dividends) that are paid following the close of a taxable
year, but that are treated for tax purposes as derived from the income of such
prior taxable year, are treated as dividends paid during such prior taxable year
for purposes of determining each class's proportionate share of a particular
type of income. The Fund currently intends to treat such dividends as having
been paid in the prior taxable year for purposes of determining each class's
proportionate share of a particular type of income with respect to such prior
taxable year. Existing authorities also do not specifically address the
allocation of taxable income among the dividends paid to holders of a class of
shares during or with respect to a taxable year. It is possible that the
Service could disagree with the Fund's position concerning the treatment of
dividends paid after the close of a taxable year or with the Fund's method of
allocation, in which case the Service could attempt to recharacterize a portion
of the dividends paid to the holders of APS and designated by the fund as exempt
interest dividends as consisting instead of capital gains or other taxable
income. If the Service were to prevail with respect to any such attempted
recharacterization, holders of APS could be subject to tax on amounts so
recharacterized and the Fund could be subject to federal income and excise tax.
In such event, no additional amounts (including Gross-up Dividends) would be
paid by the Fund with respect to dividends so recharacterized to compensate for
any additional tax owed by holders of APS.
If, in connection with the selection of a Long-Term Dividend Period, (i) the
Fund provides that a Premium Call Period will follow a Non-Call Period, (ii)
based on all the facts and circumstances at the time of the designation of the
Long-Term Dividend Period the Fund is more likely than not to redeem the
Preferred Shares during the Premium Call Period, and (iii) the premium to be
paid upon redemption during the Premium Call Period exceeds a reasonable penalty
for early redemption, it is possible that the holders of APS will be required to
accrue such premium as a dividend (to the extent of the Fund's earnings and
profits) over the term of the Non-Call Period.
The Fund will generally designate Gross-up Dividends as exempt-interest
dividends to the extent it determines such designation is consistent with the
32
allocation principles, as described in "Description of APS--Dividends--Gross-up
Dividends." However, a portion or all of a Gross-up Dividend will be taxable
either in the taxable year in which the dividend or dividends to which the
Gross-up Dividend relates was paid or in the taxable year in which the Gross-up
Dividend is paid. The Fund will not be required to pay any additional amount if
it is determined that its treatment of Gross-up Dividends was improper.
The Fund may at times buy tax-exempt investments at a discount from the price at
which they were originally issued, especially during periods of rising interest
rates. For federal income tax purposes, some or all of this market discount will
be included in the Fund's ordinary income and will be taxable to shareholders as
such when it is distributed.
The Fund's investments in certain debt obligations may cause the Fund to
recognize taxable income in excess of the cash generated by such obligations.
Thus, the Fund could be required at times to liquidate other investments in
order to satisfy its distribution requirements.
For federal income tax purposes, distributions of investment income other than
exempt interest dividends are taxable as ordinary income. Generally, gains
realized by the Fund on the sale or exchange of investments will be taxable to
its shareholders, even though the income from such investments generally will be
tax-exempt. Whether distributions of capital gains are taxed as ordinary income
or capital gains is determined by how long the Fund owned the investments that
generated such capital gains, rather than how long a shareholder has owned his
or her shares. Distributions are taxable to shareholders even if they are paid
from income or gains earned by the Fund before a shareholder's investment (and
thus were included in the price the shareholder paid). Distributions of gains
from the sale of investments that the Fund owned for more than one year will be
taxable as capital gains. Distributions of gains from the sale of investments
that the Fund owned for one year or less will be taxable as ordinary income.
Distributions are taxable whether shareholders receive them in cash or reinvest
them in additional shares through the Dividend Reinvestment Plan.
Any gain resulting from the sale or exchange of Fund shares will generally also
be subject to tax.
CALIFORNIA TAX MATTERS
The Fund's regular monthly dividends will not be subject to California personal
income taxes to the extent they are paid out of income earned on obligations
that, when held by individuals, pay interest that is exempt from taxation by
California under California law (e.g., obligations of California and its
political subdivisions) or federal law, so long as at the close of each quarter
of the Fund's taxable year at least 50 percent of the value of the Fund's total
assets consist of such obligations. The portion of the Fund's monthly dividends
that is attributable to income other than as described in the preceding sentence
will be subject to the California income tax. The Fund expects to earn no or
only a minimal amount of such non-exempt income. You will be subject to
California personal income taxes to the extent the Fund distributes any taxable
income or realized capital gains, or if you sell or exchange Common Shares and
realize a capital gain on the transaction. Please refer to the Statement of
Additional Information for more detailed information. You are urged to consult
your tax advisor.
Description of capital structure
The Fund is an unincorporated business trust established under the laws of the
Commonwealth of Massachusetts by an Agreement and Declaration of Trust dated May
10, 2001 (the "Declaration of Trust"). The Declaration of Trust provides that
the Trustees of the Fund may authorize separate classes of shares of beneficial
interest. The Trustees have authorized an unlimited number of Common Shares and
Preferred Shares. Preferred Shares (such as the APS) may be issued in one or
more series, with such par value and with such rights as determined by the Board
of Trustees, by action of the Board of Trustees without the approval of the
Common Shareholders. For a description of the APS, see "Description of APS." The
following table shows the amount of (i) shares authorized and (ii) shares
outstanding, for each class of authorized securities of the Trust as of
[________], 2001.
AMOUNT
TITLE OF CLASS AMOUNT AUTHORIZED OUTSTANDING
-------------------------------------- ------------------------------ ----------------------------
Common Shares......................... Unlimited [_____________]
Auction Preferred Shares
Series A............................ [________] -0-
Series B............................ [________] -0-
Holders of Common Shares are entitled to share equally in dividends declared by
the Board of Trustees payable to holders of Common Shares and in the net assets
of the Fund available for distribution to holders of Common Shares after payment
of the preferential amounts payable to holders of any outstanding Preferred
Shares. Neither holders of Common Shares nor holders of Preferred Shares have
pre-emptive or conversion rights and Common Shares are not redeemable. Upon
liquidation of the Fund, after paying or adequately providing for the payment of
33
all liabilities of the Fund and the liquidation preference with respect to any
outstanding Preferred Shares, and upon receipt of such releases, indemnities and
refunding agreements as they deem necessary for their protection, the Trustees
may distribute the remaining assets of the Fund among the holders of the Fund's
Common Shares.
Holders of Common Shares are entitled to one vote for each share held and will
vote with the holders of any outstanding APS or other Preferred Shares on each
matter submitted to a vote of holders of Common Shares, except as described
under "Description of APS--Voting Rights."
Shareholders are entitled to one vote for each share held. Except as provided
under "Description of APS--Voting Rights," holders of APS are entitled to elect
two Trustees, and the remaining Trustees shall be elected by holders of Common
Shares and APS, voting as a single class. Therefore, in most cases the holders
of more than 50% of the shares of Common Shares, APS and any other Preferred
Shares voting for the election of Trustees can elect all of the Trustees
standing for election by such holders, and, in such event, the holders of the
remaining shares of Common Shares, APS and any other preferred shares will not
be able to elect any of such Trustees.
So long as any APS or any other Preferred Shares are outstanding, holders of
Common Shares will not be entitled to receive any dividends of or other
distributions from the Fund, unless at the time of such declaration, (1) all
accrued dividends on Preferred Shares or accrued interest on borrowings has been
paid and (2) the value of the Fund's total assets (determined after deducting
the amount of such dividend or other distribution), less all liabilities and
indebtedness of the Fund not represented by senior securities, is at least 300%
of the aggregate amount of such securities representing indebtedness and at
least 200% of the aggregate amount of securities representing indebtedness plus
the aggregate liquidation value of the outstanding Preferred Shares (expected to
equal the aggregate original purchase price of the outstanding Preferred Shares
plus redemption premium, if any, together with any accrued and unpaid dividends
thereon, whether or not earned or declared and on a cumulative basis). In
addition to the requirements of the 1940 Act, the Fund is required to comply
with other asset coverage requirements as a condition of the Trust obtaining a
rating of the Preferred Shares from a Rating Agency. These requirements include
an asset coverage test more stringent than under the 1940 Act. See "Description
of APS--Restrictions on Dividends and Other Payments."
The Fund will send unaudited reports at least semi-annually and audited
financial statements annually to all of its shareholders.
The shares of Common Shares commenced trading on the NYSE on June 27, 2001. At
[_______], 2001, the net asset value per share of Common Shares was $[_____],
and the closing price per share of Common Shares on the NYSE was $[_____].
PREFERRED SHARES
Under the 1940 Act, the Fund is permitted to have outstanding more than one
series of Preferred Shares as long as no single series has priority over another
series as to the distribution of assets of the Fund or the payment of dividends.
Neither holders of Common Shares nor holders of Preferred Shares have pre-
emptive rights to purchase any APS or any other Preferred Shares that might be
issued. It is anticipated that the net asset value per share of the APS will
equal its original purchase price per share plus accumulated dividends per
share.
Certain provisions in the Declaration of Trust
The Declaration includes provisions that could limit the ability of other
entities or persons to acquire control of the Fund or to convert the Fund to
open-end status. Commencing with the first annual meeting of shareholders, the
Board of Trustees will be divided into three classes. At each annual meeting of
shareholders, the term of one class will expire and each Trustee elected to that
class will hold office for a term of three years. The classification of the
Board of Trustees in this manner could delay for an additional year the
replacement of a majority of the Board of Trustees. In addition, the Declaration
provides that a Trustee may be removed only for cause and only (i) by action of
at least seventy-five percent (75%) of the outstanding shares of the classes or
series of shares entitled to vote for the election of such Trustee, or (ii) by
at least seventy-five percent (75%) of the remaining Trustees.
In addition, the Declaration requires the affirmative vote or consent of at
least seventy-five percent (75%) of the Board of Trustees and holders of at
least seventy-five percent (75%) of the Fund's shares (including Common and
Preferred Shares) to authorize certain Fund transactions not in the ordinary
course of business (including a merger or consolidation, or sale or transfer of
Fund securities or assets), unless the transaction is authorized by both a
majority of the Trustees and seventy-five percent (75%) of those Trustees or
their successors ("Continuing Trustees") who are not affiliated with the other
party to the transaction (in which case no shareholder authorization would be
required by the Declaration). The Declaration also requires the affirmative vote
or consent of holders of at least seventy-five percent (75%) of each class of
the Fund's shares entitled to vote on the matter to authorize a conversion of
the Fund from a closed-end to an open-end investment company, unless the
conversion is authorized by both a majority of the Trustees and seventy-five
percent (75%) of the Continuing Trustees (in which case shareholders would have
only the minimum voting rights required by the 1940 Act with respect to the
conversion). Also, the Declaration provides that the Fund may be terminated at
any time by vote or consent of at least seventy-five percent (75%) of the Fund's
shares or, alternatively, by vote or consent of both a majority of the Trustees
34
and seventy-five percent (75%) of the Continuing Trustees. See "Certain
provisions in the Declaration of Trust" in the Statement of Additional
Information for a more detailed summary of these provisions. The Trustees may
from time to time grant other voting rights to shareholders with respect to
these and other matters in the Fund's By-Laws.
The overall effect of these provisions is to render more difficult the
accomplishment of a merger or the assumption of control by a third party. They
provide, however, the advantage of potentially requiring persons seeking control
of the Fund to negotiate with its management regarding the price to be paid and
facilitating the continuity of the Fund's investment objective and policies. The
provisions of the Declaration described above could have the effect of
discouraging a third party from seeking to obtain control of the Fund in a
tender offer or similar transaction. The Board of Trustees of the Fund has
considered the foregoing anti-takeover provisions and concluded that they are in
the best interests of the Fund.
The foregoing is intended only as a summary and is qualified in its entirety by
reference to the full text of the Declaration and the Fund's By-Laws, both of
which are on file with the Securities and Exchange Commission.
Under Massachusetts law, shareholders could, in certain circumstances, be held
personally liable for the obligations of the Fund. However, the Declaration
contains an express disclaimer of shareholder liability for debts or obligations
of the Fund and requires that notice of such limited liability be given in each
agreement, obligation or instrument entered into or executed by the Fund or the
Trustees. The Declaration further provides for indemnification out of the assets
and property of the Fund for all loss and expense of any shareholder held
personally liable for the obligations of the Fund. Thus, the risk of a
shareholder incurring financial loss on account of shareholder liability is
limited to circumstances in which the Fund would be unable to meet its
obligations. The Fund believes that the likelihood of such circumstances is
remote.
Repurchase of Fund shares; conversion to open-end fund
The Fund is a closed-end investment company and as such its shareholders will
not have the right to cause the Fund to redeem their shares. Shares of a
closed-end investment company may frequently trade at prices lower than net
asset value. The Fund's Board of Trustees regularly monitors the relationship
between the market price and net asset value of the Common Shares. If the Common
Shares were to trade at a substantial discount to net asset value for an
extended period of time, the Board may consider the repurchase of its Common
Shares on the open market or in private transactions, the making of a tender
offer for such shares, or the conversion of the Fund to an open-end investment
company.
If the Fund converted to an open-end company, it would be required to redeem all
Preferred Shares then outstanding (requiring in turn that it liquidate a portion
of its investment portfolio), and the Common Shares would likely no longer be
listed on the New York Stock Exchange. In contrast to a closed-end investment
company, shareholders of an open-end investment company may require the company
to redeem their shares at any time (except in certain circumstances as
authorized by or under the 1940 Act) at their net asset value, less any
redemption charge that is in effect at the time of redemption.
Before deciding whether to take any action to convert the Fund to an open-end
investment company, the Board would consider all relevant factors, including the
extent and duration of the discount, the liquidity of the Fund's portfolio, the
impact of any action that might be taken on the Fund or its shareholders, and
market considerations. Based on these considerations, even if the Fund's shares
should trade at a discount, the Board of Trustees may determine that, in the
interest of the Fund and its shareholders, no action should be taken. See the
Statement of Additional Information under "Repurchase of Fund shares; conversion
to open-end fund" for a further discussion of possible action to reduce or
eliminate such discount to net asset value.
Underwriting
The underwriters named below (the "Underwriters"), acting through UBS Warburg
LLC, 299 Park Avenue, New York, New York, as lead manager, and
[_______________________] as their representatives (the "Representatives"), have
severally agreed, subject to the terms and conditions of the Underwriting
Agreement with the Fund and PIMCO Advisors, to purchase from the Fund the number
of APS set forth opposite their respective names. The Underwriters are committed
to purchase and pay for all of such APS if any are purchased.
Number of
Underwriters APS
UBS Warburg LLC....................................
Total.............................................. [_________]
----------------
The Underwriters have advised the Fund that they propose initially to offer the
APS to the public at the public offering price set forth on the cover page of
this Prospectus, and to certain dealers at such price less a concession not in
excess of $[ ] per share. The Underwriters may allow, and such dealers may
reallow, a discount not in excess of $[ ] per share to other dealers. After
the initial public offering, the public offering price, concession and discount
35
may be changed. Investors must pay for any APS purchased in the initial public
offering on or before [_______], 2001.
The Underwriters will act in Auctions as Broker-Dealers as set forth under
"Description of APS--The Auction--Broker-Dealer Agreements" and will be entitled
to fees for services as Broker-Dealers as set forth under "Description of APS--
Broker-Dealers." The Underwriters also may provide information to be used in
ascertaining the Reference Rate.
The Fund anticipates that the Underwriters from time to time may act as dealers
in connection with the execution of the Fund's portfolio transactions after they
have ceased to be principal underwriters of the Fund under the 1940 Act. See
"[____]" and "[____]."
The Fund and the Adviser have agreed to indemnify the Underwriters against
certain liabilities including liabilities under the Securities Act of 1933, as
amended.
Custodian and transfer agents
The custodian of the assets of the Fund is State Street Bank and Trust Co., 225
Franklin Street, Boston, MA 02110. The Custodian performs custodial and fund
accounting services.
[__________] serves as Auction Agent for the APS, and serves as transfer agent,
registrar, dividend disbursing agent and redemption agent for the APS. PFPC
Inc., 400 Bellevue Parkway, Wilmington, DE 19809, serves as the transfer agent,
registrar, dividend disbursement agent and shareholder servicing agent for the
Fund's Common Shares, as well as agent for the Fund's Dividend Reinvestment
Plan.
Legal matters
Certain legal matters in connection with the Common Shares will be passed upon
for the Fund by Ropes & Gray, Boston, Massachusetts, and for the Underwriters by
Skadden, Arps, Slate, Meagher & Flom (Illinois), Chicago, Illinois, and its
affiliated entities.
36
TABLE OF CONTENTS FOR THE
STATEMENT OF ADDITIONAL INFORMATION
Use of proceeds...........................................
Investment objective and policies.........................
Investment restrictions...................................
Management of the Fund....................................
Investment manager and portfolio manager..................
Portfolio transactions....................................
Distributions.............................................
Description of shares.....................................
Certain provisions in the Declaration of Trust............
Repurchase of Fund shares; conversion to open-end fund....
Tax matters...............................................
Performance related and comparative information...........
Custodian, transfer agent and dividend disbursement agent.
Independent accountants...................................
Counsel...................................................
Registration statement....................................
Report of independent accountants.........................
Financial statements......................................
Appendix A--Ratings of investments........................ A-1
Appendix B--Factors Pertaining to California.............. B-1
Appendix C--Settlement Procedures......................... C-1
Appendix D--Auction Procedures............................ D-1
37
GLOSSARY
"'AA' (AA) Composite Commercial Paper Rate" on any Valuation Date, means (i) the
Interest Equivalent of the rate on commercial paper placed on behalf of issuers
whose corporate bonds are rated "AA" by S&P or "Aa" by Moody's or the equivalent
of such rating by another nationally recognized statistical rating organization,
as such rate is made available on a discount basis or otherwise by the Federal
Reserve Bank of New York for the Business Day immediately preceding such date,
or (ii) in the event that the Federal Reserve Bank of New York does not make
available such a rate, then the arithmetic average of the Interest Equivalent of
the rate on commercial paper placed on behalf of such issuers, as quoted on a
discount basis or otherwise by PaineWebber Incorporated or its successors that
are Commercial Paper Dealers, to the Auction Agent for the close of business on
the Business Day immediately preceding such date. If one of the Commercial Paper
Dealers does not quote a rate required to determine the "AA" Composite
Commercial Paper Rate, the "AA" Composite Commercial Paper Rate will be
determined on the basis of the quotation or quotations furnished by any
Substitute Commercial Paper Dealer or Substitute Commercial Paper Dealers
selected by the Fund to provide such rate or rates not being supplied by the
Commercial Paper Dealer. If the number of Dividend Period days shall be (i) 7 or
more but fewer than 49 days, such rate shall be the Interest Equivalent of the
30-day rate on such commercial paper; (ii) 49 or more but fewer than 70 days,
such rate shall be the Interest Equivalent of the 60-day rate on such commercial
paper; (iii) 70 or more days but fewer than 85 days, such rate shall be the
arithmetic average of the Interest Equivalent of the 60-day and 90-day rates on
such commercial paper; (iv) 85 or more days but fewer than 99 days, such rate
shall be the Interest Equivalent of the 90-day rate on such commercial paper;
(v) 99 or more days but fewer than 120 days, such rate shall be the arithmetic
average of the Interest Equivalent of the 90-day and 120-day rates on such
commercial paper; (vi) 120 or more days but fewer than 141 days, such rate shall
be the Interest Equivalent of the 120-day rate on such commercial paper; (vii)
141 or more days but fewer than 162 days, such rate shall be the arithmetic
average of the Interest Equivalent of the 120-day and 180-day rates on such
commercial paper; and (viii) 162 or more days but fewer than 183 days, such rate
shall be the Interest Equivalent of the 180-day rate on such commercial paper.
"Agent Member" means the member of the Securities Depository that will act on
behalf of a Beneficial Owner of one or more APS or on behalf of a Potential
Beneficial Owner.
"Amended By-Laws" means the By-laws of the Fund as amended [____], 2001,
specifying the powers, preferences and rights of the APS.
"APS" means the Auction Preferred Shares with no par value and a liquidation
preference of $25,000 per share plus an amount equal to accumulated but unpaid
dividends thereon (whether or not earned or declared) of the Fund.
"APS Basic Maintenance Amount" has the meaning set forth on page [25] of this
Prospectus.
"APS Basic Maintenance Cure Date" has the meaning set forth on page [25] of this
Prospectus.
"APS Basic Maintenance Report" has the meaning set forth on page [__] of this
Prospectus.
"Anticipation Notes" means the following Municipal Obligations: revenue
anticipation notes, tax anticipation notes, tax and revenue anticipation notes,
grant anticipation notes and bond anticipation notes.
"Applicable Percentage" has the meaning set forth on page [17] of this
Prospectus.
"Applicable Rate" means the rate per annum at which cash dividends are payable
on APS for any Dividend Period.
"Auction" means a periodic operation of the Auction Procedures.
"Auction Agent" means [__________] unless and until another commercial bank,
trust company or other financial institution appointed by a resolution of the
Board of Trustees of the Fund or a duly authorized committee thereof enters into
an agreement with the Fund to follow the Auction Procedures for the purpose of
determining the Applicable Rate and to act as transfer agent, registrar,
dividend disbursing agent and redemption agent for the APS.
"Auction Agent Agreement" means the agreement entered into between the Fund and
the Auction Agent which provides, among other things, that the Auction Agent
will follow the Auction Procedures for the purpose of determining the Applicable
Rate.
"Auction Date" has the meaning set forth on page [16] of this Prospectus.
"Auction Procedures" means the procedures for conducting Auctions set forth in
Appendix D to the Statement of Additional Information.
38
"Available APS" has the meaning set forth on page [19] of this Prospectus.
"Beneficial Owner" means a customer of a Broker-Dealer who is listed on the
records of that Broker-Dealer (or if applicable, the Auction Agent) as a holder
of APS or a Broker-Dealer that holds APS for its own account.
"Bid" has the meaning set forth on page [17] of this Prospectus.
"Bidder" has the meaning set forth on page [17] of this Prospectus.
"Board of Trustees" or "Board" means the Board of Trustees of the Fund.
"Broker-Dealer" has the meaning set forth on page [16] of this Prospectus.
"Broker-Dealer Agreement" has the meaning set forth on page [16] of this
Prospectus.
"Business Day" means a day on which the New York Stock Exchange is open for
trading and which is not a Saturday, Sunday or other day on which banks in New
York City are authorized or obligated by law to close.
"California Municipal Bonds" has the meaning set forth on page [1] of this
Prospectus.
"Code" has the meaning set forth on page [30] of this Prospectus.
"Commercial Paper Dealers" means[____] and such other commercial paper dealer or
dealers as the Fund from time to time may appoint or, in lieu thereof, their
respective affiliates and successors.
"Common Shares" means the Common Shares, no par value, of the Fund.
"Cure Date" has the meaning set forth on page [26] of the Prospectus.
"Continuing Trustees" has the meaning set forth on page [33] of this Prospectus.
"Date of Original Issue" means, with respect to each APS, the date on which such
share first is issued by the Fund.
"Declaration of Trust" has the meaning set forth on page [32] of the Prospectus.
"Deposit Securities" means cash and Municipal Obligations rated at least A2
(having a remaining maturity of 12 months or less), P-1, VMIG-1 or MIG-1 by
Moody's or A (having a remaining maturity of 12 months or less), A-1+ or SP-1+
by S&P.
"Discount Factor" means a Moody's Discount Factor.
"Discounted Value" of any asset of the Fund means with respect to an Moody's
Eligible Asset, the quotient of the market value thereof divided by the
applicable Moody's Discount Factor.
"Dividend Payment Date" has the meaning set forth on page [21] of this
Prospectus.
"Dividend Period" has the meaning set forth on page [21] of this Prospectus.
"DTC" means The Depository Trust Company.
"Eligible Assets" means Moody's Eligible Assets.
"Existing Holder" means a Broker-Dealer or any such other person as may be
permitted by the Fund that is listed as the holder of record of APS in the
records of the Auction Agent.
"Fitch" means Fitch IBCA or its successors.
"Fund" means PIMCO California Municipal Income Fund, a Massachusetts business
trust that that is the issuer of the APS.
"Gross-up Dividend" has the meaning set forth on page [__] of this Prospectus.
"Hold Order" has the meaning specified in Subsection 10(b)(i) of the Auction
Procedures.
"Initial Dividend Payment Date" has the meaning set forth on page [1] of this
Prospectus.
39
"Initial Dividend Period" has the meaning set forth on page [22] of the
Prospectus.
"Initial Margin" means the amount of cash or securities deposited with a broker
as a margin payment at the time of purchase or sale of a financial futures
contract.
"Interest Equivalent" means a yield on a 360-day basis of a discount basis
security which is equal to the yield on an equivalent interest-bearing
security.
"Issue Type Category" means, with respect to a Municipal Obligation acquired by
the Fund, for purposes of calculating Moody's Eligible Assets as of any
Valuation Date, one of the following categories into which such Municipal
Obligation falls based upon a good faith determination by the Fund: health
care issues (including issues related to teaching and non-teaching hospitals,
public or private); housing issues (including issues related to single- and
multi-family housing projects); educational facilities issues (including
issues related to public and private schools); student loan issues; resource
recovery issues; transportation issues (including issues related to mass
transit, airports and highways); industrial development bond issues (including
issues related to pollution control facilities); utility issues (including
issues related to the provision of gas, water, sewers and electricity);
general obligation issues; lease obligations (including certificates of
participation); escrowed bonds; and other issues ("Other Issues") not falling
within one of the aforementioned categories. Municipal Obligations in the
utility issuer category will be classified within one of the three following
sub-categories: (i) electric, gas and combination issues (if the combination
issue includes an electric issue); (ii) water and sewer utilities and
combination issues (if the combination issues does not include an electric
issue); and (iii) irrigation, resource recovery, solid waste and other
utilities. Municipal Obligations in the transportation issue category will be
classified within one of the two following sub-categories: (i) streets and
highways, toll roads, bridges and tunnels, airports and multi-purpose port
authorities (multiple revenue streams generated by toll roads, airports, real
estate, bridges); (ii) mass transit, parking seaports and others.
"IRS" means the United States Internal Revenue Service.
"Liens" shall have the meaning set forth in the definition of "Moody's Eligible
Asset" below.
"Long Term Dividend Period" has the meaning set forth on page [3] of this
Prospectus.
"Mandatory Redemption Price" has the meaning set forth on page [26] of this
Prospectus.
"Marginal Tax Rate" means the maximum marginal federal individual income tax
rate applicable to an individual's or a corporation's ordinary income, whichever
is greater.
"Maximum Applicable Rate" has the meaning specified under "Description of APS--
The Auction--Orders by Beneficial Owners, Potential Beneficial Owners, Existing
Holders and Potential Holders" in the Prospectus.
"Maximum Potential Gross-up Dividend Liability" has the meaning set forth on
page 25 of this Prospectus.
"Moody's" means Moody's Investors Service, Inc. or its successors.
"Moody's Discount Factor" shall mean, for purposes of determining the Discounted
Value of any Moody's Eligible Asset, the percentage determined by reference to
the rating on such asset and the shortest Exposure Period set forth opposite
such rating that is the same length as or is longer than the Moody's Exposure
Period, in accordance with the table set forth below:
RATING CATEGORY
--------------------------------------------------------------------------
EXPOSURE PERIOD Aaa* AA* A* BAA* OTHER** (V)MIG-1*** SP-1+*** UNRATED*****
----- ---- ---- ----- -------- ------------ ---------- -----------
7 weeks................ 151% 159% 166% 173% 187% 136% 148% 225%
8 weeks or less but
greater than seven
weeks............... 154 161 168 176 190 137 149 231
9 weeks or less but
greater than eight
weeks............... 158 163 170 177 192 138 150 240
40
----------
* Moody's rating.
** Municipal Obligations not rated by Moody's but rated BBB by S&P.
*** Municipal Obligations rated MIG-1 or VMIG-1, which do not mature or have
a demand feature at par exercisable in 30 days and which do not have a
long-term rating.
**** Municipal Obligations not rated by Moody's but rated SP-1+ by S&P, which
do not mature or have a demand feature at par exercisable in 30 days and
which do not have a long-term rating.
***** Municipal Obligations rated less than Baa3 by Moody's or less than BBB
by S&P or not rated by Moody's or S&P.
Notwithstanding the foregoing, (i) the Moody's Discount Factor for short-term
Municipal Obligations will be 115%, so long as such Municipal Obligations are
rated at least MIG-1, VMIG-l or P-1 by Moody's and mature or have a demand
feature at par exercisable in 30 days or less or 125% as long as such Municipal
Obligations are rated at least A-1+/AA or SP-1+/AA by S&P and mature or have a
demand feature at par exercisable in 30 days or less and (ii) no Moody's
Discount Factor will be applied to cash or to Receivables for Municipal
Obligations Sold.
"Moody's Eligible Asset" shall mean cash, Receivables for Municipal Obligations
Sold or a Municipal Obligation that (i) pays interest in cash, (ii) does not
have its Moody's rating, as applicable, suspended by Moody's, and (iii) is part
of an issue of Municipal Obligations of at least $5,000,000 except for Municipal
Obligations rated below A by Moody's, Municipal Obligations within the
healthcare Issue Type Category, in which case the minimum issue size is
$10,000,000. Except for general obligation bonds, Municipal Obligations issued
by any one issuer and rated BBB or lower by S&P, Ba or B by Moody's or not rated
by S&P and Moody's ("Other Securities") may comprise no more than 4% of total
Moody's Eligible Assets; such Other Securities, if any, together with any
Municipal Obligations issued by the same issuer and rated Baa by Moody's or A by
S&P, may comprise no more than 6% of total Moody's Eligible Assets; such Other
Securities, Baa and A-rated Municipal Obligations, if any, together with any
Municipal Obligations issued by the same issuer and rated A by Moody's or AA by
S&P, may comprise no more than 10% of total Moody's Eligible Assets; and such
Other Securities, Baa, A and AA-rated Municipal Obligations, if any, together
with any Municipal Obligations issued by the same issuer and rated Aa by Moody's
or AAA by S&P, may comprise no more than 20% of total Moody's Eligible Assets.
For purposes of the foregoing sentence, any Municipal Obligation backed by the
guaranty, letter of credit or insurance issued by a third party shall be deemed
to be issued by such third party if the issuance of such third party credit is
the sole determinant of the rating on such Municipal Obligation. Other
Securities falling within a particular Issue Type Category may comprise no more
than 12% of total Moody's Eligible Assets; such Other Securities, if any,
together with any Municipal Obligations falling within a particular Issue Type
Category and rated Baa by Moody's or A by S&P, may comprise no more than 20% of
total Moody's Eligible Assets; such Other Securities, Baa and A-rated Municipal
Obligations, if any, together with any Municipal Obligations falling within a
particular Issue Type Category and rated A by Moody's or AA by S&P, may comprise
no more than 40% of total Moody's Eligible Assets; and such Other Securities,
Baa, A and AA-rated Municipal Obligations, if any, together with any Municipal
Obligations falling within a particular Issue Type Category and rated Aa by
Moody's or AAA by S&P, may comprise no more than 60% of total Moody's Eligible
Assets. For purposes of this definition, a Municipal Obligation shall be deemed
to be rated BBB by S&P if rated BBB or BBB+ by S&P. Notwithstanding any other
provision of this definition, (A) in the case of general obligation Municipal
Obligations only, Other Securities issued by issuers located within any one
county may comprise no more than 4% of Moody's Eligible Assets; such Other
Securities, if any, together with any Municipal Obligations issued by issuers
located within the same county and rated Baa by Moody's or A by S&P, may
comprise no more than 6% of Moody's Eligible Assets; such Other Securities, Baa
and A-rated Municipal Obligations, if any, together with any Municipal
Obligations issued by issuers located within the same county and rated A by
Moody's or AA by S&P, may comprise no more than 10% of Moody's Eligible Assets;
and such Other Securities, Baa, A and AA-rated Municipal Obligations, if any,
together with any Municipal Obligations issued by issuers located within the
same county and rated Aa by Moody's or AAA by S&P, may comprise no more than 20%
of Moody's Eligible Assets; and (B) in no event may (i) student loan Municipal
Obligations comprise more than 10% of Moody's Eligible Assets; (ii) resource
recovery Municipal Obligations comprise more than 10% of Moody's Eligible
Assets; and (iii) Other Issues comprise more than 10% of Moody's Eligible
Assets. For purposes of applying the foregoing requirements, a Municipal
Obligation rated BBB- by S&P shall not be considered to be rated BBB by S&P,
Moody's Eligible Assets shall be calculated without including cash, and
Municipal Obligations rated MIG-1, VMIG-1 or P-1 or, if not rated by Moody's,
rated A-1+/AA or SP-1+/AA by S&P, shall be considered to have a long-term rating
of A. When the Fund sells a Municipal Obligation and agrees to repurchase such
Municipal Obligation at a future date, such Municipal Obligation shall be valued
at its Discounted Value for purposes of determining Moody's Eligible Assets, and
the amount of the repurchase price of such Municipal Obligation shall be
included as a liability for purposes of calculating the APS Basic Maintenance
Amount. When the Fund purchases a Moody's Eligible Asset and agrees to sell it
at a future date, such Eligible Asset shall be valued at the amount of cash to
be received by the Fund upon such future date, provided that the counterparty to
the transaction has a long-term debt rating of at least A2 from Moody's and the
transaction has a term of no more than 30 days, otherwise such Eligible Asset
shall be valued at the Discounted Value of such Eligible Asset.
41
Notwithstanding the foregoing, an asset will not be considered a Moody's
Eligible Asset to the extent it is (i) subject to any material lien, mortgage,
pledge, security interest or security agreement of any kind (collectively,
"Liens"), except for (a) Liens which are being contested in good faith by
appropriate proceedings and which Moody's has indicated to the Fund will not
affect the status of such asset as a Moody's Eligible Asset, (b) Liens for taxes
that are not then due and payable or that can be paid thereafter without
penalty, (c) Liens to secure payment for services rendered or cash advanced to
the Fund by PIMCO Advisors, PIMCO or their affiliates, State Street Bank and
Trust Company or the Auction Agent and (d) Liens by virtue of any repurchase
agreement; or (ii) deposited irrevocably for the payment of any liabilities for
purposes of determining the APS Basic Maintenance Amount.
"Moody's Exposure Period" means [___________].
"Moody's Hedging Transactions" has the meaning set forth on page [__] of this
Prospectus.
"Moody's Volatility Factor" means [___]% or such other potential dividend rate
increase factor as Moody's advises the Fund in writing is applicable.
"Municipal Obligations" means municipal bonds the interest from which is exempt
from federal income taxes.
"Municipal Index" has the meaning set forth on page [__] of this Prospectus.
"1940 Act" means the Investment Company Act of 1940, as amended from time to
time.
"1940 Act APS Asset Coverage" has the meaning set forth on page [15] of this
Prospectus.
"1940 Act Cure Date" has the meaning set forth on page [24] of this Prospectus.
"Non-Call Period" has the meaning set forth under "Specific Redemption
Provisions" below.
"Non-Payment Period" has the meaning set forth on page [30] of this Prospectus.
"Non-Payment Period Rate" has the meaning set forth on page [__] of this
Prospectus.
"Normal Dividend Payment Date" has the meaning set forth on page [21] of this
Prospectus.
"Notice of Revocation" has the meaning set forth on page [22] of this
Prospectus.
"Notice of Special Dividend Period" has the meaning set forth on page [22] of
this Prospectus.
"Optional Redemption Price" has the meaning set forth on page [26] of this
Prospectus.
"Order" has the meaning set forth on page [17] of this Prospectus.
"Other Issues" has the meaning set forth in the definition of "Issue Type
Category" above.
"Other Securities" has the meaning set forth in the definition of "Moody's
Eligible Asset" above.
"PIMCO" means Pacific Investment Management Company LLC.
"PIMCO Advisors" means PIMCO Advisors L.P.
"Potential Beneficial Owner" means a customer of a Broker-Dealer or a Broker-
Dealer that is not a Beneficial Owner of APS but that wishes to purchase such
shares, or that is a Beneficial Owner that wishes to purchase additional shares
of APS.
"Potential Holder" means any Broker-Dealer or any such other person as may be
permitted by the Fund, including any Existing Holder, who may be interested in
acquiring APS (or, in the case of an Existing Holder, additional APS).
"Preference Item" has the meaning set forth on page [21] of this Prospectus.
"Preferred Shares" means preferred shares of beneficial interest of the Fund.
"Premium Call Period" has the meaning set forth under "Specific Redemption
Provisions" below.
"Rating Agency" means a nationally recognized statistical rating organization.
42
"Receivables For Municipal Obligations Sold" has the meaning set forth on page
[__] of this Prospectus.
"Reference Rate" means: (i) with respect to any 7-Day Dividend Period or any
Short Term Dividend Period having 28 or fewer days, the higher of the applicable
"AA" Composite Commercial Paper Rate and the Taxable Equivalent of the Short
Term Municipal Obligation Rate, (ii) with respect to any Short Term Dividend
Period having more than 28 but fewer than 183 days, the applicable "AA"
Composite Commercial Paper Rate, (iii) with respect to any Short Term Dividend
Period having 183 or more but fewer than 364 days, the applicable U.S. Treasury
Bill Rate and (iv) with respect to any Long Term Dividend Period, the applicable
U.S. Treasury Note Rate.
"Request for Special Dividend Period" has the meaning set forth on page [22] of
this Prospectus.
"Response" has the meaning set forth on page [22] of this Prospectus.
"Retroactive Taxable Allocation" has the meaning set forth on page [__] of this
Prospectus.
"RIBS" means residual interest municipal bonds.
"S&P" means Standard & Poor's, a division of The McGraw-Hill Companies, Inc., or
its successors.
"Securities Depository" means The Depository Trust Company and its successors
and assigns or any successor securities depository selected by the Fund that
agrees to follow the procedures required to be followed by such securities
depository in connection with the APS.
"Sell Order" has the meaning specified in Subsection 10(b)(i) of the Auction
Procedures.
"7-Day Dividend Period" means a Dividend Period consisting of seven days.
"Short Term Dividend Period" has the meaning set forth on page [3] of this
Prospectus.
"Special Dividend Period" has the meaning set forth on page [3] of this
Prospectus.
"Specific Redemption Provisions" means, with respect to a Special Dividend
Period, either, or any combination of, (i) a period (a
"Non-Call Period") determined by the Board of Trustees of the Fund, after
consultation with the Auction Agent and the Broker-Dealers, during which the APS
subject to such Dividend Period shall not be subject to redemption at the option
of the Fund and (ii) a period (a "Premium Call Period"), consisting of a number
of whole years and determined by the Board of Trustees of the Fund, after
consultation with the Auction Agent and the Broker-Dealers, during each year of
which the APS subject to such Dividend Period shall be redeemable at the Fund's
option at a price per share equal to $25,000 plus accumulated but unpaid
dividends plus a premium expressed as a percentage of $25,000, as determined by
the Board of Trustees of the Fund after consultation with the Auction Agent and
the Broker-Dealers.
"Submission Deadline" has the meaning set forth on page [18] of this Prospectus.
"Submitted Bid" has the meaning set forth on page [19] of this Prospectus.
"Submitted Hold Order" has the meaning set forth on page [19] of this
Prospectus.
"Submitted Order" has the meaning set forth on page [19] of this Prospectus.
"Submitted Sell Order" has the meaning set forth on page [19] of this
Prospectus.
"Subsequent Dividend Period" means each Dividend Period after the Initial
Dividend Period.
"Substitute Rating Agency" shall mean a nationally recognized statistical rating
organization selected by UBS Warburg LLC, or its respective affiliates and
successors, after consultation with the Fund, to act as a substitute rating
agency to determine the credit ratings of the APS.
"Sufficient Clearing Bids" has the meaning specified in Subsection 11.4(i) of
the Auction Procedures.
"Taxable Equivalent of the Short-Term Municipal Obligations Rate" on any date
means 90% of the quotient of (A) the per annum rate expressed on an interest
43
equivalent basis equal to the Kenny S&P 30 day High Grade Index (the "Kenny
Index"), or any successor index made available for the Business Day immediately
preceding such date but in any event not later than 8:30 a.m., New York City
time, on such date by Kenny Information Systems Inc. or any successor thereto,
based upon 30-day yield evaluations at par of bonds the interest on which is
excludable for federal income tax purposes under the Code of "high grade"
component issuers selected by Kenny Information Systems Inc. or any such
successor from time to time in its discretion, which component issuers shall
include, without limitation, issuers of general obligation bonds but shall
exclude any bonds the interest on which constitutes a Preference Item, divided
by (B) 1.00 minus the Marginal Tax Rate (expressed as a decimal); provided,
however, that if the Kenny Index is not made so available by 8:30 a.m., New York
City time, on such date by Kenny Information Systems Inc. or any successor, the
Taxable Equivalent of the Short-Term Municipal Obligations Rate shall mean the
quotient of (A) the per annum rate expressed on an interest equivalent basis
equal to the most recent Kenny Index so made available for any preceding
Business Day, divided by (B) 1.00 minus the marginal tax rate noted above
(expressed as a decimal). The Fund may not utilize a successor index to the
Kenny Index unless S&P provides the Fund with written confirmation that the use
of such successor index will not adversely affect the then-current S&P rating of
the APS.
"Taxable Income" has the meaning set forth on page [3] of this Prospectus.
"Treasury Bonds" has the meaning set forth on page [__] of this Prospectus.
"Underwriters" has the meaning set forth on page [1] of this Prospectus.
"U.S. Treasury Bill Rate" on any date means (i) the Interest Equivalent of the
rate on the actively traded Treasury Bill with a maturity most nearly comparable
to the length of the related Dividend Period, as such rate is made available on
a discount basis or otherwise by the Federal Reserve Bank of New York in its
Composite 3:30 p.m. Quotations for U.S. Government Securities report for such
Business Day, or (ii) if such yield as so calculated is not available, the
Alternate Treasury Bill Rate on such date. "Alternate Treasury Bill Rate" on any
date means the Interest Equivalent of the yield as calculated by reference to
the arithmetic average of the bid price quotations of the actively traded
Treasury Bill with a maturity most nearly comparable to the length of the
related Dividend Period, as determined by bid price quotations as of any time on
the Business Day immediately preceding such date, obtained from at least three
recognized primary U.S. Government securities dealers selected by the Auction
Agent.
"U.S. Treasury Note Rate" on any date means (i) the yield as calculated by
reference to the bid price quotation of the actively traded, current coupon
Treasury Note with a maturity most nearly comparable to the length of the
related Dividend Period, as such bid price quotation is published on the
Business Day immediately preceding such date by the Federal Reserve Bank of New
York in its Composite 3:30 p.m. Quotations for U.S. Government Securities report
for such Business Day, or (ii) if such yield as so calculated is not available,
the Alternate Treasury Note Rate on such date. "Alternate Treasury Note Rate" on
any date means the yield as calculated by reference to the arithmetic average of
the bid price quotations of the actively traded, current coupon Treasury Note
with a maturity most nearly comparable to the length of the related Dividend
Period, as determined by the bid price quotations as of any time on the Business
Day immediately preceding such date, obtained from at least three recognized
primary U.S. Government securities dealers selected by the Auction Agent.
"Valuation Date" has the meaning set forth on page [25] of this Prospectus.
"Variation Margin" means, in connection with an outstanding financial futures
contract owned or sold by the Fund, the amount of cash or securities paid to or
received from a broker (subsequent to the Initial Margin payment) from time to
time as the price of such financial futures contract fluctuates.
"Winning Bid Rate" has the meaning set forth on page [19] of this Prospectus.
44
[LOGO]
45
The information in this Statement of Additional Information is not complete
and may be changed. We may not sell these securities until the registration
statement filed with the Securities and Exchange Commission is effective. This
Statement of Additional Information is not an offer to sell these securities and
it is not soliciting an offer to buy these securities in any state where the
offer or sale is not permitted.
SUBJECT TO COMPLETION - DATED , 2001
PIMCO CALIFORNIA MUNICIPAL INCOME FUND
STATEMENT OF ADDITIONAL INFORMATION
August , 2001
PIMCO California Municipal Income Fund (the "Fund") is a newly organized,
non-diversified, closed-end management investment company.
This Statement of Additional Information relating to preferred shares of
the Fund ("Preferred Shares" or "APS") does not constitute a prospectus, but
should be read in conjunction with the Fund's prospectus relating thereto dated
August , 2001 (the "Prospectus"). This Statement of Additional Information
does not include all information that a prospective investor should consider
before purchasing Preferred Shares, and investors should obtain and read the
Prospectus prior to purchasing such shares. A copy of the Prospectus may be
obtained without charge by calling (877) 819-2224. You may also obtain a copy
of the Prospectus on the Securities and Exchange Commission's ("SEC") web site
(http://www.sec.gov). Capitalized terms used but not defined in this Statement
of Additional Information have the meanings ascribed to them in the Prospectus.
1
TABLE OF CONTENTS
USE OF PROCEEDS.................................................... 3
INVESTMENT OBJECTIVE AND POLICIES.................................. 3
INVESTMENT RESTRICTIONS............................................ 26
MANAGEMENT OF THE FUND............................................. 29
INVESTMENT MANAGER AND PORTFOLIO MANAGER........................... 33
PORTFOLIO TRANSACTIONS............................................. 37
DISTRIBUTIONS...................................................... 39
DESCRIPTION OF SHARES.............................................. 39
CERTAIN PROVISIONS IN THE DECLARATION OF TRUST..................... 40
REPURCHASE OF FUND SHARES; CONVERSION TO OPEN-END FUND............. 43
TAX MATTERS........................................................ 44
PERFORMANCE RELATED AND COMPARATIVE INFORMATION.................... 51
CUSTODIAN, TRANSFER AGENT AND DIVIDEND DISBURSING AGENT............ 51
INDEPENDENT ACCOUNTANTS............................................ 52
COUNSEL............................................................ 52
REGISTRATION STATEMENT............................................. 52
REPORT OF INDEPENDENT ACCOUNTANTS.................................. 53
FINANCIAL STATEMENTS............................................... 54
APPENDIX A - Ratings of Investments................................ A-1
APPENDIX B - Factors Pertaining to California...................... B-1
APPENDIX C - Settlement Procedures................................. C-1
APPENDIX D - Auction Procedures.................................... D-1
This Statement of Additional Information is dated August , 2001.
2
USE OF PROCEEDS
The net proceeds of the offering of Preferred Shares of the Fund will be
approximately $ after payment of offering costs and the sales load.
Pending investment in Municipal Bonds (as hereinafter defined) that meet
the Fund's investment objective and policies, the net proceeds of the offering
will be invested in high quality, short-term tax-exempt money market securities
or in high quality Municipal Bonds with relatively low volatility (such as pre-
refunded and intermediate-term bonds), to the extent such securities are
available. If necessary to invest fully the net proceeds of the offering
immediately, the Fund may also purchase, as temporary investments, short-term
taxable investments of the type described under "Investment Objective and
Policies--Short-Term Investments/Temporary Defensive Strategies," the income on
which is subject to regular federal and California income tax, and securities of
other open- or closed-end investment companies that invest primarily in
Municipal Bonds of the type in which the Fund may invest directly.
INVESTMENT OBJECTIVE AND POLICIES
The investment objective and general investment policies of the Fund are
described in the Prospectus. Additional information concerning the
characteristics of certain of the Fund's investments is set forth below.
MUNICIPAL BONDS
Under normal market conditions, the Fund will invest substantially all (at
least 90%) of its total assets in municipal bonds which pay interest that, in
the opinion of bond counsel to the issuer (or on the basis of other authority
believed by the Fund's portfolio manager to be reliable), is exempt from federal
and California income taxes. The Fund will seek to avoid bonds generating
interest potentially subjecting individuals to the alternative minimum tax.
"Municipal Bonds" as used in this Statement of Additional Information refers
generally to municipal bonds which pay interest that is exempt from federal
income tax.
Municipal Bonds share the attributes of debt/fixed income securities in
general, but are generally issued by states, municipalities and other political
subdivisions, agencies, authorities and instrumentalities of states and multi-
state agencies or authorities. The Municipal Bonds which the Fund may purchase
include general obligation bonds and limited obligation bonds (or revenue
bonds), including industrial development bonds issued pursuant to former federal
tax law. General obligation bonds are obligations involving the credit of an
issuer possessing taxing power and are payable from such issuer's general
revenues and not from any particular source. Limited obligation bonds are
payable only from the revenues derived from a particular facility or class of
facilities or, in some cases, from the proceeds of a special excise or other
specific revenue source. Tax-exempt private activity bonds and industrial
development bonds generally are also revenue bonds and thus are not payable from
the issuer's general revenues. The credit and quality of private activity bonds
and industrial development bonds are usually related to the credit of the
corporate user of the facilities. Payment of interest on and repayment of
principal of such bonds is the responsibility of the corporate user (and/or any
guarantor).
3
The Fund will invest at least 80% of its net assets in Municipal Bonds that
at the time of investment are investment grade quality. Investment grade
quality bonds are bonds rated within the four highest grades (Baa or BBB or
better by Moody's Investors Service, Inc. ("Moody's"), Standard & Poor's ("S&P")
or Fitch IBCA, Inc. ("Fitch")) or bonds that are unrated but judged to be of
comparable quality by the Fund's portfolio manager, Pacific Investment
Management Company LLC ("PIMCO"). The Fund may invest up to 20% of its net
assets in Municipal Bonds that, at the time of investment, are rated Ba/BB or B
by Moody's, S&P or Fitch or unrated but judged to be of comparable quality by
PIMCO. Bonds of below investment grade quality (Ba/BB or below) are commonly
referred to as "junk bonds." For a description of the risks associated with
lower quality securities, see "High Yield Securities (`Junk Bonds')" below.
The Fund will primarily invest in Municipal Bonds with long-term maturities
in order to maintain a weighted average maturity of 15-30 years, but the average
weighted maturity of obligations held by the Fund may be shortened, depending on
market conditions. As a result, the Fund's portfolio at any given time may
include both long-term and intermediate-term Municipal Bonds. Moreover, during
temporary or defensive periods (e.g., times when PIMCO believes that temporary
imbalances of supply and demand or other temporary dislocations in the tax-
exempt bond market adversely affect the price at which long-term or
intermediate-term Municipal Bonds are available), and in order to keep the
Fund's cash fully invested, including the period during which the net proceeds
of the offering are being invested, the Fund may invest any percentage of its
net assets in short-term investments including high quality, short-term
securities that may be either tax-exempt or taxable and up to 10% of its net
assets in securities of other open- or closed-end investment companies that
invest primarily in Municipal Bonds of the type in which the Fund may invest
directly. The Fund intends to invest in taxable short-term investments only in
the event that suitable tax-exempt short-term investments are not available at
reasonable prices and yields. See "Tax Matters" for information relating to the
allocation of taxable income between the Fund's common shares (called "Common
Shares" herein) and the Preferred Shares. Tax-exempt short-term investments
include various obligations issued by state and local governmental issuers, such
as tax-exempt notes (bond anticipation notes, tax anticipation notes and revenue
anticipation notes or other such Municipal Bonds maturing in three years or less
from the date of issuance) and municipal commercial paper. The Fund will invest
only in taxable short-term investments which are U.S. Government securities or
securities rated within the highest grade by Moody's, S&P or Fitch, and which
mature within one year from the date of purchase or carry a variable or floating
rate of interest. See Appendix A for a general description of Moody's, S&P's
and Fitch's ratings of securities in such categories. Taxable short-term
investments of the Fund may include certificates of deposit issued by U.S. banks
with assets of at least $1 billion, or commercial paper or corporate notes,
bonds or debentures with a remaining maturity of one year or less, or repurchase
agreements. See "Short-Term Investments/ Temporary Defensive Strategies." To
the extent the Fund invests in taxable investments, the Fund will not at such
times be in a position to achieve its investment objective.
Also included within the general category of Municipal Bonds in which the
Fund may invest are participations in lease obligations or installment purchase
contract obligations of municipal authorities or entities ("Municipal Lease
Obligations"). Although a Municipal Lease Obligation does not constitute a
general obligation of the municipality for which the municipality's taxing power
is pledged, a Municipal Lease Obligation is ordinarily backed by the
municipality's covenant to budget for, appropriate and make the payments due
under the
4
Municipal Lease Obligation. However, certain Municipal Lease Obligations contain
"non-appropriation" clauses which provide that the municipality has no
obligation to make lease or installment purchase payments in future years unless
money is appropriated for such purpose on a yearly basis. In the case of a
"non-appropriation" lease, the Fund's ability to recover under the lease in the
event of non-appropriation or default will be limited solely to the repossession
of the leased property, without recourse to the general credit of the lessee,
and disposition or releasing of the property might prove difficult. There have
been challenges to the legality of lease financing in numerous states, and, from
time to time, certain municipalities have considered not appropriating money for
lease payments. In deciding whether to purchase a Municipal Lease Obligation,
PIMCO will assess the financial condition of the borrower, the merits of the
project, the level of public support for the project, and the legislative
history of lease financing in the state. These securities may be less readily
marketable than other Municipal Bonds. The Fund may also purchase unrated lease
obligations if determined by PIMCO to be of comparable quality to rated
securities in which the Fund is permitted to invest.
The Fund may seek to enhance its yield through the purchase of private
placements. These securities are sold through private negotiations, usually to
institutions or mutual funds, and may have resale restrictions. Their yields are
usually higher than comparable public securities to compensate the investor for
their limited marketability. The Fund may not invest more than 15% of its net
assets in illiquid securities, including unmarketable private placements.
Some longer-term Municipal Bonds give the investor the right to "put" or
sell the security at par (face value) within a specified number of days
following the investor's request--usually one to seven days. This demand feature
enhances a security's liquidity by shortening its effective maturity and enables
it to trade at a price equal to or very close to par. If a demand feature
terminates prior to being exercised, the Fund would hold the longer-term
security, which could experience substantially more volatility.
The Fund may invest in Municipal Bonds with credit enhancements such as
letters of credit, municipal bond insurance and Standby Bond Purchase Agreements
("SBPAs"). Letters of credit are issued by a third party, usually a bank, to
enhance liquidity and ensure repayment of principal and any accrued interest if
the underlying Municipal Bond should default. Municipal bond insurance, which
is usually purchased by the bond issuer from a private, nongovernmental
insurance company, provides an unconditional and irrevocable guarantee that the
insured bond's principal and interest will be paid when due. Insurance does not
guarantee the price of the bond or the share price of the Fund. The credit
rating of an insured bond reflects the credit rating of the insurer, based on
its claims-paying ability. The obligation of a municipal bond insurance company
to pay a claim extends over the life of each insured bond. Although defaults on
insured Municipal Bonds have been low to date and municipal bond insurers have
met their claims, there is no assurance this will continue. A higher-than-
expected default rate could strain the insurer's loss reserves and adversely
affect its ability to pay claims to bondholders. The number of municipal bond
insurers is relatively small, and not all of them have the highest rating. An
SBPA is a liquidity facility provided to pay the purchase price of bonds that
cannot be re-marketed. The obligation of the liquidity provider (usually a bank)
is only to advance funds to purchase tendered bonds that cannot be remarketed
and does not cover principal or interest under any other circumstances. The
liquidity provider's obligations under the SBPA are usually subject to numerous
conditions, including the continued creditworthiness of the underlying borrower.
5
The Fund also may invest in participation interests. Participation
interests are various types of securities created by converting fixed rate bonds
into short-term, variable rate certificates. These securities have been
developed in the secondary market to meet the demand for short-term, tax-exempt
securities. The Fund will invest only in securities deemed tax-exempt by a
nationally recognized bond counsel, but there is no guarantee the interest will
be exempt.
The Fund may also invest up to 10% of its assets in residual interest
Municipal Bonds, which may involve leverage and related risks. See "Residual
Interest Municipal Bonds (RIBS)" below.
The Fund may purchase custodial receipts representing the right to receive
either the principal amount or the periodic interest payments or both with
respect to specific underlying Municipal Bonds. In a typical custodial receipt
arrangement, an issuer or third party owner of Municipal Bonds deposits the
bonds with a custodian in exchange for two classes of custodial receipts. The
two classes have different characteristics, but, in each case, payments on the
two classes are based on payments received on the underlying Municipal Bonds. In
no event will the aggregate interest paid with respect to the two classes exceed
the interest paid by the underlying Municipal Bond. Custodial receipts are sold
in private placements. The value of a custodial receipt may fluctuate more than
the value of a Municipal Bond of comparable quality and maturity.
Municipal Bonds are subject to credit and market risk. Generally, prices
of higher quality issues tend to fluctuate less with changes in market interest
rates than prices of lower quality issues and prices of longer maturity issues
tend to fluctuate more than prices of shorter maturity issues.
The Fund may purchase and sell portfolio investments to take advantage of
changes or anticipated changes in yield relationships, markets or economic
conditions. The Fund may also sell Municipal Bonds due to changes in PIMCO's
evaluation of the issuer. The secondary market for Municipal Bonds typically
has been less liquid than that for taxable debt/fixed income securities, and
this may affect the Fund's ability to sell particular Municipal Bonds at then-
current market prices, especially in periods when other investors are attempting
to sell the same securities.
Prices and yields on Municipal Bonds are dependent on a variety of factors,
including general money-market conditions, the financial condition of the
issuer, general conditions of the Municipal Bond market, the size of a
particular offering, the maturity of the obligation and the rating of the issue.
A number of these factors, including the ratings of particular issues, are
subject to change from time to time. Information about the financial condition
of an issuer of Municipal Bonds may not be as extensive as that which is made
available by corporations whose securities are publicly traded.
Obligations of issuers of Municipal Bonds are subject to the provisions of
bankruptcy, insolvency and other laws, such as the Federal Bankruptcy Reform Act
of 1978, affecting the rights and remedies of creditors. Congress or state
legislatures may seek to extend the time for payment of principal or interest,
or both, or to impose other constraints upon enforcement of such obligations.
There is also the possibility that as a result of litigation or other
conditions, the
6
power or ability of issuers to meet their obligations for the payment of
interest and principal on their Municipal Bonds may be materially affected or
their obligations may be found to be invalid or unenforceable. Such litigation
or conditions may from time to time have the effect of introducing uncertainties
in the market for Municipal Bonds or certain segments thereof, or of materially
affecting the credit risk with respect to particular bonds. Adverse economic,
business, legal or political developments might affect all or a substantial
portion of the Fund's Municipal Bonds in the same manner. The Fund will be
particularly subject to these risks because it focuses its investments in a
particular state.
FACTORS PERTAINING TO CALIFORNIA
Factors pertaining to California are set forth in Appendix B.
RESIDUAL INTEREST MUNICIPAL BONDS (RIBS)
The Fund may also invest up to 10% of its assets in residual interest
Municipal Bonds ("RIBS") whose interest rates bear an inverse relationship to
the interest rate on another security or the value of an index. RIBS are
created by dividing the income stream provided by an underlying bond to create
two securities, one short-term and one long-term. The interest rate on the
short-term component is reset by an index or auction process normally every
seven to 35 days. After income is paid on the short-term securities at current
rates, the residual income goes to the long-term securities. Therefore, rising
short-term interest rates result in lower income for the longer-term portion,
and vice versa. The longer-term bonds can be very volatile and may be less
liquid than other Municipal Bonds of comparable maturity. An investment in RIBS
typically will involve greater risk than an investment in a fixed rate bond.
Because changes in the interest rate on the other security or index inversely
affect the residual interest paid on a RIB, the value of a RIB is generally more
volatile than that of a fixed rate bond. RIBS have interest rate adjustment
formulas which generally reduce or, in the extreme, eliminate the interest paid
to the Fund when short-term interest rates rise, and increase the interest paid
to the Fund when short-term interest rates fall. RIBS have varying degrees of
liquidity, and the market for these securities is volatile. These securities
generally will to underperform the market for fixed rate bonds in a rising
interest rate environment, but tend to outperform the market for fixed rate
bonds when interest rates decline or remain relatively stable. Although
volatile, RIBS typically offer the potential for yields exceeding the yields
available on fixed rate bonds with comparable credit quality, coupon, call
provisions and maturity. The Fund may also invest in RIBS for the purpose of
increasing the Fund's leverage as a more flexible alternative to the issuance of
Preferred Shares. Should short-term interest rates rise, the combination of the
Fund's investment in RIBS and its use of other forms of leverage (including
through the issuance of Preferred Shares or the use of other derivative
instruments) likely will adversely affect the Fund's net asset value per share
and income and distributions to shareholders. Trusts in which RIBS may be held
could be terminated, in which case the residual bond holder would take
possession of the underlying bond on an unleveraged basis.
SHORT-TERM INVESTMENTS / TEMPORARY DEFENSIVE STRATEGIES
Upon PIMCO's recommendation, temporarily or for defensive purposes and in
order to keep the Fund's cash fully invested, including the period during which
the net proceeds of the
7
offering are being invested, the Fund may invest up to 100% of its net assets in
short-term investments including high quality, short- term securities that may
be either tax-exempt or taxable. The Fund intends to invest in taxable
short-term investments only in the event that suitable tax- exempt short-term
investments are not available at reasonable prices and yields. To the extent the
Fund invests in taxable short-term investments, the Fund will not at such times
be in a position to achieve its investment objective of providing current income
exempt from federal income tax.
Short-Term Taxable Fixed Income Securities
------------------------------------------
Short-term taxable fixed income investments are defined to include, without
limitation, the following:
(1) U.S. government securities, including bills, notes and bonds
differing as to maturity and rates of interest that are either issued or
guaranteed by the U.S. Treasury or by U.S. government agencies or
instrumentalities. U.S. government agency securities include securities
issued by (a) the Federal Housing Administration, Farmers Home
Administration, Export-Import Bank of the United States, Small Business
Administration, and the Government National Mortgage Association, whose
securities are supported by the full faith and credit of the United States;
(b) the Federal Home Loan Banks, Federal Intermediate Credit Banks, and the
Tennessee Valley Authority, whose securities are supported by the right of
the agency to borrow from the U.S. Treasury; (c) the Federal National
Mortgage Association, whose securities are supported by the discretionary
authority of the U.S. government to purchase certain obligations of the
agency or instrumentality; and (d) the Student Loan Marketing Association,
whose securities are supported only by its credit. While the U.S.
government provides financial support to such U.S. government-sponsored
agencies or instrumentalities, no assurance can be given that it always
will do so since it is not so obligated by law. The U.S. government, its
agencies, and instrumentalities do not guarantee the market value of their
securities. Consequently, the value of such securities may fluctuate.
(2) Certificates of deposit issued against funds deposited in a bank
or a savings and loan association. Such certificates are for a definite
period of time, earn a specified rate of return, and are normally
negotiable. The issuer of a certificate of deposit agrees to pay the
amount deposited plus interest to the bearer of the certificate on the date
specified thereon. Under current FDIC regulations, the maximum insurance
payable as to any one certificate of deposit is $100,000; therefore,
certificates of deposit purchased by the Fund may not be fully insured.
(3) Repurchase agreements, which involve purchases of debt
securities. A repurchase agreement is a contractual agreement whereby the
seller of securities (U.S. Government securities or Municipal Bonds) agrees
to repurchase the same security at a specified price on a future date
agreed upon by the parties. The agreed-upon repurchase price determines
the yield during the Fund's holding period. Repurchase agreements are
considered to be loans collateralized by the underlying security that is
the subject of the repurchase contract. Income generated from transactions
in repurchase agreements will be taxable. The Fund will only enter into
repurchase agreements with registered
8
securities dealers or domestic banks that PIMCO believes present minimal
credit risk. The risk to the Fund is limited to the ability of the issuer
to pay the agreed-upon repurchase price on the delivery date; however,
although the value of the underlying collateral at the time the transaction
is entered into always equals or exceeds the agreed-upon repurchase price,
if the value of the collateral declines there is a risk of loss of both
principal and interest. In the event of default, the collateral may be sold
but the Fund might incur a loss if the value of the collateral declines,
and might incur disposition costs or experience delays in connection with
liquidating the collateral. In addition, if bankruptcy proceedings are
commenced with respect to the seller of the security, realization upon the
collateral by the Fund may be delayed or limited. PIMCO will monitor the
value of the collateral at the time the transaction is entered into and at
all times subsequent during the term of the repurchase agreement in an
effort to determine that such value always equals or exceeds the
agreed-upon repurchase price. In the event the value of the collateral
declines below the repurchase price, PIMCO will demand additional
collateral from the issuer to increase the value of the collateral to at
least that of the repurchase price, including interest.
(4) Commercial paper, which consists of short-term unsecured
promissory notes, including variable rate master demand notes issued by
corporations to finance their current operations. Master demand notes are
direct lending arrangements between the Fund and a corporation. There is
no secondary market for such notes. However, they are redeemable by the
Fund at any time. PIMCO will consider the financial condition of the
corporation (e.g., earning power, cash flow, and other liquidity ratios)
and will continuously monitor the corporation's ability to meet all of its
financial obligations, because the Fund's liquidity might be impaired if
the corporation were unable to pay principal and interest on demand.
Investments in commercial paper will be limited to commercial paper rated
in the highest categories by a major rating agency and which mature within
one year of the date of purchase or carry a variable or floating rate of
interest.
Short-Term Tax-Exempt Fixed Income Securities
---------------------------------------------
Short-term tax-exempt fixed-income securities are securities that are
exempt from regular federal income tax and mature within three years or less
from the date of issuance. Short-term tax-exempt fixed income securities are
defined to include, without limitation, the following:
Bond Anticipation Notes ("BANs") are usually general obligations of state
and local governmental issuers which are sold to obtain interim financing for
projects that will eventually be funded through the sale of long-term debt
obligations or bonds. The ability of an issuer to meet its obligations on its
BANs is primarily dependent on the issuer's access to the long-term Municipal
Bond market and the likelihood that the proceeds of such bond sales will be used
to pay the principal and interest on the BANs.
Tax Anticipation Notes ("TANs") are issued by state and local governments
to finance the current operations of such governments. Repayment is generally
to be derived from specific future tax revenues. TANs are usually general
obligations of the issuer. A weakness in an issuer's capacity to raise taxes
due to, among other things, a decline in its tax base or a rise in
9
delinquencies, could adversely affect the issuer's ability to meet its
obligations on outstanding TANs.
Revenue Anticipation Notes ("RANs") are issued by governments or
governmental bodies with the expectation that future revenues from a designated
source will be used to repay the notes. In general, they also constitute
general obligations of the issuer. A decline in the receipt of projected
revenues, such as anticipated revenues from another level of government, could
adversely affect an issuer's ability to meet its obligations on outstanding
RANs. In addition, the possibility that the revenues would, when received, be
used to meet other obligations could affect the ability of the issuer to pay the
principal and interest on RANs.
Construction Loan Notes are issued to provide construction financing for
specific projects. Frequently, these notes are redeemed with funds obtained
from the Federal Housing Administration.
Bank Notes are notes issued by local government bodies and agencies, such
as those described above to commercial banks as evidence of borrowings. The
purposes for which the notes are issued are varied but they are frequently
issued to meet short-term working capital or capital-project needs. These notes
may have risks similar to the risks associated with TANs and RANs.
Tax-Exempt Commercial Paper ("Municipal Paper") represents very short-term
unsecured, negotiable promissory notes issued by states, municipalities and
their agencies. Payment of principal and interest on issues of Municipal Paper
may be made from various sources, to the extent the funds are available
therefrom. Maturities of Municipal Paper generally will be shorter than the
maturities of TANs, BANs or RANs. There is a limited secondary market for
issues of Municipal Paper.
Certain Municipal Bonds may carry variable or floating rates of interest
whereby the rate of interest is not fixed but varies with changes in specified
market rates or indices, such as a bank prime rate or a tax-exempt money market
index.
While the various types of notes described above as a group represent the
major portion of the tax-exempt note market, other types of notes are available
in the marketplace and the Fund may invest in such other types of notes to the
extent permitted under its investment objective, policies and limitations. Such
notes may be issued for different purposes and may be secured differently from
those mentioned above.
HIGH YIELD SECURITIES ("JUNK BONDS")
The Fund may invest up to 20% of its net assets in Municipal Bonds that, at
the time of investment, are rated Ba/BB or B by Moody's, S&P or Fitch or unrated
but judged to be of comparable quality by PIMCO. Bonds of below investment
grade quality (Ba/BB or below) are commonly referred to as "high yield
securities" or "junk bonds." Issuers of bonds rated Ba/BB or B are regarded as
having current capacity to make principal and interest payments but are subject
to business, financial or economic conditions which could adversely affect such
payment capacity. Municipal bonds rated Baa or BBB are considered "investment
grade" securities, although such bonds may be considered to possess some
speculative characteristics. Municipal
10
Bonds rated AAA in which the Fund may invest may have been so rated on the basis
of the existence of insurance guaranteeing the timely payment, when due, of all
principal and interest.
High yield securities are regarded as predominantly speculative with
respect to the issuer's continuing ability to meet principal and interest
payments and, therefore, carry greater price volatility and principal and income
risk, including the possibility of issuer default and bankruptcy and increased
market price volatility.
High yield securities may be more susceptible to real or perceived adverse
economic and competitive industry conditions than investment grade securities.
A projection of an economic downturn or of a period of rising interest rates,
for example, could cause a decline in high yield security prices because the
advent of a recession could lessen the ability of an issuer to make principal
and interest payments on its debt securities. If an issuer of high yield
securities defaults, in addition to risking payment of all or a portion of
interest and principal, the Fund may incur additional expenses to seek recovery.
In the case of high yield securities structured as zero-coupon or pay-in-kind
securities, their market prices are affected to a greater extent by interest
rate changes, and therefore tend to be more volatile than securities which pay
interest periodically and in cash. PIMCO seeks to reduce these risks through
diversification, credit analysis and attention to current developments and
trends in both the economy and financial markets.
The secondary market on which high yield securities are traded may be less
liquid than the market for higher grade securities. Less liquidity in the
secondary trading market could adversely affect the price at which the Fund
could sell a high yield security, and could adversely affect the daily net asset
value of the shares. Adverse publicity and investor perceptions, whether or not
based on fundamental analysis, may decrease the values and liquidity of high
yield securities, especially in a thinly traded market. When secondary markets
for high yield securities are less liquid than the market for higher grade
securities, it may be more difficult to value the securities because such
valuation may require more research, and elements of judgment may play a greater
role in the valuation because there is less reliable, objective data available.
During periods of thin trading in these markets, the spread between bid and
asked prices is likely to increase significantly and the Fund may have greater
difficulty selling its portfolio securities. The Fund will be more dependent on
PIMCO's research and analysis when investing in high yield securities. PIMCO
seeks to minimize the risks of investing in all securities through
diversification, in-depth credit analysis and attention to current developments
in interest rates and market conditions.
A general description of Moody's, S&P's and Fitch's ratings of Municipal
Bonds is set forth in Appendix A hereto. The ratings of Moody's, S&P and Fitch
represent their opinions as to the quality of the Municipal Bonds they rate. It
should be emphasized, however, that ratings are general and are not absolute
standards of quality. Consequently, Municipal Bonds with the same maturity,
coupon and rating may have different yields while obligations with the same
maturity and coupon with different ratings may have the same yield. For these
reasons, the use of credit ratings as the sole method of evaluating high yield
securities can involve certain risks. For example, credit ratings evaluate the
safety of principal and interest payments, not the market value risk of high
yield securities. Also, credit rating agencies may fail to change credit
ratings in a timely fashion to reflect events since the security was last rated.
PIMCO does not rely solely
11
on credit ratings when selecting securities for the Fund, and develops its own
independent analysis of issuer credit quality.
The Fund's credit quality policies 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 or PIMCO downgrades its assessment of the credit
characteristics of a particular issue. In determining whether to retain or sell
such a security, PIMCO may consider such factors as PIMCO's 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, assigned to such security by other rating
agencies. However, analysis of the creditworthiness of issuers of high yield
securities may be more complex than for issuers of higher quality debt
securities.
MUNICIPAL WARRANTS
The Fund may invest in municipal warrants, which are essentially call
options on Municipal Bonds. In exchange for a premium, they give the purchaser
the right, but not the obligation, to purchase a Municipal Bond in the future.
The Fund might purchase a warrant to lock in forward supply in an environment
where the current issuance of bonds is sharply reduced. Like options, warrants
may expire worthless and they may have reduced liquidity.
VARIABLE AND FLOATING RATE SECURITIES
Variable and floating rate securities provide for a periodic adjustment in
the interest rate paid on the obligations. The terms of such obligations must
provide that interest rates are adjusted periodically based upon an interest
rate adjustment index as provided in the respective obligations. The adjustment
intervals may be regular, and range from daily up to annually, or may be event
based, such as based on a change in the prime rate.
The Fund may invest in floating rate debt instruments ("floaters") and
engage in credit spread trades. The interest rate on a floater is a variable
rate which is tied to another interest rate, such as a municipal bond index or
Treasury bill rate. The interest rate on a floater resets periodically,
typically every six months. While, because of the interest rate reset feature,
floaters provide the Fund with a certain degree of protection against rises in
interest rates, the Fund will participate in any declines in interest rates as
well. A credit spread trade is an investment position relating to a difference
in the prices or interest rates of two bonds or other securities, where the
value of the investment position is determined by movements in the difference
between the prices or interest rates, as the case may be, of the respective
securities or currencies.
STRUCTURED NOTES AND OTHER HYBRID INSTRUMENTS
The Fund may invest in "structured" notes, which are privately negotiated
debt obligations where the principal and/or interest is determined by reference
to the performance of a benchmark asset or market, such as selected securities
or an index of securities, or the differential performance of two assets or
markets, such as indices reflecting taxable and tax-exempt bonds. Depending on
the terms of the note, the Fund may forgo all or part of the interest and
principal that would be payable on a comparable conventional note. The rate of
return on structured notes may be determined by applying a multiplier to the
performance or differential performance of the referenced index(es) or other
asset(s). Application of a multiplier involves
12
leverage which will serve to magnify the potential for gain and the risk of
loss. The Fund currently intends that any use of structured notes will be for
the purpose of reducing the interest rate sensitivity of the Fund's portfolio
(and thereby decreasing the Fund's exposure to interest rate risk) and, in any
event, that the interest income on the notes will be exempt from federal and
California income tax. Like other sophisticated strategies, the Fund's use of
structured notes may not work as intended; for example, by reducing the duration
of the Fund's portfolio, structured notes may limit the Fund's return when
having a longer duration would be beneficial (for instance, when interest rates
decline).
The Fund may also invest in other "hybrid" instruments which combine the
characteristics of securities, futures, and options. Hybrids can be used as an
efficient means of pursuing a variety of investment goals, including duration
management and increased total return. Hybrids may not bear interest or pay
dividends. The value of a hybrid or its interest rate may be a multiple of a
benchmark and, as a result, may be leveraged and move (up or down) more steeply
and rapidly than the benchmark. These benchmarks may be sensitive to economic
and political events that cannot be readily foreseen by the purchaser of a
hybrid. Under certain conditions, the redemption value of a hybrid could be
zero. Thus, an investment in a hybrid may entail significant market risks that
are not associated with a similar investment in a traditional, U.S. dollar-
denominated bond that has a fixed principal amount and pays a fixed rate or
floating rate of interest. The purchase of hybrids also exposes the Fund to the
credit risk of the issuer of the hybrids. These risks may cause significant
fluctuations in the net asset value of the Fund.
Certain issuers of structured products such as hybrid instruments may be
deemed to be investment companies as defined in the Investment Company Act of
1940 and the rules and regulations thereunder, as amended from time to time (the
"1940 Act"). As a result, the Fund's investments in these products will be
subject to limits applicable to investments in investment companies and may be
subject to restrictions contained in the 1940 Act.
BORROWING
The Fund may borrow money to the extent permitted under the 1940 Act as
interpreted, modified or otherwise permitted by regulatory authority having
jurisdiction, from time to time. This means that, in general, the Fund may
borrow money from banks for any purpose on a secured basis in an amount up to
one-third of the Fund's total assets. The Fund may also borrow money for
temporary administrative purposes on an unsecured basis to the extent permitted
by law.
Specifically, provisions of the 1940 Act require the Fund to maintain
continuous asset coverage (that is, total assets including borrowings, less
liabilities exclusive of borrowings) of 300% of the amount borrowed, with an
exception for borrowings not in excess of 5% of the Fund's total assets made for
temporary administrative purposes. Any borrowings for temporary administrative
purposes in excess of 5% of the Fund's total assets must maintain continuous
asset coverage. If the 300% asset coverage should decline as a result of market
fluctuations or other reasons, the Fund may be required to sell some of its
portfolio holdings within three days to reduce the debt and restore the 300%
asset coverage, even though it may be disadvantageous from an investment
standpoint to sell securities at that time.
13
As noted below, the Fund also may enter into certain transactions,
including reverse repurchase agreements, that can be viewed as constituting a
form of borrowing or financing transaction by the Fund. To the extent the Fund
covers its commitment under a reverse repurchase agreement (or economically
similar transaction) by the segregation of assets determined to be liquid by
PIMCO in accordance with procedures adopted by the Trustees, equal in value to
the amount of the Fund's commitment to repurchase, such an agreement will not be
considered a "senior security" by the Fund and therefore will not be subject to
the 300% asset coverage requirement otherwise applicable to borrowings by the
Fund. Borrowing will tend to exaggerate the effect on net asset value of any
increase or decrease in the market value of the Fund's portfolio. Money
borrowed will be subject to interest costs which may or may not be recovered by
appreciation of the securities purchased. The Fund also may be required to
maintain minimum average balances in connection with such borrowing or to pay a
commitment or other fee to maintain a line of credit; either of these
requirements would increase the cost of borrowing over the stated interest rate.
The Fund may enter into reverse repurchase agreements and economically
similar transactions. 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 assets determined to be liquid by PIMCO in accordance
with procedures established by the Board of Trustees, 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 liquid assets at least equal to the amount of any forward
purchase commitment, such transactions would be subject to the Fund's
limitations on borrowings, which would, among other things, restrict the
aggregate of such transactions (plus any other borrowings) to one-third of the
Fund's total assets.
The Fund also may effect simultaneous purchase and sale transactions that
are known as "sale-buybacks." A sale-buyback is similar to a reverse repurchase
agreement, except that in a sale-buyback, the counterparty who purchases the
security is entitled to receive any principal or interest payments made on the
underlying security pending settlement of the Fund's repurchase of the
underlying security. The Fund's obligations under a sale-buyback typically
would be offset by liquid assets equal in value to the amount of the Fund's
forward commitment to repurchase the subject security.
DERIVATIVE INSTRUMENTS
In pursuing its investment objective, the Fund may purchase and sell
(write) both put options and call options on securities, swap agreements, and
securities indexes, and enter into interest rate and index futures contracts and
purchase and sell options on such futures contracts ("futures options") for
hedging purposes or as part of its overall investment strategy. The Fund also
may enter into swap agreements with respect to interest rates and indexes of
securities. If other types of financial instruments, including other types of
options, futures contracts, or futures
14
options are traded in the future, the Fund may also use those instruments,
provided that the Trustees determine that their use is consistent with the
Fund's investment objective.
The value of some derivative instruments in which the Fund may invest may
be particularly sensitive to changes in prevailing interest rates, and, like the
other investments of the Fund, the ability of the Fund to successfully utilize
these instruments may depend in part upon the ability of PIMCO to forecast
interest rates and other economic factors correctly. If PIMCO incorrectly
forecasts such factors and has taken positions in derivative instruments
contrary to prevailing market trends, the Fund could be exposed to the risk of
loss.
The Fund might not employ any of the strategies described below, and no
assurance can be given that any strategy used will succeed. If PIMCO
incorrectly forecasts interest rates, market values or other economic factors in
utilizing a derivatives strategy for the Fund, the Fund might have been in a
better position if it had not entered into the transaction at all. Also,
suitable derivative transactions may not be available in all circumstances. The
use of these strategies involves certain special risks, including a possible
imperfect correlation, or even no correlation, between price movements of
derivative instruments and price movements of related investments. While some
strategies involving derivative instruments can reduce the risk of loss, they
can also reduce the opportunity for gain or even result in losses by offsetting
favorable price movements in related investments or otherwise, due to the
possible inability of the Fund to purchase or sell a portfolio security at a
time that otherwise would be favorable or the possible need to sell a portfolio
security at a disadvantageous time because the Fund is required to maintain
asset coverage or offsetting positions in connection with transactions in
derivative instruments, and the possible inability of the Fund to close out or
to liquidate its derivatives positions. Income earned by the Fund from many
derivative strategies will be treated as capital gain and, if not offset by net
realized capital loss, will be distributed to shareholders in taxable
distributions.
OPTIONS ON SECURITIES, SWAP AGREEMENTS AND INDEXES. The Fund may purchase
and sell both put and call options on Municipal Bonds or other securities, swap
agreements or indexes in standardized contracts traded on domestic or other
securities exchanges, boards of trade, or similar entities, or quoted on NASDAQ
or on an over-the-counter market, and agreements, sometimes called cash puts,
which may accompany the purchase of a new issue of bonds from a dealer.
An option on a security (or index) is a contract that gives the holder of
the option, in return for a premium, the right to buy from (in the case of a
call) or sell to (in the case of a put) the writer of the option the security
underlying the option (or the cash value of the index) at a specified exercise
price at any time during the term of the option. The writer of an option on a
security has the obligation upon exercise of the option to deliver the
underlying security upon payment of the exercise price or to pay the exercise
price upon delivery of the underlying security. Upon exercise, the writer of an
option on an index is obligated to pay the difference between the cash value of
the index and the exercise price multiplied by the specified multiplier for the
index option. (An index is designed to reflect features of a particular
Municipal Bond or other market, a specific group of financial instruments or
securities, or certain economic indicators.)
15
The Fund will write call options and put options only if they are
"covered." In the case of a call option on a Municipal Bond or other security,
the option is "covered" if 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, cash or other
assets determined to be liquid by PIMCO in accordance with procedures
established by the Board of Trustees, in such amount are segregated by its
custodian) upon conversion or exchange of other securities held by the Fund.
For a call option on an index, the option is covered if the Fund maintains with
its custodian assets determined to be liquid by PIMCO in accordance with
procedures established by the Board of Trustees, in an amount equal to the
contract value of the index. A call option is also covered if the Fund holds a
call on the same security or index as the call written where the exercise price
of the call held is (i) equal to or less than the exercise 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 assets determined to be
liquid by PIMCO in accordance with procedures established by the Board of
Trustees. A put option on a security or an index is "covered" if the Fund
segregates assets determined to be liquid by PIMCO in accordance with procedures
established by the Board of Trustees equal to the exercise price. A put option
is also covered if the Fund holds a put on the same security or index as the put
written where the exercise price of the put held 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
assets determined to be liquid by PIMCO in accordance with procedures
established by the Board of Trustees.
If an option written by the Fund expires unexercised, the Fund realizes a
capital gain equal to the premium received at the time the option was written.
If an option purchased by the Fund expires unexercised, the Fund realizes a
capital loss equal to the premium paid. Prior to the earlier of exercise or
expiration, an exchange traded option may be closed out by an offsetting
purchase or sale of an option of the same series (type, exchange, underlying
security or index, exercise price, and expiration). There can be no assurance,
however, that a closing purchase or sale transaction can be effected when the
Fund desires.
The Fund may sell put or call options it has previously purchased, which
could result in a net gain or loss depending on whether the amount realized on
the sale is more or less than the premium and other transaction costs paid on
the put or call option which is sold. Prior to exercise or expiration, an
option may be closed out by an offsetting purchase or sale of an option of the
same series. The Fund will realize a capital gain from a closing purchase
transaction if the cost of the closing option is less than the premium received
from writing the option, or, if it is more, the Fund will realize a capital
loss. If the premium received from a closing sale transaction is more than the
premium paid to purchase the option, the Fund will realize a capital gain or, if
it is less, the Fund will realize a capital loss. 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 or index in
relation to the exercise price of the option, the volatility of the underlying
security or index, and the time remaining until the expiration date.
The premium paid for a put or call option purchased by the Fund is an asset
of the Fund. The premium received for an option written by the Fund is recorded
as a deferred credit. The value of an option purchased or written is marked to
market daily and is valued at the closing
16
price on the exchange on which it is traded or, if not traded on an exchange or
no closing price is available, at the mean between the last bid and asked
prices.
The Fund may write covered straddles consisting of a combination of a call
and a put written on the same underlying security. A straddle will be covered
when sufficient assets are deposited to meet the Fund's immediate obligations.
The Fund may use the same liquid assets to cover both the call and put options
where the exercise price of the call and put are the same, or the exercise price
of the call is higher than that of the put. In such cases, the Fund will also
segregate liquid assets equivalent to the amount, if any, by which the put is
"in the money."
Risks Associated with Options on Securities and Indexes. There are several
risks associated with transactions in options on securities and on indexes. For
example, there are significant differences between the securities and options
markets that could result in an imperfect correlation between these markets,
causing a given transaction not to achieve its objectives. A decision as to
whether, when and how to use options involves the exercise of skill and
judgment, and even a well-conceived transaction may be unsuccessful to some
degree because of market behavior or unexpected events.
During the option period, the covered call writer has, in return for the
premium on the option, given up the opportunity to profit from a price increase
in the underlying security above the exercise price, but, as long as its
obligation as a writer continues, has retained the risk of loss should the price
of the underlying security decline. The writer of an option has no control over
the time when it may be required to fulfill its obligation as a writer of the
option. 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 and must deliver the underlying security at the exercise price. If a put
or call option purchased by the Fund is not sold when it has remaining value,
and if the market price of the underlying security remains equal to or greater
than the exercise price (in the case of a put), or remains less than or equal to
the exercise price (in the case of a call), the Fund will lose its entire
investment in the option. Also, where a put or call option on a particular
security is purchased to hedge against price movements in a related security,
the price of the put or call option may move more or less than the price of the
related security.
There can be no assurance that a liquid market will exist when the Fund
seeks to close out an option position. If the Fund were unable to close out an
option that it had purchased on a security, it would have to exercise the option
in order to realize any profit or the option may expire worthless. If the Fund
were unable to close out a covered call option that it had written on a
security, it would not be able to sell the underlying security unless the option
expired without exercise. As the writer of a covered call option, the Fund
forgoes, during the option's life, the opportunity to profit from increases in
the market value of the security covering the call option above the sum of the
premium and the exercise price of the call.
If trading were suspended in an option purchased by the Fund, the Fund
would not be able to close out the option. If restrictions on exercise were
imposed, the Fund might be unable to exercise an option it has purchased. Except
to the extent that a call option on an index written by the Fund is covered by
an option on the same index purchased by the Fund, movements in the index may
result in a loss to the Fund; however, such losses may be mitigated by changes
in the value of the Fund's securities during the period the option was
outstanding.
17
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS. The Fund may invest in
interest rate futures contracts and options thereon ("futures options"). The
Fund may also purchase and sell futures contracts on Municipal Bonds and U.S.
government securities, as well as purchase put and call options on such futures
contracts.
An interest rate or index futures contract provides for the future sale by
one party and purchase by another party of a specified quantity of a Municipal
Bond or other financial instrument or the cash value of an index at a specified
price and time. A futures contract on a Municipal Bond or other index is an
agreement pursuant to which two parties agree to take or make delivery of an
amount of cash equal to the difference between the value of the index at the
close of the last trading day of the contract and the price at which the index
contract was originally written. Although the value of an index might be a
function of the value of certain specified securities, no physical delivery of
these securities is made. A public market exists in futures contracts covering a
number of indexes as well as financial instruments, including: certain Municipal
Bonds; U.S. Treasury bonds; U.S. Treasury notes; three-month U.S. Treasury
bills; 90-day commercial paper; and bank certificates of deposit. It is expected
that other futures contracts will be developed and traded in the future.
The Fund may purchase and write call and put futures options. Futures
options possess many of the same characteristics as options on securities and
indexes (discussed above). A futures option gives the holder the right, in
return for the premium paid, to assume a long position (call) or short position
(put) in a futures contract at a specified exercise price at any time during the
period of the option. Upon exercise of a call option, the holder acquires a long
position in the futures contract and the writer is assigned the opposite short
position. In the case of a put option, the opposite is true.
To comply with applicable rules of the Commodity Futures Trading Commission
("CFTC") under which the Fund avoids being deemed a "commodity pool" or a
"commodity pool operator," the Fund intends generally to limit its use of
futures contracts and futures options to "bona fide hedging" transactions, as
such term is defined in applicable regulations, interpretations and practice.
For example, the Fund might use futures contracts to hedge against anticipated
changes in interest rates that might adversely affect either the value of the
Fund's Municipal Bonds or the price of the bonds which the Fund intends to
purchase. The Fund's hedging activities may include sales of futures contracts
as an offset against the effect of expected increases in interest rates, and
purchases of futures contracts as an offset against the effect of expected
declines in interest rates. Although other techniques could be used to reduce
the Fund's exposure to interest rate fluctuations, the Fund may be able to hedge
its exposure more effectively and perhaps at a lower cost by using futures
contracts and futures options.
The Fund will only enter into futures contracts and futures options which
are standardized and traded on a U.S. or other exchange, board of trade, or
similar entity, or quoted on an automated quotation system.
When a purchase or sale of a futures contract is made by the Fund, the Fund
is required to
18
deposit with its custodian (or broker, if legally permitted) a specified amount
of assets determined to be liquid by PIMCO in accordance with procedures
established by the Board of Trustees ("initial margin"). The margin required for
a futures contract is set by the exchange on which the contract is traded and
may be modified during the term of the contract. The initial margin is in the
nature of a performance bond or good faith deposit on the futures contract which
is returned to the Fund upon termination of the contract, assuming all
contractual obligations have been satisfied. The Fund expects to earn taxable
interest income on its initial margin deposits. A futures contract held by the
Fund is valued daily at the official settlement price of the exchange on which
it is traded. Each day the Fund pays or receives cash, called "variation
margin," equal to the daily change in value of the futures contract. This
process is known as "marking to market." Variation margin does not represent a
borrowing or loan by the Fund but is instead a settlement between the Fund and
the broker of the amount one would owe the other if the futures contract
expired. In computing daily net asset value, each Fund will mark to market its
open futures positions.
The Fund is also required to deposit and maintain margin with respect to
put and call options on futures contracts written by it. Such margin deposits
will vary depending on the nature of the underlying futures contract (and the
related initial margin requirements), the current market value of the option,
and other futures positions held by the Fund.
Although some futures contracts call for making or taking delivery of the
underlying securities, generally these obligations are closed out prior to
delivery by offsetting purchases or sales of matching futures contracts
(involving the same exchange, underlying security or index, and delivery month).
If an offsetting purchase price is less than the original sale price, the Fund
realizes a capital gain, or if it is more, the Fund realizes a capital loss.
Conversely, if an offsetting sale price is more than the original purchase
price, the Fund realizes a capital gain, or if it is less, the Fund realizes a
capital loss. The transaction costs must also be included in these calculations.
The Fund may write covered straddles consisting of a call and a put written
on the same underlying futures contract. A straddle will be covered when
sufficient assets are deposited to meet the Fund's immediate obligations. The
Fund may use the same liquid assets to cover both the call and put options where
the exercise price of the call and put are the same, or the exercise price of
the call is higher than that of the put. In such cases, the Fund will also
segregate liquid assets equivalent to the amount, if any, by which the put is
"in the money."
LIMITATIONS ON USE OF FUTURES AND FUTURES OPTIONS. As noted above, the Fund
generally intends to enter into positions in futures contracts and related
options only for "bona fide hedging" purposes. With respect to positions in
futures and related options that do not constitute bona fide hedging positions,
the Fund will not enter into a futures contract or futures option contract if,
immediately thereafter, the aggregate initial margin deposits relating to such
positions plus premiums paid by it for open futures option positions, less the
amount by which any such options are "in-the-money," would exceed 5% of the
Fund's net assets. A call option is "in-the-money" if the value of the futures
contract that is the subject of the option exceeds the exercise price. A put
option is "in-the-money" if the exercise price exceeds the value of the futures
contract that is the subject of the option.
19
When purchasing a futures contract, the Fund will maintain with its
custodian (and mark-to-market on a daily basis) assets determined to be liquid
by PIMCO in accordance with procedures established by the Board of Trustees,
that, when added to the amounts deposited with a futures commission merchant as
margin, are equal to the market value of the futures contract. Alternatively,
the Fund may "cover" its position by purchasing a put option on the same futures
contract with a strike price as high or higher than the price of the contract
held by the Fund.
When selling a futures contract, the Fund will maintain with its custodian
(and mark-to-market on a daily basis) assets determined to be liquid by PIMCO in
accordance with procedures established by the Board of Trustees, that are equal
to the market value of the instruments underlying the contract. Alternatively,
the Fund may "cover" its position by owning the instruments underlying the
contract (or, in the case of an index futures contract, a portfolio with a
volatility substantially similar to that of the index on which the futures
contract is based), or by holding a call option permitting the Fund to purchase
the same futures contract at a price no higher than the price of the contract
written by the Fund (or at a higher price if the difference is maintained in
liquid assets with the Trust's custodian).
When selling a call option on a futures contract, the Fund will maintain
with its custodian (and mark-to-market on a daily basis) assets determined to be
liquid by PIMCO in accordance with procedures established by the Board of
Trustees, that, when added to the amounts deposited with a futures commission
merchant as margin, equal the total market value of the futures contract
underlying the call option. Alternatively, the Fund may cover its position by
entering into a long position in the same futures contract at a price no higher
than the strike price of the call option, by owning the instruments underlying
the futures contract, or by holding a separate call option permitting the Fund
to purchase the same futures contract at a price not higher than the strike
price of the call option sold by the Fund.
When selling a put option on a futures contract, the Fund will maintain
with its custodian (and mark-to-market on a daily basis) assets determined to be
liquid by PIMCO in accordance with procedures established by the Board of
Trustees, that equal the purchase price of the futures contract, less any margin
on deposit. Alternatively, the Fund may cover the position either by entering
into a short position in the same futures contract, or by owning a separate put
option permitting it to sell the same futures contract so long as the strike
price of the purchased put option is the same or higher than the strike price of
the put option sold by the Fund.
To the extent that securities with maturities greater than one year are
used to segregate assets to cover the Fund's obligations under futures contracts
and related options, such use will not eliminate the risk of a form of leverage,
which may tend to exaggerate the effect on net asset value of any increase or
decrease in the market value of the Fund's portfolio, and may require
liquidation of portfolio positions when it is not advantageous to do so.
RISKS ASSOCIATED WITH FUTURES AND FUTURES OPTIONS. There are several risks
associated with the use of futures contracts and futures options as hedging
techniques. A purchase or sale of a futures contract may result in losses in
excess of the amount invested in the futures contract. There can be no guarantee
that there will be a correlation between price movements in the
20
hedging vehicle and in the Fund securities being hedged. In addition, there are
significant differences between the securities and futures markets that could
result in an imperfect correlation between the markets, causing a given hedge
not to achieve its objectives. The degree of imperfection of correlation depends
on circumstances such as variations in speculative market demand for futures and
futures options on securities, including technical influences in futures trading
and futures options, and differences between the financial instruments being
hedged and the instruments underlying the standard contracts available for
trading in such respects as interest rate levels, maturities, and
creditworthiness of issuers. A decision as to whether, when and how to hedge
involves the exercise of skill and judgment, and even a well-conceived hedge may
be unsuccessful to some degree because of market behavior or unexpected interest
rate trends.
Futures contracts on U.S. Government securities historically have reacted
to an increase or decrease in interest rates in a manner similar to that in
which the underlying U.S. Government securities reacted. To the extent, however,
that the Fund enters into such futures contracts, the value of such futures will
not vary in direct proportion to the value of the Fund's holdings of Municipal
Bonds. Thus, the anticipated spread between the price of the futures contract
and the hedged security may be distorted due to differences in the nature of the
markets. The spread also may be distorted by differences in initial and
variation margin requirements, the liquidity of such markets and the
participation of speculators in such markets.
Futures exchanges may limit the amount of fluctuation permitted in certain
futures contract prices during a single trading day. The daily limit establishes
the maximum amount that the price of a futures contract may vary either up or
down from the previous day's settlement price at the end of the current trading
session. Once the daily limit has been reached in a futures contract subject to
the limit, no more trades may be made on that day at a price beyond that limit.
The daily limit governs only price movements during a particular trading day and
therefore does not limit potential losses because the limit may work to prevent
the liquidation of unfavorable positions. For example, futures prices have
occasionally moved to the daily limit for several consecutive trading days with
little or no trading, thereby preventing prompt liquidation of positions and
subjecting some holders of futures contracts to substantial losses.
There can be no assurance that a liquid market will exist at a time when
the Fund seeks to close out a futures or a futures option position, and the Fund
would remain obligated to meet margin requirements until the position is closed.
In addition, many of the contracts discussed above are relatively new
instruments without a significant trading history. As a result, there can be no
assurance that an active secondary market will develop or continue to exist.
Swap Agreements. The Fund may enter into interest rate, index, and credit
swap agreements. The Fund may also enter into options on swap agreements ("swap
options"). These transactions are entered into in an attempt to obtain a
particular return when it is considered desirable to do so, possibly at a lower
cost to the Fund than if the Fund had invested directly in an instrument that
yielded that desired return. Swap agreements are two-party contracts entered
into primarily by institutional investors for periods ranging from a few weeks
to more than one year. In a standard "swap" transaction, two parties agree to
exchange the returns (or differentials in rates of return) earned or realized on
particular predetermined investments or instruments, which may be adjusted for
an interest factor. The gross returns to be exchanged or
21
"swapped" between the parties are generally calculated with respect to a
"notional amount," i.e., the return on or increase in value of a particular
dollar amount invested at a particular interest rate or in a "basket" of
securities representing a particular index. Forms of swap agreements include
interest rate caps, under which, in return for a premium, one party agrees to
make payments to the other to the extent that interest rates exceed a specified
rate, or "cap"; interest rate floors, under which, in return for a premium, one
party agrees to make payments to the other to the extent that interest rates
fall below a specified rate, or "floor"; and interest rate collars, under which
a party sells a cap and purchases a floor or vice versa in an attempt to protect
itself against interest rate movements exceeding given minimum or maximum
levels. A swap option is a contract that gives a counterparty the right (but not
the obligation) to enter into a new swap agreement or to shorten, extend, cancel
or otherwise modify an existing swap agreement, at some designated future time
on specified terms. The Fund may write (sell) and purchase put and call swap
options.
Most swap agreements entered into by the Fund would calculate the
obligations of the parties to the agreement on a "net basis." Consequently, the
Fund's current obligations (or rights) under a swap agreement 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 party to the agreement (the
"net amount"). The Fund's current obligations under a swap agreement will be
accrued daily (offset against any amounts owed to the Fund) and any accrued but
unpaid net amounts owed to a swap counterparty will be covered by the
segregation of assets determined to be liquid by PIMCO in accordance with
procedures established by the Board of Trustees, to avoid any potential
leveraging of the Fund's portfolio. Obligations under swap agreements so covered
will not be construed to be "senior securities" for purposes of the Fund's
investment restriction concerning senior securities. The Fund will not enter
into a swap agreement with any single party if the net amount owed or to be
received under existing contracts with that party would exceed 5% of the Fund's
assets.
Whether the Fund's use of swap agreements or swap options will be
successful in furthering its investment objective will depend on PIMCO's ability
to predict correctly whether certain types of investments are likely to produce
greater returns than other investments. Because they are two-party contracts and
because they may have terms of greater than seven days, swap agreements may be
considered to be illiquid. Moreover, the Fund bears the risk of loss of the
amount expected to be received under a swap agreement in the event of the
default or bankruptcy of a swap agreement counterparty. The Fund will enter into
swap agreements only with counterparties that meet certain standards of
creditworthiness (generally, such counterparties would have to be eligible
counterparties under the terms of the Fund's repurchase agreement guidelines).
The swaps market is a relatively new market and is largely unregulated. It is
possible that developments in the swaps market, including potential government
regulation, could adversely affect the Fund's ability to terminate existing swap
agreements or to realize amounts to be received under such agreements.
Depending on the terms of the particular option agreement, the Fund will
generally incur a greater degree of risk when it writes a swap option than it
will incur when it purchases a swap option. When the Fund purchases a swap
option, it risks losing only the amount of the premium it has paid should it
decide to let the option expire unexercised. However, when the Fund writes
22
a swap option, upon exercise of the option the Fund will become obligated
according to the terms of the underlying agreement.
Certain swap agreements are exempt from most provisions of the Commodity
Exchange Act ("CEA") and, therefore, are not regulated as futures or commodity
option transactions under the CEA, pursuant to regulations approved by the CFTC
effective February 22, 1993. To qualify for this exemption, a swap agreement
must be entered into by "eligible participants," which includes the following,
provided the participants' total assets exceed established levels: a bank or
trust company, savings association or credit union, insurance company,
investment company subject to regulation under the 1940 Act, commodity pool,
corporation, partnership, proprietorship, organization, trust or other entity,
employee benefit plan, governmental entity, broker-dealer, futures commission
merchant, natural person, or regulated foreign person. To be eligible, natural
persons and most other entities must have total assets exceeding $10 million;
commodity pools and employee benefit plans must have assets exceeding $5
million. In addition, an eligible swap transaction must meet three conditions.
First, the swap agreement may not be part of a fungible class of agreements that
are standardized as to their material economic terms. Second, the
creditworthiness of parties with actual or potential obligations under the swap
agreement must be a material consideration in entering into or determining the
terms of the swap agreement, including pricing, cost or credit enhancement
terms. Third, swap agreements may not be entered into and traded on or through a
multilateral transaction execution facility. Swap agreements are likely to
generate capital gains income which would in turn be distributed to
shareholders.
This exemption is not exclusive, and participants may continue to rely on
existing exclusions for swaps, such as the Policy Statement issued in July 1989
which recognized a safe harbor for swap transactions from regulation as futures
or commodity option transactions under the CEA or its regulations. The Policy
Statement applies to swap transactions settled in cash that (1) have
individually tailored terms, (2) lack exchange-style offset and the use of a
clearing organization or margin system, (3) are undertaken in conjunction with a
line of business, and (4) are not marketed to the public.
SHORT SALES
The Fund may make short sales of securities as part of its overall
portfolio management strategy involving the use of derivative instruments and to
offset potential declines in long positions in securities in the Fund's
portfolio. A short sale is a transaction in which the Fund sells a security it
does not own in anticipation that the market price of that security will
decline. Although short sale transactions are not currently available with
respect to Municipal Bonds, the Fund may engage in short sales on taxable bonds
and on futures contracts with respect to Municipal Bonds and taxable bonds.
When the Fund makes a short sale on a security, it must borrow the security
sold short and deliver it to the broker-dealer through which it made the short
sale as collateral for its obligation to deliver the security upon conclusion of
the sale. The Fund may have to pay a fee to borrow particular securities and is
often obligated to pay over any accrued interest and dividends on such borrowed
securities.
23
If the price of the security sold short increases between the time of the
short sale and the time the Fund replaces the borrowed security, the Fund will
incur a loss; conversely, if the price declines, the Fund will realize a capital
gain. Any gain will be decreased, and any loss increased, by the transaction
costs described above. The successful use of short selling may be adversely
affected by imperfect correlation between movements in the price of the security
sold short and the securities being hedged.
To the extent that the Fund engages in short sales, it will provide
collateral to the broker-dealer and (except in the case of short sales "against
the box") will maintain additional asset coverage in the form of segregated
assets determined to be liquid by PIMCO in accordance with procedures
established by the Board of Trustees. The Fund does not intend to enter into
short sales (other than those "against the box") if immediately after such sale
the aggregate of the value of all collateral plus the amount of the segregated
assets exceeds one-third of the value of the Fund's net assets. This percentage
may be varied by action of the Trustees. 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. The Fund will engage
in short selling to the extent permitted by the 1940 Act and rules and
interpretations thereunder.
ILLIQUID SECURITIES
The Fund may invest up to 15% of its net assets in illiquid securities.
The term "illiquid securities" for this purpose means securities that cannot be
disposed of within seven days in the ordinary course of business at
approximately the amount at which the Fund has valued the securities. Illiquid
securities are considered to include, among other things, written over-the-
counter options, securities or other liquid assets being used as cover for such
options, repurchase agreements with maturities in excess of seven days, certain
loan participation interests, fixed time deposits which are not subject to
prepayment or provide for withdrawal penalties upon prepayment (other than
overnight deposits), and other securities whose disposition is restricted under
the federal securities laws (other than securities issued pursuant to Rule 144A
under the 1933 Act and certain commercial paper that PIMCO has determined to be
liquid under procedures approved by the Board of Trustees).
Illiquid securities may include privately placed securities, which are sold
directly to a small number of investors, usually institutions. Unlike public
offerings, such securities are not registered under the federal securities laws.
Although certain of these securities may be readily sold, others may be
illiquid, and their sale may involve substantial delays and additional costs.
PORTFOLIO TRADING AND TURNOVER RATE
Portfolio trading may be undertaken to accomplish the investment objective
of the Fund in relation to actual and anticipated movements in interest rates.
In addition, a security may be sold and another of comparable quality purchased
at approximately the same time to take advantage of what PIMCO believes to be a
temporary price disparity between the two securities. Temporary price
disparities between two comparable securities may result from supply and demand
imbalances where, for example, a temporary oversupply of certain bonds may cause
a temporarily low price for such bonds, as compared with other bonds of like
quality and characteristics. The Fund may also engage to a limited extent in
short-term trading consistent
24
with its investment objective. Securities may be sold in anticipation of a
market decline (a rise in interest rates) or purchased in anticipation of a
market rise (a decline in interest rates) and later sold, or to recognize a
gain.
A change in the securities held by the Fund is known as "portfolio
turnover." PIMCO manages the Fund without regard generally to restrictions on
portfolio turnover. The use of certain derivative instruments with relatively
short maturities may tend to exaggerate the portfolio turnover rate for the
Fund. Trading in fixed income securities does not generally involve the payment
of brokerage commissions, but does involve indirect transaction costs. The use
of futures contracts may involve the payment of commissions to futures
commission merchants. High portfolio turnover (e.g., greater than 100%)
involves correspondingly greater expenses to the Fund, including brokerage
commissions or dealer mark-ups and other transaction costs on the sale of
securities and reinvestments in other securities. The higher the rate of
portfolio turnover of the Fund, the higher these transaction costs borne by the
Fund generally will be. Transactions in the Fund's portfolio securities may
result in realization of taxable capital gains (including short-term capital
gains which are generally taxed to shareholders at ordinary income tax rates).
The trading costs and tax effects associated with portfolio turnover may
adversely affect the Fund's performance.
The portfolio turnover rate of the Fund is calculated by dividing (a) the
lesser of purchases or sales of portfolio securities for the particular fiscal
year by (b) the monthly average of the value of the portfolio securities owned
by the Fund during the particular fiscal year. In calculating the rate of
portfolio turnover, there is excluded from both (a) and (b) all securities,
including options, whose maturities or expiration dates at the time of
acquisition were one year or less.
OTHER INVESTMENT COMPANIES
The Fund may invest in securities of other open- or closed-end investment
companies that invest primarily in Municipal Bonds of the types in which the
Fund may invest directly. The Fund may invest in other investment companies
either during periods when it has large amounts of uninvested cash, such as the
period shortly after the Fund receives the proceeds of the offering of its
Common Shares or Preferred Shares, during periods when there is a shortage of
attractive, high-yielding Municipal Bonds available in the market, or when PIMCO
believes share prices of other investment companies offer attractive values.
The Fund may invest in investment companies that are advised by PIMCO or its
affiliates to the extent permitted by applicable law and/or pursuant to
exemptive relief from the SEC. As a stockholder in an investment company, the
Fund will bear its ratable share of that investment company's expenses and would
remain subject to payment of the Fund's management fees with respect to assets
so invested. PIMCO will take expenses into account when evaluating the
investment merits of an investment in an investment company relative to
available Municipal Bond investments. 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 Fund's Prospectus in
the section entitled "Risks," the net asset value and market value of
25
leveraged shares will be more volatile and the yield to shareholders will tend
to fluctuate more than the yield generated by unleveraged shares.
WHEN-ISSUED, DELAYED DELIVERY AND FORWARD COMMITMENT TRANSACTIONS
The Fund may purchase or sell securities on a when-issued, delayed
delivery, or forward commitment basis. When such purchases are outstanding, the
Fund will segregate until the settlement date assets determined to be liquid by
PIMCO in accordance with procedures established by the Board of Trustees, in an
amount sufficient to meet the purchase price. Typically, no income accrues on
securities the Fund has committed to purchase prior to the time delivery of the
securities is made, although the Fund may earn income on securities it has
segregated.
When purchasing a security on a when-issued, delayed delivery, or forward
commitment basis, the Fund assumes the rights and risks of ownership of the
security, including the risk of price and yield fluctuations, and takes such
fluctuations into account when determining its net asset value. Because the
Fund is not required to pay for the security until the delivery date, these
risks are in addition to the risks associated with the Fund's other investments.
If the Fund remains substantially fully invested at a time when when-issued,
delayed delivery, or forward commitment purchases are outstanding, the purchases
may result in a form of leverage.
When the Fund has sold a security on a when-issued, delayed delivery, or
forward commitment basis, the Fund does not participate in future gains or
losses with respect to the security. If the other party to a transaction fails
to deliver or pay for the securities, the Fund could miss a favorable price or
yield opportunity or could suffer a loss. The Fund may dispose of or
renegotiate a transaction after it is entered into, and may sell when-issued,
delayed delivery or forward commitment securities before they are delivered,
which may result in a capital gain or loss. There is no percentage limitation
on the extent to which the Fund may purchase or sell securities on a when-
issued, delayed delivery, or forward commitment basis.
ZERO COUPON BONDS
The Fund may invest in zero coupon bonds. A zero coupon bond is a bond
that does not pay interest for its entire life. The market prices of zero
coupon bonds are affected to a greater extent by changes in prevailing levels of
interest rates and thereby tend to be more volatile in price than securities
that pay interest periodically. In addition, because the Fund accrues income
with respect to these securities prior to the receipt of such interest, it may
have to dispose of portfolio securities under disadvantageous circumstances in
order to obtain cash needed to pay income dividends in amounts necessary to
avoid unfavorable tax consequences.
INVESTMENT RESTRICTIONS
FUNDAMENTAL INVESTMENT RESTRICTIONS
Except as described below, the Fund, as a fundamental policy, may not,
without the approval of the holders of a majority of the outstanding Common
Shares and Preferred Shares
26
voting together as a single class, and of the holders of a majority of the
outstanding Preferred Shares voting as a separate class:
(1) Concentrate its investments in a particular industry, as that
term is used in the Investment Company Act of 1940, as amended, and as
interpreted, modified, or otherwise permitted by regulatory authority
having jurisdiction, from time to time.
(2) Purchase or sell real estate, although it may purchase securities
(including Municipal Bonds) secured by real estate or interests therein, or
securities issued by companies which invest in real estate, or interests
therein.
(3) Purchase or sell commodities or commodities contracts or oil, gas
or mineral programs. This restriction shall not prohibit the Fund, subject
to restrictions described in the Prospectus and elsewhere in this Statement
of Additional Information, from purchasing, selling or entering into
futures contracts, options on futures contracts, forward contracts, or any
interest rate, securities-related or other hedging instrument, including
swap agreements and other derivative instruments, subject to compliance
with any applicable provisions of the federal securities or commodities
laws.
(4) Borrow money or issue any senior security, except to the extent
permitted under the Investment Company Act of 1940, as amended, and as
interpreted, modified, or otherwise permitted by regulatory authority
having jurisdiction, from time to time.
(5) Make loans, except to the extent permitted under the Investment
Company Act of 1940, as amended, and as interpreted, modified, or otherwise
permitted by regulatory authority having jurisdiction, from time to time.
(6) Act as an underwriter of securities of other issuers, except to
the extent that in connection with the disposition of portfolio securities,
it may be deemed to be an underwriter under the federal securities laws.
For purposes of the foregoing, "majority of the outstanding," when used
with respect to particular shares of the Fund (whether voting together as a
single class or voting as separate classes), means (i) 67% or more of such
shares present at a meeting, if the holders of more than 50% of such shares are
present or represented by proxy, or (ii) more than 50% of such shares, whichever
is less.
Unless otherwise indicated, all limitations applicable to the Fund's
investments (as stated above and elsewhere in this Statement of Additional
Information) apply only at the time a transaction is entered into. Any
subsequent change in a rating assigned by any rating service to a security (or,
if unrated, deemed by PIMCO to be of comparable quality), or change in the
percentage of the Fund's assets invested in certain securities or other
instruments, or change in the average maturity or duration of the Fund's
investment portfolio, resulting from market fluctuations or other changes in the
Fund's total assets, will not require the Fund to dispose of an investment until
PIMCO determines that it is practicable to sell or close out the investment
without undue market or tax consequences to the Fund. In the event that ratings
services assign different ratings to the same security, PIMCO will determine
which rating it believes best
27
reflects the security's quality and risk at that time, which may be the higher
of the several assigned ratings.
The Fund's industry concentration policy does not preclude it from focusing
investments in issuers in a group of related industries (such as different types
of utilities).
Under the 1940 Act, a "senior security" does not include any promissory
note or evidence of indebtedness where such loan is for temporary purposes only
and in an amount not exceeding 5% of the value of the total assets of the issuer
at the time the loan is made. A loan is presumed to be for temporary purposes if
it is repaid within sixty days and is not extended or renewed.
To the extent the Fund covers its commitment under a reverse repurchase
agreement (or economically similar transaction) by the segregation of assets
determined by PIMCO to be liquid in accordance with procedures adopted by the
Trustees, equal in value to the amount of the Fund's commitment to repurchase,
such an agreement will not be considered a "senior security" by the Fund and
therefore will not be subject to the 300% asset coverage requirement otherwise
applicable to borrowings by the Fund.
The staff of the SEC has taken the position that purchased over-the-counter
("OTC") options and the assets used as cover for written OTC options are
illiquid securities. Therefore, the Fund has adopted an investment policy
pursuant to which it will not purchase or sell OTC options if, as a result of
such transactions, the sum of: 1) the market value of OTC options currently
outstanding which are held by the Fund, 2) the market value of the underlying
securities covered by OTC call options currently outstanding which were sold by
the Fund and 3) margin deposits on the Fund's existing OTC options on futures
contracts, exceeds 15% of the net assets of the Fund, taken at market value,
together with all other assets of the Fund which are illiquid or are otherwise
not readily marketable. However, if an OTC option is sold by the Fund to a
primary U.S. Government securities dealer recognized by the Federal Reserve Bank
of New York and if the Fund has the unconditional contractual right to
repurchase such OTC option from the dealer at a predetermined price, then the
Fund will treat as illiquid such amount of the underlying securities equal to
the repurchase price less the amount by which the option is "in-the-money"
(i.e., current market value of the underlying securities minus the option's
strike price). The repurchase price with the primary dealers is typically a
formula price which is generally based on a multiple of the premium received for
the option, plus the amount by which the option is "in-the-money." This policy
is not a fundamental policy of the Fund and may be amended by the Trustees
without the approval of shareholders. However, the Fund will not change or
modify this policy prior to the change or modification by the SEC staff of its
position.
The Fund interprets its policies with respect to borrowing and lending to
permit such activities as may be lawful for the Fund, to the full extent
permitted by the 1940 Act or by exemption from the provisions therefrom pursuant
to exemptive order of the SEC.
The Fund intends to apply for ratings for its Preferred Shares from
Moody's. In order to obtain and maintain the required ratings, the Fund may be
required to comply with investment quality, diversification and other guidelines
established by Moody's. Such guidelines will likely be more restrictive than the
restrictions set forth above. The Fund does not anticipate that such guidelines
would have a material adverse effect on its holders of Common Shares ("Common
Shareholders") or its ability to
28
achieve its investment objective. The Fund presently anticipates that any
Preferred Shares that it intends to issue would be initially given the highest
ratings by Moody's ("Aaa"), but no assurance can be given that such ratings will
be obtained. No minimum rating is required for the issuance of Preferred Shares
by the Fund. Moody's receives fees in connection with its ratings issuances.
MANAGEMENT OF THE FUND
TRUSTEES AND OFFICERS
The business of the Fund is managed under the direction of the Fund's Board
of Trustees. Subject to the provisions of the Fund's Agreement and Declaration
of Trust (the "Declaration"), its Bylaws and Massachusetts law, the Trustees
have all powers necessary and convenient to carry out this responsibility,
including the election and removal of the Fund's officers.
The Trustees and officers of the Fund, their ages, and a description of
their principal occupations during the past five years are listed below. Except
as shown, each Trustee's and officer's principal occupation and business
experience for the last five years have been with the employer(s) indicated,
although in some cases the Trustee or officer may have held different positions
with such employer(s). Unless otherwise indicated, the business address of the
persons listed below is c/o PIMCO Advisory Services, 1345 Avenue of the
Americas, New York, New York 10105.
POSITION(S) WITH THE PRINCIPAL OCCUPATION(S) DURING THE PAST FIVE YEARS
NAME, ADDRESS AND AGE FUND
Stephen J. Treadway* Chairman, President, Executive Vice President, PIMCO Advisors; Chairman and
2187 Atlantic Street Trustee Chief Executive Officer, PIMCO Funds Distributors LLC
Stamford, CT 06902 ("PFD"); Trustee, President and Chief Executive
Age 52 Officer, PIMCO Funds: Multi-Manager Series; Chairman,
Fixed Income Shares; Trustee, Chairman and President,
OCC Cash Reserves, Inc., OCC Accumulation Trust, PIMCO
Municipal Income Fund and PIMCO New York Municipal
Income Fund; Executive Vice President, Value Advisors
LLC; Chairman, Municipal Advantage Fund, Inc.;
President, The Emerging Markets Income Fund, Inc., The
Emerging Markets Income Fund II, Inc., The Emerging
Markets Floating Rate Fund, Inc., Global Partners
Income Fund, Inc., Municipal Partners Fund, Inc. and
Municipal Partners Fund II, Inc. Formerly, Trustee,
President and Chief Executive Officer of Cash
Accumulation Trust; Chairman, The Central European
Value Fund, Inc.; Executive Vice President, Smith
Barney Inc.
Paul Belica Trustee Trustee, Fixed Income Shares, PIMCO Municipal Income
Age 79 Fund and PIMCO New York Municipal Income Fund; Manager,
Stratigos Fund, L.L.C., Whistler Fund, L.L.C., Xanthus
Fund, L.L.C. and Wynstone Fund,
29
POSITION(S) WITH THE PRINCIPAL OCCUPATION(S) DURING THE PAST FIVE YEARS
NAME, ADDRESS AND AGE FUND
L.L.C.; Director, Student Loan Finance
Corporation, Education Loans, Inc., Goal Funding,
Inc. and Surety Loan Funding Company; Former
Advisor, Salomon Smith Barney Inc.; Former
Director, Central European Value Fund, Inc., Deck
House, Inc., a manufacturing company, The Czech
Republic Fund, Inc.; Director, Senior Vice
President and Managing Director, Smith Barney,
Harris Upham and Co.; Director and Treasurer,
Isabela Home Inc., Isabela Housing Company Inc.,
and Isabela Nursing Home Inc.; Director, Dreyfus
Tax Exempt Bond Fund, Inc., Dreyfus New York State
Tax Exempt Bond Fund, Inc., and Union Dime Savings
Bank; Executive Director, New York State Housing
Finance Agency, New York State Medical Care
Facilities Finance Agency, New York State
Municipal Bond Bank Agency, New York State Project
Finance Agency and Chairman, State of New York
Mortgage Agency; President, Paul Belica and
Company, Inc., a financial advisory business;
Project Manager, Walsh Construction Company;
Member, Ministry of Foreign Affairs of
Czechoslovakia in Prague and Czechoslovak Embassy
in Vienna.
Robert E. Connor Vice President, Trustee Trustee, Fixed Income Shares, PIMCO Municipal Income
Age 66 Fund and PIMCO New York Municipal Income Fund;
Director, Municipal Advantage Fund, Inc.; Corporate
Affairs Consultant; Formerly, Senior Vice President,
Corporate Office, Salomon Smith Barney Inc.
Newton B. Schott, Jr. Vice President, Secretary Executive Vice President, Chief Administrative Officer,
2187 Atlantic Street Secretary and General Counsel, PFD; Senior Vice
Stamford, CT 06902 President -- Mutual Fund Division, PIMCO Advisors; Vice
Age 57 President and Secretary, PIMCO Funds: Multi-Manager
Series, PIMCO Municipal Income Fund and PIMCO New York
Municipal Income Fund; Executive Vice President and
Secretary, The Emerging Markets Income Fund, Inc., The
Emerging Markets Income Fund II, Inc., The Emerging
Markets Floating Rate Fund, Inc., Global Partners
Income Fund, Inc., Municipal Advantage Fund, Inc.,
Municipal Partners Fund, Inc. and Municipal Partners
Fund II, Inc.; Secretary, Fixed Income Shares.
Formerly, Vice President and Clerk, PIMCO Advisors
Funds and Cash Accumulation Trust.
30
POSITION(S) WITH THE PRINCIPAL OCCUPATION(S) DURING THE PAST FIVE YEARS
NAME, ADDRESS AND AGE FUND
Brian S. Shlissel Treasurer; Principal Vice President, PIMCO Advisors; Executive Vice
Age 36 Financial and President and Treasurer, OCC Cash Reserves, Inc. and
Accounting Officer OCC Accumulation Trust; President, Chief Executive
Officer and Treasurer, Fixed Income Shares; Treasurer,
Municipal Advantage Fund Inc.; Treasurer and Principal
Financial and Accounting Officer, PIMCO Municipal
Income Fund and PIMCO New York Municipal Income Fund.
Formerly, Vice President, Mitchell Hutchins Asset
Management Inc.
Mark V. McCray Vice President Executive Vice President, PIMCO; Vice President, PIMCO
840 Newport Center Drive Municipal Income Fund and PIMCO New York Municipal
Newport Beach, CA 92660 Income Fund Formerly, Vice President and co-head of
Age 34 municipal bond trading, Goldman Sachs & Co.
Michael B. Zuckerman Assistant Secretary Vice President, PIMCO Advisors L.P.; Secretary, OCC
Age 36 Accumulation Trust and OCC Cash Reserves, Inc.;
Assistant Secretary, PIMCO Municipal Income Fund and
PIMCO New York Municipal Income Fund Formerly,
Associate, Dechert Price and Rhoads; Associate Counsel,
Metropolitan Life Insurance Company.
* Denotes those Trustees who are "interested persons" (as defined in Section
2(a)(19) of the 1940 Act) of the Fund, PIMCO Advisors, PIMCO or one or more of
the Underwriters. Mr. Treadway is an "interested person" because of his
affiliation with PIMCO Advisors.
As of , 2001, the Fund's officers and Trustees as a group owned
less than 1% of the outstanding Common Shares.
As of , 2001, owned of record Common
Shares, representing % of the Fund's outstanding shares.
Messrs. Belica, Connor and Treadway also serve as Trustees of PIMCO
California Municipal Income Fund and PIMCO New York Municipal Income Fund
(together with the Fund, the "Municipal Funds"), two closed-end funds for which
PIMCO Advisors serves as Investment Manager and PIMCO serves as Portfolio
Manager. In addition, Mr. Belica is a director or Trustee, as the case may be,
of one open-end investment company (comprising two separate investment
portfolios) advised by PIMCO Advisors. Mr. Connor is a director or Trustee, as
the case may be, of one open-end investment company (comprising two separate
investment portfolios) and one closed-end investment company advised by PIMCO
Advisors. Mr. Treadway is a director or Trustee, as the case may be, of two
open-end investment companies (which have multiple series) and seven closed-end
investment companies advised by PIMCO Advisors or its affiliates. None of the
independent Trustees has ever been a director, officer, or employee of, or a
consultant to, PIMCO Advisors, PIMCO, any one or more of the Underwriters or any
one or more affiliates of any of the foregoing. As indicated above, certain of
the officers and Trustees of the Fund are affiliated with PIMCO Advisors and/or
PIMCO.
31
At the next annual meeting of the Fund's shareholders, holders of Preferred
Shares ("Preferred Shareholders"), voting as a separate class, will elect two
Trustees and the remaining Trustees shall be elected by Common Shareholders and
Preferred Shareholders, voting together as a single class. Holders of Preferred
Shares will be entitled to elect a majority of the Fund's Trustees under certain
circumstances. See " " in the Prospectus. See "Certain Provisions in the
Declaration of Trust" for a description of the various classes of Trustees and
their terms in office.
Each Municipal Fund has the same Board of Trustees. The Municipal Funds
are expected to hold joint meetings of their Boards of Trustees whenever
possible. Each Trustee, other than those affiliated with PIMCO Advisors or its
affiliates, receives $6,000 for each joint meeting ($2,000 for each Municipal
Fund) for the first four joint meetings in each year and $3,000 for each
additional joint meeting ($1,000 for each Municipal Fund) in such year if the
meetings are attended in person. Trustees receive $1,500 per joint meeting
($500 for each Municipal Fund) if the meetings are attended telephonically.
Members of the Audit Oversight Committee will receive $1,500 per joint meeting
($500 for each Municipal Fund) of the Municipal Funds' Audit Oversight
Committees if the meeting takes place on a day other than the day of a regularly
scheduled Board meeting. Trustees will also be reimbursed for meeting-related
expenses.
The Municipal Funds will allocate the costs of their joint meetings to the
Municipal Funds pro rata based on the Funds' net assets, including assets
attributable to the Preferred Shares.
It is estimated that the Trustees will receive the amounts set forth below
for the fiscal year ending April 30, 2002. For the calendar year ended December
31, 2000, the Trustees received the compensation set forth in the following
table for serving as trustees of other funds in the "Fund Complex." The
officers and Trustees affiliated with PIMCO Advisors serve without any
compensation from the Fund.
Estimated Compensation Total Compensation
from the Fund for the from the Fund Complex Paid to
Fiscal Year Ended the Trustees for the Calendar
Name of Trustee April 30, 2002* Year Ended December 31, 2000**
--------------- --------------- ------------------------------
Paul Belica $7,980 $2,000
Robert E. Connor $7,980 $8,550
------------------
* Since the Fund has not completed its first full fiscal year, compensation
is estimated based upon future payments to be made and upon estimated relative
Fund net assets.
** During the year ended December 31, 2000, Mr. Belica served as a Trustee
of one open-end investment company (comprising two separate investment
portfolios) advised by PIMCO Advisors, and Mr. Connor served as a director or
Trustee of one open-end investment company (comprising two separate investment
portfolios) and one
32
closed-end investment company advised by PIMCO Advisors. These investment
companies are considered to be in the same "Fund Complex" as the Fund.
The Fund has no employees. Its officers are compensated by PIMCO Advisors
and/or PIMCO.
INVESTMENT MANAGER AND PORTFOLIO MANAGER
INVESTMENT MANAGER
PIMCO Advisors serves as investment manager to the Fund pursuant to an
investment management agreement (the "Investment Management Agreement") between
it and the Fund. PIMCO Advisors was organized as a limited partnership under
Delaware law in 1987. Its sole general partner is Allianz-PacLife Partners
LLC. Allianz-PacLife Partners LLC is a Delaware limited liability company with
two members, Allianz GP Sub LLC, a Delaware limited liability company, and
Pacific Asset Management LLC, a Delaware limited liability company. Allianz GP
Sub LLC is a wholly-owned subsidiary of Allianz of America, Inc., which is a
wholly-owned subsidiary of Allianz AG. Pacific Asset Management LLC is a
wholly-owned subsidiary of Pacific Life Insurance Company, which is a wholly-
owned subsidiary of Pacific Mutual Holding Company. Allianz AG is a German
based insurer. Pacific Mutual Holding Company is a Newport Beach, California
based insurance holding company.
The general partner of PIMCO Advisors has substantially delegated its
management and control of PIMCO Advisors to an Executive Committee. The
Executive Committee is comprised of Joachim Faber, Udo Frank, Kenneth M. Poovey,
William S. Thompson, Jr. and Marcus Riess.
PIMCO Advisors is located at 1345 Avenue of the Americas, New York, New
York 10105. PIMCO Advisors and its subsidiary partnerships and limited
liability companies had approximately $275 billion of assets under management as
of March 31, 2001.
Agreement with Allianz AG
-------------------------
On May 5, 2000, the general partners of PIMCO Advisors closed the
transactions contemplated by the Implementation and Merger Agreement dated as of
October 31, 1999 ("Implementation Agreement"), as amended March 3, 2000, with
Allianz of America, Inc. ("Allianz of America"), Pacific Asset Management LLC,
PIMCO Partners, LLC, PIMCO Holding LLC, PIMCO Partners, G.P., and other parties
to the Implementation Agreement. As a result of completing these transactions,
PIMCO Advisors is now majority-owned indirectly by Allianz AG, with subsidiaries
of Pacific Life Insurance Company ("Pacific Life") retaining a significant
minority interest. Allianz AG is a German-based insurer. Pacific Life is a
Newport Beach, California-based insurer.
In connection with the closing, Allianz of America entered into a put/call
arrangement for the possible disposition of Pacific Life's indirect interest in
PIMCO Advisors. The put option held by Pacific Life will allow it to require
Allianz of America, on the last business day of each calendar quarter following
the closing, to purchase at a formula-based price all of the PIMCO Advisors'
units owned directly or indirectly by Pacific Life. The call option held by
Allianz of
33
America will allow it, beginning January 31, 2003 or upon a change in control of
Pacific Life, to require Pacific Life to sell or cause to be sold to Allianz of
America, at the same formula-based price, all of the PIMCO Advisors' units owned
directly or indirectly by Pacific Life. Allianz AG's address is Koniginstrasse
28, D-80802, Munich, Germany. Pacific Life's address is 700 Newport Center
Drive, Newport Beach, CA 92660.
Allianz AG, the parent of Allianz of America, is a publicly traded German
company which, together with its subsidiaries, comprises the world's second
largest insurance company as measured by premium income. Allianz AG is a
leading provider of financial services, particularly in Europe, and is
represented in 68 countries world-wide through subsidiaries, branch and
representative offices, and other affiliated entities. As of June 30, 2000, the
Allianz Group (including PIMCO Advisors and PIMCO) had assets under management
of more than $650 billion, and in its last fiscal year wrote approximately $50
billion in gross insurance premiums.
As of the date of this Statement of Additional Information, significant
institutional shareholders of Allianz AG currently include Dresdner Bank AG,
Munich Reinsurance and HypoVereinsbank. Credit Lyonnais, Munich Reinsurance,
HypoVereinsbank and Dresdner Bank AG, as well as certain broker-dealers that
might be controlled by or affiliated with these entities, such as DB Alex. Brown
LLC and Dresdner Klienwort Benson North America LLC (collectively, the
"Affiliated Brokers"), may be considered to be affiliated persons of PIMCO
Advisors and PIMCO. Absent an SEC exemption or other relief, the Fund generally
is precluded from effecting principal transactions with the Affiliated Brokers,
and its ability to purchase securities being underwritten by an Affiliated
Broker or a syndicate including an Affiliated Broker or to utilize the
Affiliated Brokers for agency transactions is subject to restrictions. PIMCO
does not believe that the restrictions on transactions with the Affiliated
Brokers described above materially adversely affect its ability to provide
services to the Fund, the Fund's ability to take advantage of market
opportunities, or the Fund's overall performance.
PIMCO Advisors, subject to the supervision of the Board of Trustees, is
responsible for managing, either directly or through others selected by PIMCO
Advisers, the investments of the Fund. PIMCO Advisors also furnishes to the
Board of Trustees periodic reports on the investment performance of the Fund.
As more fully discussed below, PIMCO Advisors has retained PIMCO, its affiliate,
to serve as the Fund's portfolio manager.
Under the terms of the Investment Management Agreement, subject to such
policies as the Trustees of the Trust may determine, PIMCO Advisors, at its
expense, will furnish continuously an investment program for the Fund and will
make investment decisions on behalf of the Fund and place all orders for the
purchase and sale of portfolio securities subject always to the Fund's
investment objective, policies and restrictions; provided that, so long as PIMCO
serves as the portfolio manager for the Fund, PIMCO Advisors' obligation under
the Investment Management Agreement with respect to the Fund is, subject always
to the control of the Trustees, to determine and review with PIMCO the
investment policies of the Fund.
Subject to the control of the Trustees, PIMCO Advisors also manages,
supervises and conducts the other affairs and business of the Fund, furnishes
office space and equipment, provides bookkeeping and certain clerical services
(excluding determination of the net asset
34
value of the Fund, shareholder accounting services and the accounting services
for the Fund) and pays all salaries, fees and expenses of officers and Trustees
of the Fund who are affiliated with PIMCO Advisors. As indicated under
"Portfolio Transactions-- Brokerage and Research Services," the Fund's portfolio
transactions may be placed with broker-dealers which furnish PIMCO Advisors and
PIMCO, without cost, certain research, statistical and quotation services of
value to them or their respective affiliates in advising the Fund or their other
clients. In so doing, the Fund may incur greater brokerage commissions and other
transactions costs than it might otherwise pay.
Pursuant to the Investment Management Agreement, the Fund has agreed to pay
PIMCO Advisors an annual management fee, payable on a monthly basis, at the
annual rate of 0.65% of the Fund's average daily net assets (including net
assets attributable to Preferred Shares) for the services and facilities it
provides. All fees and expenses are accrued daily and deducted before payment of
dividends to investors.
From the commencement of the Fund's operations through June 30, 2009, PIMCO
Advisors has contractually agreed to waive a portion of the management fees it
is entitled to receive from the Fund in the amounts, and for the time periods,
set forth below:
Percentage Waived (annual Percentage Waived (annual
Period Ending rate as a percentage of Period Ending rate as a percentage of
June 30 average daily net assets)(1) June 30 average daily net assets)(1)
------- --------------------------- ------- ---------------------------
2002(2)........ 0.20% 2006 0.20%
2003........... 0.20% 2007 0.15%
2004........... 0.20% 2008 0.10%
2005........... 0.20% 2009 0.05%
--------------------
(1) Including net assets attributable to Preferred Shares.
(2) From the commencement of the Fund's operations.
PIMCO Advisors has not agreed to waive any portion of its fees beyond June
30, 2009.
Except as otherwise described in the Prospectus, the Fund pays, in addition
to the investment management fee described above, all expenses not assumed by
PIMCO Advisors, including, without limitation, fees and expenses of Trustees who
are not "interested persons" of PIMCO Advisors or the Fund, interest charges,
taxes, brokerage commissions, expenses of issue of shares, fees and expenses of
registering and qualifying the Fund and its classes of shares for distribution
under federal and state laws and regulations, charges of custodians, auditing
and legal expenses, expenses of determining net asset value of the Fund, reports
to shareholders, expenses of meetings of shareholders, expenses of printing and
mailing prospectuses, proxy statements and proxies to existing shareholders, and
its proportionate share of insurance premiums and professional association dues
or assessments. The Fund is also responsible for such nonrecurring expenses as
may arise, including litigation in which the Fund may be a party, and other
expenses as determined by the Trustees. The Fund may have an obligation to
indemnify its officers and Trustees with respect to such litigation.
35
PORTFOLIO MANAGER
PIMCO serves as portfolio manager for the Fund pursuant to a portfolio
management agreement (the "Portfolio Management Agreement") between PIMCO and
PIMCO Advisors. Under the Portfolio Management Agreement, subject always to
the control of the Trustees and the supervision of PIMCO Advisors, PIMCO's
obligation is to furnish continuously an investment program for the Fund, to
make investment decisions on behalf of the Fund and to place all orders for the
purchase and sale of portfolio securities and all other investments for the
Fund.
Under the Portfolio Management Agreement, PIMCO Advisors pays a portion of
the fees it receives from the Fund to PIMCO in return for PIMCO's services, at
the maximum annual rate of 0.37% of the Fund's average daily net assets
(including assets attributable to the Preferred Shares). PIMCO has
contractually agreed to waive a portion of the fee it is entitled to receive
from PIMCO Advisors such that PIMCO will receive 0.25% of the Fund's average
daily net assets from the commencement of Fund operations through June 30, 2006
(i.e., roughly the first 5 years of Fund operations), 0.28% of average daily net
assets in year 6, 0.31% in year 7, and 0.34% in year 8.
Originally organized in 1971, reorganized as a Delaware general partnership
in 1994 and reorganized as a Delaware limited liability company in 2000, PIMCO
provides investment management and advisory services to private accounts of
institutional and individual clients and to mutual funds. The membership
interests of PIMCO as of January 1, 2001, were held 94% by PIMCO Advisors and 6%
by the managing directors of PIMCO. As of March 31, 2001, PIMCO had
approximately $220 billion in assets under management. PIMCO is located at 840
Newport Center Drive, Newport Beach, California 92660.
CERTAIN TERMS OF THE INVESTMENT MANAGEMENT AGREEMENT AND PORTFOLIO
MANAGEMENT AGREEMENT. The Investment Management Agreement and the Portfolio
Management Agreement were each approved by the Trustees of the Fund (including
all of the Trustees who are not "interested persons" of PIMCO Advisors or
PIMCO). The Investment Management Agreement and Portfolio Management Agreement
will each continue in force with respect to the Fund for two years from their
respective dates, and from year to year thereafter, but only so long as their
continuance is approved at least annually by (i) vote, cast in person at a
meeting called for that purpose, of a majority of those Trustees who are not
"interested persons" of PIMCO Advisors, PIMCO or the Fund, and by (ii) the
majority vote of either the full Board of Trustees or the vote of a majority of
the outstanding shares of all classes of the Fund. Each of the Investment
Management Agreement and Portfolio Management Agreement automatically terminates
on assignment. The Investment Management Agreement may be terminated on not
less than 60 days' notice by PIMCO Advisors to the Fund or by the Fund to PIMCO
Advisors. The Portfolio Management Agreement may be terminated on not less than
60 days' notice by PIMCO Advisors to PIMCO or by PIMCO to PIMCO Advisors, or by
the Fund at any time by notice to PIMCO Advisors and PIMCO.
The Investment Management Agreement and the Portfolio Management Agreement
each provide that PIMCO Advisors or PIMCO, as applicable, shall not be subject
to any liability in
36
connection with the performance of its services thereunder in the absence of
willful misfeasance, bad faith, gross negligence or reckless disregard of its
obligations and duties.
CODES OF ETHICS
The Fund, PIMCO Advisors and PIMCO have each adopted a separate code of
ethics governing personal trading activities of, as applicable, all Trustees and
officers of the Fund, and directors, officers and employees of PIMCO Advisors
and PIMCO, who, in connection with their regular functions, play a role in the
recommendation of any purchase or sale of a security by the Fund or obtain
information pertaining to such purchase or sale or who have the power to
influence the management or policies of the Fund, PIMCO Advisors or PIMCO, as
applicable. Such persons are prohibited from effecting certain transactions,
allowed to effect certain exempt transactions (including with respect to
securities that may be purchased or held by the Fund), required to preclear
certain security transactions with the applicable compliance officer or his
designee and to report certain transactions on a regular basis. The Fund, PIMCO
Advisors and PIMCO have each developed procedures for administration of their
respective codes. Text-only versions of the codes of ethics can be viewed
online or downloaded from the EDGAR Database on the SEC's internet web site at
www.sec.gov. You may also review and copy those documents by visiting the SEC's
Public Reference Room in Washington, DC. Information on the operation of the
Public Reference Room may be obtained by calling the SEC at 202-942-8090. In
addition, copies of the codes of ethics may be obtained, after mailing the
appropriate duplicating fee, by writing to the SEC's Public Reference Section,
450 5th Street, N.W., Washington, DC 20549-0102 or by e-mail request at
publicinfo@sec.gov.
PORTFOLIO TRANSACTIONS
INVESTMENT DECISIONS AND PORTFOLIO TRANSACTIONS
Investment decisions for the Fund and for the other investment advisory
clients of PIMCO Advisors and PIMCO are made with a view to achieving their
respective investment objectives. Investment decisions are the product of many
factors in addition to basic suitability for the particular client involved
(including the Fund). Some securities considered for investments by the Fund
may also be appropriate for other clients served by PIMCO Advisors and PIMCO.
Thus, a particular security may be bought or sold for certain clients even
though it could have been bought or sold for other clients at the same time. If
a purchase or sale of securities consistent with the investment policies of the
Fund and one or more of these clients served by PIMCO Advisors or PIMCO is
considered at or about the same time, transactions in such securities will be
allocated among the Fund and clients in a manner deemed fair and reasonable by
PIMCO Advisors or PIMCO, as applicable. PIMCO Advisors or PIMCO may aggregate
orders for the Fund with simultaneous transactions entered into on behalf of its
other clients so long as price and transaction expenses are averaged either for
that transaction or for the day. Likewise, a particular security may be bought
for one or more clients when one or more clients are selling the security. In
some instances, one client may sell a particular security to another client. It
also sometimes happens that two or more clients simultaneously purchase or sell
the same security, in which event each day's transactions in such security are,
insofar as possible, averaged as to price and allocated between such clients in
a manner which PIMCO
37
Advisors or PIMCO believes is equitable to each and in accordance with the
amount being purchased or sold by each. There may be circumstances when
purchases or sales of portfolio securities for one or more clients will have an
adverse effect on other clients.
BROKERAGE AND RESEARCH SERVICES
There is generally no stated commission in the case of fixed income
securities, which are traded in the over-the-counter markets, but the price paid
by the Fund usually includes an undisclosed dealer commission or mark-up. In
underwritten offerings, the price paid by the Fund includes a disclosed, fixed
commission or discount retained by the underwriter or dealer. Transactions on
U.S. stock exchanges and other agency transactions involve the payment by the
Fund of negotiated brokerage commissions. Such commissions vary among different
brokers. Also, a particular broker may charge different commissions according
to such factors as the difficulty and size of the transaction.
Subject to the supervision of PIMCO Advisors, PIMCO places all orders for
the purchase and sale of portfolio securities, options, futures contracts and
other instruments for the Fund and buys and sells such securities, options,
futures and other instruments for the Fund through a substantial number of
brokers and dealers. In so doing, PIMCO uses its best efforts to obtain for the
Fund the most favorable price and execution available, except to the extent it
may be permitted to pay higher brokerage commissions as described below. In
seeking the most favorable price and execution, PIMCO, having in mind the Fund's
best interests, considers all factors it deems relevant, including, by way of
illustration, price, the size of the transaction, the nature of the market for
the security, the amount of the commission, the timing of the transaction taking
into account market prices and trends, the reputation, experience and financial
stability of the broker-dealer involved and the quality of service rendered by
the broker-dealer in other transactions.
Subject to the supervision of PIMCO Advisors, PIMCO places orders for the
purchase and sale of portfolio investments for the Fund's account with brokers
or dealers selected by it in its discretion. In effecting purchases and sales
of portfolio securities for the account of the Fund, PIMCO will seek the best
price and execution of the Fund's orders. In doing so, the Fund may pay higher
commission rates than the lowest available when PIMCO believes it is reasonable
to do so in light of the value of the brokerage and research services provided
by the broker effecting the transaction, as discussed below.
It has for many years been a common practice in the investment advisory
business for advisers of investment companies and other institutional investors
to receive research services from broker-dealers which execute portfolio
transactions for the clients of such advisers. Consistent with this practice,
PIMCO may receive research services from many broker-dealers with which PIMCO
places the Fund's portfolio transactions. PIMCO may also receive research or
research credits from brokers which are generated from underwriting commissions
when purchasing new issues of fixed income securities or other assets for the
Fund. These services, which in some cases may also be purchased for cash,
include such matters as general economic and security market reviews, industry
and company reviews, evaluations of securities and recommendations as to the
purchase and sale of securities. Some of these services are of value to PIMCO
in advising various of its clients (including the Fund), although not all of
these services
38
are necessarily useful and of value in managing the Fund. Neither the management
fee paid by the Fund to PIMCO Advisors nor the portfolio management fee paid by
PIMCO Advisors to PIMCO is reduced because PIMCO and its affiliates receive such
services.
As permitted by Section 28(e) of the Securities Exchange Act of 1934, PIMCO
may cause the Fund to pay a broker-dealer which provides "brokerage and research
services" (as defined in such Act) to PIMCO an amount of disclosed commission
for effecting a securities transaction for the Fund in excess of the commission
which another broker-dealer would have charged for effecting that transaction.
The Fund may use broker-dealers that are affiliates (or affiliates of
affiliates) of the Fund, PIMCO Advisors and/or PIMCO, subject to certain
restrictions discussed above under "Investment Manager and Portfolio Manager--
Investment Adviser--Agreement with Allianz AG."
References to PIMCO in this section would apply equally to PIMCO Advisors
if PIMCO Advisors were to assume portfolio management responsibilities for the
Fund and place orders for the purchase and sale of the Fund's portfolio
investments.
DISTRIBUTIONS
See " " in the Prospectus for information relating to
distributions made to Fund shareholders.
For tax purposes, the Fund is currently required to allocate net capital
gain and other taxable income, if any, between and among Common Shares and any
class or classes of Preferred Shares in proportion to total distributions paid
to each class for the year in which such net capital gain or other taxable
income is realized.
While any Preferred Shares are outstanding, the Fund may not declare any
cash dividend or other distribution on its Common Shares unless at the time of
such declaration (1) all accumulated dividends on the Preferred Shares have been
paid and (2) the net asset value of the Fund's portfolio (determined after
deducting the amount of such dividend or other distribution) is at least 200% of
the liquidation value of any outstanding Preferred Shares. This latter
limitation on the Fund's ability to make distributions on its Common Shares
could cause the Fund to incur income and excise tax and, under certain
circumstances, impair the ability of the Fund to maintain its qualification for
taxation as a regulated investment company. See "Tax Matters."
DESCRIPTION OF SHARES
COMMON SHARES
The Fund's Declaration of Trust (the "Declaration") authorizes the issuance
of an unlimited number of Common Shares. The Common Shares currently
outstanding have been issued without par value. All Common Shares of the Fund
have equal rights as to the payment of
39
dividends and the distribution of assets upon liquidation of the Fund. The
Common Shares currently outstanding have been fully paid and, subject to matters
discussed in "Certain Provisions in the Declaration of Trust - Shareholder
Liability" below, are non-assessable, and have no pre-emptive or conversion
rights or rights to cumulative voting. At any time when the Fund's Preferred
Shares are outstanding, Common Shareholders will not be entitled to receive any
distributions from the Fund unless all accrued dividends on Preferred Shares
have been paid, and unless asset coverage (as defined in the 1940 Act) with
respect to Preferred Shares would be at least 200% after giving effect to such
distributions. See " " in the Prospectus.
The Common Shares are listed on the New York Stock Exchange. 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.
Shares of closed-end investment companies may frequently trade at prices
lower than net asset value. Shares of closed-end investment companies like the
Fund that invest predominantly in investment grade Municipal Bonds have during
some periods traded at prices higher than net asset value and during other
periods traded at prices lower than net asset value. There can be no assurance
that Common Shares or shares of other municipal funds will trade at a price
higher than net asset value in the future. Net asset value generally increases
when interest rates decline, and decreases when interest rates rise, and these
changes are likely to be greater in the case of a fund having a leveraged
capital structure. Whether investors realize gains or losses upon the sale of
Common Shares does not depend upon the Fund's net asset value but depends
entirely upon whether the market price of the Common Shares at the time of sale
is above or below the original purchase price for the shares. Since the market
price of the Fund's Common Shares is determined by factors beyond the control of
the Fund, the Fund cannot predict whether the Common Shares will trade at,
below, or above net asset value or at, below or above the initial public
offering price. Accordingly, the Common Shares are designed primarily for long-
term investors, and investors in the Common Shares should not view the Fund as a
vehicle for trading purposes. See "Repurchase of Fund Shares; Conversion to
Open-End Fund" and the Fund's Prospectus under "Preferred Shares and Related
Leverage" and "The Fund's Investments--Municipal Bonds."
PREFERRED SHARES
See " " in the Prospectus for information relating to the
Preferred Shares.
CERTAIN PROVISIONS IN THE DECLARATION OF TRUST
SHAREHOLDER LIABILITY
Under Massachusetts law, shareholders could, under certain circumstances,
be held personally liable for the obligations of the Fund. However, the
Declaration contains an express disclaimer of shareholder liability for acts or
obligations of the Fund and requires that notice of such disclaimer be given in
each agreement, obligation or instrument entered into or executed by the Fund or
the Trustees. The Declaration also provides for indemnification out of the
Fund's property for all loss and expense of any shareholder held personally
liable on account of being or
40
having been a shareholder. Thus, the risk of a shareholder incurring financial
loss on account of shareholder liability is limited to circumstances in which
such disclaimer is inoperative or the Fund is unable to meet its obligations,
and thus should be considered remote.
ANTI-TAKEOVER PROVISIONS
As described below, the Declaration 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, and could
have the effect of depriving Common Shareholders of opportunities to sell their
Common Shares at a premium over prevailing market prices by discouraging a third
party from seeking to obtain control of the Fund.
Commencing with the first annual meeting of shareholders, the Board of
Trustees will be divided into three classes (Class I, Class II and Class III).
At each annual meeting of shareholders, the term of one class will expire and
each Trustee elected to that class will hold office for a term of three years.
The classification of the Board of Trustees in this manner could delay for an
additional year the replacement of a majority of the Board of Trustees. In
addition, the Declaration provides that a Trustee may be removed only for cause
and only (i) by action of at least seventy-five percent (75%) of the outstanding
shares of the classes or series of shares entitled to vote for the election of
such Trustee, or (ii) by at least seventy-five percent (75%) of the remaining
Trustees.
Except as provided in the next paragraph, the affirmative vote or consent
of at least seventy-five percent (75%) of the Board of Trustees and at least
seventy-five percent (75%) of the shares of the Fund outstanding and entitled to
vote thereon are required to authorize any of the following transactions (each a
"Material Transaction"): (1) a merger, consolidation or share exchange of the
Fund or any series or class of shares of the Fund with or into any other person
or company, or of any such person or company with or into the Fund or any such
series or class of shares; (2) the issuance or transfer by the Fund or any
series or class of shares (in one or a series of transactions in any twelve-
month period) of any securities of the Fund or such series or class to any other
person or entity for cash, securities or other property (or combination thereof)
having an aggregate fair market value of $1,000,000 or more, excluding sales of
securities of the Fund or such series or class in connection with a public
offering, issuances of securities of the Fund or such series or class pursuant
to a dividend reinvestment plan adopted by the Fund and issuances of securities
of the Fund or such series or class upon the exercise of any stock subscription
rights distributed by the Fund; or (3) a sale, lease, exchange, mortgage,
pledge, transfer or other disposition by the Fund or any series or class of
shares (in one or a series of transactions in any twelve-month period) to or
with any person of any assets of the Fund or such series or class having an
aggregate fair market value of $1,000,000 or more, except for transactions in
securities effected by the Fund or such series or class in the ordinary course
of its business. The same affirmative votes are required with respect to and
any shareholder proposal as to specific investment decisions made or to be made
with respect to the Fund's assets.
Notwithstanding the approval requirements specified in the preceding
paragraph, the Declaration provides that no vote or consent of the Fund's
shareholders will be required to authorize a Material Transaction if the
transaction is approved by a vote of both a majority of the Board of Trustees
and seventy-five percent (75%) of the Continuing Trustees (as defined below),
41
so long as all other conditions and requirements, if any, provided for in the
Fund's Bylaws and applicable law have been satisfied.
In addition, the Declaration provides that the Fund may be terminated at
any time by vote or consent of at least seventy-five percent (75%) of the Fund's
shares or, alternatively, by vote or consent of both a majority of the Board of
Trustees and seventy-five percent (75%) of the Continuing Trustees (as defined
below).
In certain circumstances, the Declaration also imposes shareholder voting
requirements that are more demanding than those required under the 1940 Act in
order to authorize a conversion of the Fund from a closed-end to an open-end
investment company. See "Repurchase of Fund Shares; Conversion to Open-End
Fund" below.
As noted, the voting provisions described above could have the effect of
depriving Common Shareholders of an opportunity to sell their Common Shares at a
premium over prevailing market prices by discouraging a third party from seeking
to obtain control of the Fund in a tender offer or similar transaction. In the
view of the Fund's Board of Trustees, however, these provisions offer several
possible advantages, including: (1) requiring persons seeking control of the
Fund to negotiate with its management regarding the price to be paid for the
amount of Common Shares required to obtain control; (2) promoting continuity and
stability; and (3) enhancing the Fund's ability to pursue long-term strategies
that are consistent with its investment objective and management policies. The
Board of Trustees has determined that the voting requirements described above,
which are generally greater than the minimum requirements under the 1940 Act,
are in the best interests of the Fund's Common Shareholders generally.
A "Continuing Trustee," as used in the discussion above, is any member of
the Fund's Board of Trustees (1) who is not a person or affiliate of a person
who enters or proposes to enter into a Material Transaction with the Fund (such
a person or affiliate being referred to individually as an "Interested Party")
and who has been a member of the Board of Trustees for a period of at least
twelve months (or since the commencement of the Fund's operations, if less than
twelve months), or (2) who is a successor of a Continuing Trustee who is
unaffiliated with an Interested Party and is recommended to succeed a Continuing
Trustee by a majority of the Continuing Trustees then members of the Fund's
Board of Trustees.
The foregoing is intended only as a summary and is qualified in its
entirety by reference to the full text of the Declaration and the Fund's Bylaws,
both of which have been filed as exhibits to the Fund's registration statement
on file with the SEC.
LIABILITY OF TRUSTEES
The Declaration provides that the obligations of the Fund are not binding
upon the Trustees of the Fund individually, but only upon the assets and
property of the Fund, and that the Trustees shall not be liable for errors of
judgment or mistakes of fact or law. Nothing in the Declaration, however,
protects a Trustee against any liability to which he would otherwise be subject
by reason of willful misfeasance, bad faith, gross negligence or reckless
disregard of the duties involved in the conduct of his office.
42
REPURCHASE OF FUND SHARES; CONVERSION TO OPEN-END FUND
The Fund is a closed-end investment company and as such its shareholders
will not have the right to cause the Fund to redeem their shares. Instead, the
Fund's Common Shares will trade in the open market at a price that will be a
function of several factors, including dividend levels (which are in turn
affected by expenses), net asset value, call protection, price, dividend
stability, relative demand for and supply of such shares in the market, general
market and economic conditions and other factors. Shares of a closed-end
investment company may frequently trade at prices lower than net asset value.
The Fund's Board of Trustees regularly monitors the relationship between the
market price and net asset value of the Common Shares. If the Common Shares
were to trade at a substantial discount to net asset value for an extended
period of time, the Board may consider the repurchase of its Common Shares on
the open market or in private transactions, or the making of a tender offer for
such shares. There can be no assurance, however, that the Board of Trustees
will decide to take or propose any of these actions, or that share repurchases
or tender offers, if undertaken, will reduce market discount. The Fund has no
present intention to repurchase its Common Shares and would do so only in the
circumstances described in this section.
Notwithstanding the foregoing, at any time when the Fund's Preferred Shares
are outstanding, the Fund may not purchase, redeem or otherwise acquire any of
its Common Shares unless (1) all accrued dividends on Preferred Shares have been
paid and (2) at the time of such purchase, redemption or acquisition, the net
asset value of the Fund's portfolio (determined after deducting the acquisition
price of the Common Shares) is at least 200% of the liquidation value of the
outstanding Preferred Shares (expected to equal the original purchase price per
share plus any accrued and unpaid dividends thereon).
Subject to its investment limitations, the Fund may borrow to finance the
repurchase of shares or to make a tender offer. Interest on any borrowings to
finance share repurchase transactions or the accumulation of cash by the Fund in
anticipation of share repurchases or tenders will reduce the Fund's net income.
Any share repurchase, tender offer or borrowing that might be approved by the
Board of Trustees would have to comply with the Securities Exchange Act of 1934,
as amended, and the 1940 Act and the rules and regulations thereunder.
The Fund's Board of Trustees may also from time to time consider submitting
to the holders of the shares of beneficial interest of the Fund a proposal to
convert the Fund to an open-end investment company. In determining whether to
exercise its sole discretion to submit this issue to shareholders, the Board of
Trustees would consider all factors then relevant, including the relationship of
the market price of the Common Shares to net asset value, the extent to which
the Fund's capital structure is leveraged and the possibility of re-leveraging,
the spread, if any, between the yields on securities in the Fund's portfolio and
interest and dividend charges on Preferred Shares issued by the Fund and general
market and economic conditions.
The Declaration requires the affirmative vote or consent of holders of at
least seventy-five percent (75%) of each class of the Fund's shares entitled to
vote on the matter to authorize a conversion of the Fund from a closed-end to an
open-end investment company, unless the conversion is authorized by both a
majority of the Board of Trustees and seventy-five percent
43
(75%) of the Continuing Trustees (as defined above under "Certain Provisions in
the Declaration of Trust--Anti-Takeover Provisions"). This seventy-five percent
(75%) shareholder approval requirement is higher than is required under the 1940
Act. In the event that a conversion is approved by the Trustees and the
Continuing Trustees as described above, the minimum shareholder vote required
under the 1940 Act would be necessary to authorize the conversion. Currently,
the 1940 Act would require approval of the holders of a "majority of the
outstanding" Common Shares and Preferred Shares voting together as a single
class, and the holders of a "majority of the outstanding" Preferred Shares
voting as a separate class, in order to authorize a conversion.
If the Fund converted to an open-end company, it would be required to
redeem all Preferred Shares then outstanding (requiring in turn that it
liquidate a portion of its investment portfolio), and the Fund's Common Shares
likely would no longer be listed on the New York Stock Exchange. Shareholders
of an open-end investment company may require the company to redeem their shares
on any business day (except in certain circumstances as authorized by or under
the 1940 Act) at their net asset value, less such redemption charge, if any, as
might be in effect at the time of redemption. In order to avoid maintaining
large cash positions or liquidating favorable investments to meet redemptions,
open-end companies typically engage in a continuous offering of their shares.
Open-end companies are thus subject to periodic asset in-flows and out-flows
that can complicate portfolio management.
The repurchase by the Fund of its shares at prices below net asset value
will result in an increase in the net asset value of those shares that remain
outstanding. However, there can be no assurance that share repurchases or
tenders at or below net asset value will result in the Fund's shares trading at
a price equal to their net asset value. Nevertheless, the fact that the Fund's
shares may be the subject of repurchase or tender offers at net asset value from
time to time, or that the Fund may be converted to an open-end company, may
reduce any spread between market price and net asset value that might otherwise
exist.
In addition, a purchase by the Fund of its Common Shares will decrease the
Fund's total assets which would likely have the effect of increasing the Fund's
expense ratio. Any purchase by the Fund of its Common Shares at a time when
Preferred Shares are outstanding will increase the leverage applicable to the
outstanding Common Shares then remaining. See the Fund's Prospectus under
"Risks--Leverage Risk."
Before deciding whether to take any action if the Fund's Common Shares
trade below net asset value, the Board of Trustees would consider all relevant
factors, including the extent and duration of the discount, the liquidity of the
Fund's portfolio, the impact of any action that might be taken on the Fund or
its shareholders and market considerations. Based on these considerations, even
if the Fund's shares should trade at a discount, the Board of Trustees may
determine that, in the interest of the Fund and its shareholders, no action
should be taken.
TAX MATTERS
Taxation of the Fund. The Fund intends to qualify each year as a regulated
investment company under Subchapter M of the Internal Revenue Code of 1986, as
amended (the "Code"). In order
44
to qualify for the special tax treatment accorded regulated investment companies
and their shareholders, the Fund must, among other things:
(a) derive at least 90% of its gross income from dividends, interest,
payments with respect to certain securities loans, and gains from the sale of
stock, securities and foreign currencies, or other income (including but not
limited to gains from options, futures, or forward contracts) derived with
respect to its business of investing in such stock, securities, or
currencies;
(b) distribute with respect to each taxable year at least 90% of the sum
of its taxable net investment income, its net tax-exempt income, and the
excess, if any, of net short-term capital gains over net long-term capital
losses for such year; and
(c) diversify its holdings so that, at the end of each fiscal quarter, (i)
at least 50% of the market value of the Fund''s assets is represented by =
cash and cash items, U.S. government securities, securities of other
regulated investment companies, and other securities limited in respect of
any one issuer to a value not greater than 5% of the value of the Fund''s =
total assets and not more than 10% of the outstanding voting securities of
such issuer, and (ii) not more than 25% of the value of the Fund''s assets =
is invested in the securities (other than those of the U.S. Government or
other regulated investment companies) of any one issuer or of two or more
issuers which the Fund controls and which are engaged in the same, similar,
or related trades or businesses.
If the Fund qualifies as a regulated investment company that is accorded special
tax treatment, the Fund will not be subject to federal income tax on income
distributed in a timely manner to its shareholders in the form of dividends
(including capital gain dividends).
If the Fund failed to qualify as a regulated investment company accorded
special tax treatment in any taxable year, the Fund would be subject to tax on
its taxable income at corporate rates, and all distributions from earnings and
profits, including any distributions of net tax-exempt income and net long-term
capital gains, would be taxable to shareholders as ordinary income. In addition,
the Fund could be required to recognize unrealized gains, pay substantial taxes
and interest and make substantial distributions before requalifying as a
regulated investment company that is accorded special tax treatment.
The Fund may retain for investment its net capital gain. However, if the
Fund retains any net capital gain or any investment company taxable income, it
will be subject to tax at regular corporate rates on the amount retained. If
the Fund retains any net capital gain, it may designate the retained amount as
undistributed capital gains in a notice to its shareholders who, if subject to
federal income tax on long-term capital gains, (i) will be required to include
in income for federal income tax purposes, as long-term capital gain, their
share of such undistributed amount, and (ii) will be entitled to credit their
proportionate shares of the tax paid by the Fund on such
45
undistributed amount against their federal income tax liabilities, if any, and
to claim refunds to the extent the credit exceeds such liabilities. For federal
income tax purposes, the tax basis of shares owned by a shareholder of the Fund
will be increased by an amount equal under current law to the difference between
the amount of undistributed capital gains included in the shareholder's gross
income and the tax deemed paid by the shareholder under clause (ii) of the
preceding sentence. The Fund intends to distribute at least annually to its
shareholders all or substantially all of its net tax-exempt interest and any
investment company taxable income and net capital gain.
Treasury regulations permit a regulated investment company, in determining its
investment company taxable income and net capital gain, to elect to treat all or
part of any net capital loss, any net long-term capital loss or any net foreign
currency loss incurred after October 31 as if it had been incurred in the
succeeding year.
If the Fund fails to distribute in a calendar year at least an amount equal to
the sum of 98% of its ordinary income for such year and 98% of its capital gain
net income for the one-year period ending October 31, plus any retained amount
from the prior year, the Fund will be subject to a 4% excise tax on the
undistributed amounts. A dividend paid to shareholders in January of a year
generally is deemed to have been paid by the Fund on December 31 of the
preceding year, if the dividend was declared and payable to shareholders of
record on a date in October, November or December of that preceding year. The
Fund intends generally to make distributions sufficient to avoid imposition of
the 4% excise tax.
Fund Distributions. Distributions from the Fund (other than exempt- interest
dividends, as discussed below) will be taxable to shareholders as ordinary
income to the extent derived from investment income and net short-term capital
gains. Distributions of net capital gains (that is, the excess of net gains from
the sale of capital assets held more than one year over net losses from the sale
of capital assets held for not more than one year) will be taxable to
shareholders as such, regardless of how long a shareholder has held the shares
in the Fund.
The Fund's expenses attributable to earning tax-exempt income do not reduce
its current earnings and profits; therefore, distributions in excess of the sum
of the Fund's net tax-exempt and taxable income may be treated as taxable
dividends to the extent of the Fund's remaining earnings and profits (which
provides the measure of the Fund's dividend-paying capacity for tax purposes).
Distributions in excess of the sum of the Fund's net tax-exempt and taxable
income could occur, for example, if the Fund's book income exceeded the sum of
its net tax-exempt and taxable income. Differences in the Fund's book income
and its net tax-exempt and taxable income may arise from certain of the Fund's
hedging and investment activities. See "Hedging Transactions" below.
Exempt-interest dividends. The Fund will be qualified to pay exempt-
interest dividends to its shareholders only if, at the close of each quarter of
the Fund's taxable year, at least 50% of the total value of the Fund's assets
consists of obligations the interest on which is exempt from federal income tax
under Code Section 103(a). Distributions that the Fund properly designates as
exempt-interest dividends are treated as interest excludable from shareholders'
gross income for federal income tax purposes but may be taxable for federal
alternative minimum tax purposes
46
and for state and local purposes. Because the Fund intends to qualify to pay
exempt-interest dividends, the Fund may be limited in its ability to enter into
taxable transactions involving forward commitments, repurchase agreements,
financial futures and options contracts on financial futures, tax-exempt bond
indices and other assets.
The receipt of exempt-interest dividends may affect the portion, if any, of a
person's Social Security and Railroad Retirement benefits that will be
includable in gross income subject to federal income tax. Up to 85% of Social
Security and Railroad Retirement benefits may be included in gross income in
cases where the recipient's combined income, consisting of adjusted gross
income (with certain adjustments), tax-exempt interest income and one-half of
any Social Security and Railroad Retirement benefits, exceeds an adjusted base
amount ($34,000 for a single individual and $44,000 for individuals filing a
joint return). Shareholders receiving Social Security or Railroad Retirement
benefits should consult their tax advisers.
Under the Code, the interest on certain "private activity bonds" issued
after August 7, 1986 is treated as a preference item and is (after reduction by
applicable expenses) included in federal alternative minimum taxable income. The
Fund will furnish to shareholders annually a report indicating the percentage of
Fund income treated as a preference item for federal alternative minimum tax
("AMT") purposes. In addition, for corporations, alternative minimum taxable
income is increased by a percentage of the excess of an alternative measure of
income that includes interest on all tax-exempt securities over the amount
otherwise determined to be alternative minimum taxable income. Accordingly, the
portion of the Fund's dividends that would otherwise be tax-exempt to the
shareholders may cause an investor to be subject to the AMT or may increase the
tax liability of an investor who is subject to such tax. As described above,
the portfolio manager will normally avoid investments in bonds potentially
subjecting individuals to the AMT, which generally includes private activity
bonds.
Legislation has been introduced in recent years that would reinstate a
deductible tax (the "Environmental Tax") imposed through tax years beginning
before 1996 at a rate of 0.12% on a corporation's alternative minimum taxable
income (computed without regard to the AMT net operating loss deduction) in
excess of $2,000,000. If the Environmental Tax is reinstated, exempt-interest
dividends that are included in a corporate shareholder's alternative minimum
taxable income may subject corporate shareholders of the Fund to the
Environmental Tax.
The Fund designates distributions made to the share classes as consisting of a
portion of each type of income distributed by the Fund. The portion of each type
of income deemed received by each class of shareholders is equal to the portion
of total Fund distributions received by such class. Thus, the Fund will
designate dividends paid as exempt-interest dividends in a manner that allocates
such dividends between and among Common Shares and any class or classes of
Preferred Shares in proportion to the total dividends paid to each class during
or with respect to the taxable year, or otherwise as required by applicable law.
Long-term capital gain distributions and other income subject to regular federal
income tax will similarly be allocated between the two (or more) classes. No
dividend that the Fund pays will be increased to compensate for the fact that it
may be subject to state and local taxes.
Dividend and capital gains distributions will be taxable as described above
whether received
47
in cash or in shares. A shareholder whose distributions are reinvested in shares
will be treated as having received a dividend equal to the fair market value of
the new shares issued to the shareholder, or the amount of cash allocated to the
shareholder for the purchase of shares on its behalf.
Part or all of the interest on indebtedness, if any, incurred or continued by
a shareholder to purchase or carry shares of the Fund paying exempt-interest
dividends is not deductible. The portion of interest that is not deductible is
equal to the total interest paid or accrued on the indebtedness, multiplied by
the percentage of the Fund's total distributions (not including distributions
from net long-term capital gains) paid to the shareholder that are exempt-
interest dividends. Under rules used by the Internal Revenue Service (the
"Service") to determine when borrowed funds are considered used for the
purpose of purchasing or carrying particular assets, the purchase of shares may
be considered to have been made with borrowed funds even though such funds are
not directly traceable to the purchase of shares.
Under a published position of the Service, a shareholder's interest
deduction generally will not be disallowed if the average adjusted basis of the
shareholder's tax-exempt obligations (including shares of preferred stock) does
not exceed two percent of the average adjusted basis of the shareholder's trade
or business assets (in the case of most corporations) or portfolio investments
(in the case of individuals). Legislation has been introduced in recent years
that would further limit or repeal this two-percent de minimis exception, thus
reducing the total after-tax yield of a shareholder.
In general, exempt-interest dividends, if any, attributable to interest
received on certain private activity obligations and certain industrial
development bonds will not be tax-exempt to any shareholders who are
"substantial users," within the meaning of Section 147(a) of the Code, of the
facilities financed by such obligations or bonds or who are "related persons"
of such substantial users.
The Fund will inform investors within 60 days of the Fund's fiscal year-end
of the percentage of its income distributions designated as tax-exempt. The
percentage is applied uniformly to all distributions made in respect of Common
Shares during the year; the percentages may differ among distributions to
holders of Preferred Shares. The percentage of income designated as tax-exempt
for any particular distribution, whether to holders of Common Shares or holders
of Preferred Shares, may be substantially different from the percentage of the
Fund's income that was tax-exempt during the period covered by the distribution.
Hedging Transactions. If the Fund engages in hedging transactions, including
hedging transactions in options, futures contracts, and straddles, or other
similar transactions, it will be subject to special tax rules (including
constructive sale, mark-to-market, straddle, wash sale, and short sale rules),
the effect of which may be to accelerate income to the Fund, defer losses to the
Fund, cause adjustments in the holding periods of the Fund's securities, convert
long-term capital gains into short-term capital gains or convert short-term
capital losses into long-term capital losses. These rules could therefore affect
the amount, timing and character of distributions to shareholders. Income earned
as a result of the Fund's hedging activities will not be eligible to be treated
as exempt-interest dividends when distributed to shareholders. The Fund will
endeavor to make any available elections pertaining to such transactions in a
manner believed to be in the best interests of the Fund.
48
Certain of the Fund's hedging activities are likely to produce a difference
between its book income and the sum of its net tax-exempt and taxable income. If
the Fund's book income exceeds its net tax-exempt income, the distribution (if
any) of such excess will be treated as (i) a taxable dividend to the extent of
the Fund's remaining earnings and profits (including earnings and profits
arising from tax-exempt income), (ii) thereafter as a return of capital to the
extent of the recipient's basis in the shares, and (iii) thereafter as gain
from the sale or exchange of a capital asset. If the Fund's book income is less
than its taxable income, the Fund could be required to make distributions
exceeding book income to qualify as a regulated investment company that is
accorded special tax treatment.
Return of Capital Distributions. If the Fund makes a distribution to you in
excess of its current and accumulated earnings and profits in any taxable year,
the excess distribution will be treated as a return of capital to the extent of
your tax basis in your shares, and thereafter as capital gain. A return of
capital is not taxable, but it reduces your tax basis in your shares, thus
reducing any loss or increasing any gain on a subsequent taxable disposition by
you of your shares.
Dividends and distributions on the Fund's shares are generally subject to
federal income tax as described herein to the extent they do not exceed the
Fund's realized income and gains, even though such dividends and distributions
may economically represent a return of a particular shareholder's investment.
Such distributions are likely to occur in respect of shares purchased at a time
when the Fund's net asset value reflects gains that are either unrealized, or
realized but not distributed. Such realized gains may be required to be
distributed even when the Fund's net asset value also reflects unrealized
losses. Distributions are taxable to a shareholder even if they are paid from
income or gains earned by the Fund prior to the shareholder''s investment (and
thus included in the price paid by the shareholders).
Securities Issued or Purchased at a Discount. The Fund's investment in
securities issued at a discount and certain other obligations will (and
investments in securities purchased at a discount may) require the Fund to
accrue and distribute income not yet received. In order to generate sufficient
cash to make the requisite distributions, the Fund may be required to sell
securities in its portfolio that it otherwise would have continued to hold.
Capital Loss Carryover. Distributions from capital gains are generally made
after applying any available capital loss carryovers.
Sale or Redemption of Shares. The sale, exchange or redemption of Fund shares
may give rise to a gain or loss. In general, any gain or loss realized upon a
taxable disposition of shares will be treated as long-term capital gain or loss
if the shares have been held for more than 12 months. Otherwise the gain or loss
on the taxable disposition of Fund shares will be treated as short-term capital
gain or loss. However, if a shareholder sells shares at a loss within six months
of purchase, any loss will be disallowed for federal income tax purposes to the
extent of any exempt-interest dividends received on such shares. In addition,
any loss realized upon a taxable disposition of shares held for six months or
less but not disallowed as provided in the preceding sentence will be treated as
long-term, rather than short-term, to the extent of any long-term
49
capital gain distributions received by the shareholder with respect to the
shares. All or a portion of any loss realized upon a taxable disposition of Fund
shares will be disallowed if other shares of the Fund are purchased within 30
days before or after the disposition. In such a case, the basis of the newly
purchased shares will be adjusted to reflect the disallowed loss.
From time to time the Fund may make a tender offer for its Common Shares. It
is expected that the terms of any such offer will require a tendering
shareholder to tender all Common Shares and dispose of all APS, held, or
considered under certain attribution rules of the Code to be held, by such
shareholder. Shareholders who tender all Common Shares and dispose of all APS
held, or considered to be held, by them will be treated as having sold their
shares and generally will realize a capital gain or loss. If a shareholder
tenders fewer than all of its Common Shares, or retains a substantial portion
of its APS, such shareholder may be treated as having received a taxable
dividend upon the tender of its Common Shares. In such a case, there is a
remote risk that non-tendering shareholders will be treated as having received
taxable distributions from the Fund. Likewise, if the Fund redeems some but not
all of the APS held by a holder of APS and such shareholder is treated as having
received a taxable dividend upon such redemption, there is a remote risk that
Common Shareholders and non-redeeming holders of APS will be treated as having
received taxable distributions from the Fund. To the extent that the Fund
recognizes net gains on the liquidation of portfolio securities to meet such
tenders of Common Shares, the Fund will be required to make additional
distributions to its shareholders.
Backup Withholding. The Fund generally is required to withhold and remit to
the U.S. Treasury a percentage of the taxable dividends and other distributions
paid to any individual shareholder who fails to properly furnish the Fund with a
correct taxpayer identification number (TIN), who has under-reported dividend
or interest income, or who fails to certify to the Fund that he or she is not
subject to such withholding. Pursuant to recently enacted tax legislation, the
backup withholding tax rate will be (i) 30.5% for amounts paid after August 6,
2001 through the end of 2001, (ii) 30% for amounts paid during 2002 and 2003,
(iii) 29% for amounts paid during 2004 and 2005, and (iv) 28% for amounts paid
during 2006 through 2010. This legislation will expire and the backup
withholding rate will be 31% for amounts paid after December 31, 2010, unless
Congress enacts tax legislation providing otherwise.
The Service recently revised its regulations affecting the application to
foreign investors of the back-up withholding and withholding tax rules described
above. The new regulations are generally effective for payments made after
December 31, 2000. In some circumstances, the new rules increase the
certification and filing requirements imposed on foreign investors in order to
qualify for exemption from the back-up withholding tax rates and for reduced
withholding tax rates under income tax treaties. Foreign investors in the Fund
should consult their tax advisers with respect to the potential application of
these new regulations.
General. The federal income tax discussion set forth above is for
general information only. Prospective investors should consult their tax
advisers regarding the specific federal tax consequences of purchasing, holding,
and disposing of shares of the Fund, as well as the effects of state, local and
foreign tax law and any proposed tax law changes.
50
STATE TAX MATTERS. Tax matters pertaining to California are set forth in
Appendix B.
PERFORMANCE RELATED AND COMPARATIVE INFORMATION
The Fund may be a suitable investment for a shareholder who is a resident
of California and thinking of adding bond investments to his portfolio to
balance the appreciated stocks that the shareholder is holding. The suitability
of an investment in Common Shares will depend upon a comparison of the after-tax
yield likely to be provided from the Fund with that from comparable tax-exempt
investments (including those not subject to the alternative minimum tax), and
from comparable fully taxable investments, in light of each such investor's tax
position.
The Fund may quote certain performance-related information and may compare
certain aspects of its portfolio and structure to other substantially similar
closed-end funds as categorized by Lipper, Inc. ("Lipper"), Morningstar Inc. or
other independent services. Comparison of the Fund to an alternative investment
should be made with consideration of differences in features and expected
performance. The Fund may obtain data from sources or reporting services, such
as Bloomberg Financial ("Bloomberg") and Lipper, that the Fund believes to be
generally accurate.
The Fund, in its advertisements, may refer to pending legislation from time
to time and the possible impact of such legislation on investors, investment
strategy and related matters. This would include any tax proposals and their
effect on marginal tax rates and tax-equivalent yields. At any time in the
future, yields and total return may be higher or lower than past yields and
there can be no assurance that any historical results will continue.
Past performance is not indicative of future results.
CUSTODIAN, TRANSFER AGENTS AND DIVIDEND DISBURSING AGENTS
State Street Bank and Trust Company, 225 Franklin Street, Boston,
Massachusetts 02110, serves as custodian for assets of the Fund. The custodian
performs custodial and fund accounting services.
PFPC Inc., 400 Bellevue Parkway, Wilmington, Delaware 19809, serves as the
transfer agent, registrar, dividend disbursing agent and shareholder servicing
agent for the Common Shares, as well as agent for the Dividend Reinvestment Plan
relating to the Common Shares.
, , , , serves as auction agent for the
Preferred Shares, and as such determines the Applicable Rate and serves as the
transfer agent, registrar, dividend disbursing agent and shareholder servicing
agent for the Preferred Shares.
51
INDEPENDENT ACCOUNTANTS
, , , , serves as independent
accountants for the Fund. provides audit services, tax return
preparation and assistance and consultation in connection with review of SEC
filings to the Fund.
COUNSEL
Ropes & Gray, One International Place, Boston, MA 02110, passes upon
certain legal matters in connection with shares offered by the Fund, and also
acts as counsel to the Fund.
REGISTRATION STATEMENT
A Registration Statement on Form N-2, including any amendments thereto,
relating to the shares of the Fund offered hereby, has been filed by the Fund
with the SEC. The Fund's Prospectus and this Statement of Additional
Information do not contain all of the information set forth in the Registration
Statement, including any exhibits and schedules thereto. For further
information with respect to the Fund and the shares offered or to be offered
hereby, reference is made to the Fund's Registration Statement. Statements
contained in the Fund's Prospectus and this Statement of Additional Information
as to the contents of any contract or other document referred to are not
necessarily complete and in each instance reference is made to the copy of such
contract or other document filed as an exhibit to the Registration Statement,
each such statement being qualified in all respects by such reference. Copies
of the Registration Statement may be inspected without charge at the SEC's
principal office in Washington, D.C., and copies of all or any part thereof may
be obtained from the SEC upon the payment of certain fees prescribed by the SEC.
52
REPORT OF INDEPENDENT ACCOUNTANTS
TO BE PROVIDED
53
FINANCIAL STATEMENTS
TO BE PROVIDED
54
APPENDIX A
Ratings of Investments
Standard & Poor's a division of The McGraw-Hill Companies, Inc.--A brief
description of the applicable Standard & Poor's ("S&P") rating symbols and their
meanings (as published by S&P) follows:
An 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. It takes into
consideration the creditworthiness of guarantors, insurers, or other forms of
credit enhancement on the obligation. The issue credit rating is not a
recommendation to purchase, sell, or hold a financial obligation, inasmuch as it
does not comment as to market price or suitability for a particular investor.
Issue credit ratings are based on current information furnished by the obligors
or obtained by S&P 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 days - including 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 ratings address 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:
1. Likelihood of payment - capacity and willingness of the obligor to
meet its financial commitment on an obligation in accordance with the
terms of the obligation;
2. Nature of and provisions of the obligation; and
3. 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.
The issue ratings definitions are expressed in terms of default risk. As such,
they pertain to senior obligations of an entity. Junior obligations are
typically rated lower than senior obligations, to reflect the lower priority in
bankruptcy, as noted above.
A-1
AAA
An obligation rated `AAA' has the highest rating assigned by S&P. The obligor's
capacity to meet its financial commitment on the obligation is extremely strong.
AA
An obligation rated `AA' differs from the highest-rated obligations only in
small degree. The obligor's 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 obligor's capacity to meet it financial
commitment on the obligation is still strong.
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', `CCC', `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
obligor's 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 obligor's 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
A-2
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
The `C' rating may be used to cover a situation where a bankruptcy petition has
been filed or similar action has been taken, but payments on this obligation are
being continued.
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 a similar action if
payments on an obligation are jeopardized.
Plus (+) or minus (-) The ratings from `AA' to `CCC' may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
c The `c' subscript is used to provide additional information to investors that
the bank may terminate its obligation to purchase tendered bonds if the long-
term credit rating of the issuer is below an investment-grade level and/or the
issuer's bonds are deemed taxable.
p The letter `p' indicates that the rating is provisional. A provisional
rating assumes the successful completion of the project financed by the debt
being rated and indicates that payment of debt service requirements is largely
or entirely dependent upon the successful, timely completion of the project.
This rating, however, while addressing credit quality subsequent to completion
of the project, makes no comment on the likelihood of or the risk of default
upon failure of such completion. The investor should exercise his own judgment
with respect to such likelihood and risk.
* Continuance of the ratings is contingent upon S&P's receipt of an executed
copy of the escrow agreement or closing documentation confirming investments and
cash flows.
r The `r' highlights derivative, hybrid, and certain other obligations that S&P
believes may experience high volatility or high variability in expected returns
as a result of noncredit risks. Examples of such obligations are securities
with principal or interest return indexed to equities, commodities, or
currencies; certain swaps and options; and interest-only and principal-only
mortgage securities. The absence of an `r' symbol should not be taken as an
indication that an obligation will exhibit no volatility or variability in total
return.
N.R. Not rated.
A-3
Debt obligations of issuers outside the United States and its territories are
rated on the same basis as domestic corporate and municipal issues. The ratings
measure the creditworthiness of the obligor but do not take into account
currency exchange and related uncertainties.
Bond Investment Quality Standards Under present commercial bank regulations
issued by the Comptroller of the Currency, bonds rated in the top four
categories (`AAA', `AA', `BBB', commonly known as investment-grade ratings)
generally are regarded as eligible for bank investment. Also, the laws of
various states governing legal investments impose certain rating or other
standards for obligations eligible for investment by savings banks, trust
companies, insurance companies, and fiduciaries in general.
Short-Term Issue Credit Ratings
-------------------------------
An S&P note ratings reflects the liquidity factors and market access risks
unique to notes. Notes due in three years or less will likely receive a note
rating. Notes maturing beyond three years will most likely receive a long-term
debt rating. The following criteria will be used in making that assessment:
. Amortization schedule -- the larger the final maturity relative to other
maturities, the more likely it will be treated as a note; and
. Source of payment -- the more dependent the issue is on the market for its
refinancing, the more likely it will be treated as a note.
Note rating symbols are as follows:
SP-1 Strong capacity to pay principal and interest. An issue determined to
possess a very strong capacity to pay debt service is given a plus (+)
designation.
SP-2 Satisfactory capacity to pay principal and interest, with some
vulnerability to adverse financial and economic changes over the term of the
notes.
SP-3 Speculative capacity to pay principal and interest.
A note rating is not a recommendation to purchase, sell, or hold a security
inasmuch as it does not comment as to market price or suitability for a
particular investor. The ratings are based on current information furnished to
S&P by the issuer or obtained by S&P from other sources it considers reliable.
S&P does not perform an audit in connection with any rating and may, on
occasion, rely on unaudited financial information. The ratings may be changed,
suspended, or withdrawn as a result of changes in or unavailability of such
information or based on other circumstances.
Commercial Paper
An S&P commercial paper rating is a current assessment of the likelihood of
timely payment of debt having an original maturity of no more than 365 days.
A-4
Ratings are graded into several categories, ranging from `A-1' for the highest
quality obligations to `D' for the lowest. These categories are as follows:
A-1 A short-term obligation rated `A-1' is rated in the highest category by
S&P. The obligor's capacity to meet its financial commitment on the
obligation is strong. Within this category, certain obligations are
designated with a plus sign (+). This indicates that the obligor's
capacity to meet its financial commitment on these obligations is extremely
strong.
A-2 A short-term obligation rated `A-2' is somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than
obligations in higher rating categories. However, the obligor's capacity
to meet its financial commitment on the obligation is satisfactory.
A-3 A short-term obligation rated `A-3' 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.
B A short-term obligation rated `B' is regarded as having significant
speculative characteristics. The obligor currently has the capacity to
meet its financial commitment on the obligation; however, it faces major
ongoing uncertainties which could lead to the obligor's inadequate capacity
to meet its financial commitment on the obligation.
C A short-term obligation rated `C' 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.
D A short-term 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 a similar action if payments on an obligation are jeopardized.
A commercial rating is not a recommendation to purchase, sell, or hold a
security inasmuch as it does not comment as to market price or suitability for a
particular investor. The ratings are based on current information furnished to
S&P by the issuer or obtained by S&P from other sources it considers reliable.
S&P does not perform an audit in connection with any rating and may, on
occasion, rely on unaudited financial information. The ratings may be changed,
suspended, or withdrawn as a result of changes in or unavailability of such
information or based on other circumstances.
MOODY'S INVESTORS SERVICE, INC.
A brief description of the applicable Moody's Investors Service, Inc.
("Moody's") rating symbols and their meanings (as published by Moody's) follows:
A-5
Municipal Bonds
---------------
Aaa Bonds which are rated `Aaa' are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to
as "gilt edged." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized
are most unlikely to impair the fundamentally strong position of such
issues.
Aa Bonds which are rated `Aa' are judged to be of high quality by all
standards. Together with the `Aaa' group they comprise what are generally
known as high grade bonds. They are rated lower than the best bonds
because margins of protection may not be as large as in `Aaa' securities or
fluctuation of protective elements may be of greater amplitude or there may
be other elements present which make the long-term risks appear somewhat
larger than in `Aaa' securities.
A Bonds which are rated `A' possess many favorable investment attributes and
are to be considered as upper medium grade obligations. Factors giving
security to principal and interest are considered adequate, but elements
may be present which suggest a susceptibility to impairment sometime in the
future.
Baa Bonds which are rated `Baa' are considered as medium grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest
payments and principal security appear adequate for the present but certain
protective elements may be lacking or may be characteristically unreliable
over any great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
Ba Bonds which are rated `Ba' are judged to have speculative elements; their
future cannot be considered as well assured. Often the protection of
interest and principal payments may be very moderate and thereby not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
B Bonds which are rated `B' generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance
of other terms of the contract over any long period of time may be small.
Caa Bonds which are rated `Caa' are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to
principal or interest.
Ca Bonds which are rated `Ca' represent obligations which are speculative in a
high degree. Such issues are often in default or have other marked
shortcomings.
C Bonds which are rated `C' are the lowest rated class of bonds, and issues
so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
Issues that are secured by escrowed funds held in trust, reinvested in direct,
non-callable U.S. government obligations or non-callable obligations
unconditionally guaranteed by the U.S.
A-6
Government or Resolution Funding Corporation are identified with a # (hatchmark)
symbol, e.g., #Aaa.
Con. (...): Bonds for which the security depends upon the completion of some
act or the fulfillment of some condition are rated conditionally.
These are bonds secured by (a) earnings of projects under
construction, (b) earnings of projects unseasoned in operation
experience, (c) rentals which begin when facilities are
completed, or (d) payments to which some other limiting condition
attaches. The parenthetical rating denotes probable credit
stature upon completion of construction or elimination of the
basis of the condition.
Moody's applies numerical modifiers 1, 2 and 3 in 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.
Short-Term Loans
----------------
MIG 1/VMIG 1 This designation denotes superior credit quality. Excellent
protection is afforded by established cash flows, highly reliable
liquidity support, or demonstrated broad-based access to the
market for refinancing.
MIG 2/VMIG 2 This designation denotes strong credit quality. Margins of
protection are ample, although not as large as in the preceding
group.
MIG 3/VMIG 3 This designation denotes acceptable credit quality. Liquidity
and cash-flow protection may be narrow, and market access for
refinancing is likely to be less well-established.
SG This designation denotes speculative-grade credit quality. Debt
instruments in this category may lack sufficient margins of
protection.
Commercial Paper
----------------
Issuers rated PRIME-1 (or related supporting institutions) have a superior
ability for repayment of senior short-term debt obligations. Prime-1 repayment
ability will normally be evidenced by the following characteristics:
-- Leading market positions in well-established industries.
-- High rates of return on funds employed.
-- Conservative capitalization structures with moderate reliance on debt
and ample asset protection.
-- Broad margins in earnings coverage of fixed financial charges and high
internal cash generation.
A-7
-- Well-established access to a range of financial markets and assured
sources of alternate liquidity.
Issuers rated PRIME-2 (or related supporting institutions) have a strong ability
for repayment of senior short-term debt obligations. This will normally be
evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, will be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternate liquidity is maintained.
Issuers rated PRIME-3 (or related supporting institutions) have an acceptable
ability for repayment of senior short-term debt obligations. The effect of
industry characteristics and market composition may be more pronounced.
Variability in earnings and profitability may result in changes in the level of
debt protection measurements and the requirement for relatively high financial
leverage. Adequate alternate liquidity is maintained.
Issuers rated NOT PRIME do not fall within any of the Prime rating categories.
FITCH IBCA, INC.
A brief description of the applicable Fitch IBCA, Inc. ("Fitch") ratings symbols
and meanings (as published by Fitch) follows:
Long-Term Credit Ratings
------------------------
Investment Grade
AAA
Highest credit quality. `AAA' ratings denote the lowest expectation of credit
risk. They are assigned only in case of exceptionally strong capacity for
timely payment of financial commitments. This capacity is highly unlikely to be
adversely affected by foreseeable events.
AA
Very high credit quality. `AA' ratings denote a very low expectation of credit
risk. They indicate very strong capacity for timely payment of financial
commitments. This capacity is not significantly vulnerable to foreseeable
events.
A
High credit quality. `A' ratings denote a low expectation of credit risk. The
capacity for timely payment of financial commitments is considered strong. This
capacity may, nevertheless, be more vulnerable to changes in circumstances or in
economic conditions than is the case for higher ratings.
A-8
BBB
Good credit quality. `BBB' ratings indicate that there is currently a low
expectation of credit risk. The capacity for timely payment of financial
commitments is considered adequate, but adverse changes in circumstances and in
economic conditions are more likely to impair this capacity. This is the lowest
investment-grade category.
Speculative Grade
BB
Speculative. `BB' ratings indicate that there is a possibility of credit risk
developing, particularly as the result of adverse economic change over time;
however, business or financial alternatives may be available to allow financial
commitments to be met. Securities rated in this category are not investment
grade.
B
Highly speculative. `B' ratings indicate that significant credit risk is
present, but a limited margin of safety remains. Financial commitments are
currently being met; however, capacity for continued payment is contingent upon
a sustained, favorable business and economic environment.
CCC, CC, C
High default risk. Default is a real possibility. Capacity for meeting
financial commitments is solely reliant upon sustained, favorable business or
economic developments. A `CC' rating indicates that default of some kind
appears probable. `C' ratings signal imminent default.
DDD, DD, D
Default. The ratings of obligations in this category are based on their
prospects for achieving partial or full recovery in a reorganization or
liquidation of the obligor. While expected recovery values are highly
speculative and cannot be estimated with any precision, the following serve as
general guidelines. `DDD' obligations have the highest potential for recovery,
around 90%-100% of outstanding amounts and accrued interest. `DD' indicates
potential recoveries in the range of 50%-90%, and `D' the lowest recovery
potential, i.e., below 50%. Entities rated in this category have defaulted on
some or all of their obligations. Entities rated `DDD' have the highest
prospect for resumption of performance or continued operation with or without a
formal reorganization process. Entities rated `DD' and `D' are generally
undergoing a formal reorganization or liquidation process; those rated `DD' are
likely to satisfy a higher portion of their outstanding obligations, while
entities rated `D' have a poor prospect for repaying all obligations.
A-9
Short-Term Credit Ratings
-------------------------
A short-term rating has a time horizon of less than 12 months for most
obligations, or up to three years for U.S. public finance securities, and thus
places greater emphasis on the liquidity necessary to meet financial commitments
in a timely manner.
F1 Highest credit quality . Indicates the strongest capacity for timely
payment of financial commitments; may have an added "+" to denote any
exceptionally strong credit feature.
F2 Good credit quality. A satisfactory capacity for timely payment of
financial commitments, but the margin of safety is not as great as in the
case of the higher ratings.
F3 Fair credit quality. The capacity for timely payment of financial
commitments is adequate; however, near-term adverse changes could result in
a reduction to non-investment grade.
B Speculative. Minimal capacity for timely payment of financial commitments,
plus vulnerability to near-term adverse changes in financial and economic
conditions.
C High default risk. Default is a real possibility. Capacity for meeting
financial commitments is solely reliant upon a sustained, favorable
business and economic environment.
D Default. Denotes actual or imminent payment default.
"+" or "-" may be appended to a rating to denote relative status within major
rating categories. Such suffixes are not added to the `AAA' long-term rating
category, to categories below `CCC', or to short-term ratings other than `F1'.
`NR' indicates that Fitch does not rate the issuer or issue in question.
`WITHDRAWN': A rating is withdrawn when Fitch deems the amount of information
available to be inadequate for rating purposes, or when an obligation matures,
is called, or refinanced.
RATING WATCH: Ratings are placed on RatingWatch to notify investors that there
is a reasonable probability of a rating change and the likely direction of such
change. These are designated as "Positive", indicating a potential upgrade,
"Negative", for a potential downgrade, or "Evolving", if ratings may be raised,
lowered or maintained. Rating Watch is typically resolved over a relatively
short period.
A Rating Outlook indicates the direction a rating is likely to move over a one
to two year period. Outlooks may be positive, stable, or negative. A positive
or negative Rating Outlook does not imply a rating change is inevitable.
Similarly, companies whose outlooks are `stable' could be downgraded before an
outlook moves to positive or negative if circumstances warrant such an action.
Occasionally, Fitch may be unable to identify the fundamental trend. In these
cases, the Rating Outlook may be described as evolving.
A-10
APPENDIX B
FACTORS PERTAINING TO CALIFORNIA
Under normal market conditions, the Fund will invest substantially all (at
least 90%) of its total assets in municipal bonds which pay interest that, in
the opinion of bond counsel to the issuer (or on the basis of other authority
believed by the Fund's portfolio manager to be reliable), is exempt from federal
and California income taxes ("California Municipal Bonds"). The California
Municipal Bonds in which the Fund will invest are generally issued by the State
of California, a city in California, or a political subdivision, agency,
authority or instrumentality of such state or city. As a result of this
investment focus the Fund, and consequently investments in the Fund, are
particularly susceptible to economic, regulatory, political and other factors
that affect issuers of these bonds. Among other things, these factors may
increase the risk that issuers of these California Municipal Bonds may default
on their obligations or that the value of the bonds will decrease. The
information set forth below constitutes only a brief summary of a number of
complex factors which may impact issuers of California Municipal Bonds. This
information is derived from sources that are generally available to investors,
including information promulgated by the State's Department of Finance and
State's Treasurer's Office which can be found at www.dof.ca.gov and
www.treasurer.ca.gov, but does not purport to be comprehensive. Such
information has not been independently verified by the Fund, and the Fund
assumes no responsibility for the completeness or accuracy of such information.
The information is intended to give recent historical description and is not
intended to indicate future or continuing trends in the financial or other
positions of California. The summary below does not include all of the
information pertaining to the budget, receipts and disbursements of the State
that would ordinarily be included in various public documents issued thereby,
such as an Official Statement prepared in connection with the issuance of
general obligation bonds of the State. Such an Official Statement, together
with any updates or supplements thereto, may generally be obtained upon request
to the Budget Office of the State.
It should be noted that the financial strength of local California issuers
and the creditworthiness of obligations issued by local California issuers is
not directly related to the financial strength of the State or the
creditworthiness of obligations issued by the State, and there is no obligation
on the part of the State to make payment on such local obligations in the event
of default.
ECONOMIC FACTORS
According to the State's Legislative Analyst Office, with a gross state
product in excess of $1 trillion, California's economy is the largest state
economy in the United States, accounting for 13% of the nation's output, and the
sixth largest economy in the world, trailing only the United States as a whole,
Japan, Germany, England and France. In addition to its size, California's
economy is diverse, with no industry sector accounting for more than one-quarter
of the State's output.
While California's economy is broad, it does have major concentrations in
high technology, aerospace and defense related manufacturing, entertainment, and
real estate and financial services, and may be sensitive to economic factors
affecting those industries. One
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example of such potential sensitivity occurred from mid-1990 to late 1993, when
the State suffered a recession. Construction, manufacturing (especially
aerospace), and financial services, among others, were all severely affected,
particularly in Southern California. More recently, reflective of the nationwide
economic slowdown, the high technology sector of the State's economy has entered
a cyclical downturn. Overall, following the strongest growth in a decade in 1999
and 2000, the State's economy is projected to grow more slowly in 2001.
In addition, widely publicized difficulties in California's energy
supplies, highlighted by the Governor of California declaring a state of
emergency in January 2001, pose risks to the economy, especially if there are
prolonged blackouts, shortages of natural gas or significant rate increases.
While these factors are partially mitigated by the fact that California's
economy is relatively energy-efficient (U.S. Department of Energy statistics for
1999 revealed that California electricity usage per capita was the lowest in the
nation, forty-two percent (42%) below the national average) it is not possible
to predict at this time what the long-term impact of these developments will
have on the State's economy, and any significant interruptions in energy
supplies or significant rate increases could adversely affect the State's
revenues.
STATE FINANCES
Under the State Constitution, money may be drawn from the Treasury only
through an appropriation made by law. The primary source of the annual
expenditure authorizations is the Budget Act as approved by the Legislature and
signed by the Governor. The 2000-01 Budget Act was signed by the Governor on
June 30, 2000.
The State's funds are segregated into the General Fund and over 900 special
funds, including bond, trust and pension funds. The General Fund consists of
revenues received by the State Treasury that are not required by law to be
credited to any other fund, as well as earnings from the investment of state
moneys not allocable to another fund. The General Fund is the principal
operating fund for the majority of governmental activities and is the depository
of most of the major revenue sources of the State. The General Fund may be
expended as a consequence of appropriation measures enacted by the Legislature
and approved by the Governor, as well as appropriations pursuant to various
constitutional authorizations and initiative statutes.
The principal sources of General Fund revenues in 1999-2000 were the
California personal income tax (55% of total revenues), the sales tax (29%),
bank and corporation taxes (9%), and the gross premium tax on insurance (2%). An
estimated 20% of personal income tax receipts (10% of the total General Fund) is
derived from capital gains realizations and stock option income. While these
sources have been extraordinarily strong in the past few years, they are
particularly volatile and are expected to decrease dramatically in 2001. For
example, the Governor of California, in his May 2001 revision to his January
2001 budget proposal, forecasted that revenues for the 2001-02 budget year would
decrease by $5.3 billion relative to the January projection. The single largest
source of this budget-year decline is personal income tax, which is being
adversely affected by falling stock options and capital gains. In recognition
of the decreased revenue projections, the May 2001 revision proposed reducing
State expenditures by more than $3 billion for the 2001-02 budget year. Despite
the economic turndown and revised revenue and expenditure projections for the
2001-02 budget year, the State had Cash and Borrowables of approximately $14.9
billion on April 30, 2001.
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The State maintains a Special Fund for Economic Uncertainties (the "SFEU"),
derived from General Fund revenues, as a reserve to protect the State from
unforeseen revenue reductions or unanticipated expenditure increases, but which
is required to be replenished as soon as sufficient revenues are available.
Year-end balances in the SFEU are included for financial reporting purposes in
the General Fund balance. The proposed 2001-02 budget, as revised, continues to
fund the SFEU at greater than $1 billion, or approximately 1.4% of General Fund
revenues.
Although the State's strong economy has produced record revenues to the
State government in recent years, the State's budget continues to be marked by
mandated spending of significant funds on education, a large prison population,
and social needs of a growing population with many immigrants. These factors
limit the growth of State spending in other areas and also put pressure on local
governments. There can be no assurances that, if economic conditions continue
to weaken, or other factors intercede, the State will not experience budget
gaps.
OBLIGATIONS OF THE STATE OF CALIFORNIA
The California Constitution prohibits the creation of general obligation
indebtedness of the State unless a bond law is approved by a majority of the
electorate voting at a general election or a direct primary. Several general
obligation bond acts exist, providing that debt service on general obligation
bonds shall be appropriated annually from the State's General Fund and all debt
service on general obligation bonds shall be paid from the General Fund.
Certain general obligation bond programs receive revenues from sources other
than the sale of bonds or the investment of bond proceeds. Under the California
Constitution, debt service on outstanding general obligation bonds is the second
charge to the General Fund after support of the public school system and public
institutions of higher education.
According to the State's Treasurer's Office, as of March 1, 2001,
California had outstanding approximately $19.1 billion of general obligation
bonds and approximately $6.5 billion in lease debt supported by the State
General Fund. As of March 1, 2001, the State had available approximately $7.0
billion of authorized general obligation bonds which had not yet been issued.
In fiscal year 1999-2000, debt service on general obligation bonds and lease
debt was approximately 3.7% of General Fund revenues. In addition to those
State obligations supported by the General Fund, certain State agencies and
authorities issue revenue obligations for which the General Fund has no
liability. Revenue bonds represent obligations payable from State revenue-
producing enterprises and projects, which are not payable from the General Fund,
and conduit obligations payable only from revenues paid by private users of
facilities financed by revenue bonds. As of February 1, 2001, State agencies
and authorities had $28.6 billion aggregate principal amount of revenue bonds
and notes which are non-recourse to the General Fund.
B-3
CONSTITUTIONAL LIMITATIONS ON TAXES, OTHER CHARGES AND APPROPRIATIONS
In California, certain constitutional amendments, legislative measures,
executive orders, administrative regulations and voter initiatives have
established tax, spending or appropriation limitations that could potentially
limit the financial flexibility of State and local governments and ultimately
impair their ability to repay their debt obligations. The following constitutes
a brief summary of some of these limitations.
Limitation on Property Taxes. Certain California Municipal Bonds may be
obligations of issuers which rely in whole or in part, directly or indirectly,
on ad valorem property taxes as a source of revenue. The taxing powers of
California local governments and districts are limited by Article XIIIA of the
California Constitution, enacted by the voters in 1978 and commonly known as
"Proposition 13." Briefly, Article XIIIA limits to 1% of full cash value of the
rate of ad valorem property taxes on real property and generally restricts the
reassessment of property to 2% per year, except under new construction or change
of ownership (subject to a number of exemptions). Taxing entities may, however,
raise ad valorem taxes above the 1% limit to pay debt service on voter-approved
bonded indebtedness.
Under Article XIIIA, the basic 1% ad valorem tax levy is applied against
the assessed value of property as of the owner's date of acquisition (or as of
March 1, 1975, if acquired earlier), subject to certain adjustments. This system
has resulted in widely varying amounts of tax on similarly situated properties.
Article XIIIA prohibits local governments from raising revenues through ad
valorem taxes above the 1% limit; it also requires voters of any governmental
unit to give two-thirds approval to levy any "special tax."
Limitations on ad valorem property taxes may particularly affect "tax
allocation" bonds issued by California redevelopment agencies. Such bonds are
secured solely by the increase in assessed valuation of a redevelopment project
area after the start of redevelopment activity. In the event that assessed
values in the redevelopment project decline (for example, because of a major
natural disaster such as an earthquake), the tax increment revenue may be
insufficient to make principal and interest payments on these bonds. Both
Moody's and S&P suspended ratings on California tax allocation bonds after the
enactment of Articles XIIIA and XIIIB of the California constitution, and only
resumed such ratings on a selective basis.
Proposition 87, approved by California voters in 1988, requires that all
revenues produced by a tax rate increase go directly to the taxing entity which
increased such tax rate to repay that entity's general obligation indebtedness.
As a result, redevelopment agencies (which, typically, are the issuers of tax
allocation securities) no longer receive an increase in tax increment when taxes
on property in the project area are increased to repay voter-approved bonded
indebtedness.
Limitations on Other Taxes, Fees and Charges. Articles XIIIC and XIIID to
the State Constitution, added by Proposition 218 in 1996, contain a number of
provisions affecting the ability of local agencies to levy and collect both
existing and future taxes, assessments, fees and charges.
B-4
Article XIIIC requires that all new or increased local taxes be submitted
to the electorate before they become effective. Taxes for general governmental
purposes require a majority vote and taxes for specific purposes require a two-
thirds vote.
Article XIIID contains several provisions making it generally more
difficult for local agencies to levy and maintain "assessments" for municipal
services and programs and also contains several provisions affecting "fees" and
"charges," defined for purposes of Article XIIID to mean "any levy other than an
ad valorem tax, a special tax, or an assessment, imposed by a local government
upon a parcel or upon a person as an incident of property ownership, including a
user fee or charge for a property-related service." All new and existing
property-related fees and charges must conform to requirements prohibiting,
among other things, fees and charges which generate revenues exceeding the funds
required to provide the property-related service or are used for unrelated
purposes. Furthermore, no property-related fee or charge may be imposed or
increased without majority approval by the property owners subject to the fee or
charge or, at the option of the local agency, two-thirds voter approval by the
electorate residing in the affected area.
In addition to the provisions described above, Article XIIIC removes
limitations on the initiative power in matters of local taxes, assessments, fees
and charges. Consequently, local voters could, by future initiative, repeal,
reduce or prohibit the future imposition or increase of any local tax,
assessment, fee or charge. It is unclear how this right of local initiative may
be used in cases where taxes or charges have been or will be specifically
pledged to secure debt issues.
The interpretation and application of Proposition 218 will ultimately be
determined by the courts with respect to a number of matters, and it is not
possible at this time to predict with certainty the outcome of such
determinations. Proposition 218 is generally viewed as restricting the fiscal
flexibility of local governments, and for this reason, some ratings of
California cities and counties have been affected.
Appropriations Limits. The State and its local governments are each
subject to an annual "appropriations limit" imposed by Article XIIIB of the
California Constitution. "Appropriations subject to limitation" are
authorizations to spend "proceeds of taxes," which consist of tax revenues and
certain other funds, including proceeds from regulatory licenses, user charges
or other fees, to the extent that such proceeds exceed the cost of providing the
product or service, but "proceeds of taxes" exclude most State subventions to
local governments. No limit is imposed on appropriations of funds which are not
"proceeds of taxes," such as reasonable user charges or fees, and certain other
non-tax funds, including bond proceeds.
Among the expenditures not included in the Article XIIIB appropriations
limit are (1) the debt service cost of bonds issued or authorized prior to
January 1, 1979, or subsequently authorized by the voters, (2) appropriations to
comply with mandates of courts or the federal government, (3) appropriations for
certain capital outlay projects, (4) appropriations by the State of post-1989
increases in gasoline taxes and motor vehicle weight fees, and (5)
appropriations made in certain cases of emergency.
B-5
The appropriations limit for each year is adjusted annually to reflect
changes in cost of living and population, and any transfers of service
responsibilities between government units. The definitions for such adjustments
were liberalized in 1990 to follow more closely growth in the State's economy.
Proposition 111 requires that each agency's actual appropriations be tested
against its limit every two years. If the aggregate "proceeds of taxes" for the
preceding two-year period exceeds the aggregate limit, the excess must be
returned to the agency's taxpayers through tax rate or fee reductions over the
following two years. If the State's aggregate "proceeds of taxes" for the
preceding two-year period exceeds the aggregate limit, 50% of the excess is
transferred to fund the State's contribution to school and community college
districts and the remainder is refunded to the taxpayers. With more liberal
annual adjustment factors since 1988, and depressed revenues in the early 1990's
because of the recession, few governments have been operating near their
spending limits, but this condition may change over time. Local governments may
by voter approval exceed their spending limits for up to four years. For the
last ten years, appropriations subject to limitation have been under the State's
limit. However, because of extraordinary revenue receipts in fiscal year 1999-
2000, State appropriations were estimated to be about $700 million above the
limit. No refund will occur unless the State also exceeds its limit in fiscal
year 2000-01; the State Department of Finance has estimated the State will be
about $3.6 billion below its appropriation limit in fiscal year 2000-01.
Because of the complex nature of Articles XIIIA, XIIIB, XIIIC and XIIID of
the California Constitution, the ambiguities and possible inconsistencies in
their terms, and the impossibility of predicting future appropriations or
changes in population and cost of living, and the probability of continuing
legal challenges, it is not currently possible to determine fully the impact of
these Articles on California Municipal Bonds or on the ability of the State or
local governments to pay debt service on such California Municipal Bonds. It is
not possible, at the present time, to predict the outcome of any pending
litigation with respect to the ultimate scope, impact or constitutionality of
these Articles or the impact of any such determinations upon State agencies or
local governments, or upon their ability to pay debt service on their
obligations. Furthermore, other measures affecting the taxing or spending
authority of California or its political subdivisions may be approved or enacted
in the future. Ballot initiatives of legislation may be introduced which would
modify existing taxes or other revenue-raising measures or which either would
further limit or, alternatively, would increase the abilities of state and local
governments to impose new taxes or increase existing taxes. It is not possible,
at present, to predict the extent to which any such initiatives or legislation
will be enacted. Nor is it possible, at present, to determine the impact of any
such initiatives or legislation on California Municipal Bonds in which the Fund
may invest, future allocations of state revenues to local governments or the
abilities of state or local governments to pay the interest on, or repay the
principal of, such California Municipal Bonds.
BOND RATING
Three major credit rating agencies, Moody's Investors Service, Inc., S&P
and Fitch IBCA, Inc., assign ratings to California long-term general obligation
bonds. A general description of Moody's, S&P's and Fitch's ratings of
municipal bonds is set forth in Appendix A to this Statement of Additional
Information. The ratings of Moody's, S&P and Fitch represent
B-6
their opinions as to the quality of the municipal bonds they rate. It should be
emphasized, however, that ratings are general and are not absolute standards of
quality. Consequently, municipal bonds with the same maturity, coupon and rating
may have different yields while obligations with the same maturity and coupon
with different ratings may have the same yield.
As of May 14, 2001, California general obligation bonds were assigned
ratings of "A+" from Standard & Poor's, "Aa2" from Moody's and "AA" from Fitch.
These ratings reflect a downgrade by Standard & Poor's in April 2001 and a
downgrade by Moody's in May 2001. Both downgrades stem largely from each
ratings agency's concerns regarding the State's energy situation and its impact
on the State's finances. These recent reductions on the State's credit rating,
and any potential future reduction, could adversely affect the market value and
marketability of all outstanding notes and bonds issued by the State, its
agencies or its local governments and there can be no assurance that current
ratings will be maintained in the future.
LEGAL PROCEEDINGS
The State is involved in certain legal proceedings (described in the
State's recent financial statements) that, if decided against the State, may
require the State to make significant future expenditures or may substantially
impair revenues. If the State eventually loses any of these cases, the final
remedies may not have to be implemented in one year.
OBLIGATIONS OF OTHER ISSUERS
Other Issuers of California Municipal Bonds. There are a number of State
agencies, instrumentalities and political subdivisions of the State that issue
Municipal Obligations, some of which may be conduit revenue obligations payable
from payments from private borrowers. These entities are subject to various
economic risks and uncertainties, and the credit quality of the securities
issued by them may vary considerably from the credit quality of obligations
backed by the full faith and credit of the State.
State Assistance. Property tax revenues received by local governments
declined more than 50% following passage of Proposition 13. Subsequently, the
California Legislature enacted measures to provide for the redistribution of the
State's General Fund surplus to local agencies, the reallocation of certain
State revenues to local agencies and the assumption of certain governmental
functions by the State to assist municipal issuers to raise revenues. Total
local assistance from the State's General Fund was budgeted at approximately 75%
of General Fund expenditures in recent years, including the effect of
implementing reductions in certain aid programs.
In 1997, a new program provided for the State to substantially take over
funding for local trial courts (saving cities and counties some $400 million
annually). For the last several years, the State has also provided $100 million
annually to support local law enforcement costs. In 2000-01, the State provided
$200 million in unrestricted grants to cities and counties.
To the extent the State should be constrained by its Article XIIIB
appropriations limit, or its obligation to conform to Proposition 98, or other
fiscal considerations, the absolute level, or the rate of growth, of State
assistance to local governments may be reduced. Any such reductions in State aid
could compound the serious fiscal constraints already experienced by many local
B-7
governments, particularly counties. Los Angeles County, the largest in the
State, was forced to make significant cuts in services and personnel,
particularly in the health care system, in order to balance its budget in
FY1995-96 and FY1996-97. Orange County, which emerged from Federal Bankruptcy
Court protection in June 1996, has significantly reduced county services and
personnel, and faces strict financial conditions following large investment fund
losses in 1994 which resulted in bankruptcy. The ultimate financial impact on
the County and the State cannot be predicted with any certainty.
Counties and cities may face further budgetary pressures as a result of
changes in welfare and public assistance programs, which were enacted in August,
1997, in order to comply with the federal welfare reform law. Generally,
counties play a large role in the new system, and are given substantial
flexibility to develop and administer programs to bring aid recipients into the
workforce. Counties are also given financial incentives if either at the county
or statewide level, the "Welfare-to-Work" programs exceed minimum targets;
counties are also subject to financial penalties for failure to meet such
targets. Counties remain responsible to provide "general assistance" for able-
bodied indigents who are ineligible for other welfare programs. The long-term
financial impact of the new system on local governments is still unknown.
Land-Secured Bonds. California Municipal Bonds which are land-secured
bonds may be adversely affected by a general decline in real estate values or a
slowdown in real estate sales activity. In many cases, such bonds are secured by
land which is undeveloped at the time of issuance but anticipated to be
developed within a few years after issuance. In the event of such reduction or
slowdown, such development may not occur or may be delayed, thereby increasing
the risk of a default on the bonds. Because the special assessments or special
taxes securing these bonds are not the personal liability of the owners of the
property assessed, the lien on the property is the only security for the bonds.
Moreover, in most cases the issuer of these bonds is not required to make
payments on the bonds in the event of delinquency in the payment of assessments
or special taxes, except from amounts, if any, in a reserve fund established for
the bonds. Although secured by real property, the judicial foreclosure process
can be lengthy and is sometimes unsuccessful.
California Long Term Lease Obligations. Based on a series of court
decisions, certain long-term lease obligations, though typically payable from
the general fund of the State or a municipality, are not considered
"indebtedness" requiring voter approval. Such leases, however, are subject to
"abatement" in the event the facility being leased is unavailable for beneficial
use and occupancy by the municipality during the term of the lease. Abatement is
not a default, and there may be no remedies available to the holders of the
certificates evidencing the lease obligation in the event abatement occurs. The
most common cases of abatement are failure to complete construction of the
facility before the end of the period during which lease payments have been
capitalized and uninsured casualty losses to the facility (e.g., due to
earthquake). In the event abatement occurs with respect to a lease obligation,
lease payments may be interrupted (if all available insurance proceeds and
reserves are exhausted) and the certificates may not be paid when due. Although
litigation is brought from time to time which challenges the constitutionality
of such lease arrangements, the California Supreme Court issued a ruling in
August, 1998, which reconfirmed the legality of these financing methods.
B-8
OTHER CONSIDERATIONS
RECENT DEVELOPMENT REGARDING ENERGY
California has experienced difficulties with the supply and price of
electricity and natural gas in much of the State since mid-2000, which are
likely to continue for several years. In 1996 California deregulated the State's
power markets. While the transmission and distribution of electricity remained
regulated, the generation of electricity was opened up to competition. Under
the deregulation scheme, utilities were prohibited from passing through all
wholesale power costs to consumers until 2002. Energy usage in the State has
been rising sharply with the strong economy, but no new power generating plants
have been built since the 1980's. The three major investor-owned utilities in
the State ("IOUs") have been purchasing electricity to meet their needs above
their own generating capacity and contracted supplies at fluctuating short-term
and spot market rates, while the retail prices they can charge their residential
and small business customers have been capped at specified levels. Starting in
mid-2000, power purchase costs exceeded retail charges, and the IOUs incurred
substantial losses and accumulated large debts to continue to purchase power for
their customers. As a result, the credit ratings of the IOUs have deteriorated,
making it difficult to continue to purchase power. The two largest IOUs have
reported they are in default in paying certain of their obligations. On April
6, 2001, one of the IOUs filed for voluntary protection under Chapter 11 of the
federal Bankruptcy Code. The bankruptcy proceedings are pending. While the
bankruptcy court decides the allocation of the IOU's available cash flow and
assets among its creditors, the IOU will continue operations under current
management. No other IOU has sought the protection of or been forced into
bankruptcy, although this may change in the future.
In 2001, there have been rolling electricity blackouts throughout
California affecting millions of customers. The Governor declared a state of
emergency under State law on January 17, 2001, and ordered the State's
Department of Water Resources ("DWR") to begin purchasing electricity for resale
to retail end use customers, to fill the gap in supplies resulting from the
inability of the IOUs to continue to purchase power. DWR also started to enter
into long-term power supply contracts to reduce reliance on short-term and spot
markets. DWR's purchases are initially being funded by advances from the State's
General Fund; about $1.8 billion was expended in the first six weeks and as of
May 2001 a total of $6.7 billion in General Fund advances have been authorized.
DWR is entitled to repayment from a portion of retail end use customer's
payments, remitted through the IOUs, but these amounts will not equal the power
purchase costs. In May 2001, state officials announced that the DWR is
authorized to sell up to $13.4 billion of revenue bonds in mid-August to help
finance the State's plan to overcome the current energy shortages. Proceeds
from the offering would be used to buy more electricity and to pay back the
General Fund for purchases already made. State officials announced that the
State expected to sell about $12.5 billion of bonds, with approximately $8
billion of the bonds sold as tax-exempt securities. The bonds are to be issued
under a trust indenture that will provide that the bonds are payable solely from
payments from retail customers for electricity. The revenue bonds will not be a
liability of or backed by the General Fund, and neither the faith and credit nor
the taxing power of the State will be pledged to pay the revenue bonds. The
State may make additional loans or other advances from the General Fund to
support the DWR power supply program subsequent to the issuance of the DWR
revenue bonds.
B-9
The State is intensifying programs for energy conservation, load management
and improved energy efficiency in government, businesses and homes. Approval for
construction of new power generating facilities, especially smaller and
"peaking" power facilities, has been accelerated. A number of new larger power
plants are under construction and in permitting phase, and will come on line in
2001-2003. In addition, the State is seeking longer term power supply contracts
at lower costs. The combination of these elements is expected to lower wholesale
electricity costs in the future and promote the financial recovery of the IOUs.
Natural gas prices in California have been increasing significantly as a
result of limited pipeline capacity into the State, and nationwide price
increases. The prices nationally may remain high for some time until additional
supplies are produced, as natural gas prices are not regulated. One of the
State's IOUs also supplies natural gas, and its credit difficulties and
bankruptcy filing have impaired its ability to obtain supplies. Significant
interruption in natural gas supplies could adversely affect the economy,
including generation of electricity, much of which is fueled by natural gas.
A number of additional plans are under consideration by the State
Legislature, including the authorization of State agencies to own, build or
purchase power generation or transmission facilities and assist energy
conservation efforts. Plans are also being considered to assist the IOUs repay
their debts incurred in purchasing power; these may include a State purchase of
their transmission facilities, potentially funded with revenue bonds. A number
of lawsuits are pending dealing with many aspects of the energy situation in
California, including disputes over the rates which the California Public
Utilities Commission ("PUC") may charge retail customers, financial
responsibility for purchases of power by the IOUs, and various antitrust and
fraud claims against energy suppliers. In May 2001 PUC approved a $5.7 billion
energy rate increase that will impact approximately nine million residential,
industrial and agricultural customers. PUC further acknowledged that more rate
increases may be necessary unless federal regulators find a way to control the
wholesale electricity market.
A number of lawsuits have been filed concerning various aspects of the
current energy situation. These include disputes over rates set by the PUC,
responsibility for electricity and natural gas purchases made by the utilities
and the California Independent System Operator, continuing contractual
obligations of certain small power generators, and antitrust and fraud claims
against various parties.
Seismic Activity. Substantially all of California is within an active
geologic region subject to major seismic activity. Northern California in 1989
and Southern California in 1994 experienced major earthquakes causing billions
of dollars in damages. The federal government provided more than $13 billion in
aid for both earthquakes, and neither event has had any long-term negative
economic impact. Any California Municipal Obligation in the Fund could be
affected by an interruption of revenues because of damaged facilities, or,
consequently, income tax deductions for casualty losses or property tax
assessment reductions. Compensatory financial assistance could be constrained by
the inability of (i) an issuer to have obtained earthquake insurance coverage
rates; (ii) an insurer to perform on its contracts of insurance in the event of
widespread losses; or (iii) the federal or State government to appropriate
sufficient funds within their respective budget limitations.
B-10
Water Supply and Flooding. Due to aspects of its geography, climate and
continually growing population, California is subject to certain risks with
regard to its water resources. Throughout the late 1980's and early 1990's
California experienced a prolonged drought that strained the State's water
supply system. Some urban areas resorted to mandatory rationing, farmers in
several agricultural areas chose to leave part of their acreage fallow, and
ecosystems in certain regions endured harsh impacts. On the opposite end of the
spectrum, during the winter season of 1997-1998 California endured double its
normal amount of rainfall and about $550 million in flood and storm damage
statewide. As with the potential risks associated with seismic activity, any
California Municipal Obligation in the Fund could be affected by an interruption
of revenues because of damaged facilities or income tax deductions for casualty
losses or property tax assessment reductions.
CALIFORNIA TAX MATTERS
The following summary of certain California tax considerations applicable
to resident individual and corporate Common Shareholders of the Fund is based
upon the advice of Latham & Watkins, special California counsel to the fund, and
the provisions of the applicable California tax law as presently in effect.
These provisions are subject to change by legislative or administrative action,
and any such change may be retroactive with respect to transactions of the Fund.
This summary does not address the taxation of shareholders who are not residents
of California nor does it discuss any local taxes that may be applicable.
The following is based on the assumptions that the Fund will qualify under
Subchapter M of the Code as a regulated investment company, that it will satisfy
the conditions which will enable it to pay exempt-interest dividends to
shareholders, and that it will distribute all interest it receives and capital
gains it realizes to the shareholders.
The Fund will be subject to the California corporate franchise tax only if
it has a sufficient nexus with California. If it is subject to the California
corporate franchise tax, the Fund does not expect to pay a material amount of
such tax.
If at the close of each quarter of the Fund's taxable year at least 50% of
the value of its total assets consists of obligations that, when held by
individuals, pay interest that is exempt from tax by California under California
or federal law, then distributions by the Fund that are attributable to interest
on any such obligation will not be subject to the California personal income
tax. All other distributions, including distributions attributable to capital
gains, will be includable in gross income for purposes of the California
personal income tax.
Interest on "private activity bonds" is not included in an individual's
income for purposes of the California alternative minimum tax. In addition,
California does not impose personal income tax on Social Security or Railroad
Retirement benefits.
Interest on indebtedness incurred or continued for the purpose of acquiring
or maintaining an investment in the Common Shares will not be deductible for
purposes of the California personal income tax.
B-11
All distributions of the Fund, regardless of source, to corporate Common
Shareholders that are subject to the California corporate franchise tax will be
included in gross income for purposes of such tax.
Gain on the sale, exchange, or other disposition of Common Shares will be
subject to the California personal income and corporate franchise tax. In
addition, any loss realized by a holder of Common Shares upon the sale of shares
held for six months or less may be disallowed to the extent of any exempt
interest dividends received with respect to such shares. Moreover, any loss
realized upon the sale of Common Shares within thirty days before or after the
acquisition of other Common Shares may be disallowed under the "wash sale"
rules.
Common Shares may be subject to the California estate tax if held by a
California decedent at the time of death.
Common Shareholders are advised to consult with their own tax advisers for
more detailed information concerning California tax matters.
B-12
APPENDIX C
Settlement Procedures
The following summary of Settlement Procedures sets forth the procedures
expected to be followed in connection with the settlement of each Auction and
will be incorporated by reference in the Auction Agent Agreement and each
Broker-Dealer Agreement. Nothing contained in this Appendix C constitutes a
representation by the Fund that in each Auction each party referred to herein
actually will perform the procedures described herein to be performed by such
party. Capitalized terms used herein shall have the respective meanings
specified in the glossary of the Prospectus or Appendix D hereto, as the case
may be.
(a) On each Auction Date, the Auction Agent shall notify by telephone or
through the Auction Agent's Processing System the Broker-Dealers that
participated in the Auction held on such Auction Date and submitted an Order on
behalf of any Beneficial Owner or Potential Beneficial Owner of:
(i) the Applicable Rate fixed for the next succeeding Dividend Period;
(ii) whether Sufficient Clearing Bids existed for the determination of
the Applicable Rate;
(iii) if such Broker-Dealer (a "Seller's Broker-Dealer") submitted a
Bid or a Sell Order on behalf of a Beneficial Owner, the number of
Preferred Shares, if any, to be sold by such Beneficial Owner;
(iv) if such Broker-Dealer (a "Buyer's Broker-Dealer") submitted a Bid
on behalf of a Potential Beneficial Owner, the number of Preferred Shares,
if any, to be purchased by such Potential Beneficial Owner;
(v) if the aggregate number of Preferred Shares to be sold by all
Beneficial Owners on whose behalf such Broker-Dealer submitted a Bid or a
Sell Order exceeds the aggregate number of Preferred Shares to be purchased
by all Potential Beneficial Owners on whose behalf such Broker-Dealer
submitted a Bid, the name or names of one or more Buyer's Broker-Dealers
(and the name of the Agent Member, if any, of each such Buyer's Broker-
Dealer) acting for one or more purchasers of such excess number of
Preferred Shares and the number of such shares to be purchased from one or
more Beneficial Owners on whose behalf such Broker-Dealer acted by one or
more Potential Beneficial Owners on whose behalf each of such Buyer's
Broker-Dealers acted;
(vi) if the aggregate number of Preferred Shares to be purchased by
all Potential Beneficial Owners on whose behalf such Broker-Dealer
submitted a Bid exceeds the aggregate number of Preferred Shares to be sold
by all Beneficial Owners on whose behalf such Broker-Dealer submitted a Bid
or a Sell Order, the name or names of one or more Seller's Broker-Dealers
(and the name of the Agent Member, if any, of each such Seller's Broker-
Dealer) acting for one or more sellers of such excess number of Preferred
C-1
Shares and the number of such shares to be sold to one or more Potential
Beneficial Owners on whose behalf such Broker-Dealer acted by one or more
Beneficial Owners on whose behalf each of such Seller's Broker-Dealers
acted; and
(vii) the Auction Date of the next succeeding Auction with respect to
the Preferred Shares.
(b) On each Auction Date, each Broker-Dealer that submitted an Order on
behalf of any Beneficial Owner or Potential Beneficial Owner shall:
(i) in the case of a Broker-Dealer that is a Buyer's Broker-Dealer,
instruct each Potential Beneficial Owner on whose behalf such Broker-Dealer
submitted a Bid that was accepted, in whole or in part, to instruct such
Potential Beneficial Owner's Agent Member to pay to such Broker-Dealer (or
its Agent Member) through the Securities Depository the amount necessary to
purchase the number of Preferred Shares to be purchased pursuant to such
Bid against receipt of such shares and advise such Potential Beneficial
Owner of the Applicable Rate for the next succeeding Dividend Period;
(ii) in the case of a Broker-Dealer that is a Seller's Broker-Dealer,
instruct each Beneficial Owner on whose behalf such Broker-Dealer submitted
a Sell Order that was accepted, in whole or in part, or a Bid that was
accepted, in whole or in part, to instruct such Beneficial Owner's Agent
Member to deliver to such Broker-Dealer (or its Agent Member) through the
Securities Depository the number of Preferred Shares to be sold pursuant to
such Order against payment therefor and advise any such Beneficial Owner
that will continue to hold Preferred Shares of the Applicable Rate for the
next succeeding Dividend Period;
(iii) advise each Beneficial Owner on whose behalf such Broker-Dealer
submitted a Hold Order of the Applicable Rate for the next succeeding
Dividend Period;
(iv) advise each Beneficial Owner on whose behalf such Broker-Dealer
submitted an Order of the Auction Date for the next succeeding Auction; and
(v) advise each Potential Beneficial Owner on whose behalf such
Broker-Dealer submitted a Bid that was accepted, in whole or in part, of
the Auction Date for the next succeeding Auction.
(c) On the basis of the information provided to it pursuant to (a) above,
each Broker-Dealer that submitted a Bid or a Sell Order on behalf of a Potential
Beneficial Owner or a Beneficial Owner shall, in such manner and at such time or
times as in its sole discretion it may determine, allocate any funds received by
it pursuant to (b)(i) above and any Preferred Shares received by it pursuant to
(b)(ii) above among the Potential Beneficial Owners, if any, on whose behalf
such Broker-Dealer submitted Bids, the Beneficial Owners, if any, on whose
behalf such Broker-Dealer submitted Bids that were accepted or Sell Orders, and
any Broker-Dealer or Broker-Dealers identified to it by the Auction Agent
pursuant to (a)(v) or (a)(vi) above.
C-2
(d) On each Auction Date:
(i) each Potential Beneficial Owner and Beneficial Owner shall
instruct its Agent Member as provided in (b)(i) or (ii) above, as the case
may be;
(ii) each Seller's Broker-Dealer which is not an Agent Member of the
Securities Depository shall instruct its Agent Member to (A) pay through
the Securities Depository to the Agent Member of the Beneficial Owner
delivering shares to such Broker-Dealer pursuant to (b)(ii) above the
amount necessary to purchase such shares against receipt of such shares,
and (B) deliver such shares through the Securities Depository to a Buyer's
Broker-Dealer (or its Agent Member) identified to such Seller's Broker-
Dealer pursuant to (a)(v) above against payment therefor; and
(iii) each Buyer's Broker-Dealer which is not an Agent Member of the
Securities Depository shall instruct its Agent Member to (A) pay through
the Securities Depository to a Seller's Broker-Dealer (or its Agent Member)
identified pursuant to (a)(vi) above the amount necessary to purchase the
shares to be purchased pursuant to (b)(i) above against receipt of such
shares, and (B) deliver such shares through the Securities Depository to
the Agent Member of the purchaser thereof against payment therefor.
(e) On the day after the Auction Date:
(i) each Bidder's Agent Member referred to in (d)(i) above shall
instruct the Securities Depository to execute the transactions described in
(b)(i) or (ii) above, and the Securities Depository shall execute such
transactions;
(ii) each Seller's Broker-Dealer or its Agent Member shall instruct
the Securities Depository to execute the transactions described in (d)(ii)
above, and the Securities Depository shall execute such transactions; and
(iii) each Buyer's Broker-Dealer or its Agent Member shall instruct
the Securities Depository to execute the transactions described in (d)(iii)
above, and the Securities Depository shall execute such transactions.
(f) If a Beneficial Owner selling Preferred Shares in an Auction fails to
deliver such shares (by authorized book-entry), a Broker-Dealer may deliver to
the Potential Beneficial Owner on behalf of which it submitted a Bid that was
accepted a number of whole Preferred Shares that is less than the number of
shares that otherwise was to be purchased by such Potential Beneficial Owner. In
such event, the number of Preferred Shares to be so delivered shall be
determined solely by such Broker-Dealer. Delivery of such lesser number of
shares shall constitute good delivery. Notwithstanding the foregoing terms of
this paragraph (f), any delivery or non-delivery of shares which shall represent
any departure from the results of an Auction, as determined by the Auction
Agent, shall be of no effect unless and until the Auction Agent shall have been
notified of such delivery or non-delivery in accordance with the provisions of
the Auction Agent Agreement and the Broker-Dealer Agreements.
C-3
APPENDIX D
Auction Procedures
The following procedures will be set forth in provisions of the Amended
Bylaws relating to the Preferred Shares, and will be incorporated by reference
in the Auction Agent Agreement and each Broker-Dealer Agreement. The terms not
defined below are defined in the Prospectus. Nothing contained in this Appendix
D constitutes a representation by the Fund that in each Auction each party
referred to herein actually will perform the procedures described herein to be
performed by such party.
ARTICLE 11
Preferred Shares of Beneficial Interest
11.1 Certain Definitions. As used in this Article 11, the following terms
shall have the following meanings, unless the context otherwise requires:
"Auction Date" shall mean the first Business Day preceding the first
day of a Dividend Period.
"Available Preferred Shares" shall have the meaning specified in
Section 11.4(i) below.
"Bid" shall have the meaning specified in Section 11.2(i) below.
"Bidder" shall have the meaning specified in Section 11.2(i) below.
"Hold Order" shall have the meaning specified in Section 11.2(i)
below.
"Maximum Applicable Rate" for any Dividend Period will be the
Applicable Percentage of the Reference Rate. The Applicable Percentage will
be determined based on (i) the credit rating assigned on such date to such
shares by Moody's (or if Moody's shall not make such rating available, the
equivalent of such rating by a Substitute Rating Agency), and (ii) whether
the Fund has provided modification to the Auction Agent prior to the
Auction establishing the Applicable Rate for any dividend that net capital
gains or other taxable income will be included in such dividend on
Preferred Shares as follows:
Applicable Percentage of Applicable Percentage of
Reference Rate - Reference Rate -
Credit Ratings (Moody's) No Notification Notification
------------------------ --------------- ------------
aa3 or Higher 110% 150%
a3 to 125% 160%
baa3 150% 250%
Below baa3 200% 275%
D-1
The Fund shall take all reasonable action necessary to enable Moody's
to provide a rating for the Preferred Shares. If Moody's shall not make
such a rating available, UBS Warburg LLC or its affiliates and successors,
after consultation with the Fund, shall select a nationally recognized
statistical rating organization to act as a Substitute Rating Agency.
"Order" shall have the meaning specified in Section 11.2(i) below.
"Preferred Shares" shall mean the preferred shares of beneficial
interest of the Fund being auctioned pursuant to this Article 11.
"Sell Order" shall have the meaning specified in Section 11.2(i)
below.
"Submission Deadline" shall mean 1:00 p.m., New York City time, on any
Auction Date or such other time on any Auction Date as may be specified by
the Auction Agent from time to time as the time by which each Broker-Dealer
must submit to the Auction Agent in writing all Orders obtained by it for
the Auction to be conducted on such Auction Date.
"Submitted Bid" shall have the meaning specified in Section 11.4(i)
below.
"Submitted Hold Order" shall have the meaning specified in Section
11.4(i) below.
"Submitted Order" shall have the meaning specified in Section 11.4(i)
below.
"Submitted Sell Order" shall have the meaning specified in Section
11.4(i) below.
"Sufficient Clearing Bids" shall have the meaning specified in Section
11.4(i) below.
"Winning Bid Rate" shall have the meaning specified in Section 11.4(i)
below.
11.2 Orders by Beneficial Owners, Potential Beneficial Owners, Existing
------------------------------------------------------------------
Holders and Potential Holders.
-----------------------------
(i) Unless otherwise permitted by the Fund, Beneficial Owners and
Potential Beneficial Owners may only participate in Auctions through their
Broker-Dealers. Broker-Dealers will submit the Orders of their respective
customers who are Beneficial Owners and Potential Beneficial Owners to the
Auction Agent, designating themselves as Existing Holders in respect of
shares subject to Orders submitted or deemed submitted to them by
Beneficial Owners and as Potential Holders in respect of shares subject to
Orders submitted to them by Potential Beneficial Owners. A Broker-Dealer
may also hold Preferred Shares in its own account as a Beneficial Owner. A
Broker-Dealer may thus submit Orders to the Auction Agent as a Beneficial
Owner or a Potential Beneficial
D-2
Owner and therefore participate in an Auction as an Existing Holder or
Potential Holder on behalf of both itself and its customers. On or prior to
the Submission Deadline on each Auction Date:
(A) each Beneficial Owner may submit to its Broker-Dealer
information as to:
(1) the number of outstanding Preferred Shares, if any, held
by such Beneficial Owner which such Beneficial Owner desires to
continue to hold without regard to the Applicable Rate for the
next succeeding Dividend Period;
(2) the number of outstanding Preferred Shares, if any, held
by such Beneficial Owner which such Beneficial Owner desires to
continue to hold, provided that the Applicable Rate for the next
succeeding Dividend Period shall not be less than the rate per
annum specified by such Beneficial Owner, and/or
(3) the number of outstanding Preferred Shares, if any, held
by such Beneficial Owner which such Beneficial Owner offers to
sell without regard to the Applicable Rate for the next
succeeding Dividend Period; and
(B) each Broker-Dealer, using a list of Potential Beneficial
Owners that shall be maintained in good faith for the purpose of
conducting a competitive Auction, shall contact Potential Beneficial
Owners, including Persons that are not Beneficial Owners, on such list
to determine the number of outstanding Preferred Shares, if any, which
each such Potential Beneficial Owner offers to purchase, provided that
the Applicable Rate for the next succeeding Dividend Period shall not
be less than the rate per annum specified by such Potential Beneficial
Owner.
For the purposes hereof, the communication by a Beneficial Owner or
Potential Beneficial Owner to a Broker-Dealer, or the communication by a
Broker-Dealer acting for its own account to the Auction Agent, of
information referred to in clause (A) or (B) of this Section 11.2(i) is
hereinafter referred to as an "Order" and each Beneficial Owner and each
Potential Beneficial Owner placing an Order, including a Broker-Dealer
acting in such capacity for its own account, is hereinafter referred to as
a "Bidder"; an Order containing the information referred to in clause
(A)(1) of this Section 11.2(i) is hereinafter referred to as a "Hold
Order"; an Order containing the information referred to in clause (A)(2) or
(B) of this Section 11.2(i) is hereinafter referred to as a "Bid"; and an
Order containing the information referred to in clause (A)(3) of this
Section 11.2(i) is hereinafter referred to as a "Sell Order." Inasmuch as a
Broker-Dealer participates in an Auction as an Existing Holder or a
Potential Holder only to represent the interests of a Beneficial Owner or
Potential Beneficial Owner, whether it be its customers or itself, all
discussion herein relating to the consequences of an Auction for Existing
Holders and Potential Holders also applies to the underlying beneficial
ownership interests represented.
D-3
(ii)(A) A Bid by an Existing Holder shall constitute an irrevocable
offer to sell:
(1) the number of outstanding Preferred Shares specified in
such Bid if the Applicable Rate determined on such Auction Date
shall be less than the rate per annum specified in such Bid; or
(2) such number or a lesser number of outstanding Preferred
Shares to be determined as set forth in Section 11.5(i)(D) if the
Applicable Rate determined on such Auction Date shall be equal to
the rate per annum specified therein; or
(3) a lesser number of outstanding Preferred Shares to be
determined as set forth in Section 11.5(ii)(C) if such specified
rate per annum shall be higher than the Maximum Applicable Rate
and Sufficient Clearing Bids do not exist.
(B) A Sell Order by an Existing Holder shall constitute an
irrevocable offer to sell:
(1) the number of outstanding Preferred Shares specified in
such Sell Order, or
(2) such number or a lesser number of outstanding Preferred
Shares to be determined as set forth in Section 11.5(ii)(C) if
Sufficient Clearing Bids do not exist.
(C) A Bid by a Potential Holder shall constitute an irrevocable
offer to purchase:
(1) the number of outstanding Preferred Shares specified in
such Bid if the Applicable Rate determined on such Auction Date
shall be higher than the rate per annum specified in such Bid; or
(2) such number or a lesser number of outstanding Preferred
Shares to be determined as set forth in Section 11.5(i)(E) if the
Applicable Rate determined on such Auction Date shall be equal to
the rate per annum specified therein.
11.3 Submission of Orders by Broker-Dealers to Auction Agent.
-------------------------------------------------------
(i) Each Broker-Dealer shall submit in writing or through the Auction
Agent's Auction Processing System to the Auction Agent prior to the
Submission Deadline on each Auction Date all Orders obtained by such
Broker-Dealer, designating itself (unless otherwise permitted by the Fund)
as an Existing Holder in respect of shares subject to
D-4
Orders submitted or deemed submitted to it by Beneficial Owners and as a
Potential Holder in respect of shares subject to Orders submitted to it by
Potential Beneficial Owners, and specifying with respect to each Order:
(A) the name of the Bidder placing such Order (which shall be the
Broker-Dealer unless otherwise permitted by the Fund);
(B) the aggregate number of outstanding Preferred Shares that are
the subject of such Order;
(C) to the extent that such Bidder is an Existing Holder
(1) the number of outstanding Preferred Shares, if any,
subject to any Hold Order placed by such Existing Holder;
(2) the number of outstanding Preferred Shares, if any,
subject to any Bid placed by such Existing Holder and the rate
per annum specified in such Bid; and
(3) the number of outstanding Preferred Shares, if any,
subject to any Sell Order placed by such Existing Holder; and
(D) to the extent such Bidder is a Potential Holder, the rate per
annum specified in such Potential Holder's Bid.
(ii) If any rate per annum specified in any Bid contains more than
three figures to the right of the decimal point, the Auction Agent shall
round such rate up to the next highest one-thousandth (.001) of 1%.
(iii) If an Order or Orders covering all of the outstanding Preferred
Shares held by an Existing Holder are not submitted to the Auction Agent
prior to the Submission Deadline, the Auction Agent shall deem a Hold Order
(in the case of an Auction relating to a Dividend Period which is not a
Special Dividend Period) and a Sell Order (in the case of an Auction
relating to a Special Dividend Period) to have been submitted on behalf of
such Existing Holder covering the number of outstanding Preferred Shares
held by such Existing Holder and not subject to Orders submitted to the
Auction Agent.
(iv) If one or more Orders on behalf of an Existing Holder covering in
the aggregate more than the number of outstanding Preferred Shares held by
such Existing Holder are submitted to the Auction Agent, such Orders shall
be considered valid as follows and in the following order of priority:
(A) any Hold Order submitted on behalf of such Existing Holder
shall be considered valid up to and including the number of
outstanding Preferred Shares held by such Existing Holder; provided
that if more than one Hold Order is submitted on behalf of such
Existing Holder and the number of Preferred Shares
D-5
subject to such Hold Orders exceeds the number of outstanding
Preferred Shares held by such Existing Holder, the number of Preferred
Shares subject to each of such Hold Orders shall be reduced pro rata
so that such Hold Orders, in the aggregate, cover exactly the number
of outstanding Preferred Shares held by such Existing Holder;
(B) any Bids submitted on behalf of such Existing Holder shall be
considered valid, in the ascending order of their respective rates per
annum if more than one Bid is submitted on behalf of such Existing
Holder, up to and including the excess of the number of outstanding
Preferred Shares held by such Existing Holder over the number of
shares of Preferred Shares subject to any Hold Order referred to in
Section 11.3(iv)(A) above (and if more than one Bid submitted on
behalf of such Existing Holder specifies the same rate per annum and
together they cover more than the remaining number of shares that can
be the subject of valid Bids after application of Section 11.3(iv)(A)
above and of the foregoing portion of this Section 11.3(iv)(B) to any
Bid or Bids specifying a lower rate or rates per annum, the number of
shares subject to each of such Bids shall be reduced pro rata so that
such Bids, in the aggregate, cover exactly such remaining number of
shares); and the number of shares, if any, subject to Bids not valid
under this Section 11.3(iv)(B) shall be treated as the subject of a
Bid by a Potential Holder; and
(C) any Sell Order shall be considered valid up to and including
the excess of the number of outstanding Preferred Shares held by such
Existing Holder over the number of Preferred Shares subject to Hold
Orders referred to in Section 11.3(iv)(A) and Bids referred to in
Section 11.3(iv)(B); provided that if more than one Sell Order is
submitted on behalf of any Existing Holder and the number of Preferred
Shares subject to such Sell Orders is greater than such excess, the
number of Preferred Shares subject to each of such Sell Orders shall
be reduced pro rata so that such Sell Orders, in the aggregate, cover
exactly the number of Preferred Shares equal to such excess.
(v) If more than one Bid is submitted on behalf of any Potential
Holder, each Bid submitted shall be a separate Bid with the rate per annum
and number of Preferred Shares therein specified.
(vi) Any Order submitted by a Beneficial Owner or a Potential
Beneficial Owner to its Broker-Dealer, or by a Broker-Dealer to the Auction
Agent, prior to the Submission Deadline on any Auction Date shall be
irrevocable.
11.4 Determination of Sufficient Clearing Bids, Winning Bid Rate and
---------------------------------------------------------------
Applicable Rate.
---------------
(i) Not earlier than the Submission Deadline on each Auction Date, the
Auction Agent shall assemble all Orders submitted or deemed submitted to it
by the Broker-Dealers (each such Order as submitted or deemed submitted by
a Broker-Dealer being
D-6
hereinafter referred to individually as a "Submitted Hold Order," a
"Submitted Bid" or a "Submitted Sell Order," as the case may be, or as a
"Submitted Order") and shall determine:
(A) the excess of the total number of outstanding Preferred
Shares over the number of outstanding Preferred Shares that are the
subject of Submitted Hold Orders (such excess being hereinafter
referred to as the "Available Preferred Shares");
(B) from the Submitted Orders whether the number of outstanding
Preferred Shares that are the subject of Submitted Bids by Potential
Holders specifying one or more rates per annum equal to or lower than
the Maximum Applicable Rate exceeds or is equal to the sum of:
(1) the number of outstanding Preferred Shares that are the
subject of Submitted Bids by Existing Holders specifying one or
more rates per annum higher than the Maximum Applicable Rate, and
(2) the number of outstanding Preferred Shares that are
subject to Submitted Sell Orders (if such excess or such equality
exists (other than because the number of outstanding Preferred
Shares in clauses (1) and (2) above are each zero because all of
the outstanding Preferred Shares are the subject of Submitted
Hold Orders), such Submitted Bids by Potential Holders
hereinafter being referred to collectively as "Sufficient
Clearing Bids"); and
(C) if Sufficient Clearing Bids exist, the lowest rate per annum
specified in the Submitted Bids (the "Winning Bid Rate") that if:
(1) each Submitted Bid from Existing Holders specifying the
Winning Bid Rate and all other submitted Bids from Existing
Holders specifying lower rates per annum were rejected, thus
entitling such Existing Holders to continue to hold the shares of
Preferred Shares that are the subject of such Submitted Bids, and
(2) each Submitted Bid from Potential Holders specifying the
Winning Bid Rate and all other Submitted Bids from Potential
Holders specifying lower rates per annum were accepted, thus
entitling the Potential Holders to purchase the Preferred Shares
that are the subject of such Submitted Bids, would result in the
number of shares subject to all Submitted Bids specifying the
Winning Bid Rate or a lower rate per annum being at least equal
to the Available Preferred Shares.
(ii) Promptly after the Auction Agent has made the determinations
pursuant to Section 11.4(i), the Auction Agent shall advise the Fund of the
Maximum Applicable Rate and, based on such determinations, the Applicable
Rate for the next succeeding Dividend Period as follows:
D-7
(A) if Sufficient Clearing Bids exist, that the Applicable Rate
for the next succeeding Dividend Period shall be equal to the Winning
Bid Rate;
(B) if Sufficient Clearing Bids do not exist (other than because
all of the outstanding Preferred Shares are the subject of Submitted
Hold Orders), that the Applicable Rate for the next succeeding
Dividend Period shall be equal to the Maximum Applicable Rate; or
(C) if all of the outstanding Preferred Shares are the subject of
Submitted Hold Orders, that the Dividend Period next succeeding the
Auction automatically shall be the same length as the immediately
preceding Dividend Period and the Applicable Rate for the next
succeeding Dividend Period shall be equal to 59% of the Reference Rate
(or 90% of such rate if the Fund has provided notification to the
Auction Agent prior to the Auction establishing the Applicable Rate
for any dividend that net capital gains or other taxable income will
be included in such dividend on Preferred Shares) on the date of the
Auction.
11.5 Acceptance and Rejection of Submitted Bids and Submitted Sell Orders
and Allocation of Shares. Based on the determinations made pursuant to Section
11.4(i), the Submitted Bids and Submitted Sell Orders shall be accepted or
rejected and the Auction Agent shall take such other action as set forth below:
(i) If Sufficient Clearing Bids have been made, subject to the
provisions of Section 11.5(iii) and Section 11.5(iv), Submitted Bids and
Submitted Sell Orders shall be accepted or rejected in the following order
of priority and all other Submitted Bids shall be rejected:
(A) the Submitted Sell Orders of Existing Holders shall be
accepted and the Submitted Bid of each of the Existing Holders
specifying any rate per annum that is higher than the Winning Bid Rate
shall be accepted, thus requiring each such Existing Holder to sell
the outstanding Preferred Shares that are the subject of such
Submitted Sell Order or Submitted Bid;
(B) the Submitted Bid of each of the Existing Holder specifying
any rate per annum that is lower than the Winning Bid Rate shall be
rejected, thus entitling each such Existing Holder to continue to hold
the outstanding Preferred Shares that are the subject of such
Submitted Bid;
(C) the Submitted Bid of each of the Potential Holders specifying
any rate per annum that is lower than the Winning Bid Rate shall be
accepted;
(D) the Submitted Bid of each of the Existing Holders specifying
a rate per annum that is equal to the Winning Bid Rate shall be
rejected, thus entitling each such Existing Holder to continue to hold
the outstanding Preferred Shares that are the subject of such
Submitted Bid, unless the number of outstanding Preferred Shares
D-8
subject to all such Submitted Bids shall be greater than the number of
outstanding Preferred Shares ("Remaining Shares") equal to the excess
of the Available Preferred Shares over the number of outstanding
Preferred Shares subject to Submitted Bids described in Section
11.5(i)(B) and Section 11.5(i)(C), in which event the Submitted Bids
of each such Existing Holder shall be accepted, and each such Existing
Holder shall be required to sell outstanding Preferred Shares, but
only in an amount equal to the difference between (1) the number of
outstanding Preferred Shares then held by such Existing Holder subject
to such Submitted Bid and (2) the number of Preferred Shares obtained
by multiplying (x) the number of Remaining Shares by (y) a fraction
the numerator of which shall be the number of outstanding Preferred
Shares held by such Existing Holder subject to such Submitted Bid and
the denominator of which shall be the sum of the numbers of
outstanding Preferred Shares subject to such Submitted Bids made by
all such Existing Holders that specified a rate per annum equal to the
Winning Bid Rate; and
(E) the Submitted Bid of each of the Potential Holders specifying
a rate per annum that is equal to the Winning Bid Rate shall be
accepted but only in an amount equal to the number of outstanding
Preferred Shares obtained by multiplying (x) the difference between
the Available Preferred Shares and the number of outstanding Preferred
Shares subject to Submitted Bids described in Section 11.5(i)(B),
Section 11.5(i)(C) and Section 11.5(i)(D) by (y) a fraction the
numerator of which shall be the number of outstanding Preferred Shares
subject to such Submitted Bid and the denominator of which shall be
the sum of the number of outstanding Preferred Shares subject to such
Submitted Bids made by all such Potential Holders that specified rates
per annum equal to the Winning Bid Rate.
(ii) If Sufficient Clearing Bids have not been made (other than
because all of the outstanding Preferred Shares are subject to Submitted
Hold Orders), subject to the provisions of Section 11.5(iii), Submitted
Orders shall be accepted or rejected as follows in the following order of
priority and all other Submitted Bids shall be rejected:
(A) the Submitted Bid of each Existing Holder specifying any rate
per annum that is equal to or lower than the Maximum Applicable Rate
shall be rejected, thus entitling such Existing Holder to continue to
hold the outstanding Preferred Shares that are the subject of such
Submitted Bid;
(B) the Submitted Bid of each Potential Holder specifying any
rate per annum that is equal to or lower than the Maximum Applicable
Rate shall be accepted, thus requiring such Potential Holder to
purchase the outstanding Preferred Shares that are the subject of such
Submitted Bid; and
(C) the Submitted Bids of each Existing Holder specifying any
rate per annum that is higher than the Maximum Applicable Rate shall
be accepted and the Submitted Sell Orders of each Existing Holder
shall be accepted, in both cases
D-9
only in an amount equal to the difference between (1) the number of
outstanding Preferred Shares then held by such Existing Holder subject
to such Submitted Bid or Submitted Sell Order and (2) the number of
Preferred Shares obtained by multiplying (x) the difference between
the Available Preferred Shares and the aggregate number of outstanding
Preferred Shares subject to Submitted Bids described in Section
11.5(ii)(A) and Section 11.5(ii)(B) by (y) a fraction the numerator of
which shall be the number of outstanding Preferred Shares held by such
Existing Holder subject to such Submitted Bid or Submitted Sell Order
and the denominator of which shall be the number of outstanding
Preferred Shares subject to all such Submitted Bids and Submitted Sell
Orders.
(iii) If, as a result of the procedures described in Section 11.5(i)
or Section 11.5(ii), any Existing Holder would be entitled or required to
sell, or any Potential Holder would be entitled or required to purchase, a
fraction of a Preferred Share on any Auction Date, the Auction Agent shall,
in such manner as in its sole discretion it shall determine, round up or
down the number of Preferred Shares to be purchased or sold by any Existing
Holder or Potential Holder on such Auction Date so that each outstanding
Preferred Share purchased or sold by each Existing Holder or Potential
Holder on such Auction Date shall be a whole Preferred Share.
(iv) If, as a result of the procedures described in Section 11.5(i),
any Potential Holder would be entitled or required to purchase less than a
whole Preferred Share on any Auction Date, the Auction Agent, in such
manner as in its sole discretion it shall determine, shall allocate
Preferred Shares for purchase among Potential Holders so that only whole
Preferred Shares are purchased on such Auction Date by any Potential
Holder, even if such allocation results in one or more of such Potential
Holders not purchasing any Preferred Shares on such Auction Date.
(v) Based on the results of each Auction, the Auction Agent shall
determine, with respect to each Broker-Dealer that submitted Bids or Sell
Orders on behalf of Existing Holders or Potential Holders, the aggregate
number of the outstanding Preferred Shares to be purchased and the
aggregate number of outstanding Preferred Shares to be sold by such
Potential Holders and Existing Holders and, to the extent that such
aggregate number of outstanding shares to be purchased and such aggregate
number of outstanding shares to be sold differ, the Auction Agent shall
determine to which other Broker-Dealer or Broker-Dealers acting for one or
more purchasers such Broker-Dealer shall deliver, or from which other
Broker-Dealer or Broker-Dealers acting for one or more sellers such Broker-
Dealer shall receive, as the case may be, outstanding Preferred Shares.
11.6 Miscellaneous.
-------------
The Fund may interpret the provisions of this Article 11 to resolve any
inconsistency or ambiguity, remedy any formal defect or make any other change or
modification that does not substantially adversely affect the rights of
Beneficial Owners of Preferred Shares. A Beneficial Owner or an Existing Holder
(A) may sell, transfer or otherwise dispose of Preferred Shares only pursuant to
a Bid or Sell Order in accordance with the procedures described in this Article
11 or
D-10
to or through a Broker-Dealer, provided that in the case of all transfers other
than pursuant to Auctions such Beneficial Owner or Existing Holder, its
Broker-Dealer, if applicable, or its Agent Member advises the Auction Agent of
such transfer and (B) except as otherwise required by law, shall have the
ownership of the Preferred Shares held by it maintained in book entry form by
the Securities Depository in the account of its Agent Member, which in turn will
maintain records of such Beneficial Owner's beneficial ownership. Neither the
Fund nor any Affiliate shall submit an Order in any Auction. Any Beneficial
Owner that is an Affiliate shall not sell, transfer or otherwise dispose of
Preferred Shares to any Person other than the Fund. All of the outstanding
Preferred Shares of a Series shall be represented by a single certificate
registered in the name of the nominee of the Securities Depository unless
otherwise required by law or unless there is no Securities Depository. If there
is no Securities Depository, at the Fund's option and upon its receipt of such
documents as it deems appropriate, any Preferred Shares may be registered in the
Stock Register in the name of the Beneficial Owner thereof and such Beneficial
Owner thereupon will be entitled to receive certificates therefor and required
to deliver certificates thereof or upon transfer or exchange thereof.
D-11
PART C - OTHER INFORMATION
Item 24: Financial Statements and Exhibits
1. Financial Statements:
Included in Part A: Not Applicable
Included in Part B: To be filed by amendment.
2. Exhibits:
a. Amended and Restated Agreement and Declaration of Trust dated June 19,
2001.(1)
b.1 By-Laws of Registrant.(1)
b.2 Amendment No. 1 to the By-Laws of Registrant, to be filed by amendment.
c. None.
d.1 Article III (Shares) and Article V (Shareholders' Voting Powers and
Meetings) of the Amended and Restated Agreement and Declaration of
Trust.(1)
d.2 Article 10 (Shareholders' Voting Powers and Meetings) of the By-Laws of
the Registrant.(1)
d.3 Form of Share Certificate of the Common Shares.(1)
d.4 Specimen Certificate representing the Registrant's Auction Preferred
Shares of beneficial interest ("Auction Preferred Shares"), to be filed
by amendment.
e. Terms and Conditions of Dividend Reinvestment Plan.(1)
f. None.
g.1 Form of Investment Management Agreement between Registrant and PIMCO
Advisors L.P.(1)
g.2 Form of Portfolio Management Agreement between PIMCO Advisors L.P. and
Pacific Investment Management Company LLC.(1)
h. Form of Underwriting Agreement for the Auction Preferred Shares, to be
filed by Amendment.
i. None.
j. Form of Custodian Agreement between Registrant and State Street Bank and
Trust Co.(1)
k.1 Form of Transfer Agency Services Agreement between Registrant and
PFPC Inc.(1)
(1) Incorporated by reference from the corresponding exhibit of Pre-Effective
Amendment No. 2 to the Trust's Registration Statement on Form N-2 (File Nos.
811-10379 and 333-61300), as filed June 25, 2001.
C-1
k.2 Form of Organizational and Offering Expenses Reimbursement Agreement
between Registrant and PIMCO Advisors L.P.(1)
k.3 Form of Fee Waiver Agreement between Registrant and PIMCO Advisors
L.P.(1)
k.4 Form of Fee Waiver Agreement between PIMCO Advisors L.P. and Pacific
Investment Management Company LLC.(1)
k.5 Auction Agency Agreement between the Registrant and the Auction Agent as
to the Registrant's Auction Preferred Shares, to be filed by amendment.
k.6 Broker-Dealer Agreement as to the Registrant's Auction Preferred Shares,
to be filed by amendment.
k.7 Depository Trust Company Representations Letter as to the Registrant's
Auction Preferred Shares, to be filed by amendment.
l. Opinion and consent of Ropes & Gray as to the Registrant's Auction
Preferred Shares, to be filed by amendment.
m. None.
n. Consent of the Registrant's independent accountants, to be filed by
amendment.
o. None.
p. Subscription Agreement of PIMCO Advisors L.P., dated June 19, 2001,
incorporated by reference from the corresponding exhibit of Pre-Effective
Amendment No. 3 to the Trust's Registration Statement on Form N-2 (File
Nos. 811-10379 and 333-61300), as filed June 26, 2001.
q. None.
r.1 Code of Ethics of Registrant.(1)
r.2 Code of Ethics of PIMCO Advisors L.P.(1)
r.3 Code of Ethics of Pacific Investment Management Company LLC.(1)
s. Power of Attorney dated July 6, 2001 for each of Messrs. Treadway,
Shlissel, Connor and Belica, filed herewith.
--------------------------
(1) Incorporated by reference from the corresponding exhibit of Pre-Effective
Amendment No. 2 to the Trust's Registration Statement on Form N-2 (File Nos.
811-10379 and 333-61300), as filed June 25, 2001.
Item 25: Marketing Arrangements
Marketing arrangements relating to Registrant's Auction Preferred
Shares will be filed by amendment.
C-2
Item 26: Other Expenses of Issuance and Distribution
Securities and Exchange Commission fees $ *
National Association of Securities Dealers, *
Inc. fees
Printing and engraving expenses *
Legal Fees *
New York Stock Exchange listing fees *
Accounting expenses *
Underwriter reimbursement *
Miscellaneous expenses *
--------
Total $ *
========
* Estimated expense. To be filed by amendment.
Item 27: Persons Controlled by or under Common Control with Registrant
Not applicable.
Item 28: Number of Holders of Securities
At , 2001
(1) (2)
TITLE OF CLASS NUMBER OF RECORD HOLDERS
-------------- ------------------------
Auction Preferred Shares of 0
beneficial interest, no par value
Common Shares of beneficial interest, to be filed by amendment
no par value
Item 29: Indemnification
Reference is made to Article VIII, Sections 1 through 4, of the
Registrant's Amended and Restated Agreement and Declaration of Trust, which is
incorporated by reference herein.
Insofar as indemnification for liabilities arising under the Securities
Act of 1933, as amended (the "Act"), may be permitted to trustees, officers and
controlling persons of the Registrant by the Registrant pursuant to the Trust's
Amended and Restated Agreement and Declaration of Trust, its By-Laws or
otherwise, the Registrant is aware that in the opinion of the Securities and
Exchange Commission, such indemnification is against public policy as expressed
in the Act and, therefore, is unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
Registrant of expenses incurred or paid by trustees, officers or controlling
persons of the Registrant in the successful defense of any action, suit or
proceeding) is asserted by such trustees, officers or controlling persons in
connection with the securities being
C-3
registered, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Act and will be governed by the final adjudication of
such issue.
The Registant, PIMCO Advisors L.P., Pacific Investment Management Company
LLC and their respective trustees, directors and officers are insured by
directors and officers/errors and ommissions liability policies.
Item 30: Business and Other Connections of Investment Adviser
Descriptions of the business of PIMCO Advisors L.P., the Registrant's
investment manager, and Pacific Investment Management Company LLC, the
Registrant's portfolio manager, are set forth under the captions "Investment
Manager" and "Portfolio Manager" under "Management of the Fund" in both the
prospectus and Statement of Additional Information forming part of this
Registration Statement. The following sets forth business and other connections
of each director and executive officer (and persons performing similar
functions) of PIMCO Advisors L.P. and Pacific Investment Management Company LLC.
PIMCO Advisors L.P.
1345 Avenue of the Americas
New York, NY 10105
Name Position with Advisor Other Connections
---------------------- -------------------------- ------------------------------
Joachim Faber, Dr. Chief Executive Officer Member of the Board of
Allianz AG
Udo Frank Managing Director; Chief Managing Director and Chief
Investment Officer Investment Officer of Allianz
Asset Advisory and Management
GmbH
Robert M. Fitzgerald Executive Vice President Chief Financial Officer PIMCO
and Chief Financial Funds Distributors LLC,
Officer Cadence Capital Management,
NFJ Investment Group,
Parametric Portfolio
Associates, Pacific Investment
Management Company LLC and
StocksPLUS Management, Inc.;
Executive Vice President and
Chief Financial Officer, Value
Advisors LLC; and Chief
Financial Officer PIMCO Funds
Advertising Agency.
C-4
Kenneth M. Poovey Managing Director; Chief Chief Executive Officer,
Executive Officer of U.S. Value Advisors LLC,
Equity Division of PIMCO Oppenheimer Capital
Advisors
Stephen J. Treadway Managing Director Chairman, President and Chief
Executive Officer, PIMCO
Funds Advertising Agency,
Inc., PIMCO Funds
Distributors LLC
James G. Ward Executive Vice President, Executive Vice President,
Human Resources Human Resources, Value
Advisors LLC
C-5
Stewart A. Smith Secretary Secretary, NFJ Investment
Group, Parametric Portfolio
Associates; Assistant
Secretary, Cadence Capital
Management
Pacific Investment Management Company LLC
("PIMCO")
840 Newport Center Drive, Suite 300
Newport Beach, CA 92660
Name Business and Other Connections
----------------------------- --------------------------------------------------
Arnold, Tamara J. Executive Vice President, PIMCO
Benz, William R. II Managing Director, Executive Committee Member,
PIMCO
Bhansali, Vineer Executive Vice President, PIMCO
Brynjolfsson, John B. Executive Vice President, PIMCO
Burns, R. Wesley Managing Director, PIMCO; President and Trustee of
PIMCO Funds and PIMCO Variable Insurance Trust;
President and Director of PIMCO Commercial
Mortgage Securities Trust, Inc.; Director, PIMCO
Funds: Global Investors Series plc and PIMCO
Global Advisors (Ireland) Limited
Cupps, Wendy W. Executive Vice President, PIMCO
Dialynas, Chris Managing Director, PIMCO
Ehlert, A. Benjamin Executive Vice President, PIMCO
El-Erian, Mohamed A. Managing Director, PIMCO
C-6
Feingold, Andrea S. Executive Vice President, PIMCO
Gross, William H. Managing Director and Executive Committee Member,
PIMCO; Director and Vice President, StocksPLUS
Management, Inc.; Senior Vice President of PIMCO
Funds and PIMCO Variable Insurance Trust
Hague, John L. Managing Director, PIMCO
Hally, Gordon C. Executive Vice President, PIMCO
Hamalainen, Pasi M. Managing Director, PIMCO
Harris, Brent R. Managing Director and Executive Committee Member,
PIMCO; Director and Vice President, StocksPLUS
Management, Inc.; Trustee and Chairman of PIMCO
Funds and PIMCO Variable Insurance Trust; Director
and Chairman, PIMCO Commercial Mortgage Securities
Trust, Inc.
C-7
Hinman, David C. Executive Vice President, PIMCO
Hodge, Douglas M. Executive Vice President, PIMCO
Holden, Brent L. Managing Director, PIMCO
Isberg, Margaret E. Managing Director, PIMCO; Senior Vice President of
PIMCO Funds
Keller, James M. Executive Vice President, PIMCO
Kennedy, Raymond G. Executive Vice President, PIMCO
Loftus, John S. Managing Director, PIMCO; Senior Vice President of
PIMCO Funds; Vice President and Assistant
Secretary, StocksPLUS Management, Inc.
Mariappa, Sudesh N. Executive Vice President, PIMCO
Mather, Scott A. Executive Vice President, PIMCO; Senior Vice
President, PIMCO Commercial Mortgage Securities
Trust, Inc.
McCray, Mark V. Executive Vice President, PIMCO
McCulley, Paul A. Managing Director, PIMCO
McDevitt, Joseph E. Executive Vice President, PIMCO; Director and
Chief Executive Officer, PIMCO Global Advisors
(Europe) Limited
C-8
Muzzy, James F. Managing Director, PIMCO; Director and Vice
President, StocksPLUS Management, Inc.; Senior
Vice President, PIMCO Variable Insurance Trust;
Vice President of PIMCO Funds
Otterbein, Thomas J. Executive Vice President, PIMCO
Phansalkar, Mohan V. Executive Vice President, Senior Legal Officer
and Assistant Secretary, PIMCO; Vice President and
Assistant Secretary, StocksPLUS Management, Inc.
Powers, William C. Managing Director and Executive Committee Member,
PIMCO; Senior Vice President, PIMCO Commercial
Mortgage Securities Trust, Inc.
Schmider, Ernest L. Managing Director and Secretary, PIMCO; Director
and Assistant Secretary, StocksPLUS Management,
Inc.
Simon, Scott Executive Vice President, PIMCO
Thomas, Lee R. Managing Director, PIMCO
C-9
Thompson, William S. Jr. Chief Executive Officer, Managing Director and
Executive Committee Member, PIMCO; Director and
President, StocksPLUS Management, Inc.; Senior
Vice President of PIMCO Variable Insurance Trust;
Vice President of PIMCO Funds and PIMCO Commercial
Mortgage Securities Trust, Inc.
Trosky, Benjamin L. Managing Director, PIMCO; Senior Vice President,
PIMCO Commercial Mortgage Securities Trust, Inc.
Weil, Richard M. Chief Operating Officer, PIMCO
Wood, George H. Executive Vice President, PIMCO
Item 31: Location of Accounts and Records
The account books and other documents required to be maintained by the
Registrant pursuant to Section 31(a) of the Investment Company Act of 1940 and
the Rules thereunder will be maintained at the offices of State Street Bank &
Trust Co., 225 Franklin Street, Boston, MA 02110 and/or PFPC Inc., 400 Bellevue
Parkway, Wilmington, Delaware 19809.
Item 32: Management Services
Not applicable.
C-10
Item 33: Undertakings
1. Registrant undertakes to suspend the offering of its Common Shares
until it amends the prospectus filed herewith if (1) subsequent to the effective
date of its registration statement, the net asset value declines more than 10
percent from its net asset value as of the effective date of the registration
statement, or (2) the net asset value increases to an amount greater than its
net proceeds as stated in the prospectus.
2. Not applicable.
3. Not applicable.
4. Not applicable.
5. The Registrant undertakes that:
a. For purposes of determining any liability under the Securities
Act of 1933, the information omitted from the form of prospectus filed as
part of this registration statement in reliance upon Rule 430A and
contained in the form of prospectus filed by the Registrant under Rule
497(h) under the Securities Act of 1933 shall be deemed to be part of this
registration statement as of the time it was declared effective; and
b. For the purpose of determining any liability under the Securities
Act of 1933, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating to
the securities offered therein, and the offering of the securities at that
time shall be deemed to be the initial bona fide offering thereof.
6. The Registrant undertakes to send by first class mail or other means
designed to ensure equally prompt delivery, within two business days of receipt
of a written or oral request, any Statement of Additional Information.
Notice
A copy of the Agreement and Declaration of Trust of PIMCO California
Municipal Income Fund (the "Fund"), together with all amendments thereto, is on
file with the Secretary of State of The Commonwealth of Massachusetts, and
notice is hereby given that this instrument is executed on behalf of the Fund by
any officer of the Fund as an officer and not individually and that the
obligations of or arising out of this instrument are not binding upon any of the
Trustees of the Fund or shareholders of the Fund individually, but are binding
only upon the assets and property of the Fund.
C-11
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant has duly caused this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of New York, and the State of New York on the 10th day
of July, 2001.
PIMCO CALIFORNIA MUNICIPAL INCOME FUND
By: /s/ Stephen J. Treadway
-----------------------
Stephen J. Treadway,
President
Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities and on the dates indicated.
Name Capacity Date
---- -------- ----
/s/ Stephen J. Treadway Trustee and President July 10, 2001
------------------------------
Stephen J. Treadway
Paul Belica* Trustee July 10, 2001
------------------------------
Paul Belica
Robert E. Connor* Trustee July 10, 2001
------------------------------
Robert E. Connor
/s/ Brian S. Shlissel Treasurer and Principal July 10, 2001
------------------------------ Financial and Accounting
Brian S. Shlissel Officer
*By: /s/ Stephen J. Treadway
---------------------------
Stephen J. Treadway,
Attorney-In-Fact
Date: July 10, 2001
INDEX TO EXHIBITS
Exhibit Exhibit Name
------- ------------
s. Power of Attorney dated July 6, 2001 for each of Messrs. Treadway,
Shlissel, Connor and Belica.