As filed with the Securities and Exchange Commission on January 10, 2005
1933 Act File No. 333-__________
1940 Act File No. 811-21654
United States
Securities and Exchange Commission
Washington, D.C. 20549
FORM N-2
(Check appropriate box or boxes)
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 [X]
Pre-Effective Amendment No. [ ] [ ]
Post-Effective Amendment No. [ ] [ ]
and/or
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 [X]
Amendment No. 4 [X]
PIONEER FLOATING RATE TRUST
Exact Name of Registrant as Specified in Charter
60 State Street, Boston, Massachusetts 02109
Address of Principal Executive Offices (Number, Street, City, State, Zip Code)
(617) 742-7825
Registrant's Telephone Number, including Area Code
Dorothy E. Bourassa, Pioneer Investment Management, Inc.,
60 State Street, Boston, Massachusetts 02109
Name and Address (Number, Street, City, State, Zip Code) of Agent for Service
Copy to: David C. Phelan, Esq.
Wilmer Cutler Pickering Hale and Dorr LLP
60 State Street
Boston, Massachusetts 02109
Approximate Date of Proposed Public Offering: As soon as practicable after the
effective date of this Registration Statement.
If any securities being registered on this form will be offered on a delayed or
continuous basis in reliance on Rule 415 under the Securities Act of 1933, as
amended, other than securities offered in connection with a dividend
reinvestment plan, check the following box. [ ]
CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933
----------------------------------------------------------------------------------------------------------------
Title of Securities Amount Being Proposed Maximum Proposed Maximum Amount of
Being Registered Registered Offering Price Per Unit Aggregate Offering Price Registration Fee(1)
----------------------------------------------------------------------------------------------------------------
Preferred Shares 40 shares $25,000.00 $1,000,000.00 $117.70
(par value $0.0001)
----------------------------------------------------------------------------------------------------------------
(1) Transmitted prior to the filing to the designated lockbox of the Securities
and Exchange Commission at Mellon Bank in Pittsburgh, Pennsylvania.
The Registrant hereby amends this Registration Statement on such date or dates
as may be necessary to delay its effective date until the Registrant shall file
a further amendment, which specifically states that this Registration Statement
shall thereafter become effective in accordance with Section 8(a) of the
Securities Act or until the Registration Statement shall be effective on such
date as the Commission, acting pursuant to said Section 8(a), may determine.
PIONEER FLOATING RATE TRUST
CROSS-REFERENCE SHEET
PART A--PROSPECTUS
ITEMS IN PART A OF FORM N-2 LOCATION IN PROSPECTUS
--------------------------- ----------------------
Item 1. Outside Front Cover Cover Page
Item 2. Cover Pages; Other Offering Information Cover Page
Item 3. Fee Table and Synopsis Not applicable
Item 4. Financial Highlights Financial Highlights (unaudited)
Item 5. Plan of Distribution Cover Page; Prospectus Summary; The Auction;
Underwriting
Item 6. Selling Shareholders Not applicable
Item 7. Use of Proceeds Use of Proceeds
Item 8. General Description of the Registrant Cover Page; Prospectus Summary; The Fund; Investment
Objectives and Principal Investment Strategies;
Leverage; Risk Factors; Net Asset Value; Certain
Provisions of the Agreement and Declaration of Trust
and By-Laws
Item 9. Management Prospectus Summary; Management of the Fund Description
of Preferred Shares
Item 10. Capital Stock, Long-Term Debt, and Other Description of Preferred Shares; Federal Income Tax
Securities Matters
Item 11. Default and Arrears On Senior Securities Not applicable
Item 12. Legal Proceedings Not applicable
Item 13. Table of Contents of the Statement of Table of Contents of the Statement of Additional
Additional Information Information
PART B--STATEMENT OF ADDITIONAL INFORMATION
ITEMS IN PART B OF FORM N-2 LOCATION IN STATEMENT OF ADDITIONAL INFORMATION
--------------------------- -----------------------------------------------
Item 14. Cover Page Cover Page
Item 15. Table of Contents Cover Page
Item 16. General Information and History Not applicable
Item 17. Investment Objective and Policies Investment Objectives and Policies; Investment
Restrictions; Appendix A - Description of Ratings
Item 18. Management Management of the Fund
Item 19. Control Persons and Principal Holders of Management of the Fund - Control Persons and Principal
Securities Holders of Securities
Item 20. Investment Advisory and Other Services Management of the Fund
Item 21. Brokerage Allocation and Other Practices Portfolio Transactions
Item 22. Tax Status Federal Income Tax Matters
Item 23. Financial Statements Independent Registered Public Accounting Firm;
Financial Statements and Report of Independent
Registered Public Accounting Firm
PART C - OTHER INFORMATION
Items 24-33 have been answered in Part C of this Registration Statement.
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY
NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER
TO SELL THESE SECURITIES AND IS NOT SOLICITING AN OFFER TO BUY THESE SECURITIES
IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
SUBJECT TO COMPLETION
PRELIMINARY PROSPECTUS DATED JANUARY 10, 2005
PROSPECTUS
(PIONEER LOGO)
$
PIONEER FLOATING RATE TRUST
AUCTION MARKET PREFERRED SHARES ("PREFERRED SHARES")
[ ] SHARES, SERIES [ ]
[ ] SHARES, SERIES [ ]
[ ] SHARES, SERIES [ ]
LIQUIDATION PREFERENCE $25,000 PER SHARE
----------------------
Pioneer Floating Rate Trust (the "Fund") is offering [ ] Series
[ ] Auction Market Preferred Shares, [ ] Series [ ] Auction Market
Preferred Shares, and [ ] Series [ ] Auction Market Preferred Shares.
The shares are referred to in this prospectus as "Preferred Shares." The Fund is
a recently organized, non-diversified, closed-end management investment company.
The Preferred Shares are subject to mandatory redemption in certain
circumstances. Any series of Preferred Shares may be redeemed, in whole or in
part, at the option of the Fund at any time, subject to certain circumstances.
Dividends on the Preferred Shares will be cumulative from the date the shares
are issued.
Investment Objectives. The Fund's primary investment objective is to
provide a high level of current income. As a secondary investment objective, the
Fund seeks preservation of capital to the extent consistent with its primary
investment objective. There can be no assurance that the Fund will achieve its
investment objectives.
Portfolio Contents. Under normal market conditions, the Fund seeks to
achieve its investment objectives by investing at least 80% of its assets (net
assets plus borrowings for investment purposes) in senior floating rate loans
("Senior Loans"). Senior Loans are made to corporations, partnerships and other
business entities that operate in various industries and geographical regions,
including non-U.S. borrowers. Senior Loans pay interest at rates that are
redetermined periodically on the basis of a floating base lending rate plus a
premium. The Fund also may invest in other floating and variable rate
instruments, including second lien loans, and in high yield corporate bonds. The
Fund may invest in Senior Loans and other securities of any credit quality,
including Senior Loans and other investments that are rated below investment
grade, or are unrated but are determined by the investment subadviser to be of
equivalent credit quality, commonly referred to as "junk bonds." The Fund may
invest all or any portion of its assets in securities of issuers that are in
default or that are in bankruptcy. The Fund does not have a policy of
maintaining a specific average credit quality of its portfolio or a minimum
portion of its portfolio that must be rated investment grade. The Fund may
invest up to 10% of its total assets in Senior Loans and other securities of
non-U.S. issuers, including emerging market issuers, and may engage in certain
hedging transactions.
(continued on following page)
INVESTING IN THE PREFERRED SHARES INVOLVES RISKS THAT ARE DESCRIBED IN THE
"RISK FACTORS" SECTION BEGINNING ON PAGE OF THIS PROSPECTUS. THE MINIMUM
PURCHASE AMOUNT OF THE PREFERRED SHARES IS $25,000.
----------------------
PER SHARE TOTAL
--------- -----
Public offering price....................................... $25,000 $
Sales load.................................................. $ 250 $
Estimated offering expenses................................. $ $
Proceeds, after expenses, to the Fund (1)................... $ $
(1) Plus accumulated dividends, if any, from the date the Preferred
Shares are issued.
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.
The underwriters are offering the Preferred Shares subject to various
conditions. The Preferred Shares will be ready for delivery, in book-entry form
only, through the facilities of The Depository Trust Company on or about
, 2005.
----------------------
----------------------
The date of this prospectus is , 2005.
(continued from previous page)
Non-investment grade securities, commonly referred to as junk bonds, are
obligations that are rated below investment grade by the national rating
agencies that cover the obligations (i.e., Ba and below by Moody's Investors
Service, Inc. ("Moody's") or BB and below by Standard & Poor's Ratings Group
("S&P")), or if unrated, are determined by the Fund's investment subadviser,
Highland Capital Management, L.P. (the "Subadviser"), to be of comparable
quality. Investment in securities of below investment grade quality involves
substantial risk of loss. "Junk bonds" are considered predominantly speculative
with respect to the issuer's ability to pay interest and repay principal and are
susceptible to default or decline in market value due to adverse economic and
business developments. Because Senior Loans are senior in a borrower's capital
structure and often are secured by specific collateral, the Subadviser believes,
based on its experience, that Senior Loans generally have more favorable loss
recovery rates compared to most other types of below investment grade
obligations. However, there can be no assurance that the Fund's actual loss
recovery experience will be consistent with the Subadviser's prior experience or
that the Senior Loans will achieve any specific loan recovery rate.
Investment Adviser. Pioneer Investment Management, Inc. is the Fund's
investment adviser (the "Adviser"). As of December 31, 2004, the Adviser had
approximately $ billion in assets under management. The Adviser has engaged
Highland Capital Management, L.P. to act as the Fund's investment subadviser and
manage the Fund's investments. As of December 31, 2004, the Subadviser had
approximately $ billion in assets under management. See "Management of the
Fund."
You should read this prospectus, which contains important information
about the Fund, before deciding whether to invest in the Preferred Shares, and
retain it for future reference. A Statement of Additional Information, dated
, 2005, 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. 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 (800) 225-6292 or by writing to the Fund, or obtain a
copy (and other information regarding the Fund) from the Securities and Exchange
Commission's web site (http://www.sec.gov). The Fund's registration number under
the Investment Company Act of 1940, as amended (the "1940 Act"), is 811-21654.
You may also email requests for these documents to publicinfo@sec.gov or make a
request in writing to the Securities and Exchange Commission's Public Reference
Section, Washington, D.C. 20549-0102.
The public offering price per share will be increased by the amount of
dividends, if any, that have accumulated from the date the Preferred Shares are
first issued.
The Preferred Shares do not represent a deposit or obligation of, and are
not guaranteed or endorsed by, any bank or other insured depository institution
and are not federally insured by the Federal Deposit Insurance Corporation, the
Federal Reserve Board or any other government agency.
The Fund is offering [ ] Series [ ] Preferred Shares,
[ ] Series [ ] Preferred Shares, and [ ] Series [ ]Preferred
Shares. The Preferred Shares have a liquidation preference of $25,000 per share,
plus any accumulated, unpaid dividends. The Preferred Shares also have priority
over the Fund's common shares as to distribution of assets, as described in this
prospectus. It is a condition of closing this offering that the Preferred Shares
be assigned a rating of Aaa by Moody's and AAA by Fitch, Inc. ("Fitch").
The dividend rate for the initial dividend period will be [ ]% for
Series [ ] Preferred Shares, [ ]% for Series [ ] Preferred Shares, and
[ ]% for Series [ ] Preferred Shares. The initial dividend period for
Series [ ] Preferred Shares is from the date of issuance through ,
2005. The initial dividend period for Series [ ] Preferred Shares is from the
date of issuance through , 2005. The initial dividend period for
Series [ ] Preferred Shares is from the date of issuance through ,
2005. For subsequent periods, Preferred Shares will pay dividends based on
2
a rate set at auction, usually held every [ ] days in the case of Series
[ ] Preferred Shares, every [ ] days in the case of Series [ ] Preferred
Shares, and every [ ] days in the case of Series [ ] Preferred Shares.
Prospective purchasers should carefully review the auction procedures described
in this prospectus and should note: (1) a buy order (called a "bid order") or
sell order is a commitment to buy or sell Preferred Shares based on the results
of an auction; and (2) purchases and sales will be settled on the next business
day after the auction.
THE PREFERRED SHARES WILL NOT BE LISTED ON AN EXCHANGE. YOU MAY ONLY BUY
OR SELL PREFERRED SHARES THROUGH AN ORDER PLACED AT AN AUCTION WITH OR THROUGH
CERTAIN BROKER-DEALERS OR IN A SECONDARY MARKET MAINTAINED BY CERTAIN
BROKER-DEALERS. THESE BROKER-DEALERS ARE NOT REQUIRED TO MAINTAIN THIS MARKET,
AND IT MAY NOT PROVIDE YOU WITH LIQUIDITY.
3
TABLE OF CONTENTS
PAGE
----
Prospectus Summary.......................................... 5
Financial Highlights (Unaudited)............................ 30
The Fund.................................................... 32
Use of Proceeds............................................. 32
Capitalization (Unaudited).................................. 32
Portfolio Composition....................................... 33
Investment Objectives and Principal Investment Strategies... 34
Portfolio Contents.......................................... 36
Risk Factors................................................ 48
Management of the Fund...................................... 57
Description of Preferred Shares............................. 60
The Auction................................................. 72
Federal Income Tax Matters.................................. 78
Net Asset Value............................................. 82
Description of Common Shares................................ 83
Underwriting................................................ 86
Additional Compensation.....................................
Administrator, Custodian, Transfer Agent, Registrar and
Dividend Disbursing Agent................................. 87
Validity of Shares.......................................... 87
Table of Contents of the Statement of Additional
Information............................................... 88
---------------------
You should rely only on the information contained in or incorporated by
reference into this prospectus. The Fund has not, and the underwriters have not,
authorized any other person to provide you with different information. If anyone
provides you with different or inconsistent information, you should not rely on
it. The Fund is not, and the underwriters are not, making an offer to sell these
securities in any jurisdiction where the offer or sale is not permitted. The
information appearing in this prospectus is given as of the date of this
prospectus. The Fund's business, financial condition, results of operations and
prospects may have changed since the date of this prospectus.
PRIVACY PRINCIPLES OF THE FUND
The Fund is committed to maintaining the privacy of its shareholders and
to safeguarding their non-public personal information. The following information
is provided to help you understand what personal information the Fund collects,
how the Fund protects that information and why, in certain cases, the Fund may
share information with select other parties.
Generally, the Fund does not receive any non-public personal information
relating to its shareholders, although certain non-public personal information
of its shareholders may become available to the Fund. The Fund does not disclose
any non-public personal information about its shareholders or former
shareholders to anyone, except as permitted by law or as is necessary in order
to service shareholder accounts (for example, to a transfer agent or third-party
administrator).
The Fund restricts access to non-public personal information about its
shareholders to employees of the Fund's investment adviser and its affiliates
with a legitimate business need for the information. The Fund maintains
physical, electronic and procedural safeguards designed to protect the
non-public personal information of its shareholders. For more information about
the Fund's privacy policies, please visit http://www.pioneerfunds.com.
4
PROSPECTUS SUMMARY
This is only a summary. This summary does not contain all of the
information that you should consider before investing in the Fund's Preferred
Shares, especially the information set forth under the heading "Risk Factors."
You should review the more detailed information contained in this prospectus,
the Statement of Additional Information and the Fund's Statement of Preferences
of Auction Market Preferred Shares (the "Statement") attached as Appendix C to
the Statement of Additional Information.
THE FUND.................... The Pioneer Floating Rate Trust (the "Fund") is a
recently organized, non-diversified, closed-end
management investment company. The Fund closed an
initial public offering of 22,500,000 common
shares of beneficial interest, no par value, and
commenced investment operations on December 28,
2004. The Fund's common shares are traded on the
New York Stock Exchange under the symbol "PHD." As
of , 2005 the Fund had [ ]
common shares outstanding and had net assets of
[ ]. Pioneer Investment Management, Inc.
is the Fund's investment adviser. The Adviser has
engaged Highland Capital Management, L.P. to act
as the Fund's investment subadviser to manage the
Fund's investments. The Fund's principal offices
are located at 60 State Street, Boston,
Massachusetts 02109. See "The Fund."
THE OFFERING................ The Fund is offering an aggregate of [ ]
shares of Series [ ] Preferred Shares, [ ]
shares of Series [ ] Preferred Shares and
[ ] shares of Series [ ] Preferred Shares,
each at a purchase price of $25,000 per share plus
dividends, if any, that have accumulated from the
date the Fund first issues the Preferred Shares.
The Preferred Shares are being offered by the
underwriters listed under "Underwriting."
The Preferred Shares entitle their holders to
receive cash dividends at an annual rate that may
vary for successive dividend periods. In general,
except as described under "Dividends and Dividend
Periods" below and "Description of Preferred
Shares -- Dividends and Dividend Periods," the
dividend period for Series [ ] Preferred Shares
will be [ ] days, the dividend period for Series
[ ] Preferred Shares will be [ ] days, and the
dividend period for Series [ ] Preferred
Shares will be [ ] days. Deutsche Bank Trust
Company Americas (the "Auction Agent") will
determine the dividend rate for any dividend
period by an auction conducted on the business day
immediately prior to the start of that dividend
period. See "The Auction."
The Preferred Shares are not listed on an
exchange. Instead, investors may buy or sell
Preferred Shares at an auction by submitting
orders to broker-dealers ("Broker-Dealers") that
have entered into an agreement with the Auction
Agent (a "Broker-Dealer Agreement") or to
broker-dealers that have entered into separate
agreements with a Broker-Dealer.
Generally, investors in the Preferred Shares will
not receive certificates representing ownership of
their shares. The Depositary
5
Trust Company or any successor (the "Securities
Depositary") or its nominee for the account of the
investor's Broker-Dealer will maintain record
ownership of Preferred Shares in book-entry form.
An investor's Broker-Dealer, in turn, will
maintain records of that investor's beneficial
ownership of Preferred Shares.
INVESTMENT OBJECTIVES AND
PRINCIPAL INVESTMENT
STRATEGIES................ Investment Objectives. The Fund's primary
investment objective is to provide a high level of
current income. As a secondary investment
objective, the Fund seeks preservation of capital
to the extent consistent with its primary
investment objective. There can be no assurance
that the Fund will achieve its investment
objectives.
Principal Investment Strategies. Under normal
market conditions, the Fund seeks to achieve its
investment objectives by investing at least 80% of
its assets (net assets plus borrowings for
investment purposes) in senior floating rate loans
("Senior Loans"). The Fund also may invest in
other floating and variable rate instruments,
including second lien loans, and high yield, high
risk corporate bonds, investment grade
fixed-income debt securities, preferred stocks
(many of which have fixed maturities), convertible
securities, securities that make "in-kind"
interest payments, bonds not paying current
income, bonds that do not make regular interest
payments and money market instruments. The Fund
may invest up to 10% of its total assets in Senior
Loans and other securities of non-U.S. issuers,
including emerging market issuers, and may engage
in certain hedging transactions.
The Subadviser uses a fundamental research
approach in selecting the Fund's investments and
seeks to invest in those sectors, industries and
companies that provide value on a relative basis.
The Subadviser seeks to identify those companies
that are dominant players in their industries and
generally does not invest in securities of issuers
that it believes cannot be adequately researched.
The Subadviser's process focuses on those issuers
that generate positive cash flow momentum, exhibit
stable or improving debt coverage, have an
experienced management team and demonstrate net
tangible asset protection.
The Subadviser's investment philosophy is based on
the belief that fundamental research and a
disciplined asset acquisition/disposition process
will produce superior long-term results. The
Subadviser's investment process combines an
economic and industry overlay with a disciplined
securities selection process. The Subadviser's
economic and industry overlay utilizes a variety
of macro and economic variables to identify broad
market sectors that the Subadviser believes have
positive fundamentals. Within these broad sectors,
the Subadviser targets specific industries that
appear to have, in the Subadviser's view, the most
promising prospects under current market
conditions. Within a targeted industry, the
Subadviser
6
engages in a disciplined securities selection
process. In this process, the Subadviser conducts
an extensive analysis of issuers within the
targeted industry to identify issuers that appear
to have the most favorable prospects for improving
financial condition. The Subadviser also reviews
the terms of the agreements documenting the Senior
Loans to seek to identify those Senior Loans that
have the most favorable risk and return
characteristics. Based on this analysis, the
Subadviser constructs and actively manages a
portfolio of Senior Loans. The Subadviser's goal
is to achieve the highest potential level of
current income with the lowest potential
volatility over long periods of time.
Duration Management. The Subadviser expects that
the average effective duration of the Fund's
portfolio of Senior Loans will normally be between
zero and 1.5 years, reflecting the Fund's focus on
floating rate instruments. As a measure of a
fixed-income security's cash flow, duration is an
alternative to the concept of "term to maturity"
in assessing the price volatility associated with
changes in interest rates. Generally, the longer
the duration, the more volatility an investor
should expect. For example, the market price of a
fixed-income security with a duration of three
years would be expected to decline 3% if interest
rates rose 1%. Conversely, the market price of the
same security would be expected to increase 3% if
interest rates fell 1%. The market price of a
fixed-income security with a duration of six years
would be expected to increase or decline twice as
much as the market price of a security with a
three-year duration. Duration is a way of
measuring a security's maturity in terms of the
average time required to receive the present value
of all interest and principal payments as opposed
to its term to maturity. The maturity of a
security measures only the time until final
payment is due; it does not take account of the
pattern of a security's cash flows over time,
which would include how cash flow is affected by
prepayments and by changes in interest rates.
Because the interest rate on Senior Loans held by
the Fund will reset at short-term intervals, the
duration of Senior Loans will be shorter than a
fixed income security with a comparable term to
maturity. The Subadviser can manage the duration
of the portfolio by selecting Senior Loans with
different interest rate reset periods and final
maturity dates. Incorporating a security's yield,
coupon interest payments, final maturity and
option features into one measure, duration is
computed by determining the weighted average
maturity of a fixed-income security's cash flows,
where the present values of the cash flows serve
as weights. In computing the duration of the
Fund's portfolio of Senior Loans, the Subadviser
will estimate the duration of obligations that are
subject to features such as prepayment or
redemption by the issuer, put options retained by
the investor or other imbedded options, taking
into account the influence of interest rates on
prepayments and coupon flows.
7
Credit Management. The Fund may invest in Senior
Loans and other securities of any credit quality,
including Senior Loans and other investments that
are rated below investment grade or are unrated
but determined by the Subadviser to be of
equivalent credit quality. The Fund does not have
a policy of maintaining a specific average credit
quality of its portfolio nor a minimum portion of
its portfolio that must be rated investment grade.
The Subadviser's staff monitors the credit quality
and price of Senior Loans and other securities
held by the Fund, as well as other securities that
are available to the Fund. Although the Subadviser
considers ratings when making investment
decisions, it performs its own credit and
investment analysis and does not rely primarily on
ratings assigned by rating services. In evaluating
the attractiveness of a particular Senior Loan or
other security, whether rated or unrated, the
Subadviser generally gives equal weight to the
security's yield and the issuer's creditworthiness
and will normally take into consideration, among
other things, the issuer's financial resources and
operating history, its sensitivity to economic
conditions and trends, the availability of its
management, its debt maturity schedules and
borrowing requirements, and relative values based
on anticipated cash flow, interest and asset
coverage, and earnings prospects.
PORTFOLIO CONTENTS.......... Senior Loans. Senior Loans hold the most senior
position in the capital structure of a business
entity, are typically secured with specific
collateral and have a claim on the general assets
of the borrower that is senior to that held by
subordinated debtholders and stockholders of the
borrower. The proceeds of Senior Loans frequently
are used to finance leveraged buyouts,
recapitalizations, mergers, acquisitions, stock
repurchases and, to a lesser extent, to finance
internal growth and for other corporate purposes.
Senior Loans typically have rates of interest
which are redetermined either daily, monthly,
quarterly or semi-annually by reference to a base
lending rate, plus a premium. These base lending
rates generally are the London Interbank Offered
Rate ("LIBOR"), the prime rate offered by one or
more major United States banks (Prime Rate) or the
certificate of deposit (CD) rate or other base
lending rates used by commercial lenders.
The Fund may purchase obligations issued in
connection with a restructuring pursuant to
Chapter 11 of the U.S. Bankruptcy Code. While
these investments are not a primary focus of the
Fund, the Fund does not have a policy limiting
such investments to a specific percentage of the
Fund's assets.
The Fund may invest up to 10% of its total assets
in Senior Loans and other securities of non-U.S.
issuers, including emerging market issuers, and
may engage in certain hedging transactions.
Senior Loans and other corporate debt obligations
are subject to the risk of non-payment of
scheduled installments of interest or principal.
Such non-payment would result in a reduction of
income
8
to the Fund, a reduction in the value of the
investment and a potential decrease in the net
asset value of the Fund. There can be no assurance
that the liquidation of any collateral securing a
Senior Loan would satisfy a borrower's obligation
in the event of non-payment of scheduled
installments of interest or principal, or that
such collateral could be readily liquidated. In
the event of bankruptcy of a borrower, the Fund
could experience delays or limitations with
respect to its ability to realize the benefits of
the collateral securing a Senior Loan. To the
extent that a Senior Loan is collateralized by
stock in the borrower or its subsidiaries, such
stock may lose all or substantially all of its
value in the event of bankruptcy of a borrower.
Some Senior Loans are subject to the risk that a
court, pursuant to fraudulent conveyance or other
similar laws, could subordinate Senior Loans to
presently existing or future indebtedness of the
borrower or take other action detrimental to the
holders of Senior Loans including, in certain
circumstances, invalidating Senior Loans or
causing interest previously paid to be refunded to
the borrower. If interest were required to be
refunded, it could result in a loss to the Fund
negatively affecting the Fund's performance.
Many loans in which the Fund will invest may not
be rated by a rating agency, will not be
registered with the Securities and Exchange
Commission or any state securities commission and
will not be listed on any national securities
exchange. The amount of public information
available with respect to issuers of Senior Loans
will generally be less extensive than that
available for issuers of registered or exchange
listed securities. In evaluating the
creditworthiness of borrowers, the Subadviser will
consider, and may rely in part, on analyses
performed by others. The Subadviser does not view
ratings as the determinative factor in its
investment decisions and relies more upon its
credit analysis abilities than upon ratings.
Borrowers may have outstanding debt obligations
that are rated below investment grade by a rating
agency. A high percentage of Senior Loans held by
the Fund may be rated below investment grade by
independent rating agencies. In the event Senior
Loans are not rated, they are likely to be the
equivalent of below investment grade quality. Debt
securities which are unsecured and rated below
investment grade (i.e., Ba and below by Moody's or
BB and below by S&P) and comparable unrated bonds,
are viewed by the rating agencies as having
speculative characteristics and are commonly known
as "junk bonds." A description of the ratings of
corporate bonds by Moody's and S&P is included as
Appendix A to the Statement of Additional
Information. Because Senior Loans are senior to
subordinated creditors and stockholders in a
borrower's capital structure and are often secured
by specific collateral, the Subadviser believes,
based on its experience, that Senior Loans have
more favorable loss recovery rates as compared to
most other types of below investment grade
obligations. However, there can be no assurance
that the Fund's actual loss recovery experience
will be
9
consistent with the Subadviser's prior experience
or that the Senior Loans will achieve any specific
loan recovery rate.
The Fund may hold securities that are unrated or
in the lowest ratings categories (rated C by
Moody's or D by S&P). Debt securities rated C by
Moody's are regarded as having extremely poor
prospects of ever attaining any real investment
standing. Debt securities rated D by S&P are in
payment default or a bankruptcy petition has been
filed and debt service payments are jeopardized.
In order to enforce its rights with defaulted
securities, the Fund may be required to retain
legal counsel and/or a financial adviser. The Fund
may have to pursue legal remedies, the results of
which are uncertain and expensive. This may
increase operating expenses and adversely affect
net asset value. The credit quality of most
securities held by the Fund reflects a greater
possibility that adverse changes in the financial
condition of an issuer, or in general economic
conditions, or both, may impair the ability of the
issuer to make payments of interest or principal.
The inability (or perceived inability) of issuers
to make timely payment of interest and principal
would likely make the values of such securities
more volatile and could limit the Fund's ability
to sell securities at favorable prices. In the
absence of a liquid trading market for securities
held by it, the Fund may have difficulties
determining the fair market value of such
securities. Because of the greater number of
investment considerations involved in investing in
high yield, high risk Senior Loans and bonds, the
achievement of the Fund's objectives depends more
on the Subadviser's judgment and analytical
abilities than would be the case if invested
primarily in securities in the higher ratings
categories.
No active trading market may exist for many Senior
Loans, and some Senior Loans may be subject to
restrictions on resale. The Fund is not limited in
the percentage of its assets that may be invested
in Senior Loans and other securities deemed to be
illiquid. Any secondary market may be subject to
irregular trading activity, wide bid/ask spreads
and extended trade settlement periods, which may
impair the ability of the Fund to realize full
value on the disposition of an illiquid Senior
Loan and cause a material decline in the Fund's
net asset value.
Investing in Senior Loans involves investment
risk. Some borrowers default on their Senior Loan
payments. The Fund attempts to manage this credit
risk through portfolio diversification and ongoing
analysis and monitoring of borrowers. The Fund
also is subject to market, liquidity, interest
rate and other risks. See "Risk Factors."
Other Fixed Income Securities. The Fund also may
purchase unsecured loans, other floating rate debt
securities such as notes, bonds and asset-backed
securities (such as securities issued by special
purpose funds investing in bank loans), investment
grade and below investment grade fixed income debt
obligations and money market instruments, such as
commercial paper. The high
10
yield securities in which the Fund may invest are
rated Ba or lower by Moody's or BB or lower by S&P
or are unrated but determined by the Subadviser to
be of comparable quality. Debt securities rated
below investment grade are commonly referred to as
"junk bonds" and are considered speculative with
respect to the issuer's capacity to pay interest
and repay principal. Below investment grade debt
securities involve greater risk of loss, are
subject to greater price volatility and are less
liquid, especially during periods of economic
uncertainty or change, than higher rated debt
securities. The Fund's fixed-income securities may
have fixed or variable principal payments and all
types of interest rate and dividend payment and
reset terms, including fixed rate, adjustable
rate, zero coupon, contingent, deferred, payment
in kind and auction rate features. The Fund may
invest in fixed-income securities with a broad
range of maturities.
The Fund may invest in zero coupon bonds, deferred
interest bonds and bonds or preferred stocks on
which the interest is payable in-kind (PIK bonds).
To the extent the Fund invests in such
instruments, they will not contribute to the
Fund's primary goal of current income. Zero coupon
and deferred interest bonds are debt obligations
which are issued at a significant discount from
face value. While zero coupon bonds do not require
the periodic payment of interest, deferred
interest bonds provide for a period of delay
before the regular payment of interest begins. PIK
bonds are debt obligations that provide that the
issuer thereof may, at its option, pay interest on
such bonds in cash or in the form of additional
debt obligations. Such investments may experience
greater volatility in market value due to changes
in interest rates. The Fund may be required to
accrue income on these investments for federal
income tax purposes and is required to distribute
its net income each year in order to qualify for
the favorable federal income tax treatment
potentially available to regulated investment
companies. The Fund may be required to sell
securities to obtain cash needed for income
distributions at times and at prices that the
Adviser believes do not reflect the intrinsic
value of such securities.
OTHER INVESTMENTS........... Normally, the Fund will invest substantially all
of its assets to meet its investment objectives.
The Fund may invest the remainder of its assets in
securities with remaining maturities of less than
one year or cash equivalents, or it may hold cash.
For temporary defensive purposes, the Fund may
depart from its principal investment strategies
and invest part or all of its assets in securities
with remaining maturities of less than one year or
cash equivalents, or it may hold cash. During such
periods, the Fund may not be able to achieve its
investment objectives.
HEDGING AND INTEREST RATE
TRANSACTIONS.............. The Fund may, but is not required to, use various
hedging and interest rate transactions to earn
income, facilitate portfolio management and
mitigate risks. The Fund may purchase and sell
derivative instruments such as exchange-listed and
over-the-counter
11
put and call options on securities, fixed income
and interest rate indices and other financial
instruments; purchase and sell financial futures
contracts and options thereon; and enter into
various interest rate transactions such as swaps,
caps, floors or collars or credit transactions and
credit default swaps. The Fund also may purchase
derivative instruments that combine features of
these instruments. The Fund generally seeks to use
these instruments and transactions as a portfolio
management or hedging technique that seeks to
protect against possible adverse changes in the
market value of Senior Loans or other securities
held in or to be purchased for the Fund's
portfolio, to facilitate the sale of certain
securities for investment purposes, manage the
effective interest rate exposure of the Fund,
manage the effective maturity or duration of the
Fund's portfolio or establish positions in the
derivatives markets as a temporary substitute for
purchasing or selling particular securities.
USE OF LEVERAGE BY THE
FUND........................ The Fund expects to utilize financial leverage on
an ongoing basis for investment purposes, such as
through the issuance of the Preferred Shares.
After completion of the offering of the Preferred
Shares, the Fund anticipates its total leverage
from the issuance of Preferred Shares will be
approximately 33 1/3% of the Fund's total assets.
This amount may change but the Fund will not incur
additional leverage if the total leverage would
exceed 50% of the Fund's total assets. Although
the Fund may in the future offer other preferred
shares or incur indebtedness, which would further
leverage the Fund, the Fund does not currently
intend to offer preferred shares other than the
Preferred Shares offered hereby. The Fund may also
invest in derivative instruments, each of which
may amplify the effects of leverage in the Fund's
portfolio.
The Fund generally will not utilize leverage if
the Adviser anticipates that leverage would result
in a lower return to holders of the common shares
over time. Use of financial leverage creates an
opportunity for increased income for the holders
of the common shares 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 common
shares and of dividends), and there can be no
assurance that a leveraging strategy will be
successful during any period in which it is
employed. Because the fees paid to the Adviser
will be calculated on the basis of the Fund's
managed assets, the fees will be higher when
leverage (including the Preferred Shares) is
utilized, giving the Adviser an incentive to
utilize leverage.
SPECIAL RISK
CONSIDERATIONS.............. The following is a summary of the principal risks
of investing in the Preferred Shares. You should
read the fuller discussion in this prospectus
under "Risk Factors" beginning on page [ ].
Risks of Investing in Preferred Shares. The
primary risks of investing in Preferred Shares
are:
- If an auction fails you may not be able to sell
some or all of your shares.
12
- Because of the nature of the market for
Preferred Shares, you may receive less than the
price you paid for your Preferred Shares if you
sell them outside of the auction, especially
when market interest rates are rising.
- A rating agency could, at any time, downgrade or
withdraw its rating assigned to the Preferred
Shares without prior notice to the Fund or
shareholders. Any downgrading or withdrawal of
rating could affect the liquidity of the
Preferred Shares in an auction.
- The Fund may be forced to redeem Preferred
Shares to meet regulatory or rating agency
requirements or may voluntarily redeem your
shares in certain circumstances.
- In certain circumstances, the Fund may not earn
sufficient income from its investments to pay
dividends on the Preferred Shares.
- If interest rates rise, the value of the Fund's
investment portfolio will decline, reducing the
asset coverage for Preferred Shares.
Leverage Risk. The Fund's leveraged capital
structure creates special risks not associated
with unleveraged funds having a similar investment
objective and policies. These include the
possibility of higher volatility of the net asset
value of the Fund and the value of assets serving
as asset coverage for the Preferred Shares.
Interest Rate Risk. The Preferred Shares pay
dividends based on shorter-term interest rates.
The Fund may invest the proceeds from the issuance
of the Preferred Shares in Senior Loans. The
interest rates on Senior Loans are typically,
although not always, higher than shorter-term
interest rates of securities with a AAA/Aaa credit
rating, which is the credit rating the Fund
anticipates receiving from Moody's and Fitch on
the Preferred Shares. Shorter-term rates,
including the floating rates paid on the Fund's
portfolio of Senior Loans, can be expected to
fluctuate. If shorter-term interest rates rise,
dividend rates on the Preferred Shares may rise so
that the amount of dividends to be paid to holders
of Preferred Shares exceeds the income from the
Senior Loans purchased by the Fund with the
proceeds from the sale of the Preferred Shares.
Similarly, the anticipated differential on the
rate anticipated to be paid on the Preferred
Shares and the Fund's portfolio of Senior Loans
would decline or be eliminated if, in the future,
the rating agencies lower the rating assigned to
the Preferred Shares. Because income from the
Fund's entire investment portfolio (not just the
portion of the portfolio purchased with the
proceeds of the Preferred Shares offering) is
available to pay dividends on the Preferred
Shares, however, dividend rates on the Preferred
Shares would need to exceed the rate of return on
the Fund's investment portfolio by a wide margin
before the Fund's ability to pay dividends on the
Preferred Shares would be jeopardized.
Auction Risk. The dividend rate for the Preferred
Shares normally is set through an auction process.
In the auction, holders of
13
Preferred Shares may indicate the dividend rate at
which they would be willing to hold or sell their
Preferred Shares or purchase additional Preferred
Shares. The auction also provides liquidity for
the sale of Preferred Shares. An auction fails if
there are more Preferred Shares offered for sale
than there are buyers. You may not be able to sell
your Preferred Shares at an auction if the auction
fails. Also, if you place bid orders (orders to
retain Preferred Shares) at an auction only at a
specified dividend rate, and that rate exceeds the
rate set at the auction, you will not retain your
Preferred Shares. Additionally, if you buy
Preferred Shares or elect to retain Preferred
Shares without specifying a dividend rate below
which you would not wish to buy or continue to
hold those Preferred Shares, you could receive a
lower rate of return on your Preferred Shares than
the market rate. Finally, the dividend periods for
the Preferred Shares may be changed by the Fund,
subject to certain conditions and with notice to
the holders of Preferred Shares, which could also
affect the liquidity of your investment.
Secondary Market Risk. If you try to sell your
Preferred Shares between auctions you may not be
able to sell any or all of your Preferred Shares
or you may not be able to sell them for $25,000
per share or $25,000 per share plus accumulated
but unpaid dividends. If the Fund has designated a
special dividend period, changes in interest rates
could affect the price you would receive if you
sold your Preferred Shares in the secondary
market. You may transfer Preferred Shares outside
of auctions only to or through a Broker-Dealer
that has entered into a Broker-Dealer Agreement,
or other person as the Fund permits.
Ratings and Asset Coverage Risk. While it is
expected that Moody's will assign a rating of Aaa
to the Preferred Shares and Fitch will assign a
rating of AAA to the Preferred Shares, such
ratings do not eliminate or necessarily mitigate
the risks of investing in Preferred Shares.
Moody's or Fitch could downgrade its rating of the
Preferred Shares or withdraw its rating of the
Preferred Shares at any time, which may make your
shares less liquid at an auction or in the
secondary market. If the Fund fails to satisfy the
asset coverage ratios discussed under "Description
of Preferred Shares -- Rating Agency Guidelines
and Asset Coverage," the Fund will be required to
redeem a sufficient number of Preferred Shares in
order to return to compliance with the asset
coverage ratios.
Restrictions on Dividends and Other
Distributions. Restrictions imposed on the
declaration and payment of dividends or other
distributions to the holders of the Fund's common
shares and Preferred Shares, both by the 1940 Act
and by requirements imposed by rating agencies,
might impair the Fund's ability to maintain its
qualification as a regulated investment company
for federal income tax purposes.
GENERAL RISKS OF INVESTING IN THE FUND. The Fund
is not a complete investment program and should
only be considered as an
14
addition to an investor's existing diversified
portfolio of investments. Due to uncertainty
inherent in all investments, there can be no
assurance that the Fund will achieve its
investment objectives.
Limited Operating History. The Fund is a recently
organized, non-diversified, closed-end management
investment company and has a limited operating
history and a limited history of public trading.
Non-Diversified Status Risk. The Fund is
classified as "non-diversified" under the 1940
Act. As a result, it can invest a greater portion
of its assets in obligations of a single issuer
than a "diversified" fund. The Fund will therefore
be more susceptible than a diversified fund to
being adversely affected by any single corporate,
economic, political or regulatory occurrence. The
Fund intends to diversify its investments to the
extent necessary to qualify, and maintain its
status, as a regulated investment company under
U.S. federal income tax laws. See "Risks
Factors -- Non-Diversified Status Risk" and
"Federal Income Tax Matters."
Interest Rate Risk. The Fund's net asset value
will usually change in response to interest rate
fluctuations. When interest rates decline, the
value of fixed-rate securities already held by the
Fund can be expected to rise. Conversely, when
interest rates rise, the value of existing fixed-
rate portfolio securities can be expected to
decline. Because market interest rates are
currently near their lowest levels in many years,
there is a greater than normal risk that the
Fund's portfolio will decline in value due to
rising interest rates. The Fund will primarily
invest in floating rate obligations, including
Senior Loans, the rate on which periodically
adjusts with changes in interest rates.
Until the interest rates on the floating rate
obligations in its portfolio reset, the Fund's
income also would likely be affected adversely
when prevailing short term interest rates increase
and the Fund is using leverage.
To the extent that changes in market rates of
interest are reflected not in a change to a base
rate such as LIBOR but in a change in the spread
over the base rate, which is payable on loans of
the type and quality in which the Fund invests,
the Fund's net asset value could be adversely
affected. This is because the value of a Senior
Loan is partially a function of whether the Senior
Loan is paying what the market perceives to be a
market rate of interest, given its individual
credit and other characteristics. However, unlike
changes in market rates of interest for which
there is generally only a temporary lag before the
portfolio reflects those changes, changes in a
Senior Loan's value based on changes in the market
spread on Senior Loans in the Fund's portfolio may
be of longer duration.
Reinvestment Risk. Income from the Fund's
portfolio will decline if the Fund invests the
proceeds, repayment or sale of Senior Loans or
other obligations into lower yielding instruments
or Senior Loans with a lower spread over the base
lending rate. A decline in income
15
could affect the common shares' distribution rate
and their overall return.
Senior Loans Risk. The risks associated with
Senior Loans are similar to the risks of junk
bonds, although Senior Loans are typically senior
and secured in contrast to below investment grade
debt securities, commonly referred to as "junk
bonds," which are often subordinated and
unsecured.
The Fund's investments in Senior Loans are
typically below investment grade and are
considered speculative because of the credit risk
of their issuers. Moreover, any specific
collateral used to secure a loan may decline in
value or lose all its value or become illiquid,
which would adversely affect the loan's value.
Economic and other events, whether real or
perceived, can reduce the demand for certain
Senior Loans or Senior Loans generally, which may
reduce market prices and cause the Fund's net
asset value per share to fall. The frequency and
magnitude of such changes cannot be predicted.
Senior Loans and other debt securities are also
subject to the risk of price declines and to
increases in prevailing interest rates.
Conversely, the floating rate feature of Senior
Loans means the Senior Loans will not generally
experience capital appreciation in a declining
interest rate environment. Declines in interest
rates may also increase prepayments of debt
obligations and require the Fund to invest assets
at lower yields. No active trading market may
exist for certain Senior Loans, which may impair
the ability of the Fund to realize full value in
the event of the need to liquidate such assets.
Adverse market conditions may impair the liquidity
of some actively traded Senior Loans.
Credit Risk and Junk Bond Risk. Credit risk is
the risk that an issuer of a Senior Loan or other
debt security will become unable to meet its
obligation to make interest and principal
payments.
The Fund may invest all or a substantial portion
of its assets in Senior Loans and other debt
securities that are rated below investment grade
(commonly referred to as "junk bonds" or "high
yield securities"), that is, rated Ba or below by
Moody's or BB or below by S&P, or unrated
securities determined by the Subadviser to be of
comparable credit quality. Investment in Senior
Loans and other fixed income securities of
below-investment grade quality involves
substantial risk of loss. "Junk bonds" are
considered predominantly speculative with respect
to the issuer's ability to pay interest and repay
principal and are susceptible to default or
decline in market value due to adverse economic
and business developments. The market values for
fixed income securities of below-investment grade
quality tend to be more volatile, and these
securities are less liquid, than investment grade
debt securities. For
16
these reasons, an investment in the Fund is
subject to the following specific risks:
- increased price sensitivity to changing
interest rates and to a deteriorating economic
environment;
- greater risk of loss due to default or
declining credit quality;
- adverse issuer-specific events are more likely
to render the issuer unable to make interest
and/or principal payments; and
- if a negative perception of the high yield
market develops, the price and liquidity of
high yield securities may be depressed, and
this negative perception could last for a
significant period of time.
Adverse changes in economic conditions are more
likely to lead to a weakened capacity of a high
yield issuer to make principal payments and
interest payments than an investment grade issuer.
The principal amount of high yield securities
outstanding has proliferated in the past decade as
an increasing number of issuers have used high
yield securities for corporate financing. An
economic downturn could severely affect the
ability of highly leveraged issuers to service
their debt obligations or to repay their
obligations upon maturity.
Issuer Risk. The value of corporate
income-producing securities may decline for a
number of reasons which directly relate to the
issuer, such as management performance, financial
leverage and reduced demand for the issuer's goods
and services.
Inflation Risk. Inflation risk is the risk that
the value of assets or income from investment will
be worth less in the future as inflation decreases
the value of money. As inflation increases, the
real value of the common shares and distributions
thereon can decline. In addition, during any
periods of rising inflation, dividend rates of
preferred shares would likely increase, which
would tend to further reduce returns to common
shareholders.
Convertible Securities Risk. Convertible
securities generally offer lower interest or
dividend yields than non-convertible securities of
similar quality. As with all fixed income
securities, the market values of convertible
securities tend to decline as interest rates
increase and, conversely, to increase as interest
rates decline. However, when the market price of
the common stock underlying a convertible security
exceeds the conversion price, the convertible
security tends to reflect the market price of the
underlying common stock. As the market price of
the underlying common stock declines, the
convertible security tends to trade increasingly
on a yield basis and thus may not decline in price
to the same extent as the underlying common stock.
Convertible securities rank senior to common
stocks in an issuer's capital structure.
Foreign Securities Risk. The Fund's investments
in non-U.S. issuers may involve unique risks
compared to investing in securities
17
of U.S. issuers. These risks are more pronounced
to the extent that the Fund invests a significant
portion of its non-U.S. investment in one region
or in the securities of emerging market issuers.
These risks may include
- Less information about non-U.S. issuers or
markets may be available due to less rigorous
disclosure, accounting standards or regulatory
practices.
- Many non-U.S. markets are smaller, less liquid
and more volatile. In a changing market, the
Subadviser may not be able to sell the Fund's
portfolio securities at times, in amounts and
at prices it considers reasonable.
- Currency exchange rates or controls may
adversely affect the value of the Fund's
investments.
- The economies of non-U.S. countries may grow
at slower rates than expected or may
experience a downturn or recession.
- Withholdings and other non-U.S. taxes may
decrease the Fund's return.
Currency Risk. A portion of the Fund's assets may
be quoted or denominated in non-U.S. currencies.
These securities may be adversely affected by
fluctuations in relative currency exchange rates
and by exchange control regulations. The Fund's
investment performance may be negatively affected
by a devaluation of a currency in which the Fund's
investments are quoted or denominated. Further,
the Fund's investment performance may be
significantly affected, either positively or
negatively, by currency exchange rates because the
U.S. dollar value of securities quoted or
denominated in another currency will increase or
decrease in response to changes in the value of
such currency in relation to the U.S. dollar.
Liquidity Risk. Some Senior Loans are not readily
marketable and may be subject to restrictions on
resale. Senior Loans generally are not listed on
any national securities exchange or automated
quotation system and no active trading market may
exist for some of the Senior Loans in which the
Fund will invest. Where a secondary market exists,
such market for some Senior Loans may be subject
to irregular trading activity, wide bid/ask
spreads and extended trade settlement periods.
Senior Loans that are illiquid may be more
difficult to value or may impair the Fund's
ability to realize the full value of its assets in
the event of a voluntary or involuntary
liquidation of such assets and thus may cause a
decline in the Fund's net asset value. The Fund
has no limitation on the amount of its assets that
may be invested in securities which are not
readily marketable or are subject to restrictions
on resale. In certain situations, the Fund could
find it more difficult to sell such securities at
desirable times and/or prices. Most Senior Loans
are valued by an independent pricing service that
uses market quotations of investors and traders in
Senior Loans. In other cases,
18
Senior Loans are valued at their fair value in
accordance with procedures approved by the Board
of Trustees.
Derivatives Risk. Even a small investment in
derivatives can have a significant impact on the
Fund's exposure to interest rates. If changes in a
derivative's value do not correspond to changes in
the value of the Fund's other investments, the
Fund may not fully benefit from or could lose
money on the derivative position. In addition,
some derivatives involve risk of loss if the party
that entered into the derivative contract defaults
on its obligation. Certain derivatives, such as
over-the-counter options, may be less liquid and
more difficult to value than exchange traded
options and futures.
Regulatory Risk. To the extent that legislation
or federal regulators that regulate certain
financial institutions impose additional
requirements or restrictions with respect to the
ability of such institutions to make loans,
particularly in connection with highly leveraged
transactions, the availability of Senior Loans for
investment may be adversely affected. In addition,
such legislation could depress the market value of
Senior Loans.
Market Disruption Risk. The terrorist attacks in
the United States on September 11, 2001 had a
disruptive effect on the securities markets. The
Fund cannot predict the effects of similar events
in the future on the U.S. economy. These terrorist
attacks and related events, including the war in
Iraq, its aftermath, and continuing occupation of
Iraq by coalition forces, have led to increased
short-term market volatility and may have
long-term effects on U.S. and world economies and
markets. A similar disruption of the financial
markets could impact interest rates, auctions,
secondary trading, ratings, credit risk, inflation
and other factors relating to the common shares.
In particular, below investment grade securities
tend to be more volatile than higher rated fixed
income securities so that these events and any
actions resulting from them may have a greater
impact on the prices and volatility of junk bonds
and Senior Loans than on higher rated fixed income
securities.
Anti-Takeover Provisions Risk. The Fund's
Agreement and Declaration of Trust and By-Laws
include provisions that could limit the ability of
other entities or persons to acquire control of
the Fund or to change the composition of its Board
of Trustees. Such provisions could limit the
ability of shareholders to sell their shares at a
premium over prevailing market prices by
discouraging a third party from seeking to obtain
control of the Fund. These provisions include
staggered terms of office for the Trustees,
advance notice requirements for shareholder
proposals, super-majority voting requirements for
certain transactions with affiliates, open-ending
the Fund and a merger, liquidation, asset sale or
similar transaction.
INVESTMENT ADVISER.......... Pioneer Investment Management, Inc. is the Fund's
investment adviser. The Adviser has engaged
Highland Capital Management, L.P. to act as
investment subadviser to the Fund to manage the
19
Fund's portfolio. The Subadviser is responsible on
a day-to-day basis for investment of the Fund's
portfolio in accordance with its investment
objectives and principal investment strategies.
The Subadviser makes all investment decisions for
the Fund and places purchase and sale orders for
the Fund's portfolio securities.
The Adviser or its predecessors have been managing
investment companies since 1928. The Adviser is an
indirect, wholly-owned subsidiary of UniCredito
Italiano S.p.A. ("UniCredito"), one of the leading
banking groups in Italy. As of December 31, 2004,
assets under management by the Adviser and its
affiliates were approximately $____ billion
worldwide, including over $____ billion in assets
under management by the Adviser. The Adviser
supervises the Subadviser's investments on behalf
of the Fund, supervises the Fund's compliance
program and provides for the general management of
the business affairs of the Fund.
The Fund pays the Adviser a fee for its investment
advisory services equal on an annual basis to .70%
of the Fund's average daily managed assets.
"Managed assets" means the total assets of the
Fund (including any assets attributable to any
financial leverage that may be outstanding) minus
the sum of accrued liabilities (other than
liabilities representing financial leverage). The
liquidation preference on any preferred shares,
including the Preferred Shares, is not a
liability. The fee is accrued daily and payable
monthly. Because the Adviser's fee is based upon
managed assets, the Adviser may have an incentive
to leverage the Fund, including through the
issuance of the Preferred Shares.
The Adviser has agreed for the first three years
of the Fund's investment operations to limit the
Fund's total annual expenses (excluding offering
costs for common and preferred shares, interest
expense, the cost of defending or prosecuting any
claim or litigation to which the Fund is a party
(together with any amount in judgment or
settlements), indemnification expenses or taxes
incurred due to the failure of the Fund to qualify
as a regulated investment company under the
Internal Revenue Code of 1986, as amended (the
"Code"), or any other nonrecurring or
non-operating expenses) to .95% of the Fund's
average daily managed assets.
Highland Capital Management, L.P. serves as the
investment subadviser to the Fund. In this
capacity, the Subadviser is responsible for the
selection and on-going monitoring of the assets in
the Fund's investment portfolio. The Subadviser is
a Delaware limited partnership founded in 1993.
The principal office of the Subadviser is located
at 13455 Noel Road, Suite 1300, Dallas, Texas
75240. The Subadviser also maintains an office at
245 Park Avenue, 39th Floor, New York, New York
10167. The Subadviser's expertise in managing
portfolios of Senior Loans and structured finance
assets is particularly suited to the Fund's focus
on Senior Loans. As of December 31, 2004, the
Subadviser had approximately $____ billion in
assets under management.
20
The Adviser, and not the Fund, will pay a portion
of the fees it receives from the Fund to the
Subadviser in return for the Subadviser's
services.
TRADING MARKET.............. The Preferred Shares will not be listed on an
exchange. Instead, you may buy or sell Preferred
Shares at an auction that normally is held every
[ ] days in the case of Series [ ] Preferred
Shares, every [ ] days in the case of Series
[ ] Preferred Shares, and every [ ] days in
the case of Series [ ] Preferred Shares, by
submitting orders to a Broker-Dealer or to a
broker-dealer that has entered into a separate
agreement with a Broker-Dealer. In addition to the
auctions, Broker-Dealers and other broker-dealers
may maintain a secondary trading market in
Preferred Shares outside of auctions but may
discontinue this activity at any time. There is no
assurance that a secondary market will provide
holders of Preferred Shares with liquidity. You
may transfer Preferred Shares outside of auctions
only to or through a Broker-Dealer or a
broker-dealer that has entered into a separate
agreement with a Broker-Dealer.
DIVIDENDS AND
DIVIDEND PERIODS.......... The "dividend period," with respect to shares of a
series of Preferred Shares, is the period from and
including the date of original issue of shares of
such series to but excluding the initial dividend
payment date for shares of such series, and for
any dividend period thereafter from and including
the dividend payment date for shares of such
series to but excluding the next succeeding
dividend payment date for shares of such series.
Subject to certain conditions, the Fund may elect
a "special dividend period," which is a dividend
period of more than [ ] days in the case of
Series [ ] Preferred Shares, more than [ ] days
in the case of [ ] Preferred Shares, and more
than [ ] days in the case of Series [ ]
Preferred Shares. A special dividend period is a
"short-term dividend period" if it consists of a
specified number of days, evenly divisible by
seven (other than [ ] days, in the case of Series
[ ] Preferred Shares, other than [ ] days, in
the case of Series [ ] Preferred Shares, and
other than [ ] days, in the case of Series [ ]
Preferred Shares) and not more than 364, or a
"long-term dividend period" if it consists of a
specific period of one whole year or more but not
greater than five years. The "dividend payment
date" for each series of Preferred Shares, (i)
with respect to any [ ] day dividend period, any
[ ] day dividend period or any short-term
dividend period of [ ] or fewer days, is the
business day next succeeding the last day of that
dividend period and (ii) with respect to any
short-term dividend period of more than [ ] days
and with respect to any long-term dividend period,
is the first business day of each month and the
business day next succeeding the last day of such
dividend period. A "business day" is 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.
21
The Preferred Shares will entitle their holders to
receive cash dividends at a rate per annum that
may vary for the successive dividend periods for
such shares. The applicable rate for a particular
dividend period will be determined by an auction
conducted on the business day immediately
preceding the start of such dividend period.
The table below shows the dividend rate, the
dividend payment date and the number of days for
the initial dividend period of the Preferred
Shares offered in this prospectus.
DIVIDEND PAYMENT SUBSEQUENT NUMBER OF DAYS IN
INITIAL DATE FOR INITIAL DIVIDEND PAYMENT INITIAL DIVIDEND
SERIES DIVIDEND RATE DIVIDEND PERIOD DAY PERIOD
------ ------------- ---------------- ---------------- -----------------
[ ] [ ]% Every [ ] Days
[ ] [ ]% Every [ ] Days
[ ] [ ]% Every [ ] Days
After the initial dividend period, each subsequent
dividend period for Series [ ] Preferred Shares
will generally consist of [ ] days, each
subsequent dividend period for Series [ ]
Preferred Shares will generally consist of [ ]
days, and each subsequent dividend period for
Series [ ] Preferred Shares will generally
consist of [ ] days; provided, however, that
prior to any auction, the Fund may elect, subject
to certain limitations and upon notice to holders
of Preferred Shares of the applicable series, a
special dividend period for any or all series. In
most instances, dividends are payable on the first
business day following the end of the dividend
period. The rate set at auction may not exceed the
maximum applicable rate. See "Description of
Preferred Shares -- Dividends and Dividend
Periods." Dividends on the Preferred Shares will
be cumulative from the date the shares are first
issued and will be paid out of legally available
funds.
Determination of Maximum Applicable
Rate. Generally, the applicable rate for any
regular dividend period for Preferred Shares will
not be more than the maximum applicable rate
attributable to such shares. The maximum
applicable rate for each series of Preferred
Shares 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
higher of the applicable percentage of the
reference rate or the applicable spread plus the
reference rate. The reference rate (the "Reference
Rate") is the applicable LIBOR Rate (as defined in
"Description of Preferred Shares -- Dividends and
Dividend Periods -- Determination of Maximum
Applicable Rate") for a dividend period of fewer
than 365 days or the applicable Treasury Index
Rate (as defined in "Description of Preferred
Shares -- Dividends and Dividend
Periods -- Determination of Maximum Applicable
Rate") for a dividend period of 365 days or more.
The applicable percentage or applicable spread as
so determined is further subject to upward but not
downward adjustment in the discretion of the
Fund's Board of
22
Trustees after consultation with [ ]. In
the case of a special dividend period, the maximum
applicable rate will be specified by the Fund in
the notice of the special dividend period for such
special dividend payment period.
The applicable percentage and spread are as
follows:
APPLICABLE PERCENTAGE PAYMENT TABLE
----------------------------------------------------------------------
CREDIT RATINGS APPLICABLE PERCENTAGE APPLICABLE SPREAD
--------------------------- --------------------- -----------------
MOODY'S FITCH
------------- ------------
Aaa AAA 125% 1.25%
Aa3 to Aa1 AA- to AA+ 150% 1.50%
A3 to A1 A- to A+ 200% 2.00%
Baa3 to Baa1 BBB- to BBB+ 250% 2.50%
BB+ and
Ba1 and lower lower 300% 3.00%
There is no minimum applicable rate in respect of
any dividend period. See "Description of Preferred
Shares -- Dividends and Dividend Periods."
Assuming the Fund maintains a Aaa/AAA rating on
the Preferred Shares, the practical effect of the
different methods used to calculate the maximum
applicable rate is shown in the table below:
MAXIMUM MAXIMUM METHOD USED TO
APPLICABLE RATE APPLICABLE RATE DETERMINE THE
USING THE USING THE MAXIMUM
REFERENCE RATE APPLICABLE PERCENTAGE APPLICABLE SPREAD APPLICABLE RATE
-------------- --------------------- ----------------- ---------------
1% 1.25% 2.25% Spread
2% 2.50% 3.25% Spread
3% 3.75% 4.25% Spread
4% 5.00% 5.25% Spread
5% 6.25% 6.25% Either
6% 7.50% 7.25% Percentage
Prior to each dividend payment date, the Fund is
required to deposit with the Auction Agent
sufficient funds for the payment of declared
dividends. The failure to make such a deposit will
result in the cancellation of any auction and the
dividend rate will be the maximum applicable rate
until such failure to deposit is cured or, if not
timely cured, a non-payment rate of 300% of the
Reference Rate. The Fund does not intend to
establish any reserves for the payment of
dividends.
RATINGS..................... The Preferred Shares are expected to receive a
rating of Aaa from Moody's and AAA from Fitch.
These ratings are an assessment of the capacity
and willingness of an issuer to pay preferred
stock obligations. The ratings are not a
recommendation to purchase, hold or sell those
shares inasmuch as the rating does not comment as
to market price or suitability for a particular
investor. The ratings also do not address the
likelihood that an owner of Preferred Shares will
be able to sell such shares in an auction or
otherwise. The ratings are based on information
obtained from the Fund and other
23
sources. The ratings may be changed, suspended, or
withdrawn in the rating agencies' discretion as a
result of changes in, or the unavailability of,
such information. See "Description of Preferred
Shares -- Rating Agency Guidelines and Asset
Coverage."
REDEMPTION.................. The Fund is required to redeem Preferred Shares if
the Fund does not meet the asset coverage ratio
required by the 1940 Act, or to correct a failure
to meet a rating agency guideline in a timely
manner. The Fund may voluntarily redeem Preferred
Shares, in whole or in part, subject to certain
conditions. See "Description of Preferred
Shares -- Redemption" and "Description of
Preferred Shares -- Rating Agency Guidelines and
Asset Coverage."
ASSET MAINTENANCE........... Under the Statement, which establishes and fixes
the rights and preferences of the shares of each
series of Preferred Shares, the Fund must maintain
asset coverage of the Preferred Shares as required
by the rating agency or agencies rating the
Preferred Shares (the "Preferred Shares Basic
Maintenance Amount"). The Preferred Shares Basic
Maintenance Amount is the sum of (a) the aggregate
liquidation preference of the Preferred Shares
then outstanding, together with the aggregate
liquidation preference on any other series of
preferred shares (plus redemption premium, if
any), and (b) certain accrued and projected
dividend and other payment obligations of the
Fund. Moody's and Fitch have each established
separate guidelines for calculating discounted
value of the Fund's assets for purposes of this
asset coverage test. To the extent any particular
portfolio holding does not satisfy a rating
agency's guidelines, all or a portion of the
holding's value will not be included in the rating
agency's calculation of discounted value. The
Moody's and Fitch guidelines also impose certain
diversification requirements on the Fund's
portfolio.
As required by the 1940 Act, the Fund must also
maintain asset coverage of at least 200% with
respect to outstanding senior securities that are
preferred stock, including the Preferred Shares
(the "1940 Act Preferred Share Asset Coverage").
In the event that the Fund does not satisfy these
coverage tests, some or all of the Preferred
Shares will be subject to mandatory redemption.
See "Description of Preferred
Shares -- Redemption."
Based on the composition of the Fund's portfolio
as of [ ], 2005, the asset coverage of
the Preferred Shares, as measured pursuant to the
1940 Act, would be approximately [ ]% if the
Fund were to issue Preferred Shares representing
approximately 33.3% of the Fund's managed assets.
MANDATORY REDEMPTION........ If the Preferred Shares Basic Maintenance Amount
or the 1940 Act Preferred Share Asset Coverage is
not maintained or restored as specified herein,
the Preferred Shares will be subject to mandatory
redemption, out of funds legally available
therefore, at the mandatory redemption price of
$25,000 per share plus an amount equal to
dividends thereon (whether or not earned or
24
declared) accumulated but unpaid to the date fixed
for redemption. Any such redemption will be
limited to the minimum number of Preferred Shares
necessary to restore the Preferred Shares Basic
Maintenance Amount or the 1940 Act Preferred Share
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 1940 Act.
OPTIONAL REDEMPTION......... The Preferred Shares are redeemable at the option
of the Fund, as a whole or in part, on any
dividend payment date (except on an initial
dividend payment date or a special dividend period
with respect to which the Fund has agreed not to
redeem Preferred Shares voluntarily (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. A
"Premium Call Period" is a period during which
Preferred Shares are only redeemable at the option
of the Fund at a price per share equal to $25,000
plus accumulated but unpaid dividends, plus a
premium.
LIQUIDATION PREFERENCE...... The liquidation preference for shares of Preferred
Shares will be $25,000 per share plus accumulated
but unpaid dividends, if any, whether or not
declared. See "Description of Preferred Shares --
Liquidation."
VOTING RIGHTS............... The holders of preferred shares, including the
Preferred Shares, voting as a separate class, have
the right to elect at least two Trustees of the
Fund at all times. Such holders also have the
right to elect a majority of the Trustees in the
event that two years' dividends on such preferred
shares are unpaid. In each case, the remaining
Trustees will be elected by holders of common
shares and preferred shares, including the
Preferred Shares, voting together as a single
class. The holders of preferred shares, including
the Preferred Shares, will vote as a separate
class or classes on certain other matters required
under the Statement, the 1940 Act and Delaware
law. See "Description of Preferred
Shares -- Voting Rights," and "Certain Provisions
of the Agreement and Declaration of Trust and
By-Laws."
AUCTION PROCEDURES.......... Separate auctions will be conducted for each
series of Preferred Shares. Unless otherwise
permitted by the Fund, investors may only
participate in auctions through their
Broker-Dealers. The process for determining the
applicable rate on the Preferred Shares described
in this section is referred to as the "Auction
Procedures" and each setting of the applicable
rate is referred to as an "auction."
Prior to the submission deadline on each auction
date for shares of a series of Preferred Shares,
each customer of a Broker-Dealer who is listed on
the records of that Broker-Dealer (or, if
applicable, the Auction Agent) as a beneficial
owner of such shares may submit
25
the following types of orders with respect to
shares to that Broker-Dealer:
1. Hold Order -- indicating its desire to hold
shares of such series without regard to the
applicable rate for the next dividend period.
2. Bid -- indicating its desire to purchase or
hold the indicated number of shares of such
series at $25,000 per share if the applicable
rate for shares of such series for the next
dividend period is not less than the rate
specified in the bid. A bid order by an
existing holder will be deemed an irrevocable
offer to sell shares of such series at $25,000
per share if the applicable rate for shares of
such series for the next dividend period is
less than the rate or spread specified in the
bid.
3. Sell Order -- indicating its desire to sell
shares of such series at $25,000 per share
without regard to the applicable rate for
shares of such series for the next dividend
period.
A beneficial owner may submit different types of
orders to its Broker-Dealer with respect to
different shares of a series of Preferred Shares
then held by the beneficial owner. A beneficial
owner of shares of such series that submits its
bid with respect to shares of such series to its
Broker-Dealer having a rate higher than the
maximum applicable rate for shares of such series
on the auction date will be treated as having
submitted a sell order to its Broker-Dealer. A
beneficial owner of shares of such series that
fails to submit an order to its Broker-Dealer with
respect to such shares will ordinarily be deemed
to have submitted a hold order with respect to
such shares of such series to its Broker-Dealer.
However, if a beneficial owner of shares of such
series fails to submit an order with respect to
such shares of such series to its Broker-Dealer
for an auction relating to a special dividend
period of more than 91 days, such beneficial owner
will be deemed to have submitted a sell order to
its Broker-Dealer. A sell order constitutes an
irrevocable offer to sell the Preferred Shares
subject to the sell order. A beneficial owner that
offers to become the beneficial owner of
additional Preferred Shares is, for purposes of
such offer, a potential holder as discussed below.
A potential holder is either a customer of a
Broker-Dealer that is not a beneficial owner of a
series of Preferred Shares but that wishes to
purchase shares of such series or that is a
beneficial owner of shares of such series that
wishes to purchase additional shares of such
series. A potential holder may submit bids to its
Broker-Dealer in which it offers to purchase
shares of such series at $25,000 per share if the
applicable rate for shares of such series for the
next dividend period is not less than the
specified rate in such bid. A bid placed by a
potential holder of shares of such series
specifying a rate higher than the maximum rate for
shares of such series on the auction date will not
be accepted.
26
The Broker-Dealers in turn will submit the orders
of their respective customers who are beneficial
owners and potential holders to the Auction Agent.
They will designate themselves (unless otherwise
permitted by the Fund) as existing holders of
shares subject to orders submitted or deemed
submitted to them by beneficial owners. They will
designate themselves as potential holders of
shares subject to orders submitted to them by
potential beneficial owners. However, neither the
Fund nor the Auction Agent will be responsible for
a Broker-Dealer's failure to comply with these
Auction Procedures. Any order placed with the
Auction Agent by a Broker-Dealer as or on behalf
of an existing holder or a potential holder will
be treated the same way as an order placed with a
Broker-Dealer by a beneficial owner or potential
beneficial owner. Similarly, any failure by a
Broker-Dealer to submit to the Auction Agent an
order for any Preferred Shares held by it or
customers who are beneficial owners will be
treated as a beneficial owner's failure to submit
to its Broker-Dealer an order in respect of
Preferred Shares held by it. A Broker-Dealer may
also submit orders to the Auction Agent for its
own account as an existing holder or potential
holder, provided it is not an affiliate of the
Fund.
There are sufficient clearing bids for shares of a
series in an auction if the number of shares of
such series subject to bids submitted to the
Auction Agent by Broker-Dealers for potential
holders with rates or spreads equal to or lower
than the maximum applicable rate for such series
is at least equal to or exceeds the sum of the
number of shares of such series subject to sell
orders and the number of shares of such series
subject to bids specifying rates or spreads higher
than the maximum applicable rate for such series
submitted or deemed submitted to the Auction Agent
by Broker-Dealers for existing holders. If there
are sufficient clearing bids for shares of a
series, the applicable rate for shares of such
series for the next succeeding dividend period
thereof will be the lowest rate specified in the
submitted bids which, taking into account such
rate and all lower rates bid by Broker-Dealers as
or on behalf of existing holders and potential
holders, would result in existing holders and
potential holders owning the shares of such series
available for purchase in the auction.
If there are not sufficient clearing bids for
shares of such series, the applicable rate for the
next dividend period will be the maximum
applicable rate on the auction date. However, if
the Fund has declared a special dividend period
and there are not sufficient clearing bids, the
election of a special dividend period will not be
effective and the applicable rate for the next
rate period will be the same as during the current
rate period. If there are not sufficient clearing
bids, beneficial owners of Preferred Shares that
have submitted or are deemed to have submitted
sell orders may not be able to sell in the auction
all shares subject to such sell orders. If all of
the applicable outstanding Preferred Shares of a
series are the subject of submitted hold orders,
then the dividend period following
27
the auction will automatically be the same length
as the minimum dividend period and the applicable
rate for the next dividend period will be 90% of
the Reference Rate on the date of the applicable
auction.
The auction procedures include a pro rata
allocation of shares for purchase and sale which
may result in an existing holder continuing to
hold or selling, or a potential holder purchasing,
a number of shares of a series of Preferred Shares
that is different than the number of shares of
such series specified in its order. To the extent
the allocation procedures have that result,
Broker-Dealers that have designated themselves as
existing holders or potential holders in respect
of customer orders will be required to make
appropriate pro rata allocations among their
respective customers.
The following is a simplified example of how a
typical auction works. Assume that the Fund has
1,000 outstanding Preferred Shares of any series
and three current holders. The three current
holders and three potential holders submit orders
through broker-dealers at the auction:
Current Holder A........ Owns 500 shares, Bid order of 4.1%
wants to sell all rate for all 500
500 shares if shares
auction rate is
less than 4.1%
Current Holder B........ Owns 300 shares, Hold order -- will
wants to hold take the auction
rate
Current Holder C........ Owns 200 shares, Bid order of 3.9%
wants to sell all rate for all 200
200 shares if shares
auction rate is
less than 3.9%
Potential Holder D...... Wants to buy 200 Places order to
shares buy at or above
4.0%
Potential Holder E...... Wants to buy 300 Places order to
shares buy at or above
3.9%
Potential Holder F...... Wants to buy 200 Places order to
shares buy at or above
4.1%
The lowest dividend rate that will result in all
1,000 Preferred Shares in the above example
continuing to be held is 4.0% (the offer by D).
Therefore, the dividend rate will be 4.0%. Current
holders B and C will continue to own their shares.
Current holder A will sell its shares because A's
dividend rate bid was higher than the dividend
rate. Potential holder D will buy 200 shares and
potential holder E will buy 300 shares because
their bid rates were at or below the dividend
rate. Potential holder F will not buy any shares
because its bid rate was above the dividend rate.
28
FEDERAL INCOME TAXATION..... The Fund intends to take the position that under
present law, the Preferred Shares will constitute
stock of the Fund. Distributions with respect to
the Preferred Shares (other than distributions in
redemption of the Preferred Shares that are
treated as exchanges of stock under Section 302(b)
of the Code) will constitute dividends to the
extent of the Fund's current or accumulated
earnings and profits as calculated for U.S.
federal income tax purposes. The dividends
generally will be taxable as ordinary income.
Distributions of net capital gain that are
designated by the Fund as capital gain dividends,
if any, however, will be treated as long-term
capital gains without regarding to the length of
time the shareholder has held shares of the Fund.
ADMINISTRATOR, CUSTODIAN,
TRANSFER AGENT, REGISTRAR
AND DIVIDEND DISBURSING
AGENT..................... Pioneer Investment Management, Inc. serves as the
Fund's administrator and has appointed Princeton
Administrators, L.P. to serve as the Fund's
sub-administrator. Brown Brothers Harriman & Co.
serves as the Fund's custodian. Deutsche Bank
Trust Company Americas will serve as Auction
Agent, transfer agent, dividend paying agent and
registrar for the Preferred Shares. Pioneer
Investment Management Shareholder Services, Inc.
serves as the Fund's transfer agent, registrar and
dividend disbursing agent for the Fund's common
shares. Mellon Investor Services LLC ("Mellon")
serves as the sub-transfer agent, sub-registrar
and sub-dividend paying agent for the Fund's
common shares.
29
FINANCIAL HIGHLIGHTS (UNAUDITED)
Information contained in the table below shows the unaudited operating
performance of the Fund from the commencement of the Fund's operations on
December 28, 2004 through January , 2005. Since the Fund was recently
organized and commenced investment operations on December 28, 2004, the table
covers approximately month of operations, during which a substantial
portion of the Fund's portfolio was held in temporary investments pending
investment in securities that meet the Fund's investment objectives and
principal investment strategies. Accordingly, the information presented does not
provide a meaningful picture of the Fund's future operating performance.
FOR THE PERIOD
FROM
DECEMBER 28, 2004(1)
THROUGH
JANUARY , 2005
(UNAUDITED)
----------------------------------------------------------------------------------
PER COMMON SHARE OPERATING PERFORMANCE(2):
Net asset value, beginning of period...................... $ (5)
--------
Increase (decrease) from investment operations:
Net investment income..................................
Net realized and unrealized gain on investments........
Distributions to preferred shareowners from net
investment income.....................................
--------
Net increase from investment operations................ $
Capital charge with respect to issuance of common
shares.................................................
--------
Net increase in net asset value........................... $
--------
Net asset value, end of period(3)......................... $
========
Market value, end of period(3)............................ $
--------
Total return at market value(6)........................
Total return on NAV(7).................................
RATIOS TO AVERAGE NET ASSETS OF HOLDERS OF COMMON SHARES:
Net expenses.............................................. (4)
Net investment income before preferred share dividends.... (4)
Preferred share dividends................................. (4)
Net investment income available to holders of common
shares................................................. (4)
Portfolio turnover........................................
Net assets of holders of common shares, end of period (in
thousands)............................................. $
Preferred shares outstanding (in thousands)............... $
Asset coverage per preferred share, end of period......... $
Average market value per preferred share.................. $
Liquidation value per preferred share..................... $
RATIOS TO AVERAGE NET ASSETS OF HOLDERS OF COMMON SHARES
BEFORE REIMBURSEMENT OF ORGANIZATION EXPENSES:
Net expenses.............................................. (4)
Net investment income before preferred share dividends.... (4)
Preferred share dividends................................. (4)
Net investment income available to holders of common
shares................................................. (4)
---------------
(1) Commencement of operations.
(2) The per share data presented above is based upon the average common shares
outstanding for the period presented.
30
(3) Net asset value and market value are published in Barron's on Saturday, The
Wall Street Journal on Monday and The New York Times on Monday and Saturday.
(4) Annualized.
(5) Net asset value immediately after the closing of the first public offering
was $19.06.
(6) Total investment return is calculated assuming a purchase of common shares
at the current market value on the first day and a sale at the current
market value on the last day of the period reported. Dividends and
distributions, if any, are assumed for purposes of this calculation to be
reinvested at prices obtained under the Fund's dividend reinvestment plan.
Total investment return does not reflect brokerage commissions on the shares
of the Fund. Total investment returns for less than a full period are not
annualized. Past performance is not a guarantee of future results.
(7) Total return on net asset value is calculated assuming a purchase at the
offering price of $20.00 less the sales load of $.90, and the ending net
asset value per share of $[ ].
The information above represents the unaudited operating performance data
for a common share outstanding, total investment return, ratios to average net
assets and other supplemental data for the period indicated. This information
has been determined based upon financial information provided in the financial
statements and market value data for the Fund's common shares.
31
THE FUND
Pioneer Floating Rate Trust is a recently organized, non-diversified,
closed-end management investment company. The Fund was organized under the laws
of the State of Delaware on October 6, 2004, and has registered under the 1940
Act. As a recently organized entity, the Fund has a limited operating history.
The Fund's principal office is located at 60 State Street, Boston, Massachusetts
02109, and its telephone number is (617) 742-7825.
On December 28, 2004, the Fund issued an aggregate of 22,550,000 common
shares of beneficial interest, no par value, pursuant to an initial public
offering. On , 2005, the Fund issued an additional [ ] common
shares of beneficial interest, no par value, pursuant to an overallotment
option. The Fund's common shares are traded on the New York Stock Exchange under
the symbol "PHD."
The following provides information about the Fund's outstanding shares as
of , 2005.
AMOUNT HELD BY
AMOUNT THE FUND OR FOR ITS AMOUNT
TITLE OF CLASS AUTHORIZED ACCOUNT OUTSTANDING
-------------- ---------- ------------------- -----------
Common Shares................... Unlimited 0 [22,555,240]
Preferred Shares
Series [ ] Preferred
Shares..................... Unlimited 0 0
Series [ ] Preferred
Shares..................... Unlimited 0 0
Series [ ] Preferred
Shares..................... Unlimited 0 0
USE OF PROCEEDS
The net proceeds of this offering will be approximately $ after
payment of the estimated offering costs and the deduction of the sales load. The
Fund will invest the net proceeds of the offering in accordance with the Fund's
investment objectives and principal investment strategies as stated below.
However, investments that, in the judgment of the Subadviser, are appropriate
investments for the Fund may not be immediately available. Therefore, there will
be an initial investment period of up to three months following the completion
of this offering before the Fund is required to be invested in accordance with
its principal investment strategies. During such period, all or a portion of the
proceeds may be invested in U.S. government securities or high grade, short-term
money market instruments. See "Investment Objectives and Principal Investment
Strategies."
CAPITALIZATION (UNAUDITED)
The following table sets forth the capitalization of the Fund as of
[ ], 2005, and as adjusted to give effect to the issuance of the
Preferred Shares offered hereby assuming the Fund issues [ ] shares of
Series [ ] Preferred Shares, [ ] shares of Series [ ] Preferred
Shares and [ ] shares of Series [ ] Preferred Shares representing
approximately [ ] of the Fund's total assets (including estimated offering
expenses of [ ] and a sales load of $250 per Preferred
32
Shares). The common shareholders' paid in capital is charged with the cost of
issuance of the Preferred Shares.
ACTUAL AS ADJUSTED
------------ ------------
Preferred Shares, $.0001 par value, $25,000
stated value per share, at liquidation
value, including dividends payable;
unlimited shares authorized (no shares
issued; [ ] shares issued, as
adjusted)................................... $ --
============ ============
Shareholder's Equity:
Common shares, no par value per share;
unlimited shares authorized, [22,555,240]
shares outstanding(1).................... $ $
Undistributed net investment income.........
Accumulated net realized gain/loss on
investments..............................
Net unrealized appreciation/depreciation on
investments..............................
------------ ------------
Net assets attributable to common shares....
------------ ------------
Net assets, plus liquidation preferences of
Preferred Shares......................... $ $
============ ============
------------
(1) None of these outstanding shares are held by or for the account of the
Fund.
PORTFOLIO COMPOSITION
As of , 2005, approximately % of the market value of the
Fund's portfolio was invested in Senior Loans, approximately % of the
market value of the Fund's portfolio was invested in other fixed-income
securities and approximately % of the market value of the Fund's portfolio
was invested in short-term investment grade debt securities. The following table
sets forth certain information with respect to the composition of the Fund's
investment portfolio as of , 2005, based on the highest rating
assigned each investment.
VALUE
CREDIT RATING+ (000) PERCENT
-------------- -------- -------
$ %
Senior Loans
Aaa/AAA...............................................
Aa/AA.................................................
A/A...................................................
Baa/BB................................................
Ba/BB.................................................
B/B...................................................
Caa/CCC...............................................
Ca/CC.................................................
Unrated++.............................................
Short-Term............................................
-------- ----
TOTAL.............................................. $ %
======== ====
------------
+ Ratings assigned by Moody's and S&P, respectively. These ratings are an
assessment of the capacity and willingness of an issuer to pay the principal
and interest on the securities being rated. The ratings are not a
recommendation to purchase, hold or sell the securities being rated inasmuch
as the rating does not comment as to market price or suitability for a
particular investor. The meanings assigned by Moody's and S&P to their
ratings are attached as an appendix to the Statement of Additional
Information.
++ Refers to securities that have not been rated by Moody's or S&P. See
"Investment Objectives and Principal Investment Strategies."
33
INVESTMENT OBJECTIVES AND PRINCIPAL INVESTMENT STRATEGIES
INVESTMENT OBJECTIVES
The Fund's primary investment objective is to provide a high level of
current income. As a secondary investment objective, the Fund seeks preservation
of capital to the extent consistent with its primary investment objective. The
Fund's investment objectives are fundamental policies and may not be changed
without the approval of a majority of the outstanding voting securities (as
defined in the 1940 Act) of the Fund. There can be no assurance that the Fund
will achieve its investment objectives.
PRINCIPAL INVESTMENT STRATEGIES
Under normal market conditions, the Fund seeks to achieve its investment
objectives by investing at least 80% of its assets (net assets plus borrowings
for investment purposes) in senior floating rate loans ("Senior Loans"). Senior
Loans are made to corporations, partnerships and
other business entities that operate in various industries and geographical
regions, including non-U.S. Borrowers. Senior Loans pay interest at rates that
are redetermined periodically on the basis of a floating base lending rate plus
a premium. The Fund also may invest in other floating and variable rate senior
instruments, including second lien loans, and high yield, high risk corporate
bonds, investment grade fixed-income debt securities, preferred stocks (many of
which have fixed maturities), convertible securities, securities that make
"in-kind" interest payments, bonds not paying current income, bonds that do not
make regular interest payments and money market instruments. The Fund may invest
up to 10% of its total assets in Senior Loans and other securities of non-U.S.
issuers, including emerging market issuers, and may engage in certain hedging
transactions.
The Fund may invest in Senior Loans and other securities of any credit
quality, including Senior Loans and other investments that are rated below
investment grade or are unrated but are determined by the Subadviser to be of
equivalent credit quality. Non-investment grade securities, commonly referred to
as "junk bonds," are obligations that are rated below investment grade by the
national rating agencies that cover the obligation (i.e., Ba and below by
Moody's or BB and below by S&P), or if unrated, are determined to be of
comparable quality by the Subadviser. Investment in securities of below
investment grade quality involves substantial risk of loss. "Junk bonds" are
considered predominantly speculative with respect to the issuer's ability to pay
interest and repay principal and are susceptible to default or decline in market
value due to adverse economic and business developments. Because Senior Loans
are senior in a borrower's capital structure and often are secured by specific
collateral, the Subadviser believes, based on its experience, that Senior Loans
generally have more favorable loss recovery rates compared to most other types
of below investment grade obligations. However, there can be no assurance that
the Fund's actual loss recovery experience will be consistent with the
Subadviser's prior experience or that the Senior Loans will achieve any specific
loan recovery rate.
The Subadviser's investment philosophy is based on the belief that
fundamental research and a disciplined asset acquisition/disposition process
will produce superior long-term results. The Subadviser's investment process
combines an economic and industry overlay with a disciplined securities
selection process. The Subadviser's economic and industry overlay utilizes a
variety of macro and economic variables to identify broad market sectors that
the Subadviser believes have positive fundamentals. Within these broad sectors,
the Subadviser targets specific industries that appear to have, in the
Subadviser's view, the most promising prospects under current market conditions.
Within a targeted industry, the Subadviser engages in a disciplined securities
selection process. In this process, the Subadviser conducts an extensive
analysis of issuers within the targeted industry to identify issuers that appear
to have the most favorable prospects for improving financial condition. The
Subadviser also
34
reviews the terms of the agreements documenting the Senior Loans to seek to
identify those Senior Loans that have the most favorable risk and return
characteristics. Based on this analysis, the Subadviser constructs and actively
manages a portfolio of Senior Loans. The Subadviser's goal is to achieve the
highest potential level of current income with the lowest potential volatility
over long periods of time.
Duration Management. Interest rates on Senior Loans in which the Fund
invests adjust periodically. The interest rates are adjusted based on a base
rate plus a premium or spread over the base rate. The base rate usually is
LIBOR, the Federal Reserve federal funds rate, the Prime Rate or other base
lending rates used by commercial lenders. LIBOR usually is an average of the
interest rates quoted by several designated banks as the rates at which they pay
interest to major depositors in the London interbank market on U.S.
dollar-denominated deposits. The Subadviser believes that changes in short-term
LIBOR rates are closely related to changes in the Federal Reserve federal funds
rate, although the two are not technically linked. The Prime Rate quoted by a
major U.S. bank is generally the interest rate at which that bank is willing to
lend U.S. dollars to its most creditworthy borrowers, although it may not be the
bank's lowest available rate.
The Subadviser expects that the average effective duration of the Fund's
portfolio of Senior Loans will normally be between zero and 1.5 years,
reflecting the Fund's focus on floating rate instruments. As a measure of a
fixed-income security's cash flow, duration is an alternative to the concept of
"term to maturity" in assessing the price volatility associated with changes in
interest rates. Generally, the longer the duration, the more volatility an
investor should expect. For example, the market price of a fixed-income security
with a duration of three years would be expected to decline 3% if interest rates
rose 1%. Conversely, the market price of the same security would be expected to
increase 3% if interest rates fell 1%. The market price of a fixed-income
security with a duration of six years would be expected to increase or decline
twice as much as the market price of a security with a three-year duration.
Duration is a way of measuring a security's maturity in terms of the average
time required to receive the present value of all interest and principal
payments as opposed to its term to maturity. The maturity of a security measures
only the time until final payment is due; it does not take account of the
pattern of a security's cash flows over time, which would include how cash flow
is affected by prepayments and by changes in interest rates. Because the
interest rate on Senior Loans held by the Fund will reset at short-term
intervals, the duration of Senior Loans will be shorter than a fixed income
security with a comparable term to maturity. The Subadviser can manage the
duration of the portfolio by selecting Senior Loans with different interest rate
reset periods and final maturity dates. Incorporating a security's yield, coupon
interest payments, final maturity and option features into one measure, duration
is computed by determining the weighted average maturity of a fixed-income
security's cash flows, where the present values of the cash flows serve as
weights. In computing the duration of the Fund's portfolio, the Subadviser will
estimate the duration of obligations that are subject to features such as
prepayment or redemption by the issuer, put options retained by the investor or
other imbedded options, taking into account the influence of interest rates on
prepayments and coupon flows.
Loans in which the Fund invests typically have interest rates that reset
at least quarterly and may reset as frequently as daily. Because of prepayments,
the actual remaining maturity of a loan may be considerably less than its stated
maturity. Longer interest rate reset periods generally will increase
fluctuations in the Fund's net asset value as a result of changes in market
interest rates. The Fund may find it possible and appropriate to use interest
rate swaps and other investment practices to shorten the effective interest rate
adjustment period of a loan. If the Fund does so, it will consider the shortened
period to be the adjustment period of the loan. As short-term interest rates
rise, interest payable to the Fund should increase. As short-term interest rates
decline, interest payable to the Fund should decrease.
During normal market conditions, changes in market interest rates will
affect the Fund in certain ways. The principal effect will be that the yield on
the Fund's shares will tend to rise or fall as market interest rates rise and
fall. This is because the assets in which the Fund primarily invests pay
interest at
35
rates which float in response to changes in market rates. However, because the
interest rates on the Fund's assets reset over time, there will be an imperfect
correlation between changes in market rates and changes to rates on the
portfolio as a whole. This means that changes to the rate of interest paid on
the portfolio as a whole will tend to lag behind changes in market rates. The
amount of time that will pass before the Fund experiences the effects of
changing short-term interest rates will depend on the dollar-weighted average
time until the next interest rate adjustment on the Fund's portfolio of loans.
Because the rates of interest paid on the loans in which the Fund invests have a
weighted average reset period that typically is less than 90 days, the impact of
the lag between a change in market interest rates and the change in the overall
rate on the portfolio is expected to be minimal.
To the extent that changes in market rates of interest are reflected not
in a change to a base rate such as LIBOR but in a change in the spread over the
base rate which is payable on loans of the type and quality in which the Fund
invests, the Fund's net asset value could be adversely affected. This is because
the value of a Senior Loan is partially a function of whether the Senior Loan is
paying what the market perceives to be a market rate of interest, given its
individual credit and other characteristics. However, unlike changes in market
rates of interest for which there is generally only a temporary lag before the
portfolio reflects those changes, changes in a loan's value based on changes in
the market spread on loans in the Fund's portfolio may be of longer duration.
Credit Management. The Subadviser's staff monitors the credit quality and
price of Senior Loans and other securities held by the Fund, as well as other
securities that are available to the Fund. The Fund may invest in Senior Loans
and other securities of any credit quality, including Senior Loans and other
investments that are rated below investment grade or are unrated but are
determined by the Subadviser to be of equivalent credit quality. The Fund does
not have a policy of maintaining a specific average credit quality of its
portfolio nor a minimum portion of its portfolio that must be rated investment
grade. Although the Subadviser considers ratings when making investment
decisions, it performs its own credit and investment analysis and does not rely
primarily on ratings assigned by rating services. In evaluating the
attractiveness of a particular Senior Loan or other security, whether rated or
unrated, the Subadviser generally gives equal weight to the security's yield and
the issuer's creditworthiness and will normally take into consideration, among
other things, the issuer's financial resources and operating history, its
sensitivity to economic conditions and trends, the availability of its
management, its debt maturity schedules and borrowing requirements, and relative
values based on anticipated cash flow, interest and asset coverage, and earnings
prospects.
OTHER INVESTMENTS
Normally, the Fund will invest substantially all of its assets to meet its
investment objectives. The Fund may invest the remainder of its assets in
securities with remaining maturities of less than one year or cash equivalents,
or it may hold cash. For temporary defensive purposes, the Fund may depart from
its principal investment strategies and invest part or all of its assets in
securities with remaining maturities of less than one year or cash equivalents,
or it may hold cash. During such periods, the Fund may not be able to achieve
its investment objectives.
PORTFOLIO CONTENTS
SECURITIES RATINGS
Securities rated Baa by Moody's are considered by Moody's as medium to
lower medium investment grade securities; they are neither highly protected nor
poorly secured; interest payments and principal security appear to Moody's to be
adequate for the present, but certain protective elements may
36
be lacking or may be characteristically unreliable over time; and in the opinion
of Moody's, securities in this rating category lack outstanding investment
characteristics and in fact have speculative characteristics as well. Securities
rated BBB by S&P are regarded by S&P as having an adequate capacity to pay
interest and to repay principal; while such securities normally exhibit adequate
protection parameters, adverse economic conditions or changing circumstances are
more likely, in the opinion of S&P, to lead to a weakened capacity to pay
interest and repay principal for securities in this category than in higher
rating categories. Fixed income securities of below-investment grade quality are
regarded as having predominantly speculative characteristics with respect to the
issuer's capacity to pay interest and to repay principal and are commonly
referred to as "junk bonds" or "high yield securities." Such securities involve
greater risk of loss, are subject to greater price volatility and are less
liquid, especially during periods of economic uncertainty or change, than higher
rated fixed income securities.
The descriptions of the rating categories by Moody's and S&P, including a
description of their speculative characteristics, are set forth in the Statement
of Additional Information. All references to securities ratings by Moody's and
S&P in this prospectus shall, unless otherwise indicated, include all securities
within each such rating category (that is, (1), (2) and (3) in the case of
Moody's and (+) and (-) in the case of S&P). All percentage and ratings
limitations on securities in which the Fund may invest shall apply at the time
of acquisition and shall not be considered violated if an investment rating is
subsequently downgraded to a rating that would have precluded the Fund's initial
investment in such security or the percentage limitation is exceeded as a result
of changes in the market value of the Fund's portfolio securities. The Fund is
not required to dispose of a security in the event a rating agency downgrades or
withdraws its rating of a security. In the event that the Fund disposes of a
portfolio security subsequent to its being downgraded, the Fund may experience a
greater risk of loss than if such security had been sold prior to such
downgrading. When a security is rated by more than one of these rating agencies,
the Subadviser will use the highest rating in applying its investment policies.
SENIOR LOANS
Senior Loans hold the most senior position in the capital structure of a
business entity, are typically secured with specific collateral and have a claim
on the general assets of the borrower that is senior to that held by
subordinated debtholders and stockholders of the borrower. The proceeds of
Senior Loans primarily are used to finance leveraged buyouts, recapitalizations,
mergers, acquisitions, stock repurchases, and, to a lesser extent, to finance
internal growth and for other corporate purposes. Senior Loans typically have
rates of interest which are redetermined either daily, monthly, quarterly or
semi-annually by reference to a base lending rate, plus a premium. These base
lending rates generally are LIBOR, the prime rate offered by one or more major
United States banks (Prime Rate) or the certificate of deposit (CD) rate or
other base lending rates used by commercial lenders.
The Fund also may purchase unsecured loans, other floating rate debt
securities such as notes, bonds and asset-backed securities (such as securities
issued by special purpose funds investing in bank loans), investment grade and
below investment grade fixed income debt obligations and money market
instruments, such as commercial paper. The Fund also may purchase obligations
issued in connection with a restructuring pursuant to Chapter 11 of the U.S.
Bankruptcy Code. While these investments are not a primary focus of the Fund,
the Fund does not have a policy limiting such investments to a specific
percentage of the Fund's assets.
Loans and other corporate debt obligations are subject to the risk of
non-payment of scheduled interest or principal. Such non-payment would result in
a reduction of income to the Fund, a reduction in the value of the investment
and a potential decrease in the net asset value of the Fund. There can be
37
no assurance that the liquidation of any collateral securing a Senior Loan would
satisfy a borrower's obligation in the event of non-payment of scheduled
interest or principal payments, or that such collateral could be readily
liquidated. In the event of bankruptcy of a borrower, the Fund could experience
delays or limitations with respect to its ability to realize the benefits of the
collateral securing a Senior Loan. To the extent that a Senior Loan is
collateralized by stock in the borrower or its subsidiaries, such stock may lose
all or substantially all of its value in the event of the bankruptcy of a
borrower. Some Senior Loans are subject to the risk that a court, pursuant to
fraudulent conveyance or other similar laws, could subordinate Senior Loans to
presently existing or future indebtedness of the borrower or take other action
detrimental to the holders of Senior Loans including, in certain circumstances,
invalidating such Senior Loans or causing interest previously paid to be
refunded to the borrower. If interest were required to be refunded, it could
negatively affect the Fund's performance.
Many loans in which the Fund will invest may not be rated by a rating
agency, will not be registered with the Securities and Exchange Commission or
any state securities commission and will not be listed on any national
securities exchange. The amount of public information available with respect to
issuers of Senior Loans will generally be less extensive than that available for
issuers of registered or exchange listed securities. In evaluating the
creditworthiness of borrowers, the Subadviser will consider, and may rely in
part, on analyses performed by others. The Subadviser does not view ratings as
the determinative factor in its investment decisions and relies more upon its
credit analysis abilities than upon ratings. Borrowers may have outstanding debt
obligations that are rated below investment grade by a rating agency. A high
percentage of Senior Loans in the Fund may be rated below investment grade by
independent rating agencies. In the event Senior Loans are not rated, they are
likely to be the equivalent of below investment grade quality. Debt securities
which are unsecured and rated below investment grade (i.e., Ba and below by
Moody's or BB and below by S&P) and comparable unrated bonds, are viewed by the
rating agencies as having speculative characteristics and are commonly known as
"junk bonds." A description of the ratings of corporate bonds by Moody's and S&P
is included as Appendix A to the Statement of Additional Information. Because
Senior Loans are senior in a borrower's capital structure and are often secured
by specific collateral, the Subadviser believes that Senior Loans have more
favorable loss recovery rates as compared to most other types of below
investment grade debt obligations. However, there can be no assurance that the
Fund's actual loss recovery experience will be consistent with the Subadviser's
prior experience or that the Fund's Senior Loans will achieve any specific loss
recovery rates.
The Fund may hold securities that are unrated or in the lowest ratings
categories (rated C by Moody's or D by S&P). Debt securities rated C by Moody's
are regarded as having extremely poor prospects of ever attaining any real
investment standing. Debt securities rated D by S&P are in payment default or a
bankruptcy petition has been filed and debt service payments are jeopardized. In
order to enforce its rights with defaulted securities, the Fund may be required
to retain legal counsel and/or a financial adviser. The Fund may have to pursue
legal remedies, the results of which are uncertain and expensive. This may
increase operating expenses and adversely affect net asset value. The credit
quality of most securities held by the Fund reflects a greater possibility that
adverse changes in the financial condition of an issuer, or in general economic
conditions, or both, may impair the ability of the issuer to make payments of
interest or principal. The inability (or perceived inability) of issuers to make
timely payment of interest and principal would likely make the values of such
securities more volatile and could limit the ability to sell securities at
favorable prices. In the absence of a liquid trading market for securities held
by it, the Fund may have difficulties determining the fair market value of such
securities. Because of the greater number of investment considerations involved
in investing in high yield, high risk bonds, the achievement of the Fund's
objectives depends more on the Subadviser's judgment and analytical abilities
than would be the case if invested primarily in securities in the higher ratings
categories.
38
No active trading market may exist for many Senior Loans, and some Senior
Loans may be subject to restrictions on resale. The Fund is not limited in the
percentage of its assets that may be invested in Senior Loans and other
securities deemed to be illiquid. A secondary market may be subject to irregular
trading activity, wide bid/ask spreads and extended trade settlement periods,
which may impair the ability to realize full value on the disposition of an
illiquid Senior Loan, and cause a material decline in the Fund's net asset
value.
The Fund may invest up to 10% of total assets in obligations of non-U.S.
issuers, predominantly in developed countries, but the Fund may also invest in
securities of emerging market issuers. The value of obligations of non-U.S.
issuers is affected by changes in foreign tax laws (including withholding tax),
government policies (in this country or abroad) and relations between nations,
and trading, settlement, custodial and other operational risks. In addition, the
costs of investing abroad are generally higher than in the United States.
Use of Agents. Senior Loans generally are arranged through private
negotiations between a borrower and a group of financial institutions initially
represented by an agent who is usually one of the originating lenders. In larger
transactions, it is common to have several agents. Generally, however, only one
such agent has primary responsibility for on-going administration of a Senior
Loan. Agents are typically paid fees by the borrower for their services. The
agent is primarily responsible for negotiating the credit agreement which
establishes the terms and conditions of the Senior Loan and the rights of the
borrower and the lenders. The agent is also responsible for monitoring
collateral and for exercising remedies available to the lenders such as
foreclosure upon collateral.
Credit agreements may provide for the termination of the agent's status in
the event that it fails to act as required under the relevant credit agreement,
becomes insolvent, enters FDIC receivership or, if not FDIC insured, enters into
bankruptcy. Should such an agent, lender or assignor with respect to an
assignment inter-positioned between the Fund and the borrower become insolvent
or enter FDIC receivership or bankruptcy, any interest in the Senior Loan of
such person and any loan payment held by such person for the benefit of the Fund
should not be included in such person's or entity's bankruptcy estate. If,
however, any such amount were included in such person's or entity's bankruptcy
estate, the Fund would incur certain costs and delays in realizing payment or
could suffer a loss of principal or interest. In this event, the Fund could
experience a decrease in net asset value.
Form of Investment. The Fund's investments in Senior Loans may take one
of several forms, including acting as one of the group of lenders originating a
Senior Loan, purchasing an assignment of a portion of a Senior Loan from a third
party or acquiring a participation in a Senior Loan. When the Fund is a member
of the originating syndicate for a Senior Loan, it may share in a fee paid to
the syndicate. When the Fund acquires a participation in, or an assignment of, a
Senior Loan, it may pay a fee to, or forego a portion of interest payments from,
the lender selling the participation or assignment. The Fund will act as lender,
or purchase an assignment or participation, with respect to a Senior Loan only
if the agent is determined by the Subadviser to be creditworthy.
Original Lender. When the Fund is one of the original lenders, it will
have a direct contractual relationship with the borrower and can enforce
compliance by the borrower with terms of the credit agreement. It also may have
negotiated rights with respect to any funds acquired by other lenders through
set-off. Original lenders also negotiate voting and consent rights under the
credit agreement. Actions subject to lender vote or consent generally require
the vote or consent of the majority of the holders of some specified percentage
of the outstanding principal amount of the Senior Loan. Certain decisions, such
as reducing the interest rate, or extending the maturity of a Senior Loan, or
releasing collateral securing a Senior Loan, among others, frequently require
the unanimous vote or consent of all lenders affected.
39
Assignments. When the Fund is a purchaser of an assignment, it typically
succeeds to all the rights and obligations under the credit agreement of the
assigning lender and becomes a lender under the credit agreement with the same
rights and obligations as the assigning lender. Assignments are, however,
arranged through private negotiations between potential assignees and potential
assignors, and the rights and obligations acquired by the purchaser of an
assignment may be more limited than those held by the assigning lender.
Participations. The Fund may also invest in participations in Senior
Loans. The rights of the Fund when it acquires a participation are likely to be
more limited than the rights of an original lender or an investor who acquired
an assignment. Participation by the Fund in a lender's portion of a Senior Loan
typically means that the Fund has only a contractual relationship with the
lender, not with the borrower. This means that the Fund has the right to receive
payments of principal, interest and any fees to which it is entitled only from
the lender selling the participation and only upon receipt by the lender of
payments from the borrower.
With a participation, the Fund will have no rights to enforce compliance
by the borrower with the terms of the credit agreement or any rights with
respect to any funds acquired by other lenders through set-off against the
borrower. In addition, the Fund may not directly benefit from the collateral
supporting the Senior Loan because it may be treated as a general creditor of
the lender instead of a senior secured creditor of the borrower. As a result,
the Fund may be subject to delays, expenses and risks that are greater than
those that exist when the Fund is the original lender or holds an assignment.
This means the Fund must assume the credit risk of both the borrower and the
lender selling the participation. The Fund will consider a purchase of
participations only in those situations where the Subadviser considers the
participating lender to be creditworthy.
In the event of a bankruptcy or insolvency of a borrower, the obligation
of the borrower to repay the Senior Loan may be subject to certain defenses that
can be asserted by such borrower against the Fund as a result of improper
conduct of the lender selling the participation. A participation in a Senior
Loan will be deemed to be a Senior Loan for the purposes of the Fund's
investment objectives and policies.
Investing in Senior Loans involves investment risk. Some borrowers default
on their Senior Loan payments. The Fund attempts to manage this credit risk
through portfolio diversification and ongoing analysis and monitoring of
borrowers. The Fund also is subject to market, liquidity, interest rate and
other risks. See "Risk Factors."
OTHER FIXED INCOME SECURITIES
The Fund also may purchase unsecured loans, other floating rate debt
securities such as notes, bonds and asset-backed securities (such as securities
issued by special purpose funds investing in bank loans), investment grade and
below investment grade fixed income debt obligations and money market
instruments, such as commercial paper. The high yield securities in which the
Fund invests are rated Ba or lower by Moody's or BB or lower by S&P or are
unrated but determined by the Subadviser to be of comparable quality. Debt
securities rated below investment grade are commonly referred to as "junk bonds"
and are considered speculative with respect to the issuer's capacity to pay
interest and repay principal. Below investment grade debt securities involve
greater risk of loss, are subject to greater price volatility and are less
liquid, especially during periods of economic uncertainty or change, than higher
rated debt securities. The Fund's fixed-income securities may have fixed or
variable principal payments and all types of interest rate and dividend payment
and reset terms, including fixed rate, adjustable rate, zero coupon, contingent,
deferred, payment in kind and auction rate features. The Fund may invest in
fixed-income securities with a broad range of maturities.
40
The Fund may invest in zero coupon bonds, deferred interest bonds and
bonds or preferred stocks on which the interest is payable in-kind (PIK bonds).
To the extent the Fund invests in such instruments, they will not contribute to
the Fund's primary goal of current income. Zero coupon and deferred interest
bonds are debt obligations which are issued at a significant discount from face
value. While zero coupon bonds do not require the periodic payment of interest,
deferred interest bonds provide for a period of delay before the regular payment
of interest begins. PIK bonds are debt obligations that provide that the issuer
thereof may, at its option, pay interest on such bonds in cash or in the form of
additional debt obligations. Such investments may experience greater volatility
in market value due to changes in interest rates. The Fund may be required to
accrue income on these investments for federal income tax purposes and is
required to distribute its net income each year in order to qualify for the
favorable federal income tax treatment potentially available to regulated
investment companies. The Fund may be required to sell securities to obtain cash
needed for income distributions at times and at prices that the Adviser believes
do not reflect the intrinsic value of such securities.
SECOND LIEN LOANS AND DEBT OBLIGATIONS
The Fund may invest in loans and other debt securities that have the same
characteristics as Senior Loans except that such loans are second in lien
property rather than first. Such "second lien" loans and securities, like Senior
Loans, typically have adjustable floating rate interest payments. Accordingly,
the risks associated with "second lien" loans are higher than the risk of loans
with first priority over the collateral. In the event of default on a "second
lien" loan, the first priority lien holder has first claim to the underlying
collateral of the loan. It is possible, that no collateral value would remain
for the second priority lien holder and therefore result in a loss of investment
to the Fund.
COLLATERALIZED LOAN OBLIGATIONS AND BOND OBLIGATIONS
The Fund may invest in certain asset-backed securities that are
securitizing certain financial assets by issuing securities in the form of
negotiable paper that are issued by a financing company (generally called a
Special Purpose Vehicle or "SPV"). These securitized assets are, as a rule,
corporate financial assets brought into a pool according to specific
diversification rules. The SPV is a company founded solely for the purpose of
securitizing these claims and its only asset is the diversified asset pool. On
this basis, marketable securities are issued which, due to the diversification
of the underlying risk, generally represent a lower level of risk than the
original assets. The redemption of the securities issued by the SPV takes place
at maturity out of the cash flow generated by the collected claims.
A collateralized loan obligation ("CLO") is a structured debt security
issued by an SPV that was created to reapportion the risk and return
characteristics of a pool of assets. The assets, typically Senior Loans, are
used as collateral supporting the various debt tranches issued by the SPV. The
key feature of the CLO structure is the prioritization of the cash flows from a
pool of debt securities among the several classes of securities issued by a CLO.
The Fund may also invest in collateralized bond obligations ("CBOs"),
which are structured debt securities backed by a diversified pool of high yield,
public or private fixed income securities. These may be fixed pools or may be
"market value" (or managed) pools of collateral. The CBO issues debt securities
that are typically separated into tranches representing different degrees of
credit quality. The top tranche of securities has the greatest collateralization
and pays the lowest interest rate. Lower CBO tranches have a lesser degree of
collateralization quality and pay higher interest rates intended to compensate
for the attendant risks. The bottom tranche specifically receives the residual
interest payments (i.e., money that is left over after the higher tranches have
been paid) rather than a fixed interest rate. The return on the lower tranches
of CBOs is especially sensitive to the rate of defaults in
41
the collateral pool. Under normal market conditions, the Fund expects to invest
in the lower tranches of CBOs.
CREDIT DEFAULT SWAP
The Fund may enter into credit default swap agreements. The "buyer" in a
credit default contract is obligated to pay the "seller" a periodic stream of
payments over the term of the contract provided that no event of default on an
underlying reference obligation has occurred. If an event of default occurs, the
seller must pay the buyer the "par value" (full notional value) of the reference
obligation in exchange for the reference obligation. The Fund may be either the
buyer or seller in the transaction. If the Fund is a buyer and no event of
default occurs, the Fund loses its investment and recovers nothing. However, if
an event of default occurs, the buyer receives full notional value for a
reference obligation that may have little or no value. As a seller, the Fund
receives income throughout the term of the contract, which typically is between
six months and three years, provided that there is no default event.
Credit default swaps involve greater risks than if the Fund had invested
in the reference obligation directly. In addition to general market risks,
credit default swaps are subject to illiquidity risk, counterparty risk and
credit risks. The Fund will enter into swap agreements only with counterparties
that are rated investment grade quality by at least one nationally recognized
statistical rating organization at the time of entering into such transaction or
whose creditworthiness is believed by the Subadviser to be equivalent to such
rating. A buyer also will lose its investment and recover nothing should no
event of default occur. If an event of default were to occur, the value of the
reference obligation received by the seller, coupled with the periodic payments
previously received, may be less than the full notional value it pays to the
buyer, resulting in a loss of value to the seller. When the Fund acts as a
seller of a credit default swap agreement it is exposed to many of the same
risks of leverage described under "Risk Factors -- Leverage Risk" in this
prospectus since if an event of default occurs the seller must pay the buyer the
full notional value of the reference obligation.
SENIOR LOAN BASED DERIVATIVES
The Fund may obtain exposure to Senior Loans and baskets of Senior Loans
through the use of derivative instruments. Such derivative instruments have
recently become increasingly available. The Subadviser reserves the right to
utilize these instruments and similar instruments that may be available in the
future. For example, the Fund may invest in a derivative instrument known as the
Select Aggregate Market Index ("SAMI"), which provides investors with exposure
to a reference basket of Senior Loans. SAMIs are structured as floating rate
instruments. SAMIs consist of a basket of credit default swaps whose underlying
reference securities are Senior Loans. While investing in SAMIs will increase
the universe of floating rate debt securities to which the Fund is exposed, such
investments entail risks that are not typically associated with investments in
other floating rate debt securities. The liquidity of the market for SAMIs will
be subject to liquidity in the secured loan and credit derivatives markets.
Investment in SAMIs involves many of the risks associated with investments in
derivative instruments discussed generally below. The Fund may also be subject
to the risk that the counterparty in a derivative transaction will default on
its obligations. Derivative transactions generally involve the risk of loss due
to unanticipated adverse changes in securities prices, interest rates, the
inability to close out a position, imperfect correlation between a position and
the desired hedge, tax constraints on closing out positions and portfolio
management constraints on securities subject to such transactions. The potential
loss on derivative instruments may be substantially greater than the initial
investment therein.
42
CREDIT-LINKED NOTES
The Fund may invest in credit-linked notes ("CLNs") for risk management
purposes, including diversification. A CLN is a derivative instrument. It is a
synthetic obligation between two or more parties where the payment of principal
and/or interest is based on the performance of some obligation (a reference
obligation). In addition to credit risk of the reference obligations and
interest rate risk, the buyer/seller of the CLN is subject to counterparty risk.
COMMON STOCKS
The Fund may acquire an interest in common stocks upon the default of a
Senior Loan secured by such common stock. The Fund may also acquire warrants or
other rights to purchase a borrower's common stock in connection with the making
of a Senior Loan. Common stocks are shares of a corporation or other entity that
entitle the holder to a pro rata share of the profits, if any, of the
corporation without preference over any other shareholder or class of
shareholders, including holders of such entity's preferred stock and other
senior equity securities. Common stock usually carries with it the right to vote
and frequently an exclusive right to do so. In selecting common stocks for
investment, the Fund generally expects to focus primarily on the security's
dividend paying capacity rather than on its potential for capital appreciation.
PREFERRED SECURITIES
The Fund may invest in preferred securities. Preferred securities are
equity securities, but they have many characteristics of fixed income
securities, such as a fixed dividend payment rate and/or a liquidity preference
over the issuer's common shares. However, because preferred shares are equity
securities, they may be more susceptible to risks traditionally associated with
equity investments than the Fund's fixed income securities.
Fixed rate preferred stocks have fixed dividend rates. They can be
perpetual, with no mandatory redemption date, or issued with a fixed mandatory
redemption date. Certain issues of preferred stock are convertible into other
equity securities. Perpetual preferred stocks provide a fixed dividend
throughout the life of the issue, with no mandatory retirement provisions, but
may be callable. Sinking fund preferred stocks provide for the redemption of a
portion of the issue on a regularly scheduled basis with, in most cases, the
entire issue being retired at a future date. The value of fixed rate preferred
stocks can be expected to vary inversely with interest rates.
Adjustable rate preferred stocks have a variable dividend rate which is
determined periodically, typically quarterly, according to a formula based on a
specified premium or discount to the yield on particular U.S. Treasury
securities, typically the highest base-rate yield of one of three U.S. Treasury
securities: the 90-day Treasury bill; the 10-year Treasury note; and either the
20-year or 30-year Treasury bond or other index. The premium or discount to be
added to or subtracted from this base-rate yield is fixed at the time of
issuance and cannot be changed without the approval of the holders of the
adjustable rate preferred stock. Some adjustable rate preferred stocks have a
maximum and a minimum rate and in some cases are convertible into common stock.
Auction rate preferred stocks pay dividends that adjust based on periodic
auctions. Such preferred stocks are similar to short-term corporate money market
instruments in that an auction rate preferred stockholder has the opportunity to
sell the preferred stock at par in an auction, normally conducted at least every
49 days, through which buyers set the dividend rate in a bidding process for the
next period. The dividend rate set in the auction depends on market conditions
and the credit quality of the particular issuer. Typically, the auction rate
preferred stock's dividend rate is limited to a
43
specified maximum percentage of an external commercial paper index as of the
auction date. Further, the terms of the auction rate preferred stocks generally
provide that they are redeemable by the issuer at certain times or under certain
conditions.
CONVERTIBLE SECURITIES
The Fund's investment in fixed income securities may include bonds and
preferred stocks that are convertible into the equity securities of the issuer
or a related company. Depending on the relationship of the conversion price to
the market value of the underlying securities, convertible securities may trade
more like equity securities than debt instruments.
OTHER DEBT SECURITIES
The Fund may invest in other debt securities. Other debt securities in
which the Fund may invest include: securities issued or guaranteed by the U.S.
government, its agencies or instrumentalities and custodial receipts therefor;
securities issued or guaranteed by a foreign government or any of its political
subdivisions, authorities, agencies or instrumentalities or by international or
supranational entities; corporate debt securities, including notes, bonds and
debentures; certificates of deposit and bankers' acceptances issued or
guaranteed by, or time deposits maintained at, banks (including U.S. or foreign
branches of U.S. banks or U.S. or foreign branches of foreign banks) having
total assets of more than $1 billion; commercial paper; and mortgage related
securities. These securities may be of any maturity. The value of debt
securities can be expected to vary inversely with interest rates.
MONEY MARKET INSTRUMENTS
Money market instruments include short-term U.S. government securities,
U.S. dollar-denominated, high quality commercial paper (unsecured promissory
notes issued by corporations to finance their short-term credit needs),
certificates of deposit, bankers' acceptances and repurchase agreements relating
to any of the foregoing. U.S. government securities include Treasury notes,
bonds and bills, which are direct obligations of the U.S. government backed by
the full faith and credit of the United States and securities issued by agencies
and instrumentalities of the U.S. government, which may be guaranteed by the
U.S. Treasury, may be supported by the issuer's right to borrow from the U.S.
Treasury or may be backed only by the credit of the federal agency or
instrumentality itself.
U.S. GOVERNMENT SECURITIES
U.S. government securities in which the Fund invests include debt
obligations of varying maturities issued by the U.S. Treasury or issued or
guaranteed by an agency or instrumentality of the U.S. government, including the
Federal Housing Administration, Federal Financing Bank, Farmers Home
Administration, Export-Import Bank of the United States, Small Business
Administration, Government National Mortgage Association (GNMA), General
Services Administration, Central Bank for Cooperatives, Federal Farm Credit
Banks, Federal Home Loan Banks, Federal Home Loan Mortgage Corporation (FHLMC),
Federal National Mortgage Association (FNMA), Maritime Administration, Tennessee
Valley Authority, District of Columbia Armory Board, Student Loan Marketing
Association, Resolution Trust Corporation and various institutions that
previously were or currently are part of the Farm Credit System (which has been
undergoing reorganization since 1987). Some U.S. government securities, such as
U.S. Treasury bills, Treasury notes and Treasury bonds, which differ only in
their interest rates, maturities and times of issuance, are supported by the
full faith and credit of the United States government. Others are supported by
(i) the right of the issuer to borrow from the U.S. Treasury, such as securities
of the Federal Home Loan Banks; (ii) the
44
discretionary authority of the U.S. government to purchase the agency's
obligations, such as securities of the FNMA; or (iii) only the credit of the
issuer. No assurance can be given that the U.S. government will provide
financial support in the future to U.S. government agencies, authorities or
instrumentalities that are not supported by the full faith and credit of the
United States. Securities guaranteed as to principal and interest by the U.S.
government, its agencies, authorities or instrumentalities include (i)
securities for which the payment of principal and interest is backed by an
irrevocable letter of credit issued by the U.S. government or any of its
agencies, authorities or instrumentalities; and (ii) participations in loans
made to non-U.S. governments or other entities that are so guaranteed. The
secondary market for certain of these participations is limited and therefore
may be regarded as illiquid.
OTHER INVESTMENT COMPANIES
The Fund may invest in the securities of other investment companies to the
extent that such investments are consistent with the Fund's investment
objectives and principal investment strategies and permissible under the 1940
Act. Under one provision of the 1940 Act, the Fund may not acquire the
securities of other investment companies if, as a result, (i) more than 10% of
the Fund's total assets would be invested in securities of other investment
companies, (ii) such purchase would result in more than 3% of the total
outstanding voting securities of any one investment company being held by the
Fund or (iii) more than 5% of the Fund's total assets would be invested in any
one investment company. Other provisions of the 1940 Act are less restrictive
provided that the Fund is able to meet certain conditions. These limitations do
not apply to the acquisition of shares of any investment company in connection
with a merger, consolidation, reorganization or acquisition of substantially all
of the assets of another investment company. However, the Adviser has obtained
an exemptive order from the Securities and Exchange Commission that permits the
Fund to invest cash balances in money market funds managed by the Adviser.
The Fund, as a holder of the securities of other investment companies,
will bear its pro rata portion of the other investment companies' expenses,
including advisory fees. These expenses will be in addition to the direct
expenses incurred by the Fund.
EXCHANGE TRADED FUNDS
Subject to the limitations on investment in other investment companies,
the Fund may invest in exchange traded funds ("ETFs"). ETFs, such as SPDRs,
NASDAQ 100 Index Trading Stock (QQQs), iShares and various country index funds,
are funds whose shares are traded on a national exchange or the National
Association of Securities Dealers' Automatic Quotation System (NASDAQ). ETFs may
be based on underlying equity or fixed income securities. SPDRs, for example,
seek to provide investment results that generally correspond to the performance
of the component common stocks of the S&P 500. ETFs do not sell individual
shares directly to investors and only issue their shares in large blocks known
as "creation units." The investor purchasing a creation unit may sell the
individual shares on a secondary market. Therefore, the liquidity of ETFs
depends on the adequacy of the secondary market. There can be no assurance that
an ETF's investment objective will be achieved. ETFs based on an index may not
replicate and maintain exactly the composition and relative weightings of
securities in the index. ETFs are subject to the risks of investing in the
underlying securities. The Fund, as a holder of the securities of the ETF, will
bear its pro rata portion of the ETF's expenses, including advisory fees. These
expenses are in addition to the direct expenses of the Fund's own operations.
45
ZERO COUPON SECURITIES
The securities in which the Fund invests may include zero coupon
securities, which are debt obligations that are issued or purchased at a
significant discount from face value. The discount approximates the total amount
of interest the security will accrue and compound over the period until maturity
or the particular interest payment date at a rate of interest reflecting the
market rate of the security at the time of issuance. Zero coupon securities do
not require the periodic payment of interest. These investments benefit the
issuer by mitigating its need for cash to meet debt service but generally
require a higher rate of return to attract investors who are willing to defer
receipt of cash. These investments may experience greater volatility in market
value than securities that make regular payments of interest. The Fund accrues
income on these investments for tax and accounting purposes, which is
distributable to shareholders and which, because no cash is received at the time
of accrual, may require the liquidation of other portfolio securities to satisfy
the Fund's distribution obligations, in which case the Fund will forgo the
purchase of additional income producing assets with these funds.
STRATEGIC TRANSACTIONS
In addition to the credit default swaps and Senior Loan bond derivatives
discussed above the Fund may, but is not required to, use various strategic
transactions described below to earn income, facilitate portfolio management and
mitigate risks. Such strategic transactions are generally accepted under modern
portfolio management and are regularly used by many mutual funds and other
institutional investors. Although the Subadviser seeks to use the practices to
further the Fund's investment objectives, no assurance can be given that these
practices will achieve this result. While the Fund reserves the ability to use
these strategic transactions, the Subadviser does not anticipate that strategic
transactions other than credit default swaps and Senior Loan bond derivatives
will initially be a significant part of the Fund's investment approach. With
changes in the market or the Subadviser's strategy, it is possible that these
instruments may be a more significant part of the Fund's investment approach in
the future.
The Fund may purchase and sell derivative instruments such as
exchange-listed and over-the-counter put and call options on securities,
financial futures, equity, fixed-income and interest rate indices, and other
financial instruments, purchase and sell financial futures contracts and options
thereon, enter into various interest rate transactions such as swaps, caps,
floors or collars and enter into various currency transactions such as currency
forward contracts, currency futures contracts, currency swaps or options on
currency or currency futures or credit transactions and credit default swaps.
The Fund also may purchase derivative instruments that combine features of these
instruments. Collectively, all of the above are referred to as "Strategic
Transactions." The Fund generally seeks to use Strategic Transactions as a
portfolio management or hedging technique to seek to protect against possible
adverse changes in the market value of Senior Loans or other securities held in
or to be purchased for the Fund's portfolio, protect the value of the Fund's
portfolio, facilitate the sale of certain securities for investment purposes,
manage the effective interest rate exposure of the Fund, protect against changes
in currency exchange rates, manage the effective maturity or duration of the
Fund's portfolio, or establish positions in the derivatives markets as a
temporary substitute for purchasing or selling particular securities.
Strategic Transactions have risks, including the imperfect correlation
between the value of such instruments and the underlying assets, the possible
default of the other party to the transaction or illiquidity of the derivative
instruments. Furthermore, the ability to use successfully Strategic Transactions
depends on the Subadviser's ability to predict pertinent market movements, which
cannot be assured. Thus, the use of Strategic Transactions may result in losses
greater than if they had not
46
been used, may require the Fund to sell or purchase portfolio securities at
inopportune times or for prices other than current market values, may limit the
amount of appreciation the Fund can realize on an investment, or may cause the
Fund to hold a security that it might otherwise sell. The use of currency
transactions can result in the Fund incurring losses as a result of the
imposition of exchange controls, suspension of settlements or the inability of
the Fund to deliver or receive a specified currency. Additionally, amounts paid
by the Fund as premiums and cash or other assets held in margin accounts with
respect to Strategic Transactions are not otherwise available to the Fund for
investment purposes.
A more complete discussion of Strategic Transactions and their risks is
contained in the Statement of Additional Information.
REPURCHASE AGREEMENTS
The Fund may enter into repurchase agreements with broker-dealers, member
banks of the Federal Reserve System and other financial institutions. Repurchase
agreements are arrangements under which the Fund purchases securities and the
seller agrees to repurchase the securities within a specific time and at a
specific price. The repurchase price is generally higher than the Fund's
purchase price, with the difference being income to the Fund. Under the
direction of the Board of Trustees, the Subadviser reviews and monitors the
creditworthiness of any institution which enters into a repurchase agreement
with the Fund. The counterparty's obligations under the repurchase agreement are
collateralized with U.S. Treasury and/or agency obligations with a market value
of not less than 100% of the obligations, valued daily. Collateral is held by
the Fund's custodian in a segregated, safekeeping account for the benefit of the
Fund. Repurchase agreements afford the Fund an opportunity to earn income on
temporarily available cash at low risk. In the event of commencement of
bankruptcy or insolvency proceedings with respect to the seller of the security
before repurchase of the security under a repurchase agreement, the Fund may
encounter delay and incur costs before being able to sell the security. Such a
delay may involve loss of interest or a decline in price of the security. If the
court characterizes the transaction as a loan and the Fund has not perfected a
security interest in the security, the Fund may be required to return the
security to the seller's estate and be treated as an unsecured creditor of the
seller. As an unsecured creditor, the Fund would be at risk of losing some or
all of the principal and interest involved in the transaction.
LENDING OF PORTFOLIO SECURITIES
The Fund may lend portfolio securities to registered broker-dealers or
other institutional investors deemed by the Subadviser to be of good standing
under agreements which require that the loans be secured continuously by
collateral in cash, cash equivalents or U.S. Treasury bills maintained on a
current basis at an amount at least equal to the market value of the securities
loaned. The Fund continues to receive the equivalent of the interest or
dividends paid by the issuer on the securities loaned as well as the benefit of
an increase and the detriment of any decrease in the market value of the
securities loaned and would also receive compensation based on investment of the
collateral. The Fund would not, however, have the right to vote any securities
having voting rights during the existence of the loan, but would call the loan
in anticipation of an important vote to be taken among holders of the securities
or of the giving or withholding of consent on a material matter affecting the
investment.
As with other extensions of credit, there are risks of delay in recovery
or even loss of rights in the collateral should the borrower of the securities
fail financially. The Fund will lend portfolio securities only to firms that
have been approved in advance by the Board of Trustees, which will monitor the
creditworthiness of any such firms.
47
PORTFOLIO TURNOVER
It is the policy of the Fund not to engage in trading for short-term
profits, although portfolio turnover rate is not considered a limiting factor in
the execution of investment decisions for the Fund.
RISK FACTORS
Investing in the Fund involves risk, including the risk that you may
receive little or no return on your investment or that you may lose part or all
of your investment. Therefore, before investing you should consider carefully
the following risks that you assume when you invest in Preferred Shares.
RISKS OF INVESTMENT IN PREFERRED SHARES
Leverage Risk. The Fund expects to use financial leverage on an ongoing
basis for investment purposes. Taking into account the Preferred Shares being
offered in this prospectus, the amount of leverage would, as of [ ],
2005, represent approximately 33.3% of the Fund's total assets. The Fund's
leveraged capital structure creates special risks not associated with
unleveraged funds having a similar investment objectives and policies. These
include the possibility of higher volatility of both the net asset value of the
Fund and the value of assets serving as asset coverage for the Preferred Shares.
Because the fee paid to the Adviser will be calculated on the basis of the
Fund's managed assets (which equals the aggregate net asset value of the common
shares plus the liquidation preference of the Preferred Shares), the fee will be
higher when leverage is utilized, giving the Adviser an incentive to utilize
leverage.
Interest Rate Risk. The Preferred Shares pay dividends based on
shorter-term interest rates. The Fund may invests the proceeds from the issuance
of the Preferred Shares in Senior Loans. The interest rates on Senior Loans are
typically, although not always, higher than shorter-term interest rates of
issuers with AAA credit ratings that the Fund anticipates receiving from the
rating agencies. Shorter-term interest rates, including the floating rates paid
on the Fund's portfolio of Senior Loans, can be expected to fluctuate. If
shorter-term interest rates rise, dividend rates on the Preferred Shares may
rise so that the amount of dividends to be paid to holders of Preferred Shares
exceeds the income from the Senior Loans purchased by the Fund with the proceeds
from the sale of Preferred Shares. Similarly, the anticipated differential on
the rate of interest paid on the Preferred Shares and the Fund's portfolio of
Senior Loans would decline or be eliminated if, in the future, the rating
agencies lower the rating assigned to the Preferred Shares. Because income from
the Fund's entire investment portfolio (not just the portion of the portfolio
purchased with the proceeds of the Preferred Shares offering) is available to
pay dividends on the Preferred Shares, however, dividend rates on the Preferred
Shares would need to exceed the rate of return on the Fund's investment
portfolio by a wide margin before the Fund's ability to pay dividends on the
Preferred Shares would be jeopardized.
Auction Risk. The dividend rate for the Preferred Shares normally is set
through an auction process. In the auction, holders of Preferred Shares may
indicate the dividend rate at which they would be willing to hold or sell their
Preferred Shares or purchase additional Preferred Shares. The auction also
provides liquidity for the sale of Preferred Shares. An auction fails if there
are more Preferred Shares offered for sale than there are buyers. You may not be
able to sell your Preferred Shares at an auction if the auction fails. Also, if
you place bid orders (orders to retain Preferred Shares) at an auction only at a
specified dividend rate, and that rate exceeds the rate set at the auction, you
will not retain your Preferred Shares. Additionally, if you buy Preferred Shares
or elect to retain Preferred Shares without specifying a dividend rate below
which you would not wish to buy or continue to hold those Preferred Shares, you
could receive a lower rate of return on your Preferred Shares than the market
rate. Finally, the dividend periods for the Preferred Shares may be changed by
the Fund,
48
subject to certain conditions with notice to the holders of Preferred Shares,
which could also effect the liquidation of your investment. See "Description of
Preferred Shares" and "The Auction -- Auction Procedures."
Secondary Market Risk. If you try to sell your Preferred Shares between
auctions you may not be able to sell any or all of your Preferred Shares or you
may not be able to sell them for $25,000 per share or $25,000 per share plus
accumulated but unpaid dividends. If the Fund has designated a special dividend
period (a rate period of more than days in the case of Series [ ] Preferred
Shares and Series [ ] Preferred Shares, and a rate period of more than days
in the case of Series [ ] Preferred Shares), changes in interest rates could
affect the price you would receive if you sold your Preferred Shares in the
secondary market. You may transfer Preferred Shares outside of auctions only to
or through a Broker-Dealer that has entered into a Broker-Dealer Agreement or
such other person as the Fund permits. The Fund does not anticipate imposing
significant restrictions on transfers to other persons. However, unless any such
other person has entered into a relationship with a Broker-Dealer that has
entered into a Broker-Dealer Agreement with the Auction Agent, that person will
not be able to submit bids at auctions with respect to the Preferred Shares.
Broker-dealers that maintain a secondary trading market for Preferred Shares are
not required to maintain this market, and the Fund is not required to redeem
Preferred Shares either if an auction or an attempted secondary market sale
fails because of a lack of buyers. The Preferred Shares will not be listed on a
stock exchange or the Nasdaq National Market. If you sell your Preferred Shares
to a broker-dealer between auctions, you may receive less than the price you
paid for them, especially if market interest rates have risen since the last
auction. In addition, a Broker-Dealer may, in its own discretion, decide to sell
the Preferred Shares in the secondary market to investors at any time and at any
price, including at prices equivalent to, below or above the par value of the
Preferred Shares.
Securities and Exchange Commission Inquiries. [ ] has advised
the Fund that it and certain Broker-Dealers and other participants in the
auction rate securities markets, including both taxable and tax exempt markets,
have received letters from the Securities and Exchange Commission requesting
that each of them voluntarily conduct an investigation regarding their
respective practices and procedures in those markets. [ ] and
those other Broker-Dealers are cooperating and expect to continue to cooperate
with the Securities and Exchange Commission in providing the requested
information. No assurance can be given as to whether the results of this process
will affect the market for the Preferred Shares or the auctions.
Ratings and Asset Coverage Risk. While it is expected that Moody's will
assign a rating of Aaa to the Preferred Shares and Fitch will assign a rating of
AAA to the Preferred Shares, such ratings do not eliminate or necessarily
mitigate the risks of investing in Preferred Shares. Moody's or Fitch could
downgrade its rating of the Preferred Shares or withdraw its rating of the
Preferred Shares at any time, which may make your shares less liquid at an
auction or in the secondary market. Moody's and Fitch are not required to
provide prior notice of a decision to downgrade the Preferred Shares or to
withdraw their rating. If Moody's or Fitch downgrades the Preferred Shares, the
Fund may alter its portfolio or redeem Preferred Shares in an effort to improve
the rating, although there is no assurance that it will be able to do so to the
extent necessary to restore the prior rating. If the Fund fails to satisfy the
asset coverage ratios discussed under "Description of Preferred Shares -- Rating
Agency Guidelines and Asset Coverage," the Fund will be required to redeem a
sufficient number of Preferred Shares in order to return to compliance with the
asset coverage ratios. The Fund may be required to redeem Preferred Shares at a
time when it is not advantageous for the Fund to make such redemption or to
liquidate portfolio securities in order to have available cash for such
redemption. The Fund may voluntarily redeem Preferred Shares under certain
circumstances in order to meet asset maintenance tests. While a sale of
substantially all the assets of the Fund or the merger of the Fund into another
entity would require the approval of the holders of Preferred Shares voting as a
separate class as discussed under "Description of Preferred Shares -- Voting
Rights," a sale of substantially all the assets of the Fund or
49
the merger of the Fund with or into another entity would not be treated as a
liquidation of the Fund nor require that the Fund redeem Preferred Shares, in
whole or in part, provided that the Fund continued to comply with the asset
coverage ratios discussed under "Description of Preferred Shares -- Rating
Agency Guidelines and Asset Coverage." See "Description of Preferred
Shares -- Rating Agency Guidelines and Asset Coverage" for a description of the
asset maintenance tests the Fund must meet.
Restrictions on Dividends and Other Distributions. Restrictions imposed
on the declaration and payment of dividends or other distributions to the
holders of the Fund's common shares and Preferred Shares, both by the 1940 Act
and by requirements imposed by rating agencies, might impair the Fund's ability
to maintain its qualification as a regulated investment company for federal
income tax purposes. While the Fund may redeem Preferred Shares to enable the
Fund to distribute its income as required to maintain its qualification as a
regulated investment company under the Code, there can be no assurance that such
redemptions can be effected in time to meet the requirements of the Code. See
"Federal Income Tax Matters."
GENERAL RISKS OF INVESTING IN THE FUND
Limited Operating History. The Fund is a recently organized,
non-diversified, closed-end management investment company and has a limited
operating history and history of public trading.
Non-Diversified Status Risk. The Fund is classified as "non-diversified"
under the 1940 Act. As a result, it can invest a greater portion of its assets
in obligations of a single issuer than a "diversified" fund. The Fund will
therefore be more susceptible than a diversified fund to being adversely
affected by any single corporate, economic, political or regulatory occurrence.
The Fund intends to diversify its investments to the extent necessary to
qualify, and maintain its status, as a regulated investment company under U.S.
federal income tax laws. See "Federal Income Tax Matters."
Interest Rate Risk. The Fund's net asset value will usually change in
response to interest rate fluctuations. When interest rates decline, the value
of fixed-rate securities already held by the Fund can be expected to rise.
Conversely, when interest rates rise, the value of existing fixed-rate portfolio
securities can be expected to decline. Because market interest rates are
currently near their lowest levels in many years, there is a greater than normal
risk that the Fund's portfolio will decline in value due to rising interest
rates. The Fund will primarily invest in floating rate obligations, including
Senior Loans, the rate on which periodically adjusts with changes in interest
rates.
Until the interest rates on the floating rate obligations in the Fund's
portfolio reset, the Fund's income also would likely be affected adversely when
prevailing short term interest rates increase and the Fund is using leverage.
To the extent that changes in market rates of interest are reflected not
in a change to a base rate such as LIBOR but in a change in the spread over the
base rate which is payable on loans of the type and quality in which the Fund
invests, the Fund's net asset value could be adversely affected. This is because
the value of a Senior Loan asset in the Fund is partially a function of whether
it is paying what the market perceives to be a market rate of interest for the
particular loan, given its individual credit and other characteristics. However,
unlike changes in market rates of interest for which there is generally only a
temporary lag before the portfolio reflects those changes, changes in a loan's
value based on changes in the market spread on loans in the Fund's portfolio may
be of longer duration.
Reinvestment Risk. Income from the Fund's portfolio will decline if the
Fund invests the proceeds on repayment or sale of Senior Loans or other
obligations into lower yielding instruments or Senior Loans with a lower spread
over the base lending rate. A decline in income could affect the common shares'
distribution rate and their overall return.
50
Senior Loans Risk. The risks associated with Senior Loans are similar to
the risks of junk bonds, although Senior Loans are typically senior and secured
in contrast to below investment grade securities, commonly referred to as "junk
bonds," which are often subordinated and unsecured.
The Fund's investments in Senior Loans are typically below investment
grade and are considered speculative because of the credit risk of their
issuers. Moreover, any specific collateral used to secure a loan may decline in
value or lose all its value or become illiquid, which would adversely affect the
loan's value. Economic and other events, whether real or perceived, can reduce
the demand for certain Senior Loans or Senior Loans generally, which may reduce
market prices and cause the Fund's net asset value per share to fall. The
frequency and magnitude of such changes cannot be predicted.
Senior Loans and other debt securities are also subject to the risk of
price declines and to increases in prevailing interest rates. Conversely, the
floating rate feature of Senior Loans means the Senior Loans will not generally
experience capital appreciation in a declining interest rate environment.
Declines in interest rate may also increase prepayments of debt obligations and
require the Fund to invest assets at lower yields. No active trading market may
exist for certain Senior Loans, which may impair the ability of the Fund to
realize full value in the event of the need to liquidate such assets. Adverse
market conditions may impair the liquidity of some actively traded Senior Loans.
Although Senior Loans in which the Fund will invest will often be secured
by collateral, there can be no assurance that liquidation of such collateral
would satisfy the borrower's obligation in the event of a default or that such
collateral could be readily liquidated. In the event of bankruptcy of a
borrower, the Fund could experience delays or limitations in its ability to
realize the benefits of any collateral securing a Senior Loan. The Fund may also
invest in Senior Loans that are not secured.
Credit Risk and Junk Bond Risk. Credit risk is the risk that an issuer of
Senior Loans and other debt obligations will become unable to meet its
obligation to make interest and principal payments.
The Fund may invest all or a substantial portion of its assets in
securities that are rated below investment grade (commonly referred to as "junk
bonds" or "high yield securities"), that is, rated Ba or below by Moody's or BB
or lower by S&P, or unrated securities determined by the Subadviser to be of
comparable credit quality. Investment in securities of below-investment grade
quality involves substantial risk of loss. "Junk bonds" are considered
predominantly speculative with respect to the issuer's ability to pay interest
and principal and are susceptible to default or decline in market value due to
adverse economic and business developments. The market values for high yield
fixed income securities tend to be more volatile, and these securities are less
liquid, than investment grade debt securities. For these reasons, an investment
in the Fund is subject to the following specific risks:
- increased price sensitivity to changing interest rates and to a
deteriorating economic environment;
- greater risk of loss due to default or declining credit quality;
- adverse issuer-specific events are more likely to render the issuer
unable to make interest and/or principal payments; and
- if a negative perception of the high yield market develops, the price
and liquidity of high yield securities may be depressed, and this
negative perception could last for a significant period of time.
Adverse changes in economic conditions are more likely to lead to a
weakened capacity of a high yield issuer to make principal payments and interest
payments than an investment grade issuer. The principal amount of high yield
securities outstanding has proliferated in the past decade as an increasing
number of issuers have used high yield securities for corporate financing. An
economic downturn could severely affect the ability of highly leveraged issuers
to service their debt obligations or to repay their
51
obligations upon maturity. If the national economy enters into a recessionary
phase during 2005, or interest rates rise sharply, increasing the interest cost
on variable rate instruments and negatively impacting economic activity, the
number of defaults by high yield issuers is likely to increase. The market
values of lower quality debt securities tend to reflect individual developments
of the issuer to a greater extent than do higher quality securities, which react
primarily to fluctuations in the general level of interest rates. Factors having
an adverse impact on the market value of lower quality securities may have an
adverse effect on the Fund's net asset value and the market value of its shares.
In addition, the Fund may incur additional expenses to the extent it is required
to seek recovery upon a default in payment of principal or interest on its
portfolio holdings. In certain circumstances, the Fund may be required to
foreclose on an issuer's assets and take possession of its property or
operations. In such circumstances, the Fund would incur additional costs in
disposing of such assets and potential liabilities from operating any business
acquired.
The secondary market for high yield securities may not be as liquid as the
secondary market for more highly rated securities, a factor that may have an
adverse effect on the Fund's ability to dispose of a particular security. There
are fewer dealers in the market for high yield securities than investment grade
obligations. The prices quoted by different dealers may vary significantly, and
the spread between the bid and asked price is generally much larger than for
higher quality instruments. Under adverse market or economic conditions, the
secondary market for high yield securities could contract further, independent
of any specific adverse changes in the condition of a particular issuer, and
these instruments may become illiquid. As a result, the Fund could find it more
difficult to sell these securities or may be able to sell the securities only at
prices lower than if such securities were widely traded. Prices realized upon
the sale of such lower rated or unrated securities, under these circumstances,
may be less than the prices used in calculating the Fund's net asset value.
Issuers of such high yield securities often are highly leveraged and may
not have available to them more traditional methods of financing. Therefore, the
risk associated with acquiring the securities of such issuers generally is
greater than is the case with higher rated securities. For example, during an
economic downturn or a sustained period of rising interest rates, highly
leveraged issuers of high yield securities may experience financial stress.
During such periods, such issuers may not have sufficient revenues to meet their
interest payment obligations. The issuer's ability to service its debt
obligations may also be adversely affected by specific corporate developments,
the issuer's inability to meet specific projected business forecasts or the
unavailability of additional financing. The risk of loss from default by the
issuer is significantly greater for the holders of high yield securities (other
than Senior Loans) because such securities are generally unsecured and are often
subordinated to other creditors of the issuer. Prices and yields of high yield
securities will fluctuate over time and, during periods of economic uncertainty,
volatility of high yield securities may adversely affect the Fund's net asset
value. In addition, investments in high yield zero coupon or pay-in-kind bonds,
rather than income-bearing high yield securities, may be more speculative and
may be subject to greater fluctuations in value due to changes in interest
rates.
Issuer Risk. The value of corporate income-producing securities may
decline for a number of reasons which directly relate to the issuer, such as
management performance, financial leverage and reduced demand for the issuer's
goods and services.
Inflation Risk. Inflation risk is the risk that the value of assets or
income from investments will be worth less in the future as inflation decreases
the value of money. As inflation increases, the real value of the Fund's
portfolio can decline.
Convertible Securities Risk. Convertible securities generally offer lower
interest or dividend yields than non-convertible securities of similar quality.
As with all fixed income securities, the market values of convertible securities
tend to decline as interest rates increase and, conversely, to increase as
interest rates decline. However, when the market price of the common stock
underlying a convertible
52
security exceeds the conversion price, the convertible security tends to reflect
the market price of the underlying common stock. As the market price of the
underlying common stock declines, the convertible security tends to trade
increasingly on a yield basis and thus may not decline in price to the same
extent as the underlying common stock. Convertible securities rank senior to
common stocks in an issuer's capital structure.
Special Risks Related to Preferred Securities. There are special risks
associated with the Fund's investments in preferred securities:
- Limited Voting Rights. Generally, holders of preferred securities
have no voting rights with respect to the issuing company unless
preferred dividends have been in arrears for a specified number of
periods, at which time the preferred security holders may elect a
number of directors to the issuer's board. Generally, once the issuer
pays all the arrearages, the preferred security holders no longer have
voting rights.
- Special Redemption Rights. In certain varying circumstances, an
issuer of preferred securities may redeem the securities after a
specified date. For instance, for certain types of preferred
securities, a redemption may be triggered by a change in federal
income tax or securities laws. As with call provisions, a special
redemption by the issuer may negatively impact the return of the
security held by the Fund.
- Deferral. Preferred securities may include provisions that permit the
issuer, at its discretion, to defer distributions for a stated period
without any adverse consequences to the issuer. If the Fund owns a
preferred security that is deferring its distributions, the Fund may
be required to report income for federal income tax purposes although
it has not yet received such income in cash.
- Subordination. Preferred securities are subordinated to bonds and
other debt instruments in a company's capital structure in terms of
priority to corporate income and liquidation payments and therefore
will be subject to greater credit risk than those debt instruments.
- Liquidity. Preferred securities may be substantially less liquid than
many other securities, such as common stocks or U.S. government
securities.
Foreign Securities Risk. The Fund's investments in non-U.S. issuers may
involve unique risks compared to investing in securities of U.S. issuers. These
risks are more pronounced to the extent that the Fund invests a significant
portion of its non-U.S. investment in one region or in the securities of
emerging market issuers. These risks may include:
- Less information about non-U.S. issuers or markets may be available
due to less rigorous disclosure, accounting standards or regulatory
practices.
- Many non-U.S. markets are smaller, less liquid and more volatile. In a
changing market, the Subadviser may not be able to sell the Fund's
portfolio securities at times, in amounts and at prices it considers
reasonable.
- Currency exchange rates or controls may adversely affect the value of
the Fund's investments.
- The economies of non-U.S. countries may grow at slower rates than
expected or may experience a downturn or recession.
- Withholdings and other non-U.S. taxes may decrease the Fund's return.
There may be less publicly available information about non-U.S. markets
and issuers than is available with respect to U.S. securities and issuers.
Non-U.S. companies generally are not subject to accounting, auditing and
financial reporting standards, practices and requirements comparable to those
applicable to U.S. companies. The trading markets for most non-U.S. securities
are generally less liquid and subject to greater price volatility than the
markets for comparable securities in the U.S. The
53
markets for securities in certain emerging markets are in the earliest stages of
their development. Even the markets for relatively widely traded securities in
certain non-U.S. markets, including emerging market countries, may not be able
to absorb, without price disruptions, a significant increase in trading volume
or trades of a size customarily undertaken by institutional investors in the
U.S. Additionally, market making and arbitrage activities are generally less
extensive in such markets, which may contribute to increased volatility and
reduced liquidity.
Economies and social and political climates in individual countries may
differ unfavorably from the U.S. Non-U.S. economies may have less favorable
rates of growth of gross domestic product, rates of inflation, currency
valuation, capital reinvestment, resource self-sufficiency and balance of
payments positions. Many countries have experienced substantial, and in some
cases extremely high, rates of inflation for many years. Inflation and rapid
fluctuations in inflation rates have had, and may continue to have, very
negative effects on the economies and securities markets of certain emerging
countries. Unanticipated political or social developments may also affect the
values of the Fund's investments and the availability to the Fund of additional
investments in such countries.
Currency Risk. A portion of the Fund's assets may be quoted or
denominated in non-U.S. currencies. These securities may be adversely affected
by fluctuations in relative currency exchange rates and by exchange control
regulations. The Fund's investment performance may be negatively affected by a
devaluation of a currency in which the Fund's investments are quoted or
denominated. Further, the Fund's investment performance may be significantly
affected, either positively or negatively, by currency exchange rates because
the U.S. dollar value of securities quoted or denominated in another currency
will increase or decrease in response to changes in the value of such currency
in relation to the U.S. dollar.
Sovereign Debt Risk. An investment in debt obligations of non-U.S.
governments and their political subdivisions ("sovereign debt") involves special
risks that are not present in corporate debt obligations. The non-U.S. issuer of
the sovereign debt or the non-U.S. governmental authorities that control the
repayment of the debt may be unable or unwilling to repay principal or interest
when due, and the Fund may have limited recourse in the event of a default.
During periods of economic uncertainty, the market prices of sovereign debt may
be more volatile than prices of debt obligations of U.S. issuers. In the past,
certain non-U.S. countries have encountered difficulties in servicing their debt
obligations, withheld payments of principal and interest and declared moratoria
on the payment of principal and interest on their sovereign debt.
A sovereign debtor's willingness or ability to repay principal and pay
interest in a timely manner may be affected by, among other factors, its cash
flow situation, the extent of its foreign currency reserves, the availability of
sufficient non-U.S. exchange, the relative size of the debt service burden, the
sovereign debtor's policy toward its principal international lenders and local
political constraints. Sovereign debtors may also be dependent on expected
disbursements from non-U.S. governments, multilateral agencies and other
entities to reduce principal and interest arrearages on their debt. The failure
of a sovereign debtor to implement economic reforms, achieve specified levels of
economic performance or repay principal or interest when due may result in the
cancellation of third-party commitments to lend funds to the sovereign debtor,
which may further impair such debtor's ability or willingness to service its
debts.
Liquidity Risk. Some Senior Loans are not readily marketable and may be
subject to restrictions on resale. Senior Loans generally are not listed on any
national securities exchange or automated quotation system and no active trading
market may exist for some of the Senior Loans in which the Fund will invest.
Where a secondary market exists, such market for some Senior Loans may be
subject to irregular trading activity, wide bid/ask spreads and extended trade
settlement periods. Senior Loans that are illiquid may be more difficult to
value or may impair the Fund's ability to realize the full value of its assets
in the event of a voluntary or involuntary liquidation of such assets and thus
54
may cause a decline in the Fund's net asset value. The Fund has no limitation on
the amount of its assets that may be invested in securities which are not
readily marketable or are subject to restrictions on resale. In certain
situations, the Fund could find it more difficult to sell such securities at
desirable times and/or prices. Most Senior Loans are valued by an independent
pricing service that uses market quotations of investors and traders in Senior
Loans. In other cases, Senior Loans are valued at their fair value in accordance
with procedures approved by the Board of Trustees.
Derivatives Risk. Strategic Transactions, such as the use of derivatives,
have risks, including the imperfect correlation between the value of such
instruments and the underlying assets, the possible default of the other party
to the transaction or illiquidity of the derivative instruments. Furthermore,
the ability to successfully use Strategic Transactions depends on the
Subadviser's ability to predict pertinent market movements, which cannot be
assured. Thus, the use of Strategic Transactions may result in losses greater
than if they had not been used, may require the Fund to sell or purchase
portfolio securities at inopportune times or for prices other than current
market values, may limit the amount of appreciation the Fund can realize on an
investment or may cause the Fund to hold a security that it might otherwise
sell. Additionally, amounts paid by the Fund as premiums and cash or other
assets held in margin accounts with respect to Strategic Transactions are not
otherwise available to the Fund for investment purposes. Although the Subadviser
does not anticipate that Strategic Transactions will represent a significant
component of the Fund's investment strategy, the Fund does not have a policy
limiting the portion of the Fund's assets that may be subject to such
transactions or invested in such instruments.
There are several risks associated with the use of futures contracts and
futures options. A purchase or sale of a futures contract may result in losses
in excess of the amount invested in the futures contract. While the Fund may
enter into futures contracts and options on futures contracts for hedging
purposes, the use of futures contracts and options on futures contracts might
result in a poorer overall performance for the Fund than if it had not engaged
in any such transactions. There may be an imperfect correlation between the
Fund's portfolio holdings and futures contracts or options on futures contracts
entered into by the Fund, which may prevent the Fund from achieving the intended
hedge or expose the Fund to risk of loss. The degree of imperfection of
correlation depends on circumstances such as variations in market demand for
futures, futures options and the related securities, including technical
influences in futures and futures options trading, and differences between the
securities markets and the securities underlying the standard contracts
available for trading. Further, the Fund's use of futures contracts and options
on futures contracts to reduce risk involves costs and will be subject to the
Subadviser's ability to predict correctly changes in interest rate relationships
or other factors.
Under an interest rate swap or cap agreement (whether entered into in
connection with any preferred shares or other forms of leverage or for portfolio
management purposes), the payment obligations, if any, of the Fund and the
counterparty are netted against each other, resulting in a net payment due
either from the Fund or the counterparty. Depending on whether the Fund would be
entitled to receive net payments from the counterparty on the swap or cap, which
in turn would depend on the general state of short-term interest rates at that
point in time, a default by a counterparty could negatively impact the Fund's
overall performance. In addition, at the time an interest rate swap or cap
transaction reaches its scheduled termination date, there is a risk that the
Fund would not be able to obtain a replacement transaction or that the terms of
the replacement would not be as favorable as on the expiring transaction. If
this occurs, it could have a negative impact on the Fund's performance. If the
Fund fails to maintain a required 200% asset coverage of the liquidation value
of outstanding preferred shares, including the Preferred Shares, or if the Fund
loses its expected rating on any preferred shares, including the Preferred
Shares, or fails to maintain other covenants, the Fund may be required to redeem
some or all of the Preferred Shares. Similarly, the Fund could be required to
prepay the principal amount of any borrowings. Such redemption or prepayment
would likely result in the Fund seeking to terminate early all or a portion of
any swap or cap transaction. Early termination of a swap
55
could result in a termination payment by or to the Fund. Early termination of a
cap could result in a termination payment to the Fund. The Fund intends to
maintain in a segregated account cash or liquid securities having a value at
least equal to the Fund's net payment obligations under any swap transaction,
marked to market daily. The Fund will not enter into interest rate swap or cap
transactions having a notional amount that exceeds the outstanding amount of the
Fund's leverage.
The use of interest rate swaps and caps is a highly specialized activity
that involves investment techniques and risks different from those associated
with ordinary portfolio security transactions. Depending on the state of
interest rates in general, the Fund's use of interest rate swaps or caps could
enhance or harm the Fund's overall performance. To the extent there is a decline
in interest rates, the value of the interest rate swap or cap could decline, and
could result in a decline in the Fund's net asset value. In addition, if
short-term interest rates are lower than the Fund's fixed rate of payment on the
interest rate swap, the swap will reduce the Fund's net earnings. If, on the
other hand, short-term interest rates are higher than the fixed rate of payment
on the interest rate swap, the swap will enhance the Fund's net earnings. Buying
interest rate caps could enhance the Fund's performance by providing a maximum
leverage expense. Buying interest rate caps could also decrease the Fund's net
earnings in the event that the premium paid by the Fund to the counterparty
exceeds the additional amount the Fund would have been required to pay had it
not entered into the cap agreement.
Interest rate swaps and caps do not involve the delivery of securities or
other underlying assets or principal. Accordingly, the risk of loss with respect
to interest rate swaps is limited to the net amount of interest payments that
the Fund is contractually obligated to make and any termination payments
potentially owed by the Fund. If the counterparty defaults, the Fund would not
be able to use the anticipated net receipts under the swap or cap to offset the
dividend payments on the Fund's preferred shares or interest payments on
borrowings. Depending on whether the Fund would be entitled to receive net
payments from the counterparty on the swap or cap, which in turn would depend on
the general state of short-term interest rates at that point in time, such a
default could negatively impact the Fund's performance.
Regulatory Risk. To the extent that legislation or federal regulators
that regulate certain financial institutions impose additional requirements or
restrictions with respect to the ability of such institutions to make loans,
particularly in connection with highly leveraged transactions, the availability
of Senior Loans for investment may be adversely affected. In addition, such
legislation could depress the market value of Senior Loans.
Market Disruption Risk. The terrorist attacks in the United States on
September 11, 2001 had a disruptive effect on the securities markets. The Fund
cannot predict the effects of similar events in the future on the U.S. economy.
These terrorist attacks and related events, including the war in Iraq, its
aftermath, and continuing occupation of Iraq by coalition forces, have led to
increased short-term market volatility and may have long-term effects on U.S.
and world economies and markets. A similar disruption of the financial markets
could impact interest rates, auctions, secondary trading, ratings, credit risk,
inflation and other factors relating to the common shares. In particular, junk
bonds and Senior Loans tend to be more volatile than higher rated fixed income
securities so that these events and any actions resulting from them may have a
greater impact on the prices and volatility of junk bonds and Senior Loans than
on higher rated fixed income securities.
Anti-Takeover Provisions Risk. The Fund's Agreement and Declaration of
Trust and By-Laws include provisions that could limit the ability of other
entities or persons to acquire control of the Fund or to change the composition
of its Board of Trustees. Such provisions could limit the ability of
shareholders to sell their shares at a premium over prevailing market prices by
discouraging a third party from seeking to obtain control of the Fund. These
provisions include staggered terms of office for the Trustees, advance notice
requirements for shareholder proposals, super-majority voting requirements
56
for certain transactions with affiliates, open-ending the Fund and a merger,
liquidation, asset sale or similar transaction.
MANAGEMENT OF THE FUND
TRUSTEES AND OFFICERS
The Fund's Board of Trustees provides broad supervision over the affairs
of the Fund. The officers of the Fund are responsible for the Fund's operations.
The Trustees and officers of the Fund, together with their principal occupations
and other affiliations during the past five years, are listed in the Statement
of Additional Information. Each of the Trustees serves as a Trustee of each of
the U.S. registered investment portfolios for which the Adviser serves as
investment adviser.
INVESTMENT ADVISER AND SUBADVISER
The Fund has contracted with the Adviser to act as its investment adviser.
The Adviser is an indirect subsidiary of UniCredito. The Adviser is part of the
global asset management group providing investment management and financial
services to mutual funds and other clients. As of December 31, 2004, assets
under management by the Adviser and its affiliates were approximately $
billion worldwide, including over $ billion in assets under management by
the Adviser. Certain Trustees or officers of the Fund are also directors and/or
officers of certain of UniCredito's subsidiaries, including the Adviser. The
address of the Adviser is 60 State Street, Boston, Massachusetts 02109. The
Adviser has engaged Highland Capital Management, L.P. to act as the Fund's
investment subadviser to manage the Fund's assets. The Subadviser is a Delaware
limited partnership 100% owned by its employees. The Subadviser has one general
partner, Strand Advisors, Inc. Strand Advisors, Inc. is a Delaware corporation.
As of December 31, 2004, the Subadviser had approximately $ billion in
assets under management. The address of the Subadviser is 13455 Noel Road, Suite
1300, Dallas, Texas 75240. The Adviser supervises the Subadviser's investments
on behalf of the Fund, supervises the Fund's compliance program and provides for
the general management of the business affairs of the Fund.
In its capacity as subadviser to the Fund, the Subadviser is responsible
for the selection and on-going monitoring of the assets in the Fund's investment
portfolio. The Subadviser provides the Fund with investment research, advice and
supervision and furnishes the Fund with an investment program consistent with
the Fund's investment objectives and principal investment strategies, subject to
the supervision of the Adviser and Fund's Board of Trustees. The Subadviser,
under the supervision of the Adviser, is responsible for the day-to-day
management of the Fund's portfolio. Except as otherwise provided under
"Subadvisory Agreement" below, the Adviser also maintains books and records with
respect to the Fund's securities transactions, and reports to the Board of
Trustees on the Fund's investments and performance. The Subadviser's expertise
in managing portfolios of Senior Loans and structured finance assets is
particularly suited to the Fund's focus on Senior Loans. The Subadviser has
experience in managing portfolios of syndicated loans, high yield bonds and
distressed investments.
ADVISORY AGREEMENT
Under the terms of the advisory agreement (the "Advisory Agreement"), the
Fund will pay to the Adviser monthly, as compensation for the services rendered
and expenses paid by it, a fee equal on an annual basis to .70% of the Fund's
average daily managed assets. "Managed assets" means the total assets of the
Fund (including any assets attributable to financial leverage that may be
outstanding) minus the sum of the accrued liabilities (other than liabilities
representing financial leverage). The liquidation preference on any preferred
shares, including the Preferred Shares, is not a liability. Because
57
the fee paid to the Adviser is determined on the basis of the Fund's managed
assets, the Adviser's interest in determining whether to leverage the Fund may
differ from the interests of the Fund. The Board of Trustees intends to monitor
the spread between the dividend yield on any preferred shares and the total
return on the Fund's portfolio. If in the future that spread narrows materially,
the Board of Trustees intends to evaluate whether employing preferred shares as
a means of leverage remains in the best interest of the holders of the common
shares. The Fund's average daily managed assets are determined for the purpose
of calculating the management fee by taking the average of all of the daily
determinations of total assets during a given calendar month. The fees are
payable for each calendar month as soon as practicable after the end of that
month.
Under the terms of the Advisory Agreement, the Adviser pays all of the
operating expenses, including executive salaries and the rental of office space,
relating to its services for the Fund, with the exception of the following,
which are to be paid by the Fund: (a) charges and expenses for fund accounting,
pricing and appraisal services and related overhead, including, to the extent
such services are performed by personnel of the Adviser or its affiliates,
office space and facilities and personnel compensation, training and benefits;
(b) the charges and expenses of auditors; (c) the charges and expenses of any
administrator, custodian, transfer agent, plan agent, dividend disbursing agent
and registrar appointed by the Fund; (d) issue and transfer taxes chargeable to
the Fund in connection with securities transactions to which the Fund is a
party; (e) insurance premiums, interest charges, expenses in connection with any
preferred shares, organizational and offering expenses, dues and fees for
membership in trade associations and all taxes and corporate fees payable by the
Fund to federal, state or other governmental agencies; (f) fees and expenses
involved in registering and maintaining registrations of the Fund and/or its
shares with federal regulatory agencies, state or blue sky securities agencies
and foreign jurisdictions, including the preparation of prospectuses and
statements of additional information for filing with such regulatory
authorities; (g) all expenses of shareholders' and Trustees' meetings and of
preparing, printing and distributing prospectuses, notices, proxy statements and
all reports to shareholders and to governmental agencies; (h) charges and
expenses of legal counsel to the Fund and the Board of Trustees; (i)
compensation of those Trustees of the Fund who are not affiliated with or
interested persons of the Adviser or the Fund (other than as Trustees); (j) the
cost of preparing and printing share certificates; (k) interest on borrowed
money, if any; (l) the fees and other expenses of listing the Fund's shares on
the New York Stock Exchange or any other national stock exchange; and (m) any
other expense that the Fund, the Adviser or any other agent of the Fund may
incur (I) as a result of a change in the law or regulations, (II) as a result of
a mandate from the Board of Trustees with associated costs of a character
generally assumed by similarly structured investment companies or (III) that is
similar to the expenses listed above, and that is approved by the Board of
Trustees (including a majority of the Trustees who are not affiliates of the
Adviser) as being an appropriate expense of the Fund. In addition, the Fund will
pay all brokers' and underwriting commissions or other fees chargeable to the
Fund in connection with securities transactions to which the Fund is a party or
the origination of any Senior Loan in which the Fund invests.
The Adviser has agreed for the first three years of the Fund's investment
operations to limit the Fund's total annual expenses (excluding offering costs
for common and preferred shares, interest expense, the cost of defending or
prosecuting any claim or litigation to which the Fund is a party (together with
any amount in judgment or settlement), indemnification expenses or taxes
incurred due to the failure of the Fund to qualify as a regulated investment
company under the Code or any other nonrecurring or non-operating expenses) to
.95% of the Fund's average daily managed assets. The dividend on any preferred
shares is not an expense.
58
SUBADVISORY AGREEMENT
Under the terms of the subadvisory agreement (the "Subadvisory Agreement")
between the Adviser and the Subadviser, the Subadviser will, among other things,
(a) regularly provide the Fund with investment research, advice and supervision
and furnish continuously an investment program for the Fund; (b) subject to the
supervision of the Adviser, manage the investment and reinvestment of the Fund's
assets; (c) comply with the provisions of the Fund's Agreement and Declaration
of Trust and By-Laws, the 1940 Act, the Investment Advisers Act of 1940, as
amended and the investment objectives, policies and restrictions of the Fund;
(d) not take any action to cause the Fund to fail to comply with the
requirements of Subchapter M of the Code for qualification as a regulated
investment company; (e) comply with any policies, guidelines, procedures and
instructions as the Adviser may from time to time establish; (f) be responsible
for voting proxies and acting on other corporate actions if instructed to do so
by the Board of Trustees or the Adviser; (g) maintain separate books and
detailed records of all matters pertaining to the portion of the Fund's assets
advised by the Subadviser required by Rule 31a-1 under the 1940 Act relating to
its responsibilities provided under the Subadvisory Agreement with respect to
the Fund; and (h) furnish reports to the Trustees and the Adviser.
Under the terms of the Subadvisory Agreement, for its services the
Subadviser is entitled to a subadvisory fee from the Adviser at an annual rate
of .35% the Fund's average daily managed assets. The fee will be paid monthly in
arrears. The Fund does not pay a fee to the Subadviser.
ADMINISTRATION AGREEMENT
The Fund has entered into an administration agreement with the Adviser,
pursuant to which the Adviser will provide certain administrative and accounting
services to the Fund. The Adviser has appointed Princeton Administrators, L.P.
as the sub-administrator to the Fund to perform certain of the Adviser's
administration and accounts obligations to the Fund. Under the administration
agreement, the Fund will pay the Adviser a monthly fee equal to .07% of the
Fund's average daily managed assets up to $500 million and .03% for average
daily managed assets in excess of $500 million. The Adviser, and not the Fund,
is responsible for paying the fees of Princeton Administrators, L.P.
Pursuant to a separate agreement, the Fund may compensate the Adviser for
providing certain legal and accounting services.
PORTFOLIO MANAGER
Day-to-day management of the Fund's portfolio is the responsibility of
Mark Okada and Joe Dougherty.
Mark Okada -- Mr. Okada has over 19 years of experience in the leveraged
finance market. He is responsible for overseeing the Subadviser's investment
activities for its various funds. Formerly, Mr. Okada served as Manager of Fixed
Income for a subsidiary of Protective Life Insurance Company ("Protective") that
managed Protective's portfolio supporting its guaranteed investment contracts
from 1990 to 1993. He was primarily responsible for the bank loan portfolio and
other risk assets. Protective was one of the first non-bank entrants into the
syndicated loan market. From 1986 to 1990 he served as Vice-President, managing
over $1 billion of high yield bank loans, for Hibernia National Bank. Mr. Okada
is an honors graduate of the University of California Los Angeles with degrees
in Economics and Psychology. He completed his credit training at Mitsui. Mr.
Okada is a Chartered Financial Analyst.
Joe Dougherty -- Mr. Dougherty is a Senior Portfolio Manager at the
Subadviser. Mr. Dougherty heads the Subadviser's retail funds effort and serves
as Senior Vice President of the
59
Subadviser's two NYSE-listed bond funds, which invest in both investment grade
and high yield debt. In this capacity, Mr. Dougherty oversees investment
decisions for the retail funds, alongside several other Portfolio Managers, and
manages the team dedicated to their day-to-day administration. Prior to his
current duties, Mr. Dougherty served as Portfolio Analyst for the Subadviser
from 1998 to 1999. As a Portfolio Analyst, Mr. Dougherty also helped follow
companies within the chemical, retail, supermarket and restaurant sectors. Prior
to joining the Subadviser, Mr. Dougherty served as an Investment Analyst with
Sandera Capital Management from 1997 to 1998. Formerly, he was a Business
Development Manager at Akzo Nobel from 1994 to 1996 and a Senior Accountant at
Deloitte and Touche, LLP from 1992 to 1994. He received a BS in Accounting from
Villanova University and an MBA from Southern Methodist University. Mr.
Dougherty is a Chartered Financial Analyst and a Certified Public Accountant.
DESCRIPTION OF PREFERRED SHARES
The following is a brief description of the material terms of Preferred
Shares. For the complete terms of Preferred Shares, please refer to the detailed
description of Preferred Shares in the Statement (Appendix C to the Statement of
Additional Information).
GENERAL
The Fund's Agreement and Declaration of Trust authorizes the issuance of
an unlimited number of preferred shares in one or more classes or series with
rights as determined by the Board of Trustees without the approval of common
shareholders. The Statement currently authorizes the issuance of an unlimited
number of Series [ ] Preferred Shares, Series [ ] Preferred Shares and Series
[ ] Preferred Shares. All Preferred Shares 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).
The Preferred Shares are preferred shares of beneficial interest 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 successive dividend periods for each series of Preferred Shares.
The applicable rate for a particular dividend period for the Preferred Shares
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
Preferred Shares may participate in auctions, although, except in the case of
special dividend periods of longer than 91 days, beneficial owners desiring to
continue to hold all of their Preferred Shares regardless of the applicable rate
resulting from auctions need not participate in order to continue to hold the
Preferred Shares. For an explanation of auctions and the method of determining
the applicable rate, see "-- Dividends and Dividend Periods" below and "The
Auction."
The nominee of the Securities Depository is expected to be the sole holder
of record of the Preferred Shares. Accordingly, each purchase of Preferred
Shares 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 (as defined below), 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 purchase is not a member of the Securities
Depository, such purchaser's Agent Member, to evidence its beneficial ownership
of the Preferred Shares.
Each series of Preferred Shares will rank on parity with each other and
any other series of preferred shares of the Fund as to the payment of dividends
and the distribution of assets upon liquidation. Each share of Preferred Shares
carries one vote on matters on which Preferred Shares can be voted. When issued
and sold, the Preferred Shares will have a liquidation preference of $25,000 per
60
share plus an amount equal to accumulated but unpaid dividends (whether or not
declared) and will be fully paid and non-assessable. See "-- Liquidation." The
Preferred Shares, when issued, will be fully paid and non-assessable and have no
preemptive, conversion or cumulative voting rights. The Preferred Shares 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 Preferred
Shares will not be subject to any sinking fund but will be subject to redemption
at the option of the Fund on any dividend payment date for the Preferred Shares
(except during the initial dividend period and during a Non-Call Period) or such
series at a redemption price generally equal to $25,000 per share plus
accumulated and unpaid dividends. In certain circumstances, the Preferred Shares
will be subject to mandatory redemption by the Fund at a redemption price of
$25,000 per share plus accumulated and unpaid dividends. See "-- Redemption."
DIVIDENDS AND DIVIDEND PERIODS
The holders of Preferred Shares 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 Preferred Shares, at the applicable rate
determined as set forth below under "-- Calculation of Dividend Payment,"
payable on the dates set forth below. Dividends on the Preferred Shares so
declared and payable will be paid in preference to and in priority over any
dividends so declared and payable on the common shares.
The following is a general description of dividends and rate periods for
the Preferred Shares.
Dividend Periods. The initial dividend period for the Preferred Shares is
as set forth below:
SERIES INITIAL DIVIDEND PERIOD
------ -----------------------
[ ]................................................... [ ] Days
[ ]................................................... [ ] Days
[ ]................................................. [ ] Days
Any subsequent dividend periods of the Series [ ] Preferred Shares and
Series [ ] Preferred Shares will generally be seven days and any subsequent
dividend periods of the Series [ ] Preferred Shares will generally be [ ] days.
The Fund, subject to certain conditions, may change the length of subsequent
dividend periods by designating them as special dividend periods. See
"-- Designation of Special Dividend Periods" below.
Dividend Payment Dates. Dividends are scheduled to be paid for the
Preferred Shares as follows (each, a Dividend Payment Date):
INITIAL DIVIDEND SUBSEQUENT DIVIDEND
SERIES PAYMENT DATE PAYMENT DATES
------ ---------------- -------------------
[ ].................................... 2005 Every [ ] Days
[ ].................................... 2005 Every [ ] Days
[ ].................................. 2005 Every [ ] Days
Following the initial Dividend Payment Date, dividends on each series of
Preferred Shares will be payable (i) with respect to any seven-day or any
short-term dividend period of 35 or fewer days, on the next business day
following the last day of the dividend period 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 next business day following the last day of the dividend period. If
dividends
61
are payable on a day that is not a business day, then dividends will generally
be payable on the next day if such day is a business day or as otherwise
specified in the Statement.
Dividends will be paid through the Securities Depository on each Dividend
Payment Date. The Securities Depository, in accordance with its current
procedures, is expected to distribute dividends received from the Fund in
next-day funds on each Dividend Payment Date to Agent Members. "Agent Members"
are members of, or participants in, the Securities Depository that will act on
behalf of a beneficial owner or a potential beneficial owner of Preferred
Shares. These Agent Members are in turn expected to distribute such dividends to
the persons for whom they are acting as agents. However, each of the current
Broker-Dealers has indicated to the Fund that dividend payments will be
available in same-day funds on each Dividend Payment Date to customers that use
such Broker-Dealer or that Broker-Dealer's designee as Agent Member.
If a Dividend Payment Date is not a business day because the New York
Stock Exchange is closed due to an act of God, natural disaster, act of war,
civil or military disturbance, act of terrorism, sabotage, riots or a loss or
malfunction of utilities or communications services, or the dividend payable on
such date can not be paid for any such reason, then:
- the Dividend Payment Date for the affected dividend period will be the
next business day on which the Fund and its paying agent, if any, can
pay the dividend;
- the affected dividend period will end on the day it otherwise would have
ended; and
- the next dividend period will begin and end on the dates on which it
otherwise would have begun and ended.
Calculation of Dividend Payment. The calculation of cash dividends per
share payable on shares of a series of Preferred Shares (if declared) on any
date on which dividends shall be payable will be computed by (i) multiplying the
applicable rate for shares of such series in effect 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
360, (ii) applying the rate obtained against $25,000, and (iii) rounding the
amount to the nearest cent.
Dividends on shares of each series of Preferred Shares will accumulate
from the date of their original issue, which is , 2005. The initial
dividend rate for the Series [ ] Preferred Shares is %, for Series [ ]
Preferred Shares is %, and for Series [ ] Preferred Shares is %.
For each dividend payment period after the initial dividend period, the dividend
rate will be the dividend rate determined at auction, except that the dividend
rate that results from an auction will not be greater than the maximum
applicable rate described below.
Determination of Maximum Applicable Rate. The maximum applicable rate for
any regular dividend period will be the higher of the applicable percentage of
the Reference Rate or the Reference Rate plus the applicable spread. The
Reference Rate will be the applicable LIBOR Rate (as defined below) for a
dividend period of fewer than 365 days or the Treasury Index Rate (as defined
below) for a dividend period of 365 days or more. The applicable percentage and
the applicable spread for any regular dividend period will be determined based
on the credit ratings assigned to the Preferred Shares by Moody's and Fitch on
the auction date for such period (as set forth in the table on the next page).
If Moody's and/or Fitch do not make such rating available, the rate shall be
determined by reference to equivalent ratings issued by a substitute rating
agency. In the case of a special dividend period, (1) the maximum applicable
rate will be specified by the Fund in the notice of special rate period for such
dividend payment period, (2) the applicable percentage and applicable spread
will be determined on the
62
date two business days before the first day of such special dividend period, and
(3) the reference rate will be the applicable LIBOR Rate for a dividend period
of fewer than 365 days or the Treasury Index Rate for a dividend period of 365
days or more.
The Fund will take all reasonable action necessary to enable Moody's and
Fitch to provide ratings for each series of Preferred Shares. If such ratings
are not made available by Moody's or Fitch, the Fund, after consultation with
the lead Broker-Dealer, initially , will select one or more other
rating agencies to act as substitute rating agencies.
The "LIBOR Rate," as described in greater detail in the Statement, is the
applicable London Inter-Bank Offered Rate for deposits in U.S. dollars for the
period most closely approximating the applicable dividend period for a series of
Preferred Shares.
The "Treasury Index Rate," as described in greater detail in the
Statement, is the average yield to maturity for certain U.S. Treasury securities
having substantially the same length to maturity as the applicable dividend
period for a series of Preferred Shares.
APPLICABLE PERCENTAGE PAYMENT TABLE
--------------------------------------------------------------------------
CREDIT RATINGS APPLICABLE PERCENTAGE APPLICABLE SPREAD
------------------------------- --------------------- -----------------
MOODY'S FITCH
------------- ----------------
Aaa AAA 125% 1.25%
Aa3 to Aa1 AA- to AA+ 150% 1.50%
A3 to A1 A- to A+ 200% 2.00%
Baa3 to Baa1 BBB- to BBB+ 250% 2.50%
Ba1 and lower BB+ and lower 300% 3.00%
Assuming the Fund maintains an Aaa/AAA rating on the Preferred Shares, the
practical effect of the different methods used to calculate the maximum
applicable rate is shown in the table below:
MAXIMUM APPLICABLE MAXIMUM APPLICABLE METHOD USED TO
RATE USING THE RATE USING THE DETERMINE THE MAXIMUM
REFERENCE RATE APPLICABLE PERCENTAGE APPLICABLE SPREAD APPLICABLE RATE
-------------- --------------------- ------------------ ---------------------
1% 1.25% 2.25% Spread
2% 2.50% 3.25% Spread
3% 3.75% 4.25% Spread
4% 5.00% 5.25% Spread
5% 6.25% 6.25% Either
6% 7.50% 7.25% Percentage
The Fund's Board of Trustees may amend the maximum applicable rate to
increase the percentage amount by which the reference rate described above is
multiplied, or to increase the spread added to the reference rate, to determine
the maximum applicable rate shown without the vote or consent of the holders of
Preferred Shares, including each series, or any other shareholder of the Fund,
but only with confirmation from each rating agency then rating the Preferred
Shares that such action will not impair such agency's then-current rating of the
Preferred Shares, provided that immediately following any such increase the Fund
could meet the Preferred Shares Basic Maintenance Amount test discussed below
under "-- Rating Agency Guidelines and Asset Coverage."
Prior to each dividend payment date, the Fund is required to deposit with
the Auction Agent sufficient funds for the payment of declared dividends. The
failure to make such deposit will result in
63
the cancellation of any auction and the dividend rate will be the maximum
applicable rate until such failure to deposit is cured or, if not timely cured,
a non-payment rate of 300% of the applicable Reference Rate. The Fund does not
intend to establish any reserves for the payment of dividends.
Restrictions on Dividends and Other Distributions. While any of the
Preferred Shares are outstanding, the Fund, except as provided below, may not
declare, pay or set apart for payment, any dividend or other distribution in
respect of its common shares. In addition, the Fund may not call for redemption
or redeem any of its common shares. However, the Fund is not confined by the
above restrictions if:
- immediately after such transaction, the discounted value of the Fund's
portfolio would be equal to or greater than the Preferred Shares Basic
Maintenance Amount and the value of the Fund's portfolio would be equal
to or greater than the 1940 Act Preferred Share Asset Coverage (see
"Rating Agency Guidelines and Asset Coverage" below);
- full cumulative dividends on each series of Preferred Shares 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; and
- the Fund has redeemed the full number of Preferred Shares required to be
redeemed by any provision for mandatory redemption contained in the
Statement.
The Fund generally will not declare, pay or set apart for payment any
dividend on any class or series of shares of the Fund ranking, as to the payment
of dividends, on a parity with Preferred Shares unless the Fund has declared and
paid or contemporaneously declares and pays full cumulative dividends on each
series of Preferred Shares through its most recent dividend payment date.
However, when the Fund has not paid dividends in full upon the shares of each
series of Preferred Shares through the most recent dividend payment date or upon
any other class or series of shares of the Fund ranking, as to the payment of
dividends, on a parity with Preferred Shares through their most recent
respective dividend payment dates, the amount of dividends declared per share on
Preferred Shares and such other class or series of shares will in all cases bear
to each other the same ratio that accumulated dividends per share of Preferred
Shares and such other class or series of shares bear to each other.
Designation of Special Dividend Periods. The Fund, at its option and to
the extent permitted by law, by telephonic and written notice (a "request for
special dividend period") to the Auction Agent and to each Broker-Dealer, may
request that the next succeeding dividend period for a series of Preferred
Shares will be a number of days (other than seven days, in the case of Series
[ ] Preferred Shares and Series [ ] Preferred Shares, and other than days,
in the case of Series [ ] Preferred Shares) evenly divisible by seven, and
not more than 364 in the case of a short-term dividend period or one whole year
or more but not greater than five years in the case of a long-term dividend
period, specified in such notice, provided that the Fund may not give a request
for special dividend period (and any such request will be null and void) unless,
for any auction occurring after the initial auction, (i) an auction for shares
of such series is held on the auction date immediately preceding the first day
of such proposed special dividend period, (ii) sufficient clearing bids were
made in such auction, and (iii) full cumulative dividends and any amounts due
with respect to redemptions have been paid in full and so long as the lead
Broker-Dealer, initially shall not have objected to such request. 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 Preferred Shares 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 Preferred Shares of that series. Upon receiving such request for
special dividend period, the Broker-Dealers jointly shall determine the optional
redemption price of the Preferred Shares of that series during such special
dividend period and the specific redemption provisions
64
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 Preferred Shares, (iv) industry and financial
conditions, which may affect the Preferred Shares of that series, (v) the
investment objectives of the Fund and (vi) the dividend periods and dividend
rates at which current and potential beneficial owners of the Preferred Shares
would likely remain or become beneficial owners.
After providing the request for special dividend period to the Auction
Agent and each Broker-Dealer as set forth above, the Fund, by no later than the
second business day prior to such auction date, may give a notice (a "notice of
special dividend period") to the Auction Agent, the Securities Depository, each
Broker-Dealer and the rating agencies, which notice will specify the duration of
the special dividend period. The Fund has agreed to provide a copy of such
notice of special dividend period to the applicable rating agencies. The Fund
will not give a notice of special dividend period and, if such notice of special
dividend period was given already, will give telephonic and written notice of
its revocation (a "notice of revocation") to the Auction Agent, each
Broker-Dealer, the Securities Depository and the rating agencies on or prior to
the business day prior to the relevant auction date if (x) either the 1940 Act
Preferred Share Asset Coverage or the Preferred Shares Basic Maintenance Amount
is not satisfied on each of the two business days immediately preceding the
business day prior to the relevant auction date or (y) sufficient funds for the
payment of dividends payable on the immediately succeeding dividend payment date
have not been irrevocably deposited with the Auction Agent by the close of
business on the third business day preceding the Auction Date immediately
preceding such dividend payment date. If the Fund is prohibited from giving a
notice of special dividend period as a result of the factors enumerated in
clause (x) or (y) above or if the Fund gives a notice of revocation with respect
to a notice of special dividend period, the next succeeding dividend period will
be a seven-day dividend period, in the case of Series [ ] Preferred Shares and
Series [ ] Preferred Shares, and a [ ]-day dividend period, in the case of
Series [ ] Preferred Shares. In addition, in the event sufficient clearing bids
are not made in an auction, or if an auction is not held for any reason, the
next succeeding dividend period will be a seven-day dividend period, in the case
of Series [ ] Preferred Shares and Series [ ] Preferred Shares, and a [ ]-day
dividend period, in the case of Series [ ] Preferred Shares, and the Fund
may not again give a notice of special dividend period (and any such attempted
notice will be null and void) until sufficient clearing bids have been made in
an auction with respect to a seven-day dividend period, in the case of Series
[ ] Preferred Shares and Series [ ] Preferred Shares, and a [ ]-day dividend
period, in the case of Series [ ] Preferred Shares.
NON-PAYMENT PERIOD AND LATE CHARGE
A "failure to deposit," with respect to shares of a series of Preferred
Shares, means a failure by the Fund to pay to the Auction Agent, not later than
12:00 noon, New York City time, (A) on the business day next preceding any
dividend payment date for shares of such series, in funds available on such
dividend payment date in the City of New York, New York, the full amount of any
dividend (whether or not earned or declared) to be paid on such dividend payment
date on any share of such series or (B) on the business day next preceding any
redemption date in funds available on such redemption date for shares of such
series in the City of New York, New York, the redemption price to be paid on
such redemption date for any share of such series after notice of redemption is
mailed; provided, however, that the foregoing clause (B) shall not apply to the
Fund's failure to pay the redemption price in respect of Preferred Shares when
the related notice of redemption provides that redemption of such shares is
subject to one or more conditions precedent and any such condition
65
precedent shall not have been satisfied at the time or times and in the manner
specified in such notice of redemption. If a failure to deposit occurs with
respect to a series of Preferred Shares but, prior to 12:00 noon, New York City
time, on the third business day next succeeding the date on which such failure
to deposit occurred, such failure to deposit shall have been cured and the Fund
shall have paid to the Auction Agent a late charge ("Late Charge") equal to the
sum of (1) if such failure to deposit consisted of the failure timely to pay to
the Auction Agent the full amount of dividends with respect to any dividend
period of the shares of such series, an amount computed by multiplying (x) 300%
of the Reference Rate for the dividend period during which such failure to
deposit occurs on the dividend payment date for such dividend period by (y) a
fraction, the numerator of which shall be the number of days for which such
failure to deposit has not been cured (including the day such failure to deposit
occurs and excluding the day such failure to deposit is cured) and the
denominator of which shall be 360, and applying the rate obtained against the
aggregate liquidation preference of the outstanding shares of such series and
(2) if such failure to deposit consisted of the failure timely to pay to the
Auction Agent the redemption price of the shares, if any, of such series for
which notice of redemption has been mailed by the Fund, an amount computed by
multiplying (x) 300% of the Reference Rate for the dividend period during which
such failure to deposit occurs on the redemption date by (y) a fraction, the
numerator of which shall be the number of days for which such failure to deposit
is not cured (including the day such failure to deposit occurs and excluding the
day such failure to deposit is cured) and the denominator of which shall be 360,
and applying the rate obtained against the aggregate liquidation preference of
the outstanding shares of such series to be redeemed, then no auction will be
held in respect of shares of such series for the subsequent dividend period
thereof and the dividend rate for shares of such series for such subsequent
dividend period will be the maximum applicable rate for shares of such series on
the auction date for such subsequent dividend period. If any failure to deposit
shall have occurred with respect to the Preferred Shares of such series during
any dividend period thereof, and, prior to 12:00 noon, New York City time, on
the third business day next succeeding the date on which such failure to deposit
occurred, such failure to deposit shall not have been cured or the Fund shall
not have paid the applicable Late Charge to the Auction Agent, no auction will
be held in respect of Preferred Shares of such series for the first subsequent
dividend period thereafter (or for any dividend period thereafter to and
including the dividend period during which (1) such failure to deposit is cured
and (2) the Fund pays the applicable Late Charge to the Auction Agent (the
condition set forth in this clause (2) to apply only in the event Moody's is
rating such shares at the time the Fund cures such failure to deposit), in each
case no later than 12:00 noon, New York City time, on the fourth business day
prior to the end of such dividend period) (a "non-payment period") and the
dividend rate for shares of such series for each such subsequent dividend period
shall be a rate per annum (the "non-payment period rate") equal to 300% of the
applicable Reference Rate, provided that the Board of Trustees shall have the
authority to adjust, modify, alter or change from time to time such initial rate
if the Board of Trustees determines and the rating agencies (or any substitute
rating agency) advise the Fund in writing that such adjustment, modification,
alteration or change will not adversely affect the then-current ratings on the
Preferred Shares.
REDEMPTION
Mandatory Redemption. The Fund is required to maintain (a) a discounted
value of eligible portfolio securities equal to the Preferred Shares Basic
Maintenance Amount and (b) asset coverage of at least 200% with respect to
senior securities which are equity shares, including Preferred Shares ("1940 Act
Preferred Share Asset Coverage"). Eligible portfolio securities for purposes of
the Preferred Shares Basic Maintenance Amount will be determined from time to
time by the rating agencies then rating the Preferred Shares. If the Fund fails
to maintain such asset coverage amounts and does not timely cure such failure in
accordance with the requirements of the rating agencies that rate the Preferred
Shares, the Fund must redeem all or a portion of the Preferred Shares. This
mandatory
66
redemption will take place on a date that the Board of Trustees specifies out of
legally available funds, in accordance with the Agreement and Declaration of
Trust, the Statement and applicable law, at the redemption price of $25,000 per
share plus accumulated but unpaid dividends (whether or not declared) to (but
not including) the date fixed for redemption. The number of Preferred Shares
that must be redeemed in order to cure such failure will be allocated pro rata
among the outstanding Preferred Shares. The mandatory redemption will be limited
to the number of Preferred Shares necessary, after giving effect to such
redemption, in order that the discounted value of the Fund's portfolio equals or
exceeds the Preferred Shares Basic Maintenance Amount, and the value of the
Fund's portfolio equals or exceeds the 1940 Act Preferred Share Asset Coverage.
In determining the number of Preferred Shares required to be redeemed in
accordance with the foregoing, the Fund will allocate the number of shares
required to be redeemed to satisfy the Preferred Shares Basic Maintenance Amount
or the 1940 Act Preferred Share Asset Coverage, as the case may be, pro rata
among each series of Preferred Shares and any other preferred shares of the Fund
subject to redemption or retirement. If fewer than all outstanding shares of any
series are, as a result, to be redeemed, the Fund may redeem such shares by lot
or other method that it deems fair and equitable.
Optional Redemption. To the extent permitted under the 1940 Act and
Delaware law, the Fund at its option may, without the consent of the holders of
Preferred Shares, redeem Preferred Shares having a dividend period of one year
or less, in whole or in part, on the business day after the last day of such
dividend period upon not less than 15 calendar days' and not more than 40
calendar days' prior notice. The optional redemption price per share will be
$25,000 per share, plus an amount equal to accumulated but unpaid dividends
thereon (whether or not earned or declared) to the date fixed for redemption
plus the premium, if any, resulting from the designation of a Premium Call
Period. Preferred Shares having a dividend period of more than one year are
redeemable at the option of the Fund, in whole or in part, prior to the end of
the relevant dividend period, subject to any specific redemption provisions,
which may include the payment of redemption premiums to the extent required
under any applicable specific redemption provisions. The Fund will not make any
optional redemption unless, after giving effect thereto, (i) the Fund has
available certain deposit securities with maturities or tender dates not later
than the day preceding the applicable redemption date and having a value not
less than the amount (including any applicable premium) due to holders of
Preferred Shares by reason of the redemption of Preferred Shares on such date
fixed for the redemption and (ii) the Fund has eligible assets with an aggregate
discounted value at least equal to the Preferred Shares Basic Maintenance
Amount. Notwithstanding the foregoing, Preferred Shares may not be redeemed at
the option of the Fund unless all dividends in arrears on the outstanding
Preferred Shares, including all outstanding preferred shares, have been or are
being contemporaneously paid or set aside for payment. This would not prevent
the lawful purchase or exchange offer for Preferred Shares made on the same
terms to holders of all outstanding preferred shares.
LIQUIDATION
If the Fund is liquidated, the holders of any series of outstanding
Preferred Shares will receive the liquidation preference on such series, plus
all accumulated but unpaid dividends, before any payment is made to the holders
of common shares. The holders of Preferred Shares will be entitled to receive
these amounts from the assets of the Fund available for distribution to its
shareholders. In addition, the rights of holders of Preferred Shares to receive
these amounts are subject to the rights of holders of any series or class of
shares, including other series of preferred shares, ranking on a parity with the
Preferred Shares with respect to the distribution of assets upon liquidation of
the Fund. After the payment to the holders of Preferred Shares of the full
preferential amounts as described, the holders of Preferred Shares will have no
right or claim to any of the remaining assets of the Fund.
67
For purpose of the foregoing paragraph, a voluntary or involuntary
liquidation of the Fund does not include:
- the sale of all or substantially all the property or business of the
Fund;
- the merger or consolidation of the Fund into or with any other business
trust or corporation; or
- the merger or consolidation of any other business trust or corporation
into or with the Fund.
In addition, none of the foregoing would result in the Fund being required
to redeem any Preferred Shares if after such transaction the Fund continued to
comply with the rating agency guidelines and asset coverage ratios.
RATING AGENCY GUIDELINES AND ASSET COVERAGE
The Fund is required under guidelines of Moody's and Fitch to maintain
assets having in the aggregate a discounted value at least equal to the
Preferred Shares Basic Maintenance Amount. Moody's and Fitch have each
established separate guidelines for calculating discounted value. To the extent
any particular portfolio holding does not satisfy a rating agency's guidelines,
all or a portion of the holding's value will not be included in the rating
agency's calculation of discounted value. The Moody's and Fitch guidelines also
impose certain diversification requirements on the Fund's portfolio. The Moody's
and Fitch guidelines do not impose any limitations on the percentage of the
Fund's assets that may be invested in holdings not eligible for inclusion in the
calculation of the discounted value of the Fund's portfolio. The amount of
ineligible assets included in the Fund's portfolio at any time may vary
depending upon the rating, diversification and other characteristics of the
eligible assets included in the portfolio. The Preferred Shares Basic
Maintenance Amount is the sum of (a) the aggregate liquidation preference of the
Preferred Shares then outstanding, together with the aggregate liquidation
preference on any other series of preferred shares (plus redemption premium, if
any), and (b) certain accrued and projected dividend and other payment
obligations of the Fund.
The Fund is also required under the 1940 Act to maintain the 1940 Act
Preferred Share Asset Coverage. The Fund's 1940 Act Preferred Share Asset
Coverage is tested as of the last business day of each month in which any senior
equity securities are outstanding. The minimum required 1940 Act Preferred Share
Asset Coverage amount of 200% may be increased or decreased if the 1940 Act is
amended. Based on the composition of the portfolio of the Fund and market
conditions as of , 2005, the 1940 Act Preferred Share Asset Coverage
with respect to all of the Fund's preferred shares, assuming the issuance on
that date of all Preferred Shares offered hereby and giving effect to the
deduction of related sales load and related offering costs estimated at
approximately $ would have been computed as follows:
Value of Fund assets less liabilities
not constituting senior securities $
---------------------------------------- = ------------ = %
Senior securities representing $
indebtedness plus liquidation value of
the preferred shares
In the event the Fund does not timely cure a failure to maintain (a) a
discounted value of its portfolio at least equal to the Preferred Shares Basic
Maintenance Amount or (b) the 1940 Act Preferred Share Asset Coverage, in each
case in accordance with the requirements of the rating agency or agencies then
rating the Preferred Shares, the Fund will be required to redeem Preferred
Shares as described under "Redemption -- Mandatory Redemption" above.
68
The Fund may, but is not required to, adopt any modifications to the
guidelines that may be established by Moody's or Fitch. Failure to adopt any
such modifications, however, may result in a change in the ratings assigned to
the Preferred Shares or a withdrawal of ratings altogether. In addition, any
rating agency providing a rating for the Preferred Shares may, at any time,
change or withdraw any such rating. The Board of Trustees may, without
shareholder approval, amend, alter or repeal any or all of the definitions and
related provisions which have been adopted by the Fund pursuant to the rating
agency guidelines in the event such rating agency is no longer rating the
Preferred Shares or the Fund receives written confirmation from Moody's or
Fitch, as the case may be, that any such amendment, alteration or repeal would
not impair the rating then assigned to the Preferred Shares.
As recently described by Moody's and Fitch, a preferred stock rating is an
assessment of the capacity and willingness of an issuer to pay preferred stock
obligations. The rating on the Preferred Shares is not a recommendation to
purchase, hold or sell those shares, inasmuch as the rating does not comment as
to market price or suitability for a particular investor. The rating agency
guidelines described above also do not address the likelihood that an owner of
Preferred Shares will be able to sell such shares in an auction or otherwise.
The rating is based on current information furnished to Moody's and Fitch by the
Fund and the Adviser and information obtained from other sources. The rating may
be changed, suspended or withdrawn as a result of changes in, or the
unavailability of, such information. The common shares have not been rated by a
nationally recognized statistical rating organization.
The rating agency's guidelines will apply to the Preferred Shares only so
long as the rating agency is rating the shares. The Fund will pay certain fees
to Moody's and Fitch for rating the Preferred Shares.
VOTING RIGHTS
Except as otherwise provided in this prospectus or as otherwise required
by law, holders of Preferred Shares will have equal voting rights with holders
of common shares and any other preferred shares (one vote per share) and will
vote together with holders of common shares and any preferred shares as a single
class.
Holders of outstanding preferred shares, including Preferred Shares,
voting as a separate class, are entitled to elect two of the Fund's Trustees.
The remaining Trustees are elected by holders of common shares and preferred
shares, including Preferred Shares, voting together as a single class. In
addition, if at any time dividends (whether or not earned or declared) on
outstanding preferred shares, including Preferred Shares, are due and unpaid in
an amount equal to two full years of dividends, and sufficient cash or specified
securities have not been deposited with the Auction Agent for the payment of
such dividends, then, the sole remedy of holders of outstanding preferred
shares, including Preferred Shares, is that the number of Trustees constituting
the Board will be automatically increased by the smallest number that, when
added to the two Trustees elected exclusively by the holders of preferred
shares, including Preferred Shares, as described above, would constitute a
majority of the Board. The holders of preferred shares, including Preferred
Shares, will be entitled to elect that smallest number of additional Trustees at
a special meeting of shareholders as soon as possible and at all subsequent
meetings at which Trustees are to be elected. The terms of office of the persons
who are Trustees at the time of that election will continue. If the Fund
thereafter shall pay, or declare and set apart for payment, in full, all
dividends payable on all outstanding preferred shares, including Preferred
Shares, the special voting rights stated above will cease, and the terms of
office of the additional Trustees elected by the holders of preferred shares,
including Preferred Shares, will automatically terminate.
69
As long as any Preferred Shares are outstanding, the Fund will not,
without the affirmative vote or consent of the holders of at least a majority of
the Preferred Shares outstanding at the time (voting together as a separate
class):
(a) authorize, create or issue any class or series of shares ranking prior
to or on a parity with the Preferred Shares with respect to payment of
dividends or the distribution of assets on dissolution, liquidation or
winding up the affairs of the Fund, or authorize, create or issue
additional shares of any series of Preferred Shares or any other
preferred shares, unless, in the case of preferred shares on a parity
with the Preferred Shares, the Fund obtains written confirmation from
Moody's (if Moody's is then rating preferred shares), Fitch (if Fitch
is then rating preferred shares) or any substitute rating agency (if
any such substitute rating agency is then rating preferred shares)
that the issuance of a class or series would not impair the rating
then assigned by such rating agency to the Preferred Shares and the
Fund continues to comply with Section 13 of the 1940 Act, the 1940 Act
Preferred Share Asset Coverage requirements and the Preferred Shares
Basic Maintenance Amount requirements, in which case the vote or
consent of the holders of the Preferred Shares is not required;
(b) amend, alter or repeal the provisions of the Agreement and Declaration
of Trust, or the Statement, by merger, consolidation or otherwise, so
as to adversely affect any preference, right or power of the Preferred
Shares or holders of Preferred Shares; provided, however, that (i)
none of the actions permitted by the exception to (a) above will be
deemed to affect such preferences, rights or powers, (ii) a division
of Preferred Shares will be deemed to affect such preferences, rights
or powers only if the terms of such division adversely affect the
holders of Preferred Shares and (iii) the authorization, creation and
issuance of classes or series of shares ranking junior to the
Preferred Shares with respect to the payment of dividends and the
distribution of assets upon dissolution, liquidation or winding up of
the affairs of the Fund will be deemed to affect such preferences,
rights or powers only if Moody's or Fitch is then rating the Preferred
Shares and such issuance would, at the time thereof, cause the Fund
not to satisfy the 1940 Act Preferred Share Asset Coverage or the
Preferred Shares Basic Maintenance Amount;
(c) authorize the Fund's conversion from a closed-end to an open-end
investment company;
(d) amend the provisions of the Agreement and Declaration of Trust, which
provide for the classification of the Board of Trustees of the Fund
into three classes, each with a term of office of three years with
only one class of Trustees standing for election in any year; or
(e) approve any reorganization (as such term is used in the 1940 Act)
adversely affecting the Preferred Shares.
So long as any shares of the Preferred Shares are outstanding, the Fund
shall not, without the affirmative vote or consent of the holders of at least
66 2/3% of the Preferred Shares outstanding at the time, in person or by proxy,
either in writing or at a meeting, voting as a separate class, file a voluntary
application for relief under federal bankruptcy law or any similar application
under state law for so long as the Fund is solvent and does not foresee becoming
insolvent.
To the extent permitted under the 1940 Act, the Fund will not approve any
of the actions set forth in (a) or (b) above which adversely affects the rights
expressly set forth in the Agreement and Declaration of Trust, or the Statement,
of a holder of shares of a series of preferred shares differently than those of
a holder of shares of any other series of preferred shares without the
affirmative vote or
70
consent of the holders of at least a majority of the shares of each series
adversely affected. Unless a higher percentage is provided for under the
Agreement and Declaration of Trust, or the Statement, the affirmative vote of
the holders of a majority of the outstanding Preferred Shares, voting together
as a single class, will be required to approve any plan of reorganization
(including bankruptcy proceedings) adversely affecting such shares or any action
requiring a vote of security holders under Section 13(a) of the 1940 Act.
However, to the extent permitted by the Agreement and Declaration of Trust, or
the Statement, no vote of holders of common shares, either separately or
together with holders of preferred shares as a single class, is necessary to
take the actions contemplated by (a) and (b) above. The holders of common shares
will not be entitled to vote in respect of such matters unless, in the case of
the actions contemplated by (b) above, the action would adversely affect the
contract rights of the holders of common shares expressly set forth in the
Agreement and Declaration of Trust.
The foregoing voting provisions will not apply with respect to Preferred
Shares if, at or prior to the time when a vote is required, such shares have
been (i) redeemed or (ii) called for redemption and sufficient funds have been
deposited in the Fund to effect such redemption.
71
THE AUCTION
GENERAL
The Statement provides that, except as otherwise described in this
prospectus, the applicable rate for the shares of each series of Preferred
Shares for each dividend period after the initial dividend period will be the
rate that results from an auction conducted as set forth in the Statement, the
material terms of which are summarized below. In such an auction, persons
determine to hold or offer to sell or, based on dividend rates bid by them,
offer to purchase or sell shares of a series of Preferred Shares. See the
Statement included as Appendix C in the statement of additional information for
a more complete description of the auction process.
Auction Agency Agreement. The Fund will enter into an auction agency
agreement with the Auction Agent (currently, Deutsche Bank Trust Company
Americas) which provides, among other things, that the Auction Agent will follow
the auction procedures to determine the applicable rate for shares of each
series of Preferred Shares, so long as the applicable rate for shares of such
series of Preferred Shares is to be based on the results of an auction.
The Auction Agent will act as agent for the Fund in connection with
auctions. In the absence of bad faith or negligence on its part, the Auction
Agent will not be liable for any action taken, suffered or omitted, or for any
error of judgment made, by it in the performance of its duties under the auction
agency agreement and will not be liable for any error of judgment made in good
faith unless the Auction Agent shall have been negligent in ascertaining the
pertinent facts. Pursuant to the auction agency agreement, the Fund is required
to indemnify the Auction Agent for certain losses and liabilities incurred by
the Auction Agent without negligence or bad faith on its part in connection with
the performance of its duties under such agreement.
The Auction Agent may terminate the auction agency agreement upon notice
to the Fund no earlier than 60 days after delivery of said notice. If the
Auction Agent should resign or its appointment is terminated during any period
that any Preferred Shares are outstanding, the Fund will use its best efforts to
enter into an agreement with a successor auction agent containing substantially
the same terms and conditions as the auction agency agreement. The Fund may
remove the auction agent provided that, prior to removal, the Fund has entered
into a replacement agreement with a successor auction agent.
Broker-Dealer Agreements. Each auction requires the participation of one
or more Broker-Dealers. The Auction Agent will enter into agreements with
several Broker-Dealers selected by the Fund, which provide for the participation
of those Broker-Dealers in auctions for Preferred Shares.
The Auction Agent will pay to each Broker-Dealer after each auction, from
funds provided by the Fund, a service charge: (i) for any seven-day dividend
period, with respect to the [ ] Series Preferred Shares and [ ] Series
Preferred Shares, and [ ]-day dividend period with respect to the [ ] Series
Preferred Shares, at the annual rate of 1/4 of 1% of the liquidation preference
(such liquidation preference being $25,000 per share) of the Preferred Shares
held by a Broker-Dealer's customer upon settlement in an auction (equal to
$[ ] per Preferred Shares per year) and (ii) for any special dividend
period, as determined by mutual consent of the Fund and any such Broker-Dealer
or Broker-Dealers and which shall be based upon a selling concession that would
be applicable to an underwriting of fixed or variable rate preferred shares with
a similar fixed maturity or variable rate dividend period, respectively, at the
commencement of the dividend period with respect to such auction. This service
charge applies to Preferred Shares held on account of the Broker-Dealer's
clients as well as
72
to Preferred Shares held for the Broker-Dealer's own account. A Broker-Dealer
may share a portion of any such fees with non-participating broker-dealers that
submit orders to the Broker-Dealer for an auction that are placed by that
Broker-Dealer at such auction.
The Fund may request that the Auction Agent terminate one or more
Broker-Dealer Agreements at any time upon five days' notice, provided that at
least one Broker-Dealer Agreement is in effect after termination of the
agreement.
AUCTION PROCEDURES
The following is a brief summary of the material terms of the procedures
to be used in conducting auctions. This summary is qualified by reference to the
Auction Procedures set forth in the Statement, which is attached as Appendix C
to the statement of additional information. The settlement procedures to be used
with respect to auctions are set forth in Appendix D to the statement of
additional information.
Prior to the submission deadline on each auction date for shares of a
series of Preferred Shares, each customer of a Broker-Dealer who is listed on
the records of that Broker-Dealer (or, if applicable, the Auction Agent) as a
holder of Preferred Shares or a Broker-Dealer that holds Preferred Shares for
its own account may submit the following types of orders with respect to shares
of such series of Preferred Shares to that Broker-Dealer:
1. Hold Order -- indicating its desire to hold shares of such series
without regard to the applicable rate for the next dividend period.
2. Bid -- indicating its desire to purchase or hold the indicated number
of shares of such series at $25,000 per share if the applicable rate
for shares of such series for the next dividend period is not less than
the rate specified in the bid. A bid order by an existing holder will
be deemed an irrevocable offer to sell shares of such series at $25,000
per share if the applicable rate for shares of such series for the next
dividend period is less than the rate or spread specified in the bid.
3. Sell Order -- indicating its desire to sell shares of such series at
$25,000 per share without regard to the applicable rate for shares of
such series for the next dividend period.
A beneficial owner may submit different types of orders to its
Broker-Dealer with respect to different shares of a series of Preferred Shares
then held by the beneficial owner. A beneficial owner for shares of such series
that submits its bid with respect to shares of such series to its Broker-Dealer
having a rate higher than the maximum applicable rate for shares of such series
on the auction date will be treated as having submitted a sell order to its
Broker-Dealer. A beneficial owner of shares of such series that fails to submit
an order to its Broker-Dealer with respect to such shares will ordinarily be
deemed to have submitted a hold order with respect to such shares of such series
to its Broker-Dealer. However, if a beneficial owner of shares of such series
fails to submit an order with respect to such shares of such series to its
Broker-Dealer for an auction relating to a special dividend period of more than
91 days such beneficial owner will be deemed to have submitted a sell order to
its Broker-Dealer. A sell order constitutes an irrevocable offer to sell the
Preferred Shares subject to the sell order. A beneficial owner that offers to
become the beneficial owner of additional Preferred Shares is, for purposes of
such offer, a potential holder as discussed below.
73
A potential beneficial owner is either a customer of a Broker-Dealer that
is not a beneficial owner of a series of Preferred Shares but that wishes to
purchase shares of such series or that is a beneficial owner of shares of such
series that wishes to purchase additional shares of such series. A potential
beneficial owner may submit bids to its Broker-Dealer in which it offers to
purchase shares of such series at $25,000 per share if the applicable rate for
shares of such series for the next dividend period is not less than the
specified rate in such bid. A bid placed by a potential holder of shares of such
series specifying a rate higher than the maximum rate for shares of such series
on the auction date will not be accepted.
The Broker-Dealers in turn will submit the orders of their respective
customers who are beneficial owners and potential holders to the Auction Agent.
They will designate themselves (unless otherwise permitted by the Fund) as
existing holders of shares subject to orders submitted or deemed submitted to
them by beneficial owners. They will designate themselves as potential holders
of shares subject to orders submitted to them by potential beneficial owners.
However, neither the Fund nor the Auction Agent will be responsible for a
Broker-Dealer's failure to comply with these Auction Procedures. Any order
placed with the Auction Agent by a Broker-Dealer as or on behalf of an existing
holder or a potential holder will be treated the same way as an order placed
with a Broker-Dealer by a beneficial owner or potential holder. Similarly, any
failure by a Broker-Dealer to submit to the Auction Agent an order for any
Preferred Shares held by it or customers who are beneficial owners will be
treated as a beneficial owner's failure to submit to its Broker-Dealer an order
in respect of Preferred Shares held by it. A Broker-Dealer may also submit
orders to the Auction Agent for its own account as an existing holder or
potential holder, provided it is not an affiliate of the Fund. If a
Broker-Dealer submits an order for its own account in any auction, 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. As a result of bidding
by the Broker-Dealer in an auction, the auction rate may be higher or lower than
the rate that would have prevailed had the Broker-Dealer not bid.
There are sufficient clearing bids for shares of a series in an auction if
the number of shares of such series subject to bids submitted or deemed
submitted to the Auction Agent by Broker-Dealers for potential holders with
rates or spreads equal to or lower than the maximum applicable rate for such
series is at least equal to or exceeds the sum of the number of shares of such
series subject to sell orders and the number of shares of such series subject to
bids specifying rates or spreads higher than the maximum applicable rate for
such series submitted or deemed submitted to the Auction Agent by Broker-Dealers
for existing holders of such series. If there are sufficient clearing bids for
shares of a series, the applicable rate for shares of such series for the next
succeeding dividend period thereof will be the lowest rate specified in the
submitted bids which, taking into account such rate and all lower rates bid by
Broker-Dealers as or on behalf of existing holders and potential holders, would
result in existing holders and potential holders owning the shares of such
series available for purchase in the auction.
If there are not sufficient clearing bids for shares of such series, the
applicable rate for the next dividend period will be the maximum applicable rate
on the auction date. If the Fund has declared a special dividend period and
there are not sufficient clearing bids, the election of a special dividend
period will not be effective and the applicable rate for the next rate period
will be the same as during the current dividend period. If there are not
sufficient clearing bids, beneficial owners of Preferred Shares that have
submitted or are deemed to have submitted sell orders may not be able to sell in
the auction all shares subject to such sell orders. If all of the applicable
outstanding Preferred Shares are the subject of submitted hold orders, then the
dividend period following the auction will automatically
74
be the same length as the minimum dividend period and the applicable rate for
the next dividend period will be 90% of the Reference Rate.
A Broker-Dealer may bid in an auction in order to prevent what would
otherwise be (i) a failed auction, (ii) an "all-hold" auction, or (iii) an
applicable rate that the Broker-Dealer believes, in its sole discretion, does
not reflect the market rate for the Preferred Shares at the time of the auction.
A Broker-Dealer, may, but is not obligated to, advise beneficial owners of
Preferred Shares that the applicable rate that would apply in an "all-hold"
auction may be lower than the rate that would apply if owners submit bids and
such advice, if given, may facilitate the submission of bids by owners that
would avoid the occurrence of an "all-hold" auction.
The auction procedures include a pro rata allocation of shares for
purchase and sale which may result in an existing holder continuing to hold or
selling, or a potential holder purchasing, a number of shares of a series of
Preferred Shares that is different than the number of shares of such series
specified in its order. To the extent the allocation procedures have that
result, Broker-Dealers that have designated themselves as existing holders or
potential holders in respect of customer orders will be required to make
appropriate pro rata allocations among their respective customers.
Settlement of purchases and sales will be made on the next business day
(which is 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 to their
respective Agent Members. The Securities Depository will make payment to the
sellers' Agent Members in accordance with DTC's normal procedures, which now
provide for payment against delivery by their Agent Members in same day funds.
If an auction date is not a business day because the New York Stock
Exchange is closed for business due to an act of God, natural disaster, act of
war, civil or military disturbance, act of terrorism, sabotage, riots or a loss
or malfunction of utilities or communications services, or the Auction Agent is
not able to conduct an auction in accordance with the auction procedures for any
such reason, then the auction rate for the next dividend period will be the
auction rate determined on the previous auction date.
The following is a simplified example of how a typical auction works.
Assume that the Fund has 1,000 outstanding shares of Preferred Shares of any
series and three current holders. The three current holders and three potential
holders submit orders through broker-dealers at the auction:
Current Holder A............ Owns 500 shares, wants to sell Bid order of 4.1% rate for all
all 500 shares if auction rate is 500 shares
less than 4.1%
Current Holder B............ Owns 300 shares, wants to hold Hold order -- will take the
auction rate
Current Holder C............ Owns 200 shares, wants to sell Bid order of 3.9% rate for all
all 200 shares if auction rate is 200 shares
less than 3.9%
Potential Holder D.......... Wants to buy 200 shares Places order to buy at or above
4.0%
Potential Holder E.......... Wants to buy 300 shares Places order to buy at or above
3.9%
Potential Holder F.......... Wants to buy 200 shares Places order to buy at or above
4.1%
The lowest dividend rate that will result in all 1,000 Preferred Shares in
the above example continuing to be held is 4.0% (the offer by D). Therefore, the
dividend rate will be 4.0%. Current holders B and C will continue to own their
shares. Current holder A will sell its shares because A's
75
dividend rate bid was higher than the dividend rate. Potential holder D will buy
200 shares and potential holder E will buy 300 shares because their bid rates
were at or below the dividend rate. Potential holder F will not buy any shares
because its bid rate was above the dividend rate.
SUBMISSION OF ORDERS BY BROKER-DEALERS TO AUCTION AGENT
Prior to 1:30 p.m., New York City time, on each auction date, or such
other time on the auction date as may be specified by the Auction Agent (the
"submission deadline"), each Broker-Dealer will submit to the Auction Agent in
writing or through the Auction Agent's auction processing system all orders
obtained by it for the auction for a series of Preferred Shares 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 Preferred
Shares subject to such orders. Any order submitted by a beneficial owner or a
potential beneficial owner to its Broker-Dealer, or by a Broker-Dealer to the
Auction Agent, prior to the submission deadline for any auction date, shall be
irrevocable.
If the rate per annum specified in any bid contains more than three
figures to the right of the decimal point, the Auction Agent will round such
rate per annum up to the next highest one-thousandth (.001) of one-percent. If
one or more orders of an existing holder are submitted to the Auction Agent and
such orders cover in the aggregate more than the number of outstanding shares of
Preferred Shares 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 Preferred Shares held by such existing holder,
provided that if more than one hold order is submitted by such
existing holder and the number of Preferred Shares 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 will be reduced pro rata so that such hold
orders, in the aggregate, will cover exactly the number of
outstanding Preferred Shares 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 Preferred Shares held by such existing holder over the
number of outstanding Preferred Shares 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 Preferred Shares held by such
existing holder over the sum of the number of Preferred Shares
subject to hold orders referred to in clause (i) above and the
number of Preferred Shares 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
Preferred Shares subject to such sell orders is greater than such
excess, the number of Preferred Shares 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 Preferred Shares equal
to such excess.
76
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 Preferred Shares therein specified.
NOTIFICATION OF RESULTS AND SETTLEMENT
The Auction Agent will advise each Broker-Dealer who submitted a bid or
sell order in an auction whether such bid or sell order was accepted or rejected
in whole or in part and of the applicable rate for the next dividend period for
the related Preferred Shares by telephone or through the Auction Agent's auction
processing system at approximately 3:00 p.m., New York City time, on the auction
date for such auction. Each such Broker-Dealer that submitted an order for the
account of a customer then will advise such customer whether such bid or sell
order was accepted or rejected, will confirm purchases and sales with each
customer purchasing or selling Preferred Shares as a result of the auction and
will advise each customer purchasing or selling Preferred Shares 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 Preferred Shares as a
result of an auction fails to instruct its agent member to deliver such shares,
the Broker-Dealer that submitted such customer's bid or sell order will instruct
such agent member to deliver such shares against payment therefor. Each
Broker-Dealer that submitted a hold order in an auction on behalf of a customer
also will advise such customer of the applicable rate for the next dividend
period for the Preferred Shares. The Auction Agent will record each transfer of
Preferred Shares 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 Preferred Shares 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 Preferred Shares 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 Preferred Shares 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 Preferred Shares in an auction fails to
deliver such Preferred Shares, the Broker-Dealer of any person that was to have
purchased Preferred Shares in such auction may deliver to such person a number
of whole Preferred Shares that is less than the number of Preferred Shares that
otherwise was to be purchased by such person. In such event, the number of
Preferred Shares to be so delivered will be determined by such Broker-Dealer.
Delivery of such lesser number of Preferred 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 beneficial owner, potential beneficial owner or their respective
agent members to deliver Preferred Shares or to pay for Preferred Shares
purchased or sold pursuant to an auction or otherwise.
SECONDARY MARKET TRADING AND TRANSFERS OF PREFERRED SHARES
The Broker-Dealers are expected to maintain a secondary trading market in
Preferred Shares outside of auctions, but are not obligated to do so, and may
discontinue such activity at any time. There can be no assurance that any
secondary trading market in Preferred Shares will provide owners with liquidity
of investment. The Preferred Shares will not be registered on any stock exchange
or on the Nasdaq National Market.
77
Investors who purchase Preferred Shares in an auction (particularly if the
Fund has declared a special dividend period) should note that because the
dividend rate on such shares will be fixed for the length of that dividend
period, the value of such shares may fluctuate in response to the changes in
interest rates, and may be more or less than their original cost if sold on the
open market in advance of the next auction thereof, depending on market
conditions. In addition, a Broker-Dealer may, in its own discretion, decide to
sell Preferred Shares in the secondary trading market to investors at any time
and at any price, including at prices equivalent to, below or above the par
value of the Preferred Shares.
A beneficial owner or an existing holder may sell, transfer or otherwise
dispose of Preferred Shares only in whole shares and only:
- pursuant to a bid or sell order placed with the Auction Agent in
accordance with the auction procedures;
- to a Broker-Dealer; or
- to such other persons as may be permitted by the Fund; provided,
however, that a sale, transfer or other disposition of Preferred
Shares from a customer of a Broker-Dealer who is listed on the records
of that Broker-Dealer as the holder of such shares to that Broker-
Dealer or another customer of that Broker-Dealer shall not be deemed
to be a sale, transfer or other disposition if such Broker-Dealer
remains the existing holder of the shares; and in the case of all
transfers other than pursuant to auctions, the Broker-Dealer (or other
person, if permitted by the Fund) to whom such transfer is made will
advise the Auction Agent of such transfer.
FEDERAL INCOME TAX MATTERS
The following is a summary discussion of certain U.S. federal income tax
consequences that may be relevant to a shareholder of acquiring, holding and
disposing of Preferred Shares of the Fund. This discussion addresses only U.S.
federal income tax consequences to U.S. shareholders that hold their shares as
capital assets and does not address all of the U.S. federal income tax
consequences that may be relevant to particular shareholders in light of their
individual circumstances. This discussion also does not address the tax
consequences to shareholders who are subject to special rules, including,
without limitation, banks and financial institutions, insurance companies,
dealers in securities or foreign currencies, foreign shareholders, shareholders
who hold their shares as or in a hedge against currency risk, a constructive
sale, or a conversion transaction, shareholders who are subject to the
alternative minimum tax, or tax-exempt or tax-deferred plans, accounts, or
entities. In addition, the discussion does not address any state, local, or
foreign tax consequences, and it does not address any U.S. federal tax
consequences other than U.S. federal income tax consequences. The discussion
reflects applicable tax laws of the United States as of the date of this
prospectus, which tax laws may be changed or subject to new interpretations by
the courts, Treasury or the IRS retroactively or prospectively. No attempt is
made to present a detailed explanation of all U.S. federal income tax concerns
affecting the Fund and its shareholders, and the discussion set forth herein
does not constitute tax advice. Investors are urged to consult their own tax
advisers to determine the specific tax consequences to them of investing in the
Fund, including the applicable federal, state, local and foreign tax
consequences to them and the effect of possible changes in tax laws.
The Fund intends to elect to be treated and to qualify each year as a
"regulated investment company" under Subchapter M of the Code and to comply with
applicable distribution requirements so that it generally will not pay U.S.
federal income tax on income and capital gains distributed to shareholders. In
order to qualify as a regulated investment company, which qualification the
following discussion assumes, the Fund must satisfy certain tests regarding the
sources of its income and the
78
diversification of its assets. If the Fund qualifies as a regulated investment
company and, for each taxable year, it distributes to its shareholders an amount
equal to or exceeding the sum of (i) 90% of its "investment company taxable
income" as that term is defined in the Code (which includes, among other things,
dividends, taxable interest, and the excess of any net short-term capital gains
over net long-term capital losses, as reduced by certain deductible expenses)
without regard to the deduction for dividends paid and (ii) 90% of the excess of
its gross tax-exempt interest over certain disallowed deductions, the Fund
generally will be relieved of U.S. federal income tax on any income of the Fund,
including "net capital gain" (the excess of net long-term capital gain over net
short-term capital loss), distributed to shareholders. However, if the Fund
meets such distribution requirements but chooses to retain some portion of
investment company taxable income or net capital gain, it generally will be
subject to U.S. federal income tax at regular corporate rates on the amount
retained. The Fund intends to distribute at least annually all or substantially
all of its investment company taxable income, net tax exempt interest and net
capital gain. If for any taxable year the Fund did not qualify as a regulated
investment company, it would be treated as a corporation subject to U.S. federal
income tax thereby subjecting any income earned by the Fund to tax at the
corporate level at a maximum 35% U.S. federal income tax rate and, when such
income is distributed, to a further tax at the shareholder level.
Under the Code, the Fund will be subject to a nondeductible 4% federal
excise tax on a portion of its undistributed ordinary income and capital gain
net income if it fails to meet certain distribution requirements with respect to
each calendar year. The Fund intends to make distributions in a timely manner
and accordingly does not expect to be subject to the excise tax, but there can
be no assurance that the Fund's distributions will be sufficient to avoid this
tax entirely.
Based in part on the lack of any present intention on the part of the Fund
to redeem or purchase the Preferred Shares at any time in the future, the Fund
intends to take the position that under present law the Preferred Shares will
constitute stock of the Fund and distributions with respect to the Preferred
Shares (other than distributions in redemption of the Preferred Shares that are
treated as exchanges under Section 302(b) of the Code) will constitute dividends
to the extent of the Fund's current or accumulated earnings and profits as
calculated for U.S. federal income tax purposes. This view relies in part on a
published ruling of the IRS stating that certain preferred stock similar in many
material respects to the Preferred Shares represents equity. It is possible,
however, that the IRS might take a contrary position asserting, for example,
that the Preferred Shares constitute debt of the Fund. If this position were
upheld, the discussion of the treatment of distributions below would not apply.
Instead distributions by the Fund to holders of Preferred Shares would
constitute interest, whether or not such distributions exceeded the earnings and
profits of the Fund, would be included in the income of the recipient and would
be taxed as ordinary income.
Interest on indebtedness incurred (directly or indirectly) by a
shareholder to purchase or carry shares of the Fund will not be deductible for
U.S. federal income tax purposes to the extent it is deemed under the Code and
applicable regulations to relate to exempt-interest dividends received from the
Fund. Shareholders receiving social security or certain railroad retirement
benefits may be subject to U.S. federal income tax on a portion of such benefits
as a result of receiving investment income, including exempt-interest dividends
and other distributions paid by the Fund.
Although dividends generally will be treated as distributed when paid, any
dividend declared by the Fund as of a record date in October, November or
December and paid during the following January will be treated for U.S. federal
income tax purposes as received by shareholders on December 31 of the calendar
year in which it is declared.
In general, dividends from investment company taxable income are taxable either
as ordinary income or, if so designated by the Fund and certain other
requirements are met, as "qualified dividend income" taxable to individual
shareholders at a maximum 15% U.S. federal income tax rate, and dividends from
79
net capital gain, if any, that are designated as capital gain dividends are
taxable as long-term capital gains for U.S. federal income tax purposes without
regard to the length of time the shareholder has held shares of the Fund.
A dividend that is attributable to qualified dividend income of the Fund
that is paid by the Fund to an individual holder of Preferred Shares will not be
taxable as qualified dividend income to such shareholder if (1) the dividend is
received with respect to any Preferred Shares held by the shareholder for fewer
than 91 days during the 181 day-period beginning on the date which is 90 days
before the date on which such share became ex-dividend with respect to such
dividend, (2) to the extent that the shareholder is under an obligation (whether
pursuant to a short sale or otherwise) to make related payments with respect to
positions in substantially similar or related property, or (3) the shareholder
elects to have the dividend treated as investment income for purposes of the
limitation on deductibility of investment interest.
If the Fund retains any net capital gain for a taxable year, the Fund may
designate the retained amount as undistributed capital gains in a notice to
shareholders who, if subject to U.S. federal income tax on long-term capital
gains, (i) will be required to include in income for U.S. federal income tax
purposes, as long-term capital gain, their proportionate shares of such
undistributed amount, and (ii) will be entitled to credit their proportionate
shares of the tax paid by the Fund on the undistributed amount against their
U.S. federal income tax liabilities, if any, and to claim refunds to the extent
the credit exceeds such liabilities.
A shareholder should also be aware that the benefits of the favorable tax
rate applicable to long-term capital gains and qualified dividend income may be
impacted by the application of the alternative minimum tax to individual
shareholders.
The IRS has taken the position that if a regulated investment company has
two or more classes of shares, it must designate distributions made to each
class in any year as consisting of no more than such class's proportionate share
of particular types of income, including ordinary income and capital gains. A
class's proportionate share of a particular type of income is determined
according to the percentage of total dividends paid by the regulated investment
company to such class. Consequently, if both common shares and Preferred Shares
are outstanding, the Fund intends to designate distributions made to the classes
of particular types of income in accordance with each such class's proportionate
share of such income. The Fund will designate dividends qualifying as
exempt-interest dividends, qualified dividend income, capital gain dividends,
and other taxable dividends in a manner that allocates such income between the
holders of common shares and Preferred Shares in proportion to the total
dividends paid to each class during the taxable year, or otherwise as required
by applicable law.
Sales and other dispositions of the Fund's shares generally are taxable
events for shareholders that are subject to tax. Shareholders should consult
their own tax advisers with reference to their individual circumstances to
determine whether any particular transaction in the Fund's shares is properly
treated as a sale for tax purposes (including a redemption of Preferred Shares),
as the following discussion assumes, and the tax treatment of any gains or
losses recognized in such transactions. In general, if shares of the Fund are
sold, the shareholder will recognize gain or loss equal to the difference
between the amount realized on the sale and the shareholder's adjusted basis in
the shares sold. Such gain or loss generally will be treated as long-term gain
or loss if the shares were held for more than one year and otherwise generally
will be treated as short-term gain or loss. Any loss recognized by a shareholder
upon the sale or other disposition of shares with a tax holding period of six
months or less will be treated as a long-term capital loss to the extent of any
amounts treated as distributions of long-term capital gains with respect to such
shares. Losses on sales or other dispositions
80
of shares may be disallowed under "wash sale" rules in the event substantially
identical shares of the Fund are purchased (including those made pursuant to
reinvestment of dividends and/or capital gains distributions) within a period of
61 days beginning 30 days before and ending 30 days after a sale or other
disposition of shares.
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 holder of Preferred Shares 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 exclusion from gross income of exempt-interest dividends for U.S.
federal income tax purposes does not necessarily result in exclusion under the
tax laws of any state or local taxing authority, which laws vary with respect to
the taxation of such income. Many states will exempt from tax that portion of an
exempt-interest dividend which represents interest received by the Fund on that
state's securities, subject in some cases to compliance with concentration
and/or reporting requirements, which the Fund makes no commitment to seek to
satisfy. However, the Fund will report annually to its shareholders the
percentage of interest income received by the Fund during the preceding year on
federally tax-exempt obligations indicating, on a state-by-state basis only, the
source of such income. Each shareholder is advised to consult his own tax
adviser regarding the exclusion from gross income, if any, of exempt-interest
dividends under the state and local tax laws applicable to the shareholder.
The Fund is required in certain circumstances to backup withhold on
reportable payments, including dividends, other than exempt interest dividends,
capital gains distributions, and proceeds of sales or other dispositions of the
Fund's shares paid to certain holders of the Fund's shares who do not furnish
the Fund with their correct Social Security number or other taxpayer
identification number and make certain other certifications, or who are
otherwise subject to backup withholding. Backup withholding is not an additional
tax. Any amounts withheld from payments made to a shareholder may be refunded or
credited against such shareholder's U.S. federal income tax liability, if any,
provided that the required information is furnished to the IRS.
The foregoing is a general and abbreviated summary of the provisions of
the Code and the Treasury regulations currently in effect as they generally
affect the taxation of the Fund and its shareholders. As noted above, these
provisions are subject to change by legislative, judicial or administrative
action, and any such change may be retroactive. A further discussion of the U.S.
federal income tax rules applicable to the Fund can be found in the Statement of
Additional Information which is incorporated by reference into this prospectus.
Shareholders are urged to consult their tax advisers regarding specific
questions as to U.S. federal, foreign, state, and local income or other taxes.
81
NET ASSET VALUE
The Fund calculates a net asset value for its common shares every day the
New York Stock Exchange is open when regular trading closes (normally 4:00 p.m.
Eastern time). For purposes of determining the net asset value of a common
share, the value of the securities held by the Fund plus any cash or other
assets (including interest accrued but not yet received) minus all liabilities
(including accrued expenses and indebtedness) and the aggregate liquidation
value of any outstanding preferred shares is divided by the total number of
common shares outstanding at such time. Expenses, including the fees payable to
the Adviser, are accrued daily. Currently, the net asset values of shares of
publicly traded closed-end investment companies are published in Barron's, the
Monday edition of The Wall Street Journal and the Monday and Saturday editions
of The New York Times.
The Fund uses an independent pricing service to value most Senior Loans at
their market value. If market quotations for them are not readily available or
are deemed unreliable, or if events occurring after the close of a securities
market and before the Fund values its assets would materially affect net asset
value, the Fund may value Senior Loans at fair value pursuant to procedures
adopted by the Board of Trustees. A Senior Loan that is fair valued may be
valued at a price higher or lower than actual market quotations or the value
determined by other funds using their own fair valuation procedures. The Fund
may, with the approval of the Board of Trustees, implement new fair value
pricing methodologies of Senior Loans in the future, which may result in a
change in the Fund's net asset value per share. The Fund's net asset value per
share will also be affected by fair value pricing decisions and by changes in
the market for Senior Loans. In determining the fair value of a Senior Loan, the
Fund will consider relevant factors, data, and information, such as: (i) the
characteristics of and fundamental analytical data relating to the Senior Loan,
including the cost, size, current interest rate, period until next interest rate
reset, maturity and base lending rate of the Senior Loan, the terms and
conditions of the Senior Loan and any related agreements, and the position of
the Senior Loan in the borrower's debt structure; (ii) the nature, adequacy and
value of the collateral, including the Fund's rights, remedies and interests
with respect to the collateral; (iii) the creditworthiness of the borrower,
based on an evaluation of its financial condition, financial statements and
information about the borrower's business, cash flows, capital structure and
future prospects; (iv) information relating to the market for the Senior Loan,
including price quotations for and trading in the Senior Loan and interests in
similar Senior Loans and the market environment and investor attitudes towards
the Senior Loan and interests in similar Senior Loans; (v) the experience,
reputation, stability and financial condition of the agent and any intermediate
participants in the Senior Loan; and (vi) general economic and market conditions
affecting the fair value of the Senior Loan.
With respect to other securities, the Fund generally values securities
using closing market prices or readily available market quotations. The Fund may
use a pricing service or a pricing matrix to value some of its assets. When
closing market prices or market quotations of assets other than Senior Loans are
not available or are considered by the Fund to be unreliable, the Fund may use a
security's fair value. Fair value is the valuation of a security determined on
the basis of factors other than market value in accordance with procedures
approved by the Fund's Board of Trustees. The Fund also may use the fair value
of a security, including a non-U.S. security, when the Fund determines that the
closing market price on the primary exchange where the security is traded no
longer accurately reflects the value of the security due to factors affecting
one or more relevant securities markets or the specific issuer. The use of fair
value pricing by the Fund may cause the net asset value of its shares to differ
from the net asset value that would be calculated using closing market prices.
International securities markets may be open on days when the U.S. markets are
closed. For this reason, the value of any international securities owned by the
Fund could change on a day you cannot buy or sell shares of the Fund. Debt
securities with remaining maturities of 60 days or less are valued at amortized
cost, which
82
is a method of estimating their fair value. The value of interest rate swaps,
caps and floors is determined in accordance with a formula and then confirmed
periodically by obtaining a bank quotation. Positions in options are valued at
the last sale price on the market where any such option is principally traded.
Positions in futures contracts are valued at closing prices for such contracts
established by the exchange on which they are traded. Repurchase agreements are
valued at cost plus accrued interest. This is a method, approved by the Board of
Trustees, of determining such repurchase agreement's fair value.
DESCRIPTION OF COMMON SHARES
The Fund is authorized to issue an unlimited number of common shares,
without par value. The Fund is also authorized to issue preferred shares. The
Board of Trustees is authorized to classify and reclassify any unissued shares
into one or more additional classes or series of shares. The Board of Trustees
may establish such series or class, including preferred shares, from time to
time by setting or changing in any one or more respects the designations,
preferences, conversion or other rights, voting powers, restrictions,
limitations as to dividends, qualifications or terms or conditions of redemption
of such shares and, pursuant to such classification or reclassification, to
increase or decrease the number of authorized shares of any existing class or
series. The Board of Trustees, without shareholder approval, is authorized to
amend the Fund's Agreement and Declaration of Trust (the "Declaration of Trust")
and By-Laws to reflect the terms of any such class or series, including any
class of preferred shares. The Fund is also authorized to issue other
securities, including debt securities.
COMMON SHARES
Common shareholders are entitled to share pro rata in the net assets of
the Fund available for distribution to common shareholders upon liquidation of
the Fund. Common shareholders are entitled to one vote for each share held.
So long as any shares of the Fund's preferred shares, including the
Preferred Shares, are outstanding, holders of common shares will not be entitled
to receive any net income of or other distributions from the Fund unless all
accumulated dividends on preferred shares have been paid, and unless asset
coverage (as defined in the 1940 Act) with respect to preferred shares would be
at least 200% after giving effect to such distributions. See "Leverage."
The Fund will send unaudited semi-annual reports and audited annual
financial statements to all of its shareholders.
CERTAIN PROVISIONS OF THE AGREEMENT AND DECLARATION OF TRUST AND BY-LAWS
The Declaration of Trust includes provisions that could have the effect of
limiting the ability of other entities or persons to acquire control of the Fund
or to change the composition of its Board of Trustees and could have the effect
of depriving shareholders of an opportunity to sell their shares at a premium
over prevailing market prices by discouraging a third party from seeking to
obtain control of the Fund.
The Board of Trustees is divided into three classes of approximately equal
size. The terms of the Trustees of the different classes are staggered so that
approximately one-third of the Board of Trustees is elected by shareholders each
year.
83
A Trustee may be removed from office with or without cause by a vote of at
least a majority of the Trustees if such removal is approved by a vote of the
holders of at least 75% of the shares entitled to be voted on the matter.
The Declaration of Trust requires the favorable vote of the holders of at
least 75% of the Fund's shares to approve, adopt or authorize the following:
- a merger or consolidation or statutory share exchange of the Fund with
any other corporations;
- a sale of all or substantially all of the Fund's assets (other than in
the regular course of the Fund's investment activities); or
- a liquidation or dissolution of the Fund;
unless such action has been approved, adopted or authorized by the affirmative
vote of at least 75% of the total number of Trustees fixed in accordance with
the By-Laws, in which case the affirmative vote of a majority of the Fund's
shares is required. Following any issuance of preferred shares by the Fund, it
is anticipated that the approval, adoption or authorization of the foregoing
also would require the favorable vote of a majority of the Fund's preferred
shares then entitled to be voted, voting as a separate class.
Conversion of the Fund to an open-end investment company would require an
amendment to the Fund's Declaration of Trust. The amendment would have to be
declared advisable by the Board of Trustees prior to its submission to
shareholders. Such an amendment would require the favorable vote of the holders
of at least 75% of the Fund's outstanding shares (including any preferred
shares) entitled to vote on the matter, voting as a single class (or a majority
of such shares if the amendment was previously approved, adopted or authorized
by 75% of the total number of Trustees fixed in accordance with the By-Laws),
and, assuming preferred shares are issued, the affirmative vote of a majority of
outstanding preferred shares, voting as a separate class. Such a vote also would
satisfy a separate requirement in the 1940 Act that the change be approved by
the shareholders. Shareholders of an open-end investment company may require the
company to redeem their shares of common stock at any time (except in certain
circumstances as authorized by or under the 1940 Act) at their net asset value,
or net asset value per share less such redemption charge, if any, as might be in
effect at the time of a redemption. All redemptions will be made in cash. If the
Fund is converted to an open-end investment company, it could be required to
liquidate portfolio securities to meet requests for redemption, and the common
shares would no longer be listed on the New York Stock Exchange.
Conversion to an open-end investment company would also require changes in
certain of the Fund's investment policies and restrictions, such as those
relating to the leverage and the purchase of illiquid securities.
The Declaration of Trust requires the favorable vote of a majority of the
Trustees followed by the favorable vote of the holders of at least 75% of the
outstanding shares of each affected class or series of the Fund, voting
separately as a class or series, to approve, adopt or authorize certain
transactions with 5% or greater holders of a class or series of shares and their
associates, unless the transaction has been approved by at least 75% of the
Trustees, in which case "a majority of the outstanding voting securities" (as
defined in the 1940 Act) of the Fund shall be required. For purposes of these
provisions, a 5% or greater holder of a class or series of shares (a "Principal
Shareholder") refers to any person who, whether directly or indirectly and
whether alone or together with its affiliates and associates, beneficially owns
5% or more of the outstanding shares of any class or series of shares of
84
beneficial interest of the Fund. The 5% holder transactions subject to these
special approval requirements are:
- the merger or consolidation of the Fund or any subsidiary of the Fund
with or into any Principal Shareholder;
- the issuance of any securities of the Fund to any Principal
Shareholder for cash, other than pursuant to any automatic dividend
reinvestment plan;
- the sale, lease or exchange of all or any substantial part of the
assets of the Fund to any Principal Shareholder, except assets having
an aggregate fair market value of less than $1,000,000, aggregating
for the purpose of such computation all assets sold, leased or
exchanged in any series of similar transactions within a 12-month
period; and
- the sale, lease or exchange to the Fund or any subsidiary of the Fund,
in exchange for securities of the Fund, of any assets of any Principal
Shareholder, except assets having an aggregate fair market value of
less than $1,000,000, aggregating for purposes of such computation all
assets sold, leased or exchanged in any series of similar transactions
within a 12-month period.
The Declaration of Trust and By-Laws provide that the Board of Trustees
has the power, to the exclusion of shareholders, to make, alter or repeal any of
the By-Laws (except for any By-Law specified not to be amended or repealed by
the Board), subject to the requirements of the 1940 Act. Neither this provision
of the Declaration of Trust, nor any of the foregoing provisions thereof
requiring the affirmative vote of 75% of outstanding shares of the Fund, can be
amended or repealed except by the vote of such required number of shares. The
Fund's By-Laws generally require that advance notice be given to the Fund in the
event a shareholder desires to nominate a person for election to the Board of
Trustees or to transact any other business at an annual meeting of shareholders.
With respect to an annual meeting following the first annual meeting of
shareholders, notice of any such nomination or business must be delivered to or
received at the principal executive offices of the Fund not less than 90
calendar days nor more than 120 calendar days prior to the anniversary date of
the prior year's annual meeting (subject to certain exceptions). In the case of
the first annual meeting of shareholders, the notice must be given no later than
the tenth calendar day following public disclosure of the date of the meeting,
as specified in the By-Laws. Any notice by a shareholder must be accompanied by
certain information as provided in the By-Laws.
85
UNDERWRITING
Subject to the terms and conditions stated in the purchase agreement dated
, 2005, each underwriter named below, for which
is acting as representative, has severally agreed
to purchase, and the Fund has agreed to sell to such underwriter, the number of
Preferred Shares set forth opposite the name of such underwriter.
NUMBER OF
PREFERRED SHARES
UNDERWRITER ----------------
-----------
----------------
Total..........................................
================
The purchase agreement provides that the obligations of the underwriters
to purchase the shares included in this offering are subject to the approval of
certain legal matters by counsel and to certain other conditions, including
without limitation the receipt by the underwriters of customary closing
certificates, opinions and other documents, and the receipt by the Fund of Aaa
and AAA ratings on the Preferred Shares by Moody's and Fitch, respectively, as
of the time of the offering. The underwriters are obligated to purchase all the
Preferred Shares if they purchase any of the Preferred Shares. In the purchase
agreement, the Fund, the Adviser and the Subadviser have jointly agreed to
indemnify the underwriters against certain liabilities, including liabilities
arising under the Securities Act of 1933, as amended, or to contribute payments
the underwriters may be required to make for any of those liabilities.
The underwriters propose to initially offer some of the Preferred Shares
directly to the public at the public offering price set forth on the cover page
of this prospectus and some of the Preferred Shares to certain dealers at the
public offering price less a concession not in excess of $ per share. The sales
load the Fund will pay of $ per share is equal to % of the initial
offering price of the Preferred Shares. After this offering, the underwriters
may change the public offering price and the concession. Investors must pay for
any Preferred Shares purchased in this offering on or before , 2005.
The Fund anticipates that the underwriters may from time to time act as
brokers or dealers in executing the Fund's portfolio transactions and that the
underwriters, or their affiliates, may act as counterparties in connection with
the interest rate transactions described herein after they have ceased
86
to be underwriters. The underwriters are active underwriters of, and dealers in,
securities and act as market makers in a number of such securities, and
therefore can be expected to engage in portfolio transactions with, and perform
services for, the Fund.
[ ] has advised the Fund that it and certain Broker-Dealers and
other participants in the auction rate securities markets, including both
taxable and tax exempt markets, have received letters from the Securities and
Exchange Commission requesting that each of them voluntarily conduct an
investigation regarding their respective practices and procedures in those
markets. [ ] is cooperating and expects to continue to cooperate with
the Securities and Exchange Commission in providing the requested information.
No assurance can be given as to whether the results of this process will affect
the market for the Preferred Shares or the auctions.
The Fund anticipates that the underwriters or their respective affiliates
may, from time to time, act in auctions as Broker-Dealers and receive fees as
set forth under "The Auction" and in the Statement of Additional Information.
The principal business address of is
.
In connection with this offering, certain of the underwriters or dealers
may distribute prospectuses electronically.
The settlement date for the purchase of the Preferred Shares will be
, 2005, as agreed upon by the underwriters, the Fund and the Adviser
pursuant to Rule 15c6-1 under the Securities Exchange Act of 1934, as amended.
ADMINISTRATOR, CUSTODIAN, TRANSFER AGENT, REGISTRAR AND
DIVIDEND DISBURSING AGENT
Pioneer Investment Management, Inc. will serve as the Fund's
administrator. Pioneer Investment Management, Inc. has appointed Princeton
Administrators, L.P. as a sub-administrator to the Fund. Princeton
Administrators, L.P., is an affiliate of Merrill Lynch, Pierce, Fenner & Smith
Incorporated, one of the underwriters of this offering. The Fund's securities
and cash are held under a custodian agreement with Brown Brothers Harriman & Co.
located at 40 Water Street, Boston, Massachusetts 02109. Deutsche Bank Trust
Company Americas, located at 60 Wall street, New York, New York 10005 serves as
Auction Agent, transfer agent, dividend paying agent and registrar for the
Preferred Shares. Pioneer Investment Management Shareholder Services, Inc.
located at 60 State Street, Boston, Massachusetts 02109, serves as the transfer
agent, registrar and dividend disbursing agent for the Fund's common shares.
Mellon Investor Services LLC, located at 85 Challenger Road, Ridgefield Park,
New Jersey 07660, serves as the sub-transfer agent, sub-registrar and
sub-dividend disbursing agent for the Fund's common shares.
VALIDITY OF COMMON SHARES
Certain legal matters in connection with the shares offered hereby have
been passed upon for the Fund by Wilmer Cutler Pickering Hale and Dorr LLP,
Boston, Massachusetts. Certain matters have been passed upon for the
underwriters by New York, New York. may rely on the opinion
of Wilmer Cutler Pickering Hale and Dorr LLP as to certain matters of Delaware
Law.
87
TABLE OF CONTENTS OF THE
STATEMENT OF ADDITIONAL INFORMATION
PAGE
----
Use of Proceeds............................................. 2
Investment Objectives and Policies.......................... 2
Investment Restrictions..................................... 20
Management of the Fund...................................... 21
Portfolio Transactions...................................... 35
Additional Information Concerning the Auctions for Preferred
Shares.................................................... 36
Rating Agency Guidelines.................................... 37
Federal Income Tax Matters.................................. 38
Performance-Related, Comparative and Other Information...... 43
Independent Registered Public Accounting Firm............... 43
Additional Information...................................... 44
Financial Statements and Report of Independent Registered
Public Accounting Firm.................................... 45
Appendix A -- Description of Ratings........................ A-1
Appendix B -- Proxy Voting Policies and Procedures.......... B-1
Appendix C -- Statement of Preferences of Preferred
Shares.................................................... C-1
Appendix D -- Settlement Procedures......................... D-1
88
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
(PIONEER LOGO)
$
PIONEER FLOATING RATE TRUST
AUCTION MARKET PREFERRED
SHARES
SHARES, SERIES
SHARES, SERIES
SHARES, SERIES
LIQUIDATION PREFERENCE $25,000 PER SHARE
---------------
PROSPECTUS
---------------
, 2005
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
17009-00-0205
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
IS NOT SOLICITING AN OFFER TO BUY THESE SECURITIES IN ANY STATE WHERE THE OFFER
OR SALE IS NOT PERMITTED.
SUBJECT TO COMPLETION, DATED JANUARY 10, 2005
PIONEER FLOATING RATE TRUST
STATEMENT OF ADDITIONAL INFORMATION
Pioneer Floating Rate Trust (the "Fund") is a recently organized,
non-diversified, closed-end management investment company. The Auction Market
Preferred Shares (the "Preferred Shares") are series of preferred shares of the
Fund. This statement of additional information relating to the Fund's Series ,
and Preferred Shares does not constitute a prospectus, but should be read in
conjunction with the prospectus relating thereto, dated , 2005 (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 1-800-225-6292. You may also obtain a copy of the prospectus on the
Securities and Exchange Commission's web site (http://www.sec.gov). Capitalized
terms used but not defined in this statement of additional information shall
have the meanings given to such terms in the Fund's Statement of Preferences of
Preferred Shares (the "Statement") attached as Appendix C to this statement of
additional information.
TABLE OF CONTENTS
USE OF PROCEEDS................................................................. 2
INVESTMENT OBJECTIVES AND POLICIES.............................................. 2
INVESTMENT RESTRICTIONS......................................................... 20
MANAGEMENT OF THE FUND.......................................................... 21
PORTFOLIO TRANSACTIONS.......................................................... 35
ADDITIONAL INFORMATION CONCERNING THE AUCTIONS FOR PREFERRED SHARES............. 36
RATING AGENCY GUIDELINES........................................................ 37
FEDERAL INCOME TAX MATTERS...................................................... 38
PERFORMANCE-RELATED, COMPARATIVE AND OTHER INFORMATION.......................... 43
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM................................... 44
ADDITIONAL INFORMATION.......................................................... 44
FINANCIAL STATEMENTS AND REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM 45
APPENDIX A--DESCRIPTION OF RATINGS.............................................. A-1
APPENDIX B--PROXY VOTING POLICIES AND PROCEDURES................................ B-1
APPENDIX C -- STATEMENT OF PREFERENCE OF PREFERRED SHARES....................... C-1
APPENDIX D -- SETTLEMENT PROCEDURES............................................. D-1
This statement of additional information is dated , 2005.
1
USE OF PROCEEDS
The net proceeds will be invested in accordance with the Fund's investment
objectives and policies during a period not to exceed three months from the
closing of this offering. Pending such investment, the net proceeds may be
invested in U.S. government securities or high grade, short-term money market
instruments. If necessary, the Fund may also purchase, as temporary investments,
securities of other open-end and closed-end investment companies that invest in
equity and fixed-income securities.
INVESTMENT OBJECTIVES AND POLICIES
The prospectus presents the investment objectives and the principal investment
strategies and risks of the Fund. This section supplements the disclosure in the
Fund's prospectus and provides additional information on the Fund's investment
policies or restrictions. Restrictions or policies stated as a maximum
percentage of the Fund's assets are only applied immediately after a portfolio
investment to which the policy or restriction is applicable (other than the
limitations on borrowing). Accordingly, any later increase or decrease resulting
from a change in values, net assets or other circumstances will not be
considered in determining whether the investment complies with the Fund's
restrictions and policies.
PRIMARY INVESTMENTS
As a fundamental policy, under normal market conditions, the Fund seeks to
achieve its investment objectives by investing at least 80% of its assets (net
assets plus borrowing for investment purposes) in senior floating rate loans
("Senior Loans"). Senior Loans are made to corporations, partnerships and other
business entities that operate in various industries and geographical regions,
including non-U.S. borrowers. Senior Loans pay interest at rates that are
redetermined periodically on the basis of a floating base lending rate plus a
premium. The Fund also may invest in other floating and variable rate
instruments and loans, including second lien loans, high yield, high risk
corporate bonds, investment grade fixed-income debt securities, preferred stocks
(many of which have fixed maturities), convertible securities, securities that
make "in-kind" interest payments, bonds not paying current income, bonds that do
not make regular interest payments and money market instruments. The Fund may
invest in Senior Loans and other securities of any credit quality, including
Senior Loans and other investments that are rated below investment grade, or are
unrated but are determined by the investment subadviser to be of equivalent
credit quality, commonly referred to as "junk bonds." The Fund may invest all or
a portion of its assets in securities of issuer that are in default or that are
in bankruptcy. The Fund does not have a policy of maintaining a specific average
credit quality of its portfolio or a minimum portion of its portfolio that must
be rated investment grade. The Fund may invest up to 10% of its total assets in
Senior Loans and other securities of non-U.S. issuers, including emerging market
issuers, and may engage in certain hedging transactions.
SENIOR LOANS
STRUCTURE OF SENIOR LOANS. A Senior Loan is typically originated, negotiated and
structured by a U.S. or foreign commercial bank, insurance company, finance
company or other financial institution (the "Agent") for a group of loan
investors ("Loan Investors"). The Agent typically administers and enforces the
Senior Loan on behalf of the other Loan Investors in the syndicate. In addition,
an institution, typically but not always the Agent, holds any collateral on
behalf of the Loan Investors.
Senior Loans primarily include senior floating rate loans to corporations and
secondarily institutionally traded senior floating rate debt obligations issued
by an asset-backed pool, and interests therein. Loan interests primarily take
the form of assignments purchased in the primary or secondary market. Loan
interests may also take the form of participation interests in a Senior Loan.
Such loan interests may be acquired from U.S. or foreign commercial banks,
insurance companies, finance companies or other financial institutions who have
made loans or are Loan Investors or from other investors in loan interests.
The Fund typically purchases "Assignments" from the Agent or other Loan
Investors. The purchaser of an Assignment typically succeeds to all the rights
and obligations under the Loan Agreement of the assigning Loan Investor and
becomes a Loan Investor under the Loan Agreement with the same rights and
obligations as the assigning Loan Investor. Assignments may, however, be
arranged through private negotiations between potential
2
assignees and potential assignors, and the rights and obligations acquired by
the purchaser of an Assignment may differ from, and be more limited than, those
held by the assigning Loan Investor.
The Fund also may invest in "Participations." Participations by the Fund in a
Loan Investor's portion of a Senior Loan typically will result in the Fund
having a contractual relationship only with such Loan Investor, not with the
Borrower. As a result, the Fund may have the right to receive payments of
principal, interest and any fees to which it is entitled only from the Loan
Investor selling the Participation and only upon receipt by such Loan Investor
of such payments from the Borrower. In connection with purchasing
Participations, the Fund generally will have no right to enforce compliance by
the Borrower with the terms of the loan agreement, nor any rights with respect
to any funds acquired by other Loan Investors through set-off against the
Borrower and the Fund may not directly benefit from the collateral supporting
the Senior Loan in which it has purchased the Participation. As a result, the
Fund may assume the credit risk of both the Borrower and the Loan Investor
selling the Participation. In the event of the insolvency of the Loan Investor
selling a Participation, the Fund may be treated as a general creditor of such
Loan Investor. The selling Loan Investors and other persons interpositioned
between such Loan Investors and the Fund with respect to such Participations
will likely conduct their principal business activities in the banking, finance
and financial services industries. Persons engaged in such industries may be
more susceptible to, among other things, fluctuations in interest rates, changes
in the Federal Open Market Committee's monetary policy, governmental regulations
concerning such industries and concerning capital raising activities generally
and fluctuations in the financial markets generally.
RANKING IN CAPITAL STRUCTURE; LOAN COLLATERAL. Senior Loans typically have the
most senior position in a Borrower's capital structure, although some Senior
Loans may hold an equal ranking with the Borrower's other senior securities. The
capital structure of a Borrower may include Senior Loans, senior unsecured
loans, senior and junior subordinated debt, preferred stock and common stock,
typically in descending order of seniority with respect to claims on the
Borrower's assets. Although Senior Loans typically have the most senior position
in a Borrower's capital structure, they remain subject to the risk of
non-payment of scheduled interest or principal. Such non-payment would result in
a reduction of income to the Fund, a reduction in the value of the investment
and a potential decrease in the net asset value of the Fund. There can be no
assurance that the liquidation of any collateral securing a Senior Loan would
satisfy a borrower's obligation in the event of non-payment of scheduled
interest or principal payments, or that such collateral could be readily
liquidated. In the event of bankruptcy of a borrower, the Fund could experience
delays or limitations with respect to its ability to realize the benefits of the
collateral securing a Senior Loan. Although a Senior Loan may be senior to
equity and other debt securities in an issuer's capital structure, such
obligations may be structurally subordinated to obligations of the issuer's
subsidiaries. For example, if a holding company were to issue a Senior Loan,
even if that issuer pledges the capital stock of its subsidiaries to secure the
obligations under the Senior Loan, the assets of the operating companies are
available to the direct creditors of an operating company before they would be
available to the holders of the Senior Loan issued by the holding company.
In order to borrow money pursuant to a Senior Loan, a Borrower will frequently,
for the term of the Senior Loan, pledge collateral, including but not limited
to, (i) working capital assets, such as accounts receivable and inventory; (ii)
tangible fixed assets, such as real property, buildings and equipment; (iii)
intangible assets, such as trademarks and patent rights (but excluding
goodwill); and (iv) security interests in shares of stock of subsidiaries or
affiliates. In the case of Senior Loans made to non-public companies, the
company's shareholders or owners may provide collateral in the form of secured
guarantees and/or security interests in assets that they own. In many instances,
a Senior Loan may be secured only by stock in the Borrower or its subsidiaries.
Collateral may consist of assets that may not be readily liquidated, and there
is no assurance that the liquidation of such assets would satisfy fully a
Borrower's obligations under a Senior Loan. Some Senior Loans are subject to the
risk that a court, pursuant to fraudulent conveyance or other similar laws,
could subordinate Senior Loans to presently existing or future indebtedness of
the borrower or take other action detrimental to the holders of Senior Loans
including, in certain circumstances, invalidating Senior Loans or causing
interest previously paid to be refunded to the borrower. If interest were
required to be refunded, it could result in a loss to the Fund negatively
affecting the Fund's performance
CERTAIN FEES PAID TO THE FUND. In the process of buying, selling and holding
Senior Loans, the Fund may receive and/or pay certain fees. Any fees received
are in addition to interest payments received and may include facility fees,
commitment fees, commissions and prepayment penalty fees. When the Fund buys a
Senior Loan it may receive a facility fee and when it sells a Senior Loan it may
3
pay a facility fee. On an ongoing basis, the Fund may receive a commitment fee
based on the undrawn portion of the underlying line of credit portion of a
Senior Loan. In certain circumstances, the Fund may receive a prepayment penalty
fee upon the prepayment of a Senior Loan by a Borrower. Other fees received by
the Fund may include covenant waiver fees and covenant modification fees.
BORROWER COVENANTS. A Borrower must comply with various restrictive covenants
contained in a loan agreement or note purchase agreement between the Borrower
and the holders of the Senior Loan (the "Loan Agreement"). Such covenants, in
addition to requiring the scheduled payment of interest and principal, may
include restrictions on dividend payments and other distributions to
stockholders, provisions requiring the Borrower to maintain specific minimum
financial ratios, and limits on total debt. In addition, the Loan Agreement may
contain a covenant requiring the Borrower to prepay the Loan with any free cash
flow. Free cash flow is generally defined as net cash flow after scheduled debt
service payments and permitted capital expenditures, and includes the proceeds
from asset dispositions or sales of securities. A breach of a covenant which is
not waived by the Agent, or by the Loan Investors directly, as the case may be,
is normally an event of acceleration, i.e., the Agent, or the Loan Investors
directly, as the case may be, has the right to call the outstanding Senior Loan.
The typical practice of an Agent or a Loan Investor in relying exclusively or
primarily on reports from the Borrower may involve a risk of fraud by the
Borrower. In the case of a Senior Loan in the form of a Participation, the
agreement between the buyer and seller may limit the rights of the holder of the
Participation to vote on certain changes which may be made to the Loan
Agreement, such as waiving a breach of a covenant. However, the holder of the
Participation will, in almost all cases, have the right to vote on certain
fundamental issues such as changes in principal amount, payment dates and
interest rate.
OBLIGATIONS TO MAKE ADDITIONAL LOANS. A Loan Investor may have certain
obligations pursuant to loan agreements documenting Senior Loans, which may
include the obligation to make additional loans in certain circumstances. The
Fund generally will reserve against these contingent obligations by segregating
or otherwise designating a sufficient amount of permissible liquid assets. The
Fund will not purchase interests in Senior Loans that would require the Fund to
make additional loans if these additional loan commitments in the aggregate
would cause the Fund to fail to meet its federal tax diversification
requirements.
ADMINISTRATION OF LOANS. In a typical Senior Loan, the Agent administers the
terms of the Loan Agreement. In such cases, the Agent is normally responsible
for the collection of principal and interest payments from the Borrower and the
apportionment of these payments to the credit of all institutions that are
parties to the Loan Agreement. The Fund will generally rely upon the Agent or an
intermediate participant to receive and forward to the Fund its portion of the
principal and interest payments on the Senior Loan. Furthermore, unless under
the terms of a Participation Agreement the Fund has direct recourse against the
Borrower, the Fund will rely on the Agent and the other Loan Investors to use
appropriate credit remedies against the Borrower. The Agent is typically
responsible for monitoring compliance with covenants contained in the Loan
Agreement based upon reports prepared by the Borrower. The seller of the Senior
Loan usually does, but is often not obligated to, notify holders of Senior Loans
of any failures of compliance. The Agent may monitor the value of the collateral
and, if the value of the collateral declines, may accelerate the Senior Loan,
may give the Borrower an opportunity to provide additional collateral or may
seek other protection for the benefit of the participants in the Senior Loan.
The Agent is compensated by the Borrower for providing these services under a
Loan Agreement, and such compensation may include special fees paid upon
structuring and funding the Senior Loan and other fees paid on a continuing
basis. With respect to Senior Loans for which the Agent does not perform such
administrative and enforcement functions, the Fund will perform such tasks on
its own behalf, although a collateral bank will typically hold any collateral on
behalf of the Fund and the other Loan Investors pursuant to the applicable Loan
Agreement.
A financial institution's appointment as Agent may usually be terminated in the
event that it fails to observe the requisite standard of care or becomes
insolvent, enters Federal Deposit Insurance Corporation ("FDIC") receivership,
or, if not FDIC insured, enters into bankruptcy proceedings. A successor Agent
would generally be appointed to replace the terminated Agent, and assets held by
the Agent under the Loan Agreement should remain available to holders of Senior
Loans. However, if assets held by the Agent for the benefit of the Fund were
determined to be subject to the claims of the Agent's general creditors, the
Fund might incur certain costs and delays in realizing payment on a Senior Loan,
or suffer a loss of principal and/or interest. In situations involving
intermediate participants, similar risks may arise.
4
PREPAYMENTS. Senior Loans will usually require, in addition to scheduled
payments of interest and principal, the prepayment of the Senior Loan from a
portion of free cash flow, as defined above. The degree to which Borrowers
prepay Senior Loans, whether as a contractual requirement or at their election,
may be affected by general business conditions, the financial condition of the
Borrower and competitive conditions among Loan Investors, among other factors.
As such, prepayments cannot be predicted with accuracy. Upon a prepayment,
either in part or in full, the actual outstanding debt on which the Fund derives
interest income will be reduced. However, the Fund may receive both a prepayment
penalty fee from the prepaying Borrower and a facility fee upon the purchase of
a new Senior Loan with the proceeds from the prepayment of the former.
Prepayments generally will not materially affect the Fund's performance because
the Fund typically is able to reinvest prepayments in other Senior Loans that
have similar yields and because receipt of such fees may mitigate any adverse
impact on the Fund's yield.
OTHER INFORMATION REGARDING SENIOR LOANS. From time to time, Highland Capital
Management, L.P., the Fund's subadviser ("Highland"), and its affiliates may
borrow money from various banks in connection with their business activities.
Such banks may also sell interests in Senior Loans to or acquire them from the
Fund or may be intermediate participants with respect to Senior Loans in which
the Fund owns interests. Such banks may also act as Agents for Senior Loans held
by the Fund. Neither Highland nor its affiliates will be an obligor of any
Senior Loan or obligation underlying a participation in which the Fund may
invest.
The Fund may acquire interests in Senior Loans that are designed to provide
temporary or "bridge" financing to a Borrower pending the sale of identified
assets or the arrangement of longer-term loans or the issuance and sale of debt
obligations. The Fund may also invest in Senior Loans of Borrowers that have
obtained bridge loans from other parties. A Borrower's use of bridge loans
involves a risk that the Borrower may be unable to locate permanent financing to
replace the bridge loan, which may impair the Borrower's perceived
creditworthiness.
The Fund will be subject to the risk that collateral securing a loan will
decline in value or have no value. Such a decline, whether as a result of
bankruptcy proceedings or otherwise, could cause the Senior Loan to be
undercollateralized or unsecured. In most credit agreements, there is no formal
requirement to pledge additional collateral. In addition, the Fund may invest in
Senior Loans guaranteed by, or secured by assets of, shareholders or owners,
even if the Senior Loans are not otherwise collateralized by assets of the
Borrower; provided, however, that such guarantees are fully secured. There may
be temporary periods when the principal asset held by a Borrower is the stock of
a related company, which may not legally be pledged to secure a Senior Loan. On
occasions when such stock cannot be pledged, the Senior Loan will be temporarily
unsecured until the stock can be pledged or is exchanged for or replaced by
other assets, which will be pledged as security for the Senior Loan. However,
the Borrower's ability to dispose of such securities, other than in connection
with such pledge or replacement, will be strictly limited for the protection of
the holders of Senior Loans and, indirectly, Senior Loans themselves.
If a Borrower becomes involved in bankruptcy proceedings, a court may invalidate
the Fund's security interest in the loan collateral or subordinate the Fund's
rights under the Senior Loan to the interests of the Borrower's unsecured
creditors or cause interest previously paid to be refunded to the Borrower. If a
court required interest to be refunded, it could negatively affect the Fund's
performance. Such action by a court could be based, for example, on a
"fraudulent conveyance" claim to the effect that the Borrower did not receive
fair consideration for granting the security interest in the loan collateral to
the Fund. For Senior Loans made in connection with a highly leveraged
transaction, consideration for granting a security interest may be deemed
inadequate if the proceeds of the Senior Loan were not received or retained by
the Borrower, but were instead paid to other persons (such as shareholders of
the Borrower) in an amount that left the Borrower insolvent or without
sufficient working capital. There are also other events, such as the failure to
perfect a security interest due to faulty documentation or faulty official
filings, which could lead to the invalidation of the Fund's security interest in
loan collateral. If the Fund's security interest in loan collateral is
invalidated or the Senior Loan is subordinated to other debt of a Borrower in
bankruptcy or other proceedings, the Fund would have substantially lower
recovery, and perhaps no recovery on the full amount of the principal and
interest due on the Senior Loan.
The Fund may acquire warrants and other equity securities as part of a unit
combining a Senior Loan and equity securities of a Borrower or its affiliates.
The acquisition of such equity securities will only be incidental to the Fund's
purchase of a Senior Loan. The Fund may also acquire equity securities or debt
securities (including non-dollar-denominated debt securities) issued in exchange
for a Senior Loan, issued in connection with the debt
5
restructuring or reorganization of a Borrower, if such acquisition, in the
judgment of Highland, may enhance the value of a Senior Loan or if such
acquisition would otherwise be consistent with the Fund's investment policies.
INTEREST RATES; PORTFOLIO MATURITY AND DURATION. Interest rates on Senior Loans
in which the Fund invests adjust periodically. The interest rates are adjusted
based on a base rate plus a premium or spread over the base rate. The base rate
usually is London Interbank Offered Rate ("LIBOR"), the Federal Reserve federal
funds rate, the Prime Rate or other base lending rates used by commercial
lenders. LIBOR usually is an average of the interest rates quoted by several
designated banks as the rates at which they pay interest to major depositors in
the London interbank market on U.S. dollar-denominated deposits. The Fund's
subadviser believes that changes in short-term LIBOR rates are closely related
to changes in the Federal Reserve federal funds rate, although the two are not
technically linked. The Prime Rate quoted by a major U.S. bank is generally the
interest rate at which that bank is willing to lend U.S. dollars to its most
creditworthy Borrowers, although it may not be the bank's lowest available rate.
Highland expects that the average effective duration of the Fund's portfolio of
Senior Loans will normally be between zero and 1.5 years, reflecting the Fund's
focus on floating rate instruments. As a measure of a fixed-income security's
cash flow, duration is an alternative to the concept of "term to maturity" in
assessing the price volatility associated with changes in interest rates.
Generally, the longer the duration, the more volatility an investor should
expect. For example, the market price of a fixed-income security with a duration
of three years would be expected to decline 3% if interest rates rose 1%.
Conversely, the market price of the same security would be expected to increase
3% if interest rates fell 1%. The market price of a fixed-income security with a
duration of six years would be expected to increase or decline twice as much as
the market price of a security with a three-year duration. Duration is a way of
measuring a security's maturity in terms of the average time required to receive
the present value of all interest and principal payments as opposed to its term
to maturity. The maturity of a security measures only the time until final
payment is due; it does not take account of the pattern of a security's cash
flows over time, which would include how cash flow is affected by prepayments
and by changes in interest rates. Because the interest on Senior Loans held by
the Fund will reset at short-term intervals, the duration of Senior Loans will
be shorter than a fixed income security with a comparable term to maturity.
Highland can manage the duration of the portfolio by selecting Senior Loans with
different interest rates, reset periods and final maturity dates. Incorporating
a security's yield, coupon interest payments, final maturity and option features
into one measure, duration is computed by determining the weighted average
maturity of a fixed-income security's cash flows, where the present values of
the cash flows serve as weights. In computing the duration of the Fund's
portfolio, Highland will estimate the duration of obligations that are subject
to features such as prepayment or redemption by the issuer, put options retained
by the investor or other imbedded options, taking into account the influence of
interest rates on prepayments and coupon flows.
Loans in which the Fund invests typically have interest rates that reset at
least quarterly and may reset as frequently as daily. Because of prepayments,
the actual remaining maturity of a loan may be considerably less than its stated
maturity. Longer interest rate reset periods generally will increase
fluctuations in the Fund's net asset value as a result of changes in market
interest rates. The Fund may find it possible and appropriate to use interest
rate swaps and other investment practices to shorten the effective interest rate
adjustment period of loans. If the Fund does so, it will consider the shortened
period to be the adjustment period of the loan. As short-term interest rates
rise, interest payable to the Fund should increase. As short-term interest rates
decline, interest payable to the Fund should decrease.
During normal market conditions, changes in market interest rates will affect
the Fund in certain ways. The principal effect will be that the yield on the
Fund's shares will tend to rise or fall as market interest rates rise and fall.
This is because almost all of the assets in which the Fund invests pay interest
at rates which float in response to changes in market rates. However, because
the interest rates on the Fund's assets reset over time, there will be an
imperfect correlation between changes in market rates and changes to rates on
the portfolio as a whole. This means that changes to the rate of interest paid
on the portfolio as a whole will tend to lag behind changes in market rates. The
amount of time that will pass before the Fund experiences the effects of
changing short-term interest rates will depend on the dollar-weighted average
time until the next interest rate adjustment on the Fund's portfolio of loans.
Because the rates of interest paid on the loans in which the Fund invests have a
weighted average reset period that typically is less than 90 days, the impact of
the lag between a change in market interest rates and the change in the overall
rate on the portfolio is expected to be minimal.
6
To the extent that changes in market rates of interest are reflected not in a
change to a base rate such as LIBOR but in a change in the spread over the base
rate which is payable on loans of the type and quality in which the Fund
invests, the Fund's net asset value could be adversely affected. This is because
the value of a loan asset in the Fund is partially a function of whether it is
paying what the market perceives to be a market rate of interest for the
particular loan, given its individual credit and other characteristics. However,
unlike changes in market rates of interest for which there is generally only a
temporary lag before the portfolio reflects those changes, changes in a loan's
value based on changes in the market spread on loans in the Fund's portfolio may
be of longer duration.
DEBTOR-IN-POSSESSION FINANCING. The Fund may invest in debtor-in-possession
financings (commonly called "DIP financings"). DIP financings are arranged when
an entity seeks the protections of the bankruptcy court under Chapter 11 of the
U.S. Bankruptcy Code. These financings allow the entity to continue its business
operations while reorganizing under Chapter 11. Such financings are senior liens
on unencumbered security (i.e., security not subject to other creditors claims).
There is a risk that the entity will not emerge from Chapter 11 and be forced to
liquidate its assets under Chapter 7 of the Bankruptcy Code. In such event, the
Fund's only recourse will be against the property securing the DIP financing.
REGULATORY CHANGES. To the extent that legislation or state or federal
regulators that regulate certain financial institutions impose additional
requirements or restrictions with respect to the ability of such institutions to
make loans, particularly in connection with highly leveraged transactions, the
availability of Senior Loans for investment may be adversely affected. Further,
such legislation or regulation could depress the market value of Senior Loans.
CREDIT QUALITY. Many Senior Loans in which the Fund may invest are of below
investment grade credit quality. Accordingly, these Senior Loans are subject to
similar or identical risks and other characteristics described below in relation
to non-investment grade securities.
OTHER PERMISSIBLE PORTFOLIO INVESTMENTS
REPURCHASE AGREEMENTS. The Fund may enter into repurchase agreements (the
purchase of a security coupled with an agreement to resell at a higher price)
with respect to its permitted investments. In the event of the bankruptcy of the
other party to a repurchase agreement, the Fund might experience delays in
recovering its cash. To the extent that, in the meantime, the value of the
securities the Fund purchased may have decreased, the Fund could experience a
loss. Repurchase agreements which mature in more than seven days will be treated
as illiquid. The Fund's repurchase agreements will provide that the value of the
collateral underlying the repurchase agreement will always be at least equal to
the repurchase price, including any accrued interest earned on the agreement,
and will be marked to market daily.
FIXED-INCOME SECURITIES. In addition to corporate debt securities, which include
corporate bonds, debentures and notes, fixed-income securities also include
preferred, preference and convertible securities, equipment lease certificates,
equipment trust certificates and conditional sales contracts. Preference stocks
are stocks that have many characteristics of preferred stocks, but are typically
junior to an existing class of preferred stocks. Equipment lease certificates
are debt obligations secured by leases on equipment (such as railroad cars,
airplanes or office equipment), with the issuer of the certificate being the
owner and lessor of the equipment. Equipment trust certificates are debt
obligations secured by an interest in property (such as railroad cars or
airplanes), the title of which is held by a trustee while the property is being
used by the borrower. Conditional sales contracts are agreements under which the
seller of property continues to hold title to the property until the purchase
price is fully paid or other conditions are met by the buyer.
Fixed-rate bonds may have a demand feature allowing the holder to redeem the
bonds at specified times. These bonds are more defensive than conventional
long-term bonds (protecting to some degree against a rise in interest rates)
while providing greater opportunity than comparable intermediate term bonds,
since they may be retained if interest rates decline. Acquiring these kinds of
bonds provides the contractual right to require the issuer of the bonds to
purchase the security at an agreed upon price, which right is contained in the
obligation itself rather than in a separate agreement or instrument. Since this
right is assignable only with the bond, it will not be assigned any separate
value. Floating or variable rate obligations may be acquired as short-term
investments pending longer term investment of funds.
7
Certain securities may permit the issuer at its option to "call," or redeem, the
securities. If an issuer were to redeem securities during a time of declining
interest rates, the Fund may not be able to reinvest the proceeds in securities
providing the same investment return as the securities redeemed.
The rate of interest on a corporate debt security may be fixed, floating or
variable, and may vary inversely with respect to a reference rate. The rate of
return or return of principal on some debt obligations may be linked or indexed
to the level of exchange rates between the U.S. dollar and a foreign currency or
currencies.
HIGH YIELD SECURITIES
Investments in below investment grade debt securities generally provide greater
income and increased opportunity for capital appreciation than investments in
higher quality securities, but they also typically entail greater price
volatility and principal and income risk, including the possibility of issuer
default and bankruptcy. High yield securities are regarded as predominantly
speculative with respect to the issuer's continuing ability to meet principal
and interest payments. Debt securities in the lowest investment grade category
also may be considered to possess some speculative characteristics by certain
rating agencies. In addition, analysis of the creditworthiness of issuers of
non-investment grade bonds may be more complex than for issuers of higher
quality securities.
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 prices of high yield securities because the
advent of recession could lessen the ability of an issuer to make principal and
interest payments on its debt obligations. 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, step-up or payment-in-kind
securities, their market prices will normally be affected to a greater extent by
interest rate changes, and therefore tend to be more volatile than securities
that pay interest currently and in cash. Highland seeks to reduce these risks
through diversification, credit analysis and attention to current developments
in both the economy and financial markets.
The secondary market on which non-investment debt securities are traded may be
less liquid than the market for investment grade securities. Less liquidity in
the secondary trading market could adversely affect the 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 non-investment
grade bonds, especially in a thinly traded market. When secondary markets for
non-investment grade debt securities are less liquid than the market for
investment 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 no 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 these securities. The Fund will be more
dependent on Highland's research and analysis when investing in non-investment
grade debt securities. Highland seeks to minimize the risks of investing in all
securities through in-depth credit analysis and attention to current
developments in interest rate and market conditions.
A general description of the ratings of securities by Standard & Poor's Ratings
Group ("S&P") and Moody's Investors Service ("Moody's") is set forth in Appendix
A to this statement of additional information. Such ratings represent these
rating organizations' opinions as to the quality of the securities they rate. It
should be emphasized, however, that ratings are general and are not absolute
standards of quality. Consequently, debt obligations with the same maturity,
coupon and rating may have different yields while obligations with the same
maturity and coupon may have the same yield. For these reasons, the use of
credit ratings as the sole method of evaluating non-investment grade debt
securities can involve certain risks. For example, credit ratings evaluate the
safety or principal and interest payments, not the market value risk of
non-investment grade debt securities. Also, credit rating agencies may fail to
change credit ratings in a timely fashion to reflect events since the security
was last rated. Highland does not rely solely on credit ratings when selecting
securities for the Fund, and develops its own independent analysis of issuer
credit quality.
In the event that a rating agency or Highland downgrades its assessment of the
credit characteristics of a particular issue, the Fund is not required to
dispose of such security. In determining whether to retain or sell a downgraded
8
security, Highland may consider such factors as Highland'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 non-investment
grade bonds may be more complex than for issuers of high quality debt
securities.
ZERO-COUPON BONDS, DEFERRED INTEREST BONDS AND PAYMENT-IN-KIND SECURITIES
Zero-coupon securities are debt obligations that do not entitle the holder to
any periodic payments of interest either for the entire life of the obligation
or for an initial period after the issuance of the obligations. While zero
coupon bonds do not require the periodic payment of interest, deferred interest
bonds provide for a period of delay before the regular payment of interest
begins. Payment-in-kind securities ("PIKs") pay dividends or interest in the
form of additional securities of the issuer, rather than in cash. To the extent
the Fund invests in such instruments, they will not contribute to the Fund's
primary goal of current income. Each of these instruments is typically issued
and traded at a deep discount from its face amount. The amount of the discount
varies depending on such factors as the time remaining until maturity of the
securities, prevailing interest rates, the liquidity of the security and the
perceived credit quality of the issuer. The market prices of zero-coupon bonds,
deferred interest bonds and PIKs generally are more volatile than the market
prices of debt instruments that pay interest currently and in cash and are
likely to respond to changes in interest rates to a greater degree than do other
types of securities having similar maturities and credit quality. In order to
satisfy a requirement for qualification as a "regulated investment company"
under the Internal Revenue Code of 1986, as amended (the "Code"), an investment
company, such as the Fund, must distribute each year at least 90% of its net
investment income, including the original issue discount accrued on zero-coupon
bonds, deferred interest bonds and PIKs. Because the Fund will not, on a current
basis, receive cash payments from the issuer of these securities in respect of
any accrued original issue discount, in some years the Fund may have to
distribute cash obtained from selling other portfolio holdings of the Fund. In
some circumstances, such sales might be necessary in order to satisfy cash
distribution requirements even though investment considerations might otherwise
make it undesirable for the Fund to sell securities at such time. Under many
market conditions, investments in zero-coupon bonds, deferred interest bonds and
PIKs may be illiquid, making it difficult for the Fund to dispose of them or
determine their current value.
HYBRID INSTRUMENTS
The Fund may invest in "hybrid" instruments that combine the characteristics of
securities, futures, and options. For example, the principal amount or interest
of a hybrid could be tied (positively or negatively) to the price of some
securities index or another interest rate (each a "benchmark"). The interest
rate or (unlike many debt obligations) the principal amount payable at maturity
of a hybrid security may be increased or decreased, depending on changes in the
value of the benchmark. 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.
SECOND LIEN LOANS AND DEBT OBLIGATIONS
The Fund may invest in loans and other debt securities that have the same
characteristics as Senior Loans except that such loans are second in lien
property rather than first. Such "second lien" loans and securities, like Senior
Loans, typically have adjustable floating rate interest payments. Accordingly,
the risks associated with "second lien" loans are higher than the risk of loans
with first priority over the collateral. In the event of default on a "second
lien" loan, the first priority lien holder has first claim to the underlying
collateral of the loan. It is possible, that no collateral value would remain
for the second priority lien holder and therefore result in a loss of investment
to the Fund.
9
COLLATERALIZED LOAN OBLIGATIONS AND BOND OBLIGATIONS
The Fund may invest in certain asset-backed securities that are secured by
certain financial assets. A financing company (generally called a Special
Purpose Vehicle or "SPV") issues commercial paper or other short-term
instruments to finance the purchase of the financial assets. These securitized
assets are, as a rule, corporate financial assets brought into a pool according
to specific diversification rules. The SPV is a company founded solely for the
purpose of securitizing these claims and its only asset is the diversified asset
pool. On this basis, marketable securities are issued which, due to the
diversification of the underlying risk, generally represent a lower level of
risk than the original assets. The redemption of the securities issued by the
SPV takes place at maturity out of the cash flow generated by the collected
claims.
A collateralized loan obligation ("CLO") is a structured debt security issued by
an SPV that was created to reapportion the risk and return characteristics of a
pool of assets. The assets, typically Senior Loans, are used as collateral
supporting the various debt tranches issued by the SPV. The key feature of the
CLO structure is the prioritization of the cash flows from a pool of debt
securities among the several classes of securities issued by a CLO.
The Fund may also invest in collateralized bond obligations ("CBOs"), which are
structured debt securities backed by a diversified pool of high yield, public or
private fixed income securities. These may be fixed pools or may be "market
value" (or managed) pools of collateral. The CBO issues debt securities that are
typically separated into tranches representing different degrees of credit
quality. The top tranche of securities has the greatest collateralization and
pays the lowest interest rate. Lower CBO tranches have a lesser degree of
collateralization quality and pay higher interest rates intended to compensate
for the attendant risks. The bottom tranche specifically receives the residual
interest payments (i.e., money that is left over, if any, after the higher
tranches have been paid) rather than a fixed interest rate. The return on the
lower tranches of CBOs is especially sensitive to the rate of defaults in the
collateral pool. Under normal market conditions, the Fund expects to invest in
the lower tranches of CBOs.
DEBT SECURITIES SELECTION
In selecting fixed income securities for the Fund, Highland gives primary
consideration to the Fund's investment objective, the attractiveness of the
market for debt securities given Highland's outlook for the equity markets and
the Fund's liquidity requirements. Once Highland determines to allocate a
portion of the Fund's assets to debt securities, Highland generally focuses on
short-term instruments to provide liquidity and may invest in a range of fixed
income securities if the Fund is investing in such instruments for income or
capital gains. Highland selects individual securities based on broad economic
factors and issuer specific factors including the terms of the securities (such
as yields compared to U.S. Treasuries or comparable issues), liquidity and
rating, sector and issuer diversification.
CONVERTIBLE DEBT SECURITIES
The Fund may invest in convertible debt securities, which are debt obligations
convertible at a stated exchange rate or formula into common stock or other
equity securities of or owned by the issuer. Convertible securities rank senior
to common stocks in an issuer's capital structure and consequently may be of
higher quality and entail less risk than the issuer's common stock. As with all
debt securities, the market values of convertible securities tend to increase
when interest rates decline and, conversely, tend to decline when interest rates
increase.
DEBT SECURITIES RATING CRITERIA
Investment grade debt securities are those rated "BBB" or higher by Standard &
Poor's or the equivalent rating of other nationally recognized statistical
rating organizations. Debt securities rated BBB are considered medium grade
obligations with speculative characteristics, and adverse economic conditions or
changing circumstances may weaken the issuer's ability to pay interest and repay
principal. If the rating of an investment grade debt security falls below
investment grade, Highland will consider if any action is appropriate in light
of the Fund's investment objectives and policies.
10
Below investment grade debt securities are those rated "BB" and below by
Standard & Poor's or the equivalent rating of other nationally recognized
statistical rating organizations. See Appendix A for a description of rating
categories.
Below investment grade debt securities or comparable unrated securities are
commonly referred to as "junk bonds" and are considered predominantly
speculative and may be questionable as to principal and interest payments.
Changes in economic conditions are more likely to lead to a weakened capacity to
make principal payments and interest payments. The amount of high yield
securities outstanding has proliferated as an increasing number of issuers have
used high yield securities for corporate financing. An economic downturn could
severely affect the ability of highly leveraged issuers to service their debt
obligations or to repay their obligations upon maturity. Factors having an
adverse impact on the market value of lower quality securities will have an
adverse effect on the Fund's net asset value to the extent that it invests in
such securities. In addition, the Fund may incur additional expenses to the
extent it is required to seek recovery upon a default in payment of principal or
interest on its portfolio holdings.
The secondary market for high yield securities may not be as liquid as the
secondary market for more highly rated securities, a factor which may have an
adverse effect on the Fund's ability to dispose of a particular security when
necessary to meet its liquidity needs. Under adverse market or economic
conditions, the secondary market for high yield securities could contract
further, independent of any specific adverse changes in the condition of a
particular issuer. As a result, the Fund could find it more difficult to sell
these securities or may be able to sell the securities only at prices lower than
if such securities were widely traded. Prices realized upon the sale of such
lower rated or unrated securities, under these circumstances, may be less than
the prices used in calculating the Fund's net asset value.
Since investors generally perceive that there are greater risks associated with
lower quality debt securities of the type in which the Fund may invest a portion
of its assets, the yields and prices of such securities may tend to fluctuate
more than those for higher rated securities. In the lower quality segments of
the debt securities market, changes in perceptions of issuers' creditworthiness
tend to occur more frequently and in a more pronounced manner than do changes in
higher quality segments of the debt securities market, resulting in greater
yield and price volatility.
Lower rated and comparable unrated debt securities tend to offer higher yields
than higher rated securities with the same maturities because the historical
financial condition of the issuers of such securities may not have been as
strong as that of other issuers. However, lower rated securities generally
involve greater risks of loss of income and principal than higher rated
securities. Highland will attempt to reduce these risks through portfolio
diversification and by analysis of each issuer and its ability to make timely
payments of income and principal, as well as broad economic trends and corporate
developments.
U.S. GOVERNMENT SECURITIES
U.S. government securities in which the Fund may invest include debt obligations
of varying maturities issued by the U.S. Treasury or issued or guaranteed by an
agency or instrumentality of the U.S. government, including the Federal Housing
Administration, Federal Financing Bank, Farmers Home Administration,
Export-Import Bank of the U.S., Small Business Administration, Government
National Mortgage Association, General Services Administration, Central Bank for
Cooperatives, Federal Farm Credit Banks, Federal Home Loan Banks, Federal Home
Loan Mortgage Corporation, Federal National Mortgage Association ("FNMA"),
Maritime Administration, Tennessee Valley Authority, District of Columbia Armory
Board, Student Loan Marketing Association, Resolution Trust Corporation and
various institutions that previously were or currently are part of the Farm
Credit System (which has been undergoing reorganization since 1987). Some U.S.
government securities, such as U.S. Treasury bills, Treasury notes and Treasury
bonds, which differ only in their interest rates, maturities and times of
issuance, are supported by the full faith and credit of the United States.
Others are supported by (i) the right of the issuer to borrow from the U.S.
Treasury, such as securities of the Federal Home Loan Banks; (ii) the
discretionary authority of the U.S. government to purchase the agency's
obligations, such as securities of the FNMA; or (iii) only the credit of the
issuer. No assurance can be given that the U.S. government will provide
financial support in the future to U.S. government agencies, authorities or
instrumentalities that are not supported by the full faith and credit of the
United States. Securities guaranteed as to principal and interest by the U.S.
government, its agencies, authorities or instrumentalities include (i)
securities for which the payment of principal and interest is backed by an
irrevocable
11
letter of credit issued by the U.S. government or any of its agencies,
authorities or instrumentalities; and (ii) participations in loans made to
non-U.S. governments or other entities that are so guaranteed. The secondary
market for certain of these participations is limited and, therefore, may be
regarded as illiquid.
U.S. government securities may include zero coupon securities that may be
purchased when yields are attractive and/or to enhance portfolio liquidity. Zero
coupon U.S. government securities are debt obligations that are issued or
purchased at a significant discount from face value. The discount approximates
the total amount of interest the security will accrue and compound over the
period until maturity or the particular interest payment date at a rate of
interest reflecting the market rate of the security at the time of issuance.
Zero coupon U.S. government securities do not require the periodic payment of
interest. These investments benefit the issuer by mitigating its need for cash
to meet debt service, but generally require a higher rate of return to attract
investors who are willing to defer receipt of cash. These investments may
experience greater volatility in market value than U.S. government securities
that make regular payments of interest. The Fund accrues income on these
investments for tax and accounting purposes, which is distributable to
shareholders and which, because no cash is received at the time of accrual, may
require the liquidation of other portfolio securities to satisfy the Fund's
distribution obligations, in which case the Fund will forgo the purchase of
additional income producing assets with these funds. Zero coupon U.S. government
securities include STRIPS and CUBES, which are issued by the U.S. Treasury as
component parts of U.S. Treasury bonds and represent scheduled interest and
principal payments on the bonds.
FOREIGN INVESTMENTS
The Fund may invest in securities of non-U.S. issuers. Because foreign companies
are not subject to uniform accounting, auditing and financial reporting
standards, practices and requirements comparable to those applicable to U.S.
companies, there may be less publicly available information about a foreign
company than about a domestic company. Volume and liquidity in most foreign debt
markets is less than in the United States and securities of some foreign
companies are less liquid and more volatile than securities of comparable U.S.
companies. There is generally less government supervision and regulation of
securities exchanges, broker-dealers and listed companies than in the United
States. Mail service between the United States and foreign countries may be
slower or less reliable than within the United States, thus increasing the risk
of delayed settlements of portfolio transactions or loss of certificates for
portfolio securities. Payment for securities before delivery may be required. In
addition, with respect to certain foreign countries, there is the possibility of
expropriation or confiscatory taxation, political or social instability, or
diplomatic developments that could affect investments in those countries.
Moreover, individual foreign economies may differ favorably or unfavorably from
the U.S. economy in such respects as growth of gross national product, rate of
inflation, capital reinvestment, resource self-sufficiency and balance of
payments position. Foreign securities markets, while growing in volume and
sophistication, are generally not as developed as those in the United States,
and securities of some foreign issuers (particularly those located in developing
countries) may be less liquid and more volatile than securities of comparable
U.S. companies.
American Depositary Receipts ("ADRs"), European Depositary Receipts ("EDRs") and
Global Depositary Receipts ("GDRs") may be purchased. ADRs, EDRs and GDRs are
certificates evidencing ownership of shares of a foreign issuer and are
alternatives to purchasing directly the underlying foreign securities in their
national markets and currencies. However, they continue to be subject to many of
the risks associated with investing directly in foreign securities. These risks
include foreign exchange risk as well as the political and economic risks of the
underlying issuer's country. ADRs, EDRs and GDRs may be sponsored or
unsponsored. Unsponsored receipts are established without the participation of
the issuer. Unsponsored receipts may involve higher expenses, they may not pass-
through voting or other shareholder rights, and they may be less liquid.
WARRANTS AND STOCK PURCHASE RIGHTS
The Fund may invest in warrants, which are securities permitting, but not
obligating, their holder to subscribe for other securities. Warrants do not
carry with them the right to dividends or voting rights with respect to the
securities that they entitle their holders to purchase, and they do not
represent any rights in the assets of the issuer.
The Fund may also invest in stock purchase rights. Stock purchase rights are
instruments, frequently distributed to an issuer's shareholders as a dividend,
that entitle the holder to purchase a specific number of shares of common stock
on a specific date or during a specific period of time. The exercise price on
the rights is normally at a discount
12
from market value of the common stock at the time of distribution. The rights do
not carry with them the right to dividends or to vote and may or may not be
transferable. Stock purchase rights are frequently used outside of the United
States as a means of raising additional capital from an issuer's current
shareholders.
As a result, an investment in warrants or stock purchase rights may be
considered more speculative than certain other types of investments. In
addition, the value of a warrant or a stock purchase right does not necessarily
change with the value of the underlying securities, and warrants and stock
purchase rights expire worthless if they are not exercised on or prior to their
expiration date.
WHEN-ISSUED, DELAYED DELIVERY AND FORWARD COMMITMENT TRANSACTIONS
The Fund may purchase and sell securities, including U.S. government securities,
on a when-issued, delayed delivery or forward commitment basis. 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. See " -- Asset Segregation."
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 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.
INDEXED SECURITIES
The Fund may invest in securities that fluctuate in value with an index. Such
securities generally will either be issued by the U.S. Government or one of its
agencies or instrumentalities or, if privately issued, collateralized by
mortgages that are insured, guaranteed or otherwise backed by the U.S.
Government, its agencies or instrumentalities. The interest rate or, in some
cases, the principal payable at the maturity of an indexed security may change
positively or inversely in relation to one or more interest rates, financial
indices, securities prices or other financial indicators ("reference prices").
An indexed security may be leveraged to the extent that the magnitude of any
change in the interest rate or principal payable on an indexed security is a
multiple of the change in the reference price. Thus, indexed securities may
decline in value due to adverse market changes in reference prices. Because
indexed securities derive their value from another instrument, security or
index, they are considered derivative debt securities, and are subject to
different combinations of prepayment, extension, interest rate and/or other
market risks.
SHORT SALES AGAINST THE BOX
The Fund may sell securities short "against the box." A short sale involves the
Fund borrowing securities from a broker and selling the borrowed securities. The
Fund has an obligation to return securities identical to the borrowed securities
to the broker. In a short sale against the box, the Fund at all times owns an
equal amount of the security sold short or securities convertible into or
exchangeable for, with or without payment of additional consideration, an equal
amount of the security sold short. The Fund intends to use short sales against
the box to hedge. For example, when the Fund believes that the price of a
current portfolio security may decline, the Fund may use a short sale against
the box to lock in a sale price for a security rather than selling the security
immediately. In such a case, any future losses in the Fund's long position
should be offset by a gain in the short position and, conversely, any gain in
the long position should be reduced by a loss in the short position.
13
If the Fund effects a short sale against the box at a time when it has an
unrealized gain on the security, it may be required to recognize that gain as if
it had actually sold the security (a "constructive sale") on the date it effects
the short sale. However, such constructive sale treatment may not apply if the
Fund closes out the short sale with securities other than the appreciated
securities held at the time of the short sale provided that certain other
conditions are satisfied. Uncertainty regarding certain tax consequences of
effecting short sales may limit the extent to which the Fund may make short
sales against the box.
ASSET SEGREGATION
The 1940 Act requires that the Fund segregate assets in connection with certain
types of transactions that may have the effect of leveraging the Fund's
portfolio. If the Fund enters into a transaction requiring segregation, such as
a forward commitment, the custodian, the administrator or Highland will
segregate liquid assets in an amount required to comply with the 1940 Act. Such
segregated assets will be valued at market daily. If the aggregate value of such
segregated assets declines below the aggregate value required to satisfy the
1940 Act, additional liquid assets will be segregated.
INTEREST RATE TRANSACTIONS
INTEREST RATE SWAPS, COLLARS, CAPS AND FLOORS. In order to hedge the value of
the Fund's portfolio against interest rate fluctuations or to enhance the Fund's
income, the Fund may, but is not required to, enter into various interest rate
transactions such as interest rate swaps and the purchase or sale of interest
rate caps and floors. To the extent that the Fund enters into these
transactions, the Fund expects to do so primarily to preserve a return or spread
on a particular investment or portion of its portfolio or to protect against any
increase in the price of securities the Fund anticipates purchasing at a later
date. The Fund intends to use these transactions primarily as a hedge and not as
a speculative investment. However, the Fund also may invest in interest rate
swaps to enhance income or to increase the Fund's yield, for example, during
periods of steep interest rate yield curves (i.e., wide differences between
short-term and long-term interest rates). The Fund is not required to hedge its
portfolio and may choose not to do so. The Fund cannot guarantee that any
hedging strategies it uses will work.
In an interest rate swap, the Fund exchanges with another party their respective
commitments to pay or receive interest (e.g., an exchange of fixed rate payments
for floating rate payments). For example, if the Fund holds a debt instrument
with an interest rate that is reset only once each year, it may swap the right
to receive interest at this fixed rate for the right to receive interest at a
rate that is reset every week. This would enable the Fund to offset a decline in
the value of the debt instrument due to rising interest rates but would also
limit its ability to benefit from falling interest rates. Conversely, if the
Fund holds a debt instrument with an interest rate that is reset every week and
it would like to lock in what it believes to be a high interest rate for one
year, it may swap the right to receive interest at this variable weekly rate for
the right to receive interest at a rate that is fixed for one year. Such a swap
would protect the Fund from a reduction in yield due to falling interest rates
and may permit the Fund to enhance its income through the positive differential
between one week and one year interest rates, but would preclude it from taking
full advantage of rising interest rates.
The Fund usually will enter into interest rate swaps on a net basis (i.e., the
two payment streams are netted out with the Fund receiving or paying, as the
case may be, only the net amount of the two payments). The net amount of the
excess, if any, of the Fund's obligations over its entitlements with respect to
each interest rate swap will be accrued on a daily basis, and an amount of cash
or liquid instruments having an aggregate net asset value at least equal to the
accrued excess will be maintained in a segregated account by the Fund `s
custodian. If the interest rate swap transaction is entered into on other than a
net basis, the full amount of the Fund's obligations will be accrued on a daily
basis, and the full amount of the Fund's obligations will be maintained in a
segregated account by the Fund's custodian.
The Fund also may engage in interest rate transactions in the form of purchasing
or selling interest rate caps or floors. The Fund will not sell interest rate
caps or floors that it does not own. The purchase of an interest rate cap
entitles the purchaser, to the extent that a specified index exceeds a
predetermined interest rate, to receive payments of interest equal to the
difference of the index and the predetermined rate on a notional principal
amount (i.e., the reference amount with respect to which interest obligations
are determined although no actual exchange of principal occurs) from the party
selling such interest rate cap. The purchase of an interest rate floor entitles
the purchaser, to
14
the extent that a specified index falls below a predetermined interest rate, to
receive payments of interest at the difference of the index and the
predetermined rate on a notional principal amount from the party selling such
interest rate floor. The Fund will not enter into caps or floors if, on a net
basis, the aggregate notional principal amount with respect to such agreements
exceeds the net assets of the Fund.
Typically, the parties with which the Fund will enter into interest rate
transactions will be broker-dealers and other financial institutions. The Fund
will not enter into any interest rate swap, cap or floor transaction unless the
unsecured senior debt or the claims-paying ability of the other party thereto is
rated investment grade quality by at least one nationally recognized statistical
rating organization at the time of entering into such transaction or whose
creditworthiness is believed by Highland to be equivalent to such rating. If
there is a default by the other party to such a transaction, the Fund will have
contractual remedies pursuant to the agreements related to the transaction. The
swap market has grown substantially in recent years with a large number of banks
and investment banking firms acting both as principals and as agents utilizing
standardized swap documentation. As a result, the swap market has become
relatively liquid in comparison with other similar instruments traded in the
interbank market. Caps and floors, however, are less liquid than swaps. Certain
federal income tax requirements may limit the Fund's ability to engage in
interest rate swaps.
CREDIT DEFAULT SWAP AGREEMENTS
The Fund may enter into credit default swap agreements. The "buyer" in a credit
default contract is obligated to pay the "seller" a periodic stream of payments
over the term of the contract provided that no event of default on an underlying
reference obligation has occurred. If an event of default occurs, the seller
must pay the buyer the "par value" (full notional value) of the reference
obligation in exchange for the reference obligation. The Fund may be either the
buyer or seller in the transaction. If the Fund is a buyer and no event of
default occurs, the Fund loses its investment and recovers nothing. However, if
an event of default occurs, the buyer receives full notional value for a
reference obligation that may have little or no value. As a seller, the Fund
receives a fixed rate of income throughout the term of the contract, which
typically is between six months and three years, provided that there is no
default event. If an event of default occurs, the seller must pay the buyer the
full notional value of the reference obligation.
Credit default swaps involve greater risks than if the Fund had invested in the
reference obligation directly. In addition to general market risks, credit
default swaps are subject to illiquidity risk, counterparty risk and credit
risks. The Fund will enter into swap agreements only with counterparties who are
rated investment grade quality by at least one nationally recognized statistical
rating organization at the time of entering into such transaction or whose
creditworthiness is believed by Highland to be equivalent to such rating. A
buyer also will lose its investment and recover nothing should an event of
default occur. If an event of default were to occur, the value of the reference
obligation received by the seller, coupled with the periodic payments previously
received, may be less than the full notional value it pays to the buyer,
resulting in a loss of value to the Fund. When the Fund acts as a seller of a
credit default swap agreement it is exposed to many of the same risks of
leverage described under "Risk factors -- Leverage" and "Leverage" in the
prospectus since if an event of default occurs the seller must pay the buyer the
full notional value of the reference obligation.
If the Fund enters into a credit default swap, the Fund may be required to
report the swap as a "listed transaction" for tax shelter reporting purposes on
the Fund's federal income tax return. If the Internal Revenue Service (the
"IRS") were to determine that the credit default swap is a tax shelter, the Fund
could be subject to penalties under the Code.
The Fund may in the future employ new or additional investment strategies and
hedging instruments if those strategies and instruments are consistent with the
Fund's investment objectives and are permissible under applicable regulations
governing the Fund.
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS
To hedge against changes in interest rates or securities prices or to seek to
increase total return, the Fund may purchase and sell various kinds of futures
contracts, and purchase and write (sell) call and put options on any of such
futures contracts. The Fund may also enter into closing purchase and sale
transactions with respect to any of such contracts and options. The futures
contracts may be based on various securities (such as U.S. government
securities), securities indices and other financial instruments and indices. The
Fund will engage in futures and related options
15
transactions for bona fide hedging and non-hedging purposes as described below.
All futures contracts entered into by the Fund are traded on U.S. exchanges or
boards of trade that are licensed and regulated by the Commodity Futures Trading
Commission (the "CFTC").
FUTURES CONTRACTS. A futures contract may generally be described as an agreement
between two parties to buy and sell particular financial instruments for an
agreed price during a designated month (or to deliver the final cash settlement
price, in the case of a contract relating to an index or otherwise not calling
for physical delivery at the end of trading in the contract).
When interest rates are rising or securities prices are falling, the Fund can
seek to offset a decline in the value of its current portfolio securities
through the sale of futures contracts. When interest rates are falling or
securities prices are rising, the Fund, through the purchase of futures
contracts, can attempt to secure better rates or prices than might later be
available in the market when it effects anticipated purchases.
Positions taken in the futures markets are not normally held to maturity but are
instead liquidated through offsetting transactions which may result in a profit
or a loss. While futures contracts on securities will usually be liquidated in
this manner, the Fund may instead make, or take, delivery of the underlying
securities whenever it appears economically advantageous to do so. A clearing
corporation associated with the exchange on which futures on securities are
traded guarantees that, if still open, the sale or purchase will be performed on
the settlement date.
HEDGING STRATEGIES. Hedging, by use of futures contracts, seeks to establish
with more certainty the effective price, rate of return on portfolio securities
and securities that the Fund owns or proposes to acquire. The Fund may, for
example, take a "short" position in the futures market by selling futures
contracts in order to hedge against an anticipated rise in interest rates that
would adversely affect the value of the Fund's portfolio securities. Such
futures contracts may include contracts for the future delivery of securities
held by the Fund or securities with characteristics similar to those of the
Fund's portfolio securities. If, in the opinion of Highland, there is a
sufficient degree of correlation between price trends for the Fund's portfolio
securities and futures contracts based on other financial instruments,
securities indices or other indices, the Fund may also enter into such futures
contracts as part of its hedging strategies. Although under some circumstances
prices of securities in the Fund's portfolio may be more or less volatile than
prices of such futures contracts, Highland will attempt to estimate the extent
of this volatility difference based on historical patterns and compensate for
any such differential by having the Fund enter into a greater or lesser number
of futures contracts or by attempting to achieve only a partial hedge against
price changes affecting the Fund's portfolio securities. When hedging of this
character is successful, any depreciation in the value of portfolio securities
will be substantially offset by appreciation in the value of the futures
position. On the other hand, any unanticipated appreciation in the value of the
Fund's portfolio securities would be substantially offset by a decline in the
value of the futures position.
On other occasions, the Fund may take a "long" position by purchasing futures
contracts. This may be done, for example, when the Fund anticipates the
subsequent purchase of particular securities when it has the necessary cash, but
expects the prices then available in the market to be less favorable than prices
that are currently available.
OPTIONS ON FUTURES CONTRACTS. The acquisition of put and call options on futures
contracts will give the Fund the right (but not the obligation) for a specified
price to sell or to purchase, respectively, the underlying futures contract at
any time during the option period. As the purchaser of an option on a futures
contract, the Fund obtains the benefit of the futures position if prices move in
a favorable direction but limits its risk of loss in the event of an unfavorable
price movement to the loss of the premium and transaction costs.
The writing of a call option on a futures contract generates a premium which may
partially offset a decline in the value of the Fund's assets. By writing a call
option, the Fund becomes obligated, in exchange for the premium, to sell a
futures contract (if the option is exercised), which may have a value higher
than the exercise price. Conversely, the writing of a put option on a futures
contract generates a premium that may partially offset an increase in the price
of securities that the Fund intends to purchase. However, the Fund becomes
obligated to purchase a futures contract (if the option is exercised) that may
have a value lower than the exercise price. Thus, the loss incurred by the Fund
in writing options on futures is potentially unlimited and may exceed the amount
of the premium received. The Fund will incur transaction costs in connection
with the writing of options on futures.
16
The holder or writer of an option on a futures contract may terminate its
position by selling or purchasing an offsetting option on the same series. There
is no guarantee that such closing transactions can be effected. The Fund's
ability to establish and close out positions on such options will be subject to
the development and maintenance of a liquid market.
OTHER CONSIDERATIONS. The Fund will engage in futures and related options
transactions only in accordance with CFTC regulations which permit principals of
an investment company registered under the 1940 Act to engage in such
transactions without registering as commodity pool operators. The Fund will
engage in transactions in futures contracts and related options only to the
extent such transactions are consistent with the requirements of the Code for
maintaining its qualification as a regulated investment company for U.S. federal
income tax purposes.
Futures contracts and related options involve brokerage costs, require margin
deposits and, in the case of contracts and options obligating the Fund to
purchase securities, require the Fund to segregate assets to cover such
contracts and options.
While transactions in futures contracts and options on futures may reduce
certain risks, such transactions themselves entail certain other risks. Thus,
while the Fund may benefit from the use of futures and options on futures,
unanticipated changes in interest rates or securities prices may result in a
poorer overall performance for the Fund than if it had not entered into any
futures contracts or options transactions. In the event of an imperfect
correlation between a futures position and a portfolio position which is
intended to be protected, the desired protection may not be obtained and the
Fund may be exposed to risk of loss.
OPTIONS ON SECURITIES AND SECURITIES INDICES
The Fund may purchase put and call options on any security in which it may
invest or options on any securities index based on securities in which it may
invest. The Fund would also be able to enter into closing sale transactions in
order to realize gains or minimize losses on options it has purchased.
WRITING CALL AND PUT OPTIONS ON SECURITIES. A call option written by the Fund
obligates the Fund to sell specified securities to the holder of the option at a
specified price if the option is exercised at any time before the expiration
date. All call options written by the Fund are covered, which means that the
Fund will own the securities subject to the options as long as the options are
outstanding, or the Fund will use the other methods described below. The Fund's
purpose in writing covered call options is to realize greater income than would
be realized on portfolio securities transactions alone. However, the Fund may
forgo the opportunity to profit from an increase in the market price of the
underlying security. A put option written by the Fund would obligate the Fund to
purchase specified securities from the option holder at a specified price if the
option is exercised at any time before the expiration date. All put options
written by the Fund would be covered, which means that the Fund would have
segregated assets with a value at least equal to the exercise price of the put
option. The purpose of writing such options is to generate additional income for
the Fund. However, in return for the option premium, the Fund accepts the risk
that it may be required to purchase the underlying security at a price in excess
of its market value at the time of purchase.
Call and put options written by the Fund will also be considered to be covered
to the extent that the Fund's liabilities under such options are wholly or
partially offset by its rights under call and put options purchased by the Fund.
In addition, a written call option or put may be covered by entering into an
offsetting forward contract and/or by purchasing an offsetting option or any
other option which, by virtue of its exercise price or otherwise, reduces the
Fund's net exposure on its written option position.
WRITING CALL AND PUT OPTIONS ON SECURITIES INDICES. The Fund may also write
(sell) covered call and put options on any securities index composed of
securities in which it may invest. Options on securities indices are similar to
options on securities, except that the exercise of securities index options
requires cash payments and does not involve the actual purchase or sale of
securities. In addition, securities index options are designed to reflect price
fluctuations in a group of securities or segments of the securities market
rather than price fluctuations in a single security.
17
The Fund may cover call options on a securities index by owning securities whose
price changes are expected to be similar to those of the underlying index, or by
having an absolute and immediate right to acquire such securities without
additional cash consideration (or for additional consideration if cash in such
amount is segregated) upon conversion or exchange of other securities in its
portfolio. The Fund may cover call and put options on a securities index by
segregating assets with a value equal to the exercise price.
PURCHASING CALL AND PUT OPTIONS. The Fund would normally purchase call options
in anticipation of an increase in the market value of securities of the type in
which it may invest. The purchase of a call option would entitle the Fund, in
return for the premium paid, to purchase specified securities at a specified
price during the option period. The Fund would ordinarily realize a gain if,
during the option period, the value of such securities exceeded the sum of the
exercise price, the premium paid and transaction costs; otherwise the Fund would
realize either no gain or a loss on the purchase of the call option.
The Fund would normally purchase put options in anticipation of a decline in the
market value of securities in its portfolio ("protective puts") or in securities
in which it may invest. The purchase of a put option would entitle the Fund, in
exchange for the premium paid, to sell specified securities at a specified price
during the option period. The purchase of protective puts is designed to offset
or hedge against a decline in the market value of the Fund's holdings. Put
options may also be purchased by the Fund for the purpose of affirmatively
benefiting from a decline in the price of securities that it does not own. The
Fund would ordinarily realize a gain if, during the option period, the value of
the underlying securities decreased below the exercise price sufficiently to
more than cover the premium and transaction costs; otherwise the Fund would
realize either no gain or a loss on the purchase of the put option. Gains and
losses on the purchase of protective put options would tend to be offset by
countervailing changes in the value of the underlying portfolio securities.
The Fund may terminate its obligations under an exchange-traded call or put
option by purchasing an option identical to the one it has written. Obligations
under over-the-counter options may be terminated only by entering into an
offsetting transaction with the counterparty to such option. Such purchases are
referred to as "closing purchase transactions."
RISKS OF TRADING OPTIONS. There is no assurance that a liquid secondary market
on an options exchange will exist for any particular exchange-traded option, or
at any particular time. If the Fund is unable to effect a closing purchase
transaction with respect to covered options it has written, the Fund will not be
able to sell the underlying securities or dispose of its segregated assets until
the options expire or are exercised. Similarly, if the Fund is unable to effect
a closing sale transaction with respect to options it has purchased, it will
have to exercise the options in order to realize any profit and will incur
transaction costs upon the purchase or sale of underlying securities.
Reasons for the absence of a liquid secondary market on an exchange include the
following: (i) there may be insufficient trading interest in certain options;
(ii) restrictions may be imposed by an exchange on opening or closing
transactions or both; (iii) trading halts, suspensions or other restrictions may
be imposed with respect to particular classes or series of options; (iv) unusual
or unforeseen circumstances may interrupt normal operations on an exchange; (v)
the facilities of an exchange or the Options Clearing Corporation (the "OCC")
may not at all times be adequate to handle current trading volume; or (vi) one
or more exchanges could, for economic or other reasons, decide or be compelled
at some future date to discontinue the trading of options (or a particular class
or series of options), in which event the secondary market on that exchange (or
in that class or series of options) would cease to exist, although outstanding
options on that exchange, if any, that had been issued by the OCC as a result of
trades on that exchange would continue to be exercisable in accordance with
their terms.
The Fund may purchase and sell options that are traded on U.S. exchanges and
options traded over the counter with broker-dealers who make markets in these
options. The ability to terminate over-the-counter options is more limited than
with exchange-traded options and may involve the risk that broker-dealers
participating in such transactions will not fulfill their obligations.
Transactions by the Fund in options on securities and indices will be subject to
limitations established by each of the exchanges, boards of trade or other
trading facilities governing the maximum number of options in each class which
may be written or purchased by a single investor or group of investors acting in
concert. Thus, the number of options that the Fund may write or purchase may be
affected by options written or purchased by other investment advisory
18
clients of Pioneer or Highland. An exchange, board of trade or other trading
facility may order the liquidations of positions found to be in excess of these
limits, and it may impose certain other sanctions.
The writing and purchase of options is a highly specialized activity which
involves investment techniques and risks different from those associated with
ordinary portfolio securities transactions. The successful use of protective
puts for hedging purposes depends in part on Highland's ability to predict
future price fluctuations and the degree of correlation between the options and
securities markets.
The hours of trading for options may not conform to the hours during which the
underlying securities are traded. To the extent that the options markets close
before the markets for the underlying securities, significant price movements
can take place in the underlying markets that cannot be reflected in the options
markets.
In addition to the risks of imperfect correlation between the Fund's portfolio
and the index underlying the option, the purchase of securities index options
involves the risk that the premium and transaction costs paid by the Fund in
purchasing an option will be lost. This could occur as a result of unanticipated
movements in the price of the securities comprising the securities index on
which the option is based.
SECURITIES LENDING
As described in the prospectus, the Fund may lend a portion of its of portfolio
Senior Loans or other securities to broker-dealers or other institutional
borrowers. Loans will be made only to organizations whose credit quality or
claims paying ability is considered by Highland to be at least investment grade.
All securities loans will be collateralized on a continuous basis by cash or
U.S. government securities having a value, marked to market daily, of at least
100% of the market value of the loaned securities. The Fund may receive loan
fees in connection with loans that are collateralized by securities or on loans
of securities for which there is special demand. The Fund may also seek to earn
income on securities loans by reinvesting cash collateral in securities
consistent with its investment objectives and policies, seeking to invest at
rates that are higher than the "rebate" rate that it normally will pay to the
borrower with respect to such cash collateral. Any such reinvestment will be
subject to the investment policies, restrictions and risk considerations
described in the Prospectus and in this SAI.
The lending of Senior Loans and other securities may result in delays in
recovering, or a failure of the borrower to return, the loaned securities. The
defaulting borrower ordinarily would be liable to the Fund for any losses
resulting from such delays or failures, and the collateral provided in
connection with the loan normally would also be available for that purpose.
Securities loans normally may be terminated by either the Fund or the borrower
at any time. Upon termination and the return of the loaned securities, the Fund
would be required to return the related cash or securities collateral to the
borrower and it may be required to liquidate longer term portfolio securities in
order to do so. To the extent that such securities have decreased in value, this
may result in the Fund realizing a loss at a time when it would not otherwise do
so. The Fund also may incur losses if it is unable to reinvest cash collateral
at rates higher than applicable rebate rates paid to borrowers and related
administrative costs. These risks are substantially the same as those incurred
through investment leverage, and will be subject to the investment policies,
restrictions and risk considerations described in the prospectus and in this
SAI.
The Fund will receive amounts equivalent to any interest or other distributions
paid on securities while they are on loan, and the Fund will not be entitled to
exercise voting or other beneficial rights on loaned securities. The Fund will
exercise its right to terminate loans and thereby regain these rights whenever
Highland considers it to be in the Fund's interest to do so, taking into account
the related loss of reinvestment income and other factors.
SHORT-TERM TRADING
Securities may be sold in anticipation of market decline (a rise in interest
rates) or purchased in anticipation of a market rise (a decline in interest
rates) and later sold. In addition, a security may be sold and another purchased
at approximately the same time to take advantage of what Highland believes to be
a temporary disparity in the normal yield relationship between the two
securities. Yield disparities may occur for reasons not directly related to the
investment quality of particular issues or the general movement of interest
rates, such as changes in the overall demand for or supply of various types of
fixed income securities or changes in the investment objectives of investors.
19
TEMPORARY INVESTMENTS
The Fund may invest temporarily in cash or cash equivalents. Cash equivalents
are highly liquid, short-term securities such as commercial paper, time
deposits, certificates of deposit, short-term notes and short-term U.S.
Government obligations.
PORTFOLIO TURNOVER
It is the policy of the Fund not to engage in trading for short-term profits
although portfolio turnover rate is not considered a limiting factor in the
execution of investment decisions for the Fund. A high rate of portfolio
turnover (100% or more) involves correspondingly greater transaction costs,
which must be borne by the Fund and its shareholders.
INVESTMENT RESTRICTIONS
The following are the Fund's fundamental investment restrictions. These
restrictions may not be changed without the approval of the holders of a
majority of the Fund's outstanding voting securities (which for this purpose and
under the 1940 Act means the lesser of (i) 67% of the common shares represented
at a meeting at which more than 50% of the outstanding common shares are
represented or (ii) more than 50% of the outstanding common shares). If the Fund
were to issue a class of preferred shares, the investment restrictions could not
be changed without the approval of a majority of the outstanding common and
preferred shares, voting together as a class, and the approval of a majority of
the outstanding preferred shares, voting separately by class. Statements in
italics are not part of the restriction.
The Fund may not:
(1) Issue senior securities, other than as permitted by the 1940 Act. Senior
securities that the Fund may issue in accordance with the 1940 Act include
preferred shares, borrowing, futures, when-issued and delayed delivery
securities and forward foreign currency exchange transactions.
(2) Borrow money, other than as permitted by the 1940 Act. Under current
regulatory requirements, the Fund is permitted to (i) incur borrowings in an
amount up to 331/3% of its assets (including the amount borrowed), (ii) borrow
up to an additional 5% of the Fund's asset for temporary purposes, (iii) obtain
such short-term credits as are necessary for the clearance of portfolio
transactions, and (iv) purchase securities on margin to the extent permitted by
applicable law.
(3) Invest in real estate, except the Fund may invest in securities of issuers
that invest in real estate or interests therein, securities that are secured by
real estate or interests therein, securities of real estate investment trusts,
mortgage-backed securities and other securities that represent a similar
indirect interest in real estate, and the Fund may acquire real estate or
interests therein through exercising rights or remedies with regard to an
instrument.
(4) Make loans, except that the Fund may (i) make loans or lend portfolio
securities in accordance with the Fund's investment policies, (ii) enter into
repurchase agreements, (iii) purchase all or a portion of an issue of publicly
distributed debt securities, bank loan participation interests, bank
certificates of deposit, acceptances, debentures or other securities, whether or
not the purchase is made upon the original issuance of the securities, (iv)
participate in a credit facility whereby the Fund may directly lend to and
borrow money from other affiliated funds to the extent permitted under the 1940
Act or an exemption therefrom and (v) make loans in any other manner consistent
with applicable law, as amended and interpreted or modified from time to time by
any regulatory authority having jurisdiction.
(5) Invest in commodities or commodity contracts, except that the Fund may
invest in currency instruments and contracts and financial instruments and
contracts that might be deemed to be commodities and commodity contracts. A
futures contract, for example, may be deemed to be a commodity contract.
(6) Act as an underwriter, except insofar as the Fund technically may be deemed
to be an underwriter in connection with the purchase or sale of its portfolio
securities.
20
(7) Invest 25% or more of the value of its total assets in any one industry,
provided that this limitation does not apply to the purchase of obligations
issued or guaranteed by the U.S government, its agencies or instrumentalities.
(8) Amend its policy to invest at least 80% of its assets in Senior Loans.
All other investment policies of the Fund are considered non-fundamental and may
be changed by the Board of Trustees without prior approval of the Fund's
outstanding voting shares.
The Fund has not adopted a fundamental policy prohibiting or limiting the Fund's
use of short sales, purchases on margin and the writing of put and call options.
The Fund is subject, however, to the limitations on its use of these investments
under the 1940 Act and the rules and interpretive positions of the SEC under the
1940 Act. Certain other non-fundamental investment policies are included in the
prospectus under "Investment Objectives and Principal Investment Strategies" and
this statement of additional information under "Investment Objectives and
Policies."
Under one provision of the 1940 Act, the Fund may invest up to 10% of its total
assets in the aggregate in shares of other investment companies and up to 5% of
its total assets in any one investment company, provided the investment does not
represent more than 3% of the voting stock of the acquired investment company at
the time such shares are purchased. Other provisions of the 1940 Act may allow
the Fund to invest a greater percentage of its assets in other investment
companies subject to certain conditions. As a shareholder in any 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 advisory fees and
other expenses with respect to assets so invested. Holders of common shares
would therefore be subject to duplicative expenses to the extent the Fund
invests in other investment companies. In addition, the securities of other
investment companies may also be leveraged and will therefore be subject to the
same leverage risks described herein and in the prospectus. As described in the
prospectus in the section entitled "Risk Factors," 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.
In addition, to comply with U.S. federal income tax requirements for
qualification as a "regulated investment company," the Fund's investments will
be limited in a manner such that at the close of each quarter of each tax year,
(a) no more than 25% of the value of the Fund's total assets are invested in the
securities (other than U.S. government securities or securities of other
regulated investment companies) of a single issuer or two or more issuers
controlled by the Fund and engaged in the same, similar or related trades or
businesses and (b) with regard to at least 50% of the Fund's total assets, the
securities (other than U.S. government securities or securities of other
regulated investment companies) of a single issuer do not represent more than 5%
of the value of the Fund's total assets and do not represent more than 10% of
the outstanding voting securities of such issuer. These tax-related limitations
may be changed by the Trustees to the extent appropriate in light of changes to
applicable tax requirements.
The Fund intends to apply for ratings for the preferred shares from one or more
nationally recognized statistical rating organizations. In order to obtain and
maintain the required ratings, the Fund will be required to comply with
investment quality, diversification and other guidelines established by such
rating agency or agencies. 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 the Fund's holders of common
shares or its ability to 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 such rating agency or agencies, but no
assurance can be given that such ratings will be obtained. With the exception of
this current offering of Preferred Shares, no minimum rating is required for the
issuance of preferred shares by the Fund.
MANAGEMENT OF THE FUND
TRUSTEES AND OFFICERS
The Fund's Board of Trustees provides broad supervision over the Fund's affairs.
The officers of the Fund are responsible for the Fund's operations. The Fund's
Trustees and officers are listed below, together with their principal
occupations during the past five years. Asterisks indicate those Trustees who
are interested persons of the
21
Fund within the meaning of the 1940 Act, and such Trustees are referred to as
"Interested Trustees." Trustees who are not interested persons of the Fund are
referred to as "Independent Trustees." Each of the Trustees serves as a trustee
of each of the 73 U.S. registered investment portfolios for which Pioneer
Investment Management, Inc., the Fund's investment adviser, serves as investment
adviser (the "Pioneer Funds"). The address for all Interested Trustees and all
officers of the Fund is 60 State Street, Boston, Massachusetts 02109.
TERM OF OFFICE
NAME, AGE AND POSITIONS HELD AND LENGTH OF PRINCIPAL OCCUPATION DURING PAST OTHER DIRECTORSHIPS HELD
ADDRESS WITH THE FUND SERVICE FIVE YEARS BY THIS TRUSTEE
INTERESTED
TRUSTEES:
John F. Cogan, Jr. Chairman of the Since November Deputy Chairman and a Director of Harbor Global
(78)* Board, Trustee 2004. Term expires Director of Pioneer Global Company, Ltd.
and President in 2007. Asset Management S.p.A.
("PGAM"); Non-Executive
Chairman and a Director of
Pioneer Investment Management
USA Inc. ("PIM-USA");
Chairman and a Director of
Pioneer; Director of Pioneer
Alternative Investment Management
Limited (Dublin);
President and a Director of
Pioneer Alternative Investment
Management (Bermuda)
Limited and affiliated funds;
President and Director of Pioneer
Funds Distributor, Inc.; President
of all of the Pioneer Funds; and
Of Counsel (since 2000, partner
prior to 2000), Wilmer Cutler
Pickering Hale and Dorr LLP
(counsel to PIM-USA and the
Pioneer Funds)
Osbert M. Hood* Trustee and Since October President and Chief Executive None
(52) Executive Vice 2004. Term Officer, PIM-USA since May, 2003
President expires in 2005. (Director since January, 2001);
President and Director of
Pioneer since May, 2003;
Chairman and Director of Pioneer
Investment Management
Shareholder Services, Inc.
("PIMSS") since May, 2003;
Executive Vice President of all
of the Pioneer Funds since June
3, 2003; Executive Vice
President and Chief Operating
Officer of PIMUSA, November 2000
- May 2003; Executive Vice
President, Chief Financial
Officer and Treasurer, John
Hancock Advisers,
22
TERM OF OFFICE
NAME, AGE AND POSITIONS HELD AND LENGTH OF PRINCIPAL OCCUPATION DURING PAST OTHER DIRECTORSHIPS HELD
ADDRESS WITH THE FUND SERVICE FIVE YEARS BY THIS TRUSTEE
LLC, Boston, MA, November 1999 -
November 2000; Senior Vice
President and Chief Financial
Officer, John Hancock Advisers,
LLC, April 1997 - November 1999
INDEPENDENT
TRUSTEES:
David R. Bock Trustee Since January
2005.
Mary K. Bush (56) Trustee Since November President, Bush International Director of Brady
3509 Woodbine 2004. Term (international financial Corporation (industrial
Street; Chevy expires in 2006. advisory firm) identification and
Chase, MD 20815 specialty coated material
products manufacturer),
Millennium Chemicals,
Inc. (commodity
chemicals), Mortgage
Guaranty Insurance
Corporation, and R.J.
Reynolds Tobacco
Holdings, Inc. (tobacco)
Margaret B.W. Trustee Since November Founding Director, The Winthrop None
Graham (57) 2004. Term Group, Inc. (consulting firm);
1001 Sherbrooke expires in 2005. Professor of Management, Faculty
Street West, of Management, McGill University
Montreal, Quebec,
Canada
Marguerite A. Piret Trustee Since November President and Chief Executive Director, New America
(56) 2004. Term Officer, Newbury, Piret & High Income Fund, Inc.
One Boston Place, expires in 2006. Company, Inc. (investment (closed-end investment
26th Floor, Boston, banking firm) company)
MA 02108
Stephen K. West (76) Trustee Since November Senior Counsel, Sullivan & Director, The Swiss
125 Broad Street, 2004. Term Cromwell (law firm) Helvetia Fund, Inc.
New York, NY 10004 expires in 2007. (closed-end investment
company) and AMVESCAP PLC
(investment managers)
John Winthrop (68) Trustee Since November President, John Winthrop & Co., None
One North Adgers 2004. Term Inc. (private investment firm)
Wharf, Charleston, expires in 2005.
SC 29401
23
TERM OF OFFICE
NAME, AGE AND POSITIONS HELD AND LENGTH OF PRINCIPAL OCCUPATION DURING PAST OTHER DIRECTORSHIPS HELD
ADDRESS WITH THE FUND SERVICE FIVE YEARS BY THIS TRUSTEE
FUND OFFICERS:
Dorothy E. Bourassa Secretary Since October Secretary of PIM-USA; Senior None
(56) 2004. Serves at Vice President-Legal of Pioneer;
the discretion of and Secretary/Clerk of most of
board PIM-USA's subsidiaries since
October 2000; Secretary of all
of the Pioneer Funds since
September 2003 (Assistant
Secretary from November 2000 to
September 2003); and Senior
Counsel, Assistant Vice
President and Director of
Compliance of PIM-USA from April
1998 through October 2000
Christopher J. Assistant Since October Assistant Vice President and None
Kelley (39) Secretary 2004. Serves at Senior Counsel of Pioneer since
the discretion of July 2002; Vice President and
board Senior Counsel of BISYS Fund
Services, Inc. (April 2001 to
June 2002); Senior Vice
President and Deputy General
Counsel of Funds Distributor,
Inc. (July 2000 to April 2001;
Vice President and Associate
General Counsel from July 1996
to July 2000); Assistant
Secretary of all of the Pioneer
Funds since September 2003
David C. Phelan (47) Assistant Since October Partner, Wilmer Cutler Pickering None
Secretary 2004. Serves at Hale and Dorr LLP; Assistant
the discretion of Secretary of all of the Pioneer
board Funds since September 2003
Vincent Nave (59) Treasurer Since October Vice President-Fund Accounting, None
2004. Serves at Administration and Custody
the discretion of Services of Pioneer (Manager
board from September 1996 to February
1999); and Treasurer of all of
the Pioneer Funds (Assistant
Treasurer from June 1999 to
November 2000)
24
TERM OF OFFICE
NAME, AGE AND POSITIONS HELD AND LENGTH OF PRINCIPAL OCCUPATION DURING PAST OTHER DIRECTORSHIPS HELD
ADDRESS WITH THE FUND SERVICE FIVE YEARS BY THIS TRUSTEE
Mark E. Bradley (45) Assistant Since November Deputy Treasurer of Pioneer None
Treasurer 2004. Serves at since 2004; Treasurer and Senior
the discretion of Vice President, CDC IXIS Asset
the board Management Services from 2002 to
2003; Assistant Treasurer and
Vice President, MFS Investment
Management from 1997 to 2002;
and Assistant Treasurer of all
of the Pioneer Funds since
November 2004
Luis I. Presutti Assistant Since October Assistant Vice President-Fund None
(39) Treasurer 2004. Serves at Accounting, Administration and
the discretion of Custody Services of Pioneer
board (Fund Accounting Manager from
1994 to 1999); and Assistant
Treasurer of all of the Pioneer
Funds since November 2000
Gary Sullivan (46) Assistant Since October Fund Accounting Manager - Fund None
Treasurer 2004. Serves at Accounting, Administration and
the discretion of Custody Services of Pioneer; and
board Assistant Treasurer of all of
the Pioneer Funds since May 2002
Katharine Kim Assistant Since October Fund Administration Manager - None
Sullivan (30) Treasurer 2004. Serves at Fund Accounting, Administration
the discretion of and Custody Services since June
board 2003; Assistant Vice President -
Mutual Fund Operations of State
Street Corporation from June
2002 to June 2003 (formerly
Deutsche Bank Asset Management);
Pioneer Fund Accounting,
Administration and Custody
Services (Fund Accounting
Manager from August 1999 to May
2002, Fund Accounting Services
Supervisor from 1997 to July
1999); Assistant Treasurer of
all of the Pioneer Funds since
September 2003
25
TERM OF OFFICE
NAME, AGE AND POSITIONS HELD AND LENGTH OF PRINCIPAL OCCUPATION DURING PAST OTHER DIRECTORSHIPS HELD
ADDRESS WITH THE FUND SERVICE FIVE YEARS BY THIS TRUSTEE
Martin J. Wolin (37) Chief Since October Chief Compliance Officer of None
Compliance 2004. Serves at Pioneer (Director of Compliance
Officer the discretion of and Senior Counsel from November
the Board 2000 to September 2004); Vice
President and Associate General
Counsel of UAM Fund Services,
Inc. (mutual fund administration
company) from February 1998 to
November 2000; and Chief
Compliance Officer of all of the
Pioneer Funds.
*Mr. Cogan and Mr. Hood are Interested Trustees because each is an officer or
director of Pioneer and certain of its affiliates.
The outstanding capital stock of Pioneer is indirectly majority owned by
UniCredito Italiano S.p.A. ("UniCredito"), one of the largest banking groups in
Italy.
The Fund's Board of Trustees consists of eight members. The term of one class
expires each year commencing with the first annual meeting following this public
offering and no term shall continue for more than three years after the
applicable election. The terms of Ms. Graham, Mr. Hood and Mr. Winthrop at the
first annual meeting following this public offering, the terms of Ms. Bush and
Ms. Piret expire at the second annual meeting, and the terms of Mr. Cogan, Mr.
Bock and Mr. West expire at the third annual meeting. Subsequently, each class
of Trustees will stand for election at the conclusion of its respective term.
Such classification may prevent replacement of a majority of the Trustees for up
to a two-year period.
BOARD COMMITTEES
The Board of Trustees has an Audit Committee, an Independent Trustees Committee,
a Nominating Committee, a Valuation Committee and a Policy Administration
Committee. Committee members are as follows:
AUDIT COMMITTEE
Marguerite A. Piret (Chair), David R. Bock and Margaret B.W. Graham
INDEPENDENT TRUSTEES COMMITTEE
David R. Bock, Mary K. Bush, Margaret B.W. Graham (Chair), Marguerite A. Piret,
Stephen K. West and John Winthrop
NOMINATING COMMITTEE
Mary K. Bush, John Winthrop (Chair) and Marguerite A. Piret
VALUATION COMMITTEE
Marguerite A. Piret (Chair), Stephen K. West and John Winthrop
POLICY ADMINISTRATION COMMITTEE
Mary K. Bush (Chair), John Winthrop and Margaret B.W. Graham
The Board of Trustees has adopted a charter for the Audit Committee. In
accordance with its charter, the purposes of the Audit Committee are to:
26
- act as a liaison between the Fund's independent public accounting firm and
the full Board of Trustees of the Fund;
- discuss with the Fund's independent public accounting firm and its
judgments about the quality of the Fund's accounting principles and
underlying estimates as applied in the Fund's financial reporting;
- together with the Independent Trustees Committee, review and assess the
renewal materials of all related party contracts and agreements, including
investment advisory agreements, underwriting contracts, administration
agreements, and transfer agency contracts, among any other instruments and
agreements that may be appropriate from time to time; and
- ensure that the independent public accounting firm submits on a periodic
basis to the Audit Committee a formal written statement delineating all
relationships between the auditors and the Fund or Pioneer; actively to
engage in a dialogue with the independent public accounting firm with
respect to any disclosed relationships or services that may impact the
objectivity and independence of the independent public accounting firm;
and to recommend that the Trustees take appropriate action in response to
the independent public accounting firm's report to satisfy itself of the
independent public accounting firm's independence.
The Nominating Committee reviews the qualifications of any candidate recommended
by the Independent Trustees to serve as an Independent Trustee and makes a
recommendation regarding that person's qualifications. The Committee does not
accept nominations from shareholders.
The Valuation Committee reviews the valuation assigned to certain securities by
Pioneer in accordance with the Fund's valuation procedures.
The Policy Administration Committee reviews the implementation of certain of the
Fund's administration policies and procedures.
The Independent Trustees Committee reviews the Fund's investment advisory
agreement and other related party contracts annually and is also responsible for
any other action required to be taken, under the 1940 Act, by the Independent
Trustees acting alone.
The Fund's Declaration of Trust provides that the Fund will indemnify the
Trustees and officers against liabilities and expenses incurred in connection
with any litigation in which they may be involved because of their offices with
the Fund, unless it is determined in the manner specified in the Declaration of
Trust that they have not acted in good faith in the reasonable belief that their
actions were in the best interests of the Fund or that such indemnification
would relieve any officer or Trustee of any liability to the Fund or its
shareholders by reason of willful misfeasance, bad faith, gross negligence or
reckless disregard of his or her duties.
COMPENSATION OF OFFICERS AND TRUSTEES
The Fund pays no salaries or compensation to any of its officers. The Pioneer
Funds, including the Fund, compensate their trustees as follows:
- If the Pioneer Fund has assets greater than $250 million, the Pioneer Fund
pays each Independent Trustee an annual base fee calculated on the basis
of the Pioneer Fund's net assets.
- If the Pioneer Fund has assets less than $250 million, the Pioneer Fund
pays each Independent Trustee an annual fee of $1,000.
- If the Pioneer Fund has assets greater than $50 million, the Pioneer Fund
pays each Interested Trustee an annual fee of $500, and if the Pioneer
Fund has assets less than $50 million, the Pioneer Fund pays each
Interested Trustee and annual fee of $200 (Pioneer reimburses the Fund for
these fees).
27
- Each Pioneer Fund with assets greater than $250 million pays each
Independent Trustee who serves on a board committee an annual committee
fee based the Pioneer Fund's net assets (with additional compensation for
chairpersons of such committees).
The following table sets forth certain information with respect to the
compensation paid to each Trustee by the Fund and the Pioneer Funds as a group.
Compensation from the Fund is for the current calendar year and is estimated.
Total compensation from the Pioneer Funds as a group is for the calendar year
ended December 31, 2003.
TOTAL
PENSION OR COMPENSATION
AGGREGATE RETIREMENT BENEFITS ESTIMATED ANNUAL FROM THE FUND
COMPENSATION ACCRUED AS PART OF BENEFIT UPON AND OTHER
NAME OF TRUSTEE FROM FUND* FUND EXPENSES RETIREMENT PIONEER FUNDS**
INTERESTED TRUSTEES:
--------------------
John F. Cogan, Jr. *** $500.00 $0.00 $0.00 $19,200.00
Osbert M. Hood *** + $500.00 $0.00 $0.00 $11,520.00
INDEPENDENT TRUSTEES:
---------------------
Mary K. Bush $3,167.00 $0.00 $0.00 $104,000.00
David R. Bock++ $3,167.00 $0.00 $0.00 $0.00
Margaret B.W. Graham $3,167.00 $0.00 $0.00 $104,000.00
Marguerite A. Piret $3,167.00 $0.00 $0.00 $113,562.50
Stephen K. West $3,167.00 $0.00 $0.00 $99,750.00
John Winthrop $3,167.00 $0.00 $0.00 $99,750.00
----------------------------------------------------------------------------------
$20,002.00 $0.00 $0.00 $551,782.50
* Estimated for the fiscal year ending November 30, 2005.
** For the calendar year ended December 31, 2003. There are 65 U.S.
registered investment portfolios in the Pioneer Family of Funds.
*** Under the investment advisory agreement, Pioneer reimburses the Fund for
any Trustee fees paid by the Fund.
+ Mr. Hood became a trustee of the other Pioneer Funds during the calendar
year 2003.
++ Mr. Bock became a Trustee on January 1, 2005.
OWNERSHIP OF SHARES OF THE FUND AND OTHER PIONEER FUNDS
The following table indicates the value of shares that each Trustee beneficially
owns in the Fund and the Pioneer Funds in the aggregate. The value of shares of
the Fund and any other closed-end fund are determined based on closing market
price on December 31, 2003. The value of shares of any Pioneer Fund that is an
open-end investment company is determined on the basis of the net asset value of
the class of shares held as of December 31, 2003. The value of the shares held
are stated in ranges in accordance with the requirements of the SEC. The table
reflects the Trustee's beneficial ownership of shares of the Pioneer Funds.
Beneficial ownership is determined in accordance with the rules of the SEC.
AGGREGATE DOLLAR RANGE OF EQUITY
DOLLAR RANGE OF EQUITY SECURITIES IN ALL REGISTERED INVESTMENT
NAME OF TRUSTEE SECURITIES IN THE FUND COMPANIES IN THE PIONEER FUNDS
INTERESTED TRUSTEES:
--------------------
John F. Cogan, Jr. none Over $100,000
Osbert M. Hood none Over $100,000
INDEPENDENT TRUSTEES:
--------------------
Mary K. Bush none $10,001-$50,000
Margaret B.W. Graham none $10,001-$50,000
Marguerite A. Piret none $50,001-$100,000
Stephen K. West none Over $100,000
John Winthrop none Over $100,000
28
Material Relationships of the Independent Trustees. For purposes of the
statements below:
- the immediate family members of any person includes their spouse, children
in the person's household (including step and adoptive children) and any
dependent of the person.
- an entity in a control relationship means any person who controls, is
controlled by or is under common control with the named person. For
example, UniCredito is an entity that is in a control relationship with
Pioneer.
- a related fund is a registered investment company or an entity exempt from
the definition of an investment company pursuant to Sections 3(c)(1) or
3(c)(7) of the 1940 Act, for which Pioneer or any of its affiliates act as
investment adviser, or for which PFD or any of its affiliates act as
principal underwriter. For example, the Fund's related funds include all
of the Pioneer Funds and any non-U.S. funds managed by Pioneer or its
affiliates.
As of December 31, 2003, none of the Independent Trustees, nor any of their
immediate family members, beneficially own any securities issued by Pioneer,
UniCredito or any other entity in a control relationship to Pioneer.
During the calendar years 2002 and 2003, none of the Independent Trustees, nor
any of their immediately family members, had any direct or indirect interest
(the value of which exceeded $60,000), whether by contract, arrangement or
otherwise, in Pioneer, UniCredito or any other entity in a control relationship
to Pioneer.
During the calendar years 2002 and 2003, none of the Independent Trustees, nor
any of their immediately family members, had an interest in a transaction or a
series of transactions, or in any currently proposed transaction, or series of
similar transactions, in which the aggregate amount involved exceeded $60,000
and to which any of the following were a party (each a "fund related party"):
- the Fund
- an officer of the Fund
- a related fund
- an officer of any related fund
- Pioneer
- an officer of Pioneer
- an entity in a control relationship to Pioneer
- an officer of any such entity in a control relationship to Pioneer
During the calendar years 2002 and 2003, none of the Independent Trustees, nor
any of their immediate family members, had any relationship (the value of which
exceeded $60,000) with any fund related party, including, but not limited to,
relationships arising out of (i) the payments for property and services, (ii)
the provision of legal services, (iii) the provision of investment banking
services (other than as a member of the underwriting syndicate) or (iv) [the
provision of consulting services, except that Mr. West, an Independent Trustee,
is Senior Counsel to Sullivan & Cromwell and acts as counsel to the Independent
Trustees and the Independent Trustees of the other Pioneer Funds. The aggregate
compensation paid to Sullivan & Cromwell by the other Pioneer Funds was
approximately $53,000 and $125,603 in 2002 and 2003, respectively.
During the calendar years 2002 and 2003, none of the Independent Trustees, nor
any of their immediate family members, served as a member of a board of
directors of a company on which an officer of any of the following entities also
serves as a director:
29
- Pioneer
- UniCredito
- any other entity in a control relationship with Pioneer
None of the Fund's Trustees or officers has any arrangement with any other
person pursuant to which that Trustee or officer serves on the Board of
Trustees. During the calendar years 2002 and 2003, none of the Independent
Trustees, nor any of their immediate family members, had any position, including
as an officer, employee, director or partner, with any of the following:
- the Fund
- any related fund
- Pioneer
- any affiliated person of the Fund or Pioneer
- UniCredito
- any other entity in a control relationship to the Fund or Pioneer
FACTORS CONSIDERED BY THE INDEPENDENT TRUSTEES IN APPROVING THE INVESTMENT
ADVISORY AGREEMENT AND SUBADVISORY AGREEMENT.
The 1940 Act requires that a fund's investment advisory and subadvisory
agreements be approved annually by both the Board of Trustees and a majority of
the Independent Trustees voting separately. The Independent Trustees have
determined that the terms of the Fund's investment advisory agreement and
subadvisory agreement are fair and reasonable and that the contracts are in the
Fund's best interest. The Independent Trustees believe that the investment
advisory agreement and subadvisory agreement will enable the Fund to enjoy high
quality investment advisory and subadvisory services at a cost they deem
appropriate, reasonable and in the best interests of the Fund and its
shareholders. In making such determinations, the Independent Trustees met
independently from the Interested Trustees of the Fund and any officers of
Pioneer, Highland, or their affiliates. The Independent Trustees also relied
upon the assistance of counsel to the Independent Trustees and counsel to the
Fund.
In evaluating the investment advisory agreement and subadvisory agreement, the
Independent Trustees reviewed materials furnished by Pioneer, including
information regarding Pioneer, its affiliates and their personnel, operations
and financial condition, and materials furnished by Highland, including
information regarding Highland, its affiliates and their personnel, operations
and financial condition. The Independent Trustees discussed with representatives
of both firms the Fund's proposed operations and their respective abilities to
provide advisory and other services to the Fund. The Independent Trustees also
reviewed:
- the experience of Highland in managing other portfolios with significant
investments in Senior Loans and the performance of such portfolios;;
- the experience of the investment advisory and other personnel who would be
providing services to the Fund and the historical quality of the services
provided by Pioneer and Highland;
- the fee charged by Pioneer for investment advisory and administrative
services, as well as other compensation received by PIMSS, and the fees
Pioneer would pay to Highland;
- the Fund's projected total operating expenses, and Pioneer's agreement to
limit the Fund's expenses for three years;
30
- the fees and total expenses of investment companies with similar
objectives and strategies managed by other investment advisers; and
- the expected profitability to Pioneer of managing the Fund.
The Independent Trustees considered the following as relevant to their
recommendations: (1) the favorable history, reputation, qualification and
background of Pioneer, UniCredito and Highland, as well as the qualifications of
their personnel; (2) that the fee and expense ratios of the Fund are reasonable
given the quality of services expected to be provided and are comparable to or
lower than the fees and expense ratios of similar investment companies,
particularly other closed-end investment companies which are expected to be
leveraged that invest in dividend-paying equity securities and municipal
securities; and (3) the performance of other funds advised by Pioneer and
Highland that invest a significant portion of their assets in Senior Loans. The
Independent Trustees deemed each of these factors to be relevant to their
consideration of the Fund's investment advisory agreement and subadvisory
agreement.
CODE OF ETHICS
The Fund and Pioneer have adopted a code of ethics under Rule 17j-1 of the 1940
Act that is applicable to officers, directors/trustees and designated employees
of Pioneer and Pioneer Investment Management Limited ("PIML"). The code permits
such persons to engage in personal securities transactions for their own
accounts, including securities that may be purchased or held by the Fund, and is
designed to prescribe means reasonably necessary to prevent conflicts of
interest from arising in connection with personal securities transactions. The
code is on public file with and available from the SEC.
CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES
As of , 2005, the Trustees and officers of the Fund owned beneficially in the
aggregate less than 1% of any class of the outstanding shares of the Fund. The
Fund is not aware of any beneficial owner of 5% or more of any class of its
shares. The following is a list of the holders of record of 5% or more of any
class of the Fund's outstanding shares as of , 2005:
RECORD HOLDER SHARE CLASS NUMBER OF SHARES % OF CLASS
Cede & Co. Common Shares [___________] [ ]%
P.O. Box 20
Bowling Greene Station
New York, NY 10274
INVESTMENT ADVISER AND SUBADVISER
The Fund has contracted with Pioneer to act as its investment adviser. Pioneer
is an indirect, majority owned subsidiary of UniCredito. Pioneer is part of the
global asset management group providing investment management and financial
services to mutual funds, institutional and other clients. As of December 31,
2004, assets under management were approximately $[ ] billion worldwide,
including over $[ ] billion in assets under management by Pioneer. Certain
Trustees or officers of the Fund are also directors and/or officers of certain
of UniCredito's subsidiaries. Pioneer has entered into an agreement with its
affiliate, PIML, pursuant to which PIML provides certain services and personnel
to Pioneer.
Pioneer has engaged Highland Capital Management, L.P. (as defined above
"Highland") to act as the Fund's subadviser. Highland is a limited partnership
100% owned by its employees. Highland has one general partner, Strand Advisors,
Inc. Strand Advisors, Inc. is a Delaware corporation. As of December 31, 2004,
Highland had approximately $[ ] billion in assets under management.
As the Fund's investment adviser, Pioneer oversees the Fund's operations and
supervises Highland, which is responsible for the day-to-day management of the
Fund's portfolio (see "Investment Subadviser" below). Except as
31
otherwise provided under "Investment Subadviser" below, Pioneer also maintains
books and records with respect to the Fund's securities transactions, and
reports to the Trustees on the Fund's investments and performance. The
Highland's expertise in managing portfolios of Senior Loans and structured
finance assets is particularly suited to the Fund's focus on Senior Loans.
Highland has strong expertise in syndicated loans, high yield bonds and
distressed investments.
In its capacity as subadviser to the Fund, Highland is responsible for the
selection and on-going monitoring of assets in the Fund's investment portfolio
and foreign currency hedging. Highland provides the Fund with investment
research, advice and supervision and furnishes the Fund with an investment
program consistent with the Fund's investment objectives and policies, subject
to the supervision of the Adviser and the Fund's Trustees. Highland determines
what portfolio securities will be purchased or sold, arranges for the placing of
orders for the purchase or sale of portfolio securities, selects brokers or
dealers to place those orders, maintains books and records with respect to the
Fund's securities transactions, and reports to the Trustees on the Fund's
investments and performance.
Highland is a defendant in an action entitled Richard Haskell, et al v. Goldman
Sachs & Co., Mellon Bank, N.A., Highland Capital Management, L.P., Genesis
Health Ventures, Inc. ("Genesis"), and George V. Hager, which was commenced on
January 27, 2004. The action was brought in the Supreme Court of the State of
New York, New York County, but has been moved to the U.S. Bankruptcy Court in
Wilmington, Delaware. The case was brought by certain junior creditors of
Genesis alleging fraud, conspiracy to commit fraud, and gross negligence with
respect to the defendants' actions as senior creditors in connection with
Genesis's Chapter 11 bankruptcy proceeding. The plaintiffs are seeking damages
in excess of $200 million. A motion to dismiss filed by the defendants is
currently pending.
Under the investment advisory agreement, Pioneer is not liable to the Fund
except by willful malfeasance, bad faith, gross negligence or reckless disregard
of its duties and obligations. In providing its services to the Fund, Pioneer
may draw upon the research and investment management expertise of Pioneer's
affiliate, PIML.
The Fund will enter into an administration agreement with the Adviser, pursuant
to which the Adviser will provide certain administrative and accounting services
to the Fund. The Adviser has appointed Princeton Administrators, L.P. as the
sub-administrator to the Fund to perform certain of the Adviser's administration
and accounts obligations to the Fund. Under the administration agreement, the
Fund will pay the Adviser a monthly fee equal to .07% of the Fund's average
daily managed assets up to $500 million and .03% for average daily managed
assets in excess of $500 million. The Adviser, and not the Fund, is responsible
for paying the fees of Princeton Administrators, L.P. Princeton Administrators,
L.P. is affiliated with Merrill, Lynch & Co., one of the underwriters of the
Fund's offering of common shares.
Pursuant to a separate agreement, the Fund may compensate the Adviser for
providing certain legal and accounting services.
COMPENSATION AND EXPENSES
Under the investment advisory agreement, the Fund will pay to Pioneer monthly,
as compensation for the services rendered and expenses paid by it, a fee equal
on an annual basis to 0.70% of the Fund's average daily managed assets. Because
the fees paid to Pioneer are determined on the basis of the Fund's managed
assets, Pioneer's interest in determining whether to leverage the Fund may
differ from the interests of the Fund. The advisory fee payable by the Fund to
Pioneer is higher than the fees paid by most U.S. investment companies.
The Fund's average daily managed assets are determined for the purpose of
calculating the advisory fee by taking the average of all the daily
determinations of total assets during a given calendar month. The fee is payable
for each calendar month as soon as practicable after the end of that month.
Under the terms of its investment advisory agreement with the Fund, Pioneer pays
all the operating expenses, including executive salaries and the rental of
office space, relating to its services for the Fund, with the exception of the
following, which are to be paid by the Fund: (a) charges and expenses for fund
accounting, pricing and appraisal services and related overhead, including, to
the extent such services are performed by personnel of Pioneer or its
affiliates, office space and facilities and personnel compensation, training and
benefits; (b) the charges and expenses
32
of auditors; (c) the charges and expenses of any administrator, custodian,
transfer agent, plan agent, dividend disbursing agent and registrar appointed by
the Fund; (d) issue and transfer taxes chargeable to the Fund in connection with
securities transactions to which the Fund is a party; (e) insurance premiums,
interest charges, expenses in connection with any preferred shares,
organizational and offering expenses, dues and fees for membership in trade
associations and all taxes and corporate fees payable by the Fund to federal,
state or other governmental agencies; (f) fees and expenses involved in
registering and maintaining registrations of the Fund and/or its shares with
federal regulatory agencies, state or blue sky securities agencies and foreign
jurisdictions, including the preparation of prospectuses and statements of
additional information for filing with such regulatory authorities; (g) all
expenses of shareholders' and Trustees' meetings and of preparing, printing and
distributing prospectuses, notices, proxy statements and all reports to
shareholders and to governmental agencies; (h) charges and expenses of legal
counsel to the Fund and the Trustees; (i) compensation of those Trustees of the
Fund who are not affiliated with or interested persons of Pioneer or the Fund
(other than as Trustees); (j) the cost of preparing and printing share
certificates; (k) interest on borrowed money, if any; (l) the fees and other
expenses of listing the Fund's shares on the New York Stock Exchange or any
other national stock exchange; and (m) any other expense that the Fund, Pioneer
or any other agent of the Fund may incur (I) as a result of a change in the law
or regulations, (II) as a result of a mandate from the Board of Trustees with
associated costs of a character generally assumed by similarly structured
investment companies or (III) that is similar to the expenses listed above, and
that is approved by the Board of Trustees (including a majority of the Trustees
who are not affiliates of Pioneer) as being an appropriate expense of the Fund.
In addition, the Fund will pay all brokers' and underwriting commissions or
other fees chargeable to the Fund in connection with securities transactions to
which the Fund is a party or the origination of any Senior Loan in which the
Fund invests.
INVESTMENT SUBADVISER. As described in the prospectus, Highland serves as the
Fund's investment subadviser. Highland will, among other things, regularly
provide the Fund with investment research, advice and supervision and furnish
continuously an investment program for the Fund and, subject to the supervision
of Pioneer, manage the investment and reinvestment of the Fund's assets.
Highland, a Delaware limited partnership, is registered as an investment adviser
under the Investment Advisers Act of 1940, as amended (the "Advisers Act").
Highland was established in 1993 and had, as of December 31, 2004, approximately
$[ ] billion in assets under management. Highland's principal place of business
is located at 13455 Noel Road, Suite 1300, Dallas, Texas 75240.
Pioneer and Highland have entered into a subadvisory contract, dated as of
December 22, 2004, pursuant to which Highland has agreed, among other things,
to:
- comply with the provisions of the Fund's Declaration of Trust and By-laws,
the 1940 Act, the Advisers Act and the investment objectives, policies and
restrictions of the Fund;
- not take any action to cause the Fund to fail to comply with the
requirements of Subchapter M of the Code for qualification as a regulated
investment company;
- comply with any policies, guidelines, procedures and instructions as
Pioneer may from time to time establish;
- be responsible for voting proxies and acting on other corporate actions if
authorized to do so by the Board of Trustees or by Pioneer;
- maintain separate books and detailed records of all matters pertaining to
the portion of the Fund's assets advised by Highland required by Rule
31a-1 under the 1940 Act relating to its responsibilities provided under
the subadvisory agreement with respect to the Fund;
- require that its Access Persons comply in all respects with Highland's
Code of Ethics, as in effect from time to time; and
- furnish reports to the Trustees and Pioneer.
33
SUBADVISORY FEE. For its services, Highland is entitled to a subadvisory fee
from Pioneer at an annual rate of 0.35% of the Fund's average daily managed
assets as set forth below. The fee will be paid monthly in arrears. The Fund
does not pay a fee to Highland.
EXPENSE LIMIT. Pioneer has agreed for the first three years of the Fund's
investment operations to limit the Fund's total expenses (excluding offering
costs for common and preferred shares, interest expense, the cost of defending
or prosecuting any claim or litigation to which the Fund is a party (together
with any amount in judgment or settlement), indemnification expenses or taxes
incurred due to the failure of the Fund to qualify as a regulated investment
company under the Code or any other nonrecurring or non-operating expenses) to
0.95% of the Fund's average daily managed assets. The dividend on any preferred
shares is not an expense.
PROXY VOTING
The Fund's Trustees have delegated to Pioneer the authority to vote proxies on
behalf of the Fund. The Trustees have approved the proxy voting guidelines of
Pioneer and will review the guidelines and suggest changes they deem advisable.
A summary of Pioneer's proxy voting policies and procedures are attached to this
statement of additional information as Appendix B.
DURATION AND TERMINATIONS; NONEXCLUSIVE SERVICES
The economic terms of the investment advisory and subadvisory agreements were
approved by the Fund's Board of Trustees at a meeting of the Board of Trustees
held on December 2, 2004, including a majority of the Trustees who are not
parties to the agreement or interested persons of any such party (as such term
is defined in the 1940 Act). The 1940 Act requires that the investment advisory
agreement be approved by a majority of the Fund's Board of Trustees, including a
majority of the Trustees who are not interested persons as that term is defined
in the 1940 Act, at an in person meeting of the Board of Trustees.
The investment advisory and subadvisory agreements were approved by the sole
common shareholder of the Fund as of December 8, 2004.
Unless earlier terminated as described below, the investment advisory agreement
will remain in effect for two years from the date of its execution and from year
to year thereafter if approved annually (i) by a majority of the Independent
Trustees of the Fund and (ii) by the Board of Trustees or by a majority of the
outstanding voting securities of the Fund. The investment advisory agreement may
be terminated without penalty on 60 days' written notice by either party thereto
or by a vote of a majority of the outstanding voting securities of the Fund and
will terminate in the event it is assigned (as defined in the 1940 Act). The
services of Pioneer are not deemed to be exclusive, and nothing in the relevant
agreement will prevent Pioneer or its affiliates from providing similar services
to other investment companies and other clients (whether or not their investment
objectives and policies are similar to those of the Fund) or from engaging in
other activities.
POTENTIAL CONFLICTS OF INTEREST
The Fund is managed by Pioneer and Highland, which also serve as investment
advisers to other funds and other accounts with investment objectives identical
or similar to those of the Fund. Securities frequently meet the investment
objectives of the Fund, these other funds and such other accounts. In such
cases, the decision to recommend a purchase to one fund or account rather than
another is based on a number of factors. The determining factors in most cases
are the amount of securities of the issuer then outstanding, the value of those
securities and the market for them. Other factors considered in the investment
recommendations include other investments that each fund or account presently
has in a particular industry and the availability of investment funds in each
fund or account.
It is possible that at times identical securities will be held by more than one
fund and/or account. However, positions in the same issue may vary and the
length of time that any fund or account may choose to hold its investment in the
same issue may likewise vary. To the extent that more than one of the funds
managed by Pioneer or Highland or a private account managed by Pioneer or
Highland seeks to acquire the same security at about the same time, the Fund may
not be able to acquire as large a position in such security as it desires or it
may have to pay a higher price for
34
the security. Similarly, the Fund may not be able to obtain as large an
execution of an order to sell or as high a price for any particular portfolio
security if Pioneer or Highland decides to sell on behalf of another account the
same portfolio security at the same time. On the other hand, if the same
securities are bought or sold at the same time by more than one fund or account,
the resulting participation in volume transactions could produce better
executions for the Fund. In the event more than one account purchases or sells
the same security on a given date, the purchases and sales will normally be made
as nearly as practicable on a pro rata basis in proportion to the amounts
desired to be purchased or sold by each account. Although other funds managed by
Pioneer or Highland may have the same or similar investment objectives and
policies as the Fund, their portfolios do not generally consist of the same
investments as the Fund or each other, and their performance results are likely
to differ from those of the Fund.
PORTFOLIO TRANSACTIONS
All orders for the purchase or sale of portfolio securities are placed on behalf
of the Fund by Highland pursuant to authority contained in the Fund's investment
subadvisory agreement. Securities purchased and sold on behalf of the Fund
normally will be traded in the over-the-counter market on a net basis (i.e.,
without commission) through dealers acting for their own account and not as
brokers or otherwise through transactions directly with the issuer of the
instrument. The cost of securities purchased from underwriters includes an
underwriter's commission or concession, and the prices at which securities are
purchased and sold from and to dealers include a dealer's markup or markdown.
Highland normally seeks to deal directly with the primary market makers unless,
in its opinion, better prices are available elsewhere. Some securities are
purchased and sold on an exchange or in over-the-counter transactions conducted
on an agency basis involving a commission. Highland seeks to obtain the best
execution on portfolio trades. The price of securities and any commission rate
paid are always factors, but frequently not the only factors, in judging best
execution. In selecting brokers or dealers, Highland considers various relevant
factors, including, but not limited to, the size and type of the transaction;
the nature and character of the markets for the security to be purchased or
sold; the execution efficiency, settlement capability and financial condition of
the dealer; the dealer's execution services rendered on a continuing basis; and
the reasonableness of any dealer spreads.
Highland may select broker-dealers that provide brokerage and/or research
services to the Fund and/or other investment companies or other accounts managed
by Highland. In addition, consistent with Section 28(e) of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), if Highland determines in
good faith that the amount of commissions charged by a broker-dealer is
reasonable in relation to the value of the brokerage and research services
provided by such broker, the Fund may pay commissions to such broker-dealer in
an amount greater than the amount another firm may charge. Such services may
include advice concerning the value of securities; the advisability of investing
in, purchasing or selling securities; the availability of securities or the
purchasers or sellers of securities; providing stock quotation services, credit
rating service information and comparative fund statistics; furnishing analyses,
electronic information services, manuals and reports concerning issuers,
industries, securities, economic factors and trends, portfolio strategy, and
performance of accounts and particular investment decisions; and effecting
securities transactions and performing functions incidental thereto (such as
clearance and settlement). Highland maintains a listing of broker-dealers who
provide such services on regular basis. However, because many transactions on
behalf of the Fund and other investment companies or accounts managed by
Highland are placed with broker-dealers (including broker-dealers on the
listing) without regard to the furnishing of such services, it is not possible
to estimate the proportion of such transactions directed to such dealers solely
because such services were provided. Highland believes that no exact dollar
value can be calculated for such services.
The research received from broker-dealers may be useful to Highland in rendering
investment management services to the Fund as well as other investment companies
or other accounts managed by Highland, although not all such research may be
useful to the Fund. Conversely, such information provided by brokers or dealers
who have executed transaction orders on behalf of such other accounts may be
useful to Highland in carrying out its obligations to the Fund. The receipt of
such research has not reduced Highland's normal independent research activities;
however, it enables Highland to avoid the additional expenses that might
otherwise be incurred if it were to attempt to develop comparable information
through its own staff.
The Pioneer Funds have entered into third-party brokerage and/or expense offset
arrangements to reduce the Funds' total operating expenses. Pursuant to
third-party brokerage arrangements, certain of the funds that invest primarily
in U.S. equity securities may incur lower custody fees by directing brokerage to
third-party broker-dealers. Pursuant to
35
expense offset arrangements, the funds incur lower transfer agency expenses by
maintaining their cash balances with the custodian.
The Board of Trustees periodically reviews Pioneer's performance of its
responsibilities in connection with the placement of portfolio transactions on
behalf of the Fund.
ADDITIONAL INFORMATION CONCERNING THE AUCTIONS FOR PREFERRED SHARES
GENERAL. The Depository Trust Company ("DTC" or the "Securities Depository")
will act as the Securities Depository with respect to the Preferred Shares. One
certificate for all of the shares of each series will be registered in the name
of Cede & Co., as nominee of the Securities Depository. Such certificate will
bear a legend to the effect that such certificate is issued subject to the
provisions restricting transfers of shares of the Preferred Shares contained in
the Statement. Prior to the commencement of the right of holders of the
Preferred Shares to elect a majority of the Trustees, as described under
"Description of Preferred Shares -- Voting Rights" in the prospectus, Cede & Co.
will be the holder of record of the Preferred Shares and owners of such shares
will not be entitled to receive certificates representing their ownership
interest in such shares.
DTC, a New York-chartered limited purpose trust company, performs services for
its participants, some of whom (and/or their representatives) own DTC. DTC
maintains lists of its participants and will maintain the positions (ownership
interests) held by each such participant in the Preferred Shares, whether for
its own account or as a nominee for another person.
THE AUCTION AGENT. Deutsche Bank Trust Company Americas (the "Auction Agent")
will act as agent for the Fund in connection with the auctions of the Preferred
Shares (the "Auctions"). In the absence of willful misconduct or gross
negligence on its part, the Auction Agent will not be liable for any action
taken, suffered, or omitted or for any error of judgment made by it in the
performance of its duties under the auction agency agreement between the Fund
and the Auction Agent and will not be liable for any error of judgment made in
good faith unless the Auction Agent was grossly negligent in ascertaining the
pertinent facts.
The Auction Agent may conclusively rely upon, as evidence of the identities of
the holders of the Preferred Shares, the Auction Agent's registry of holders,
and the results of auctions and notices from any broker-dealer ("Broker-Dealer")
that has entered into an agreement with the Auction Agent (a "Broker-Dealer
Agreement") (or other person, if permitted by the Fund) with respect to
transfers described under "The Auction - Secondary Market Trading and Transfers
of Preferred Shares" in the prospectus and notices from the Fund. The Auction
Agent is not required to accept any such notice for an auction unless it is
received by the Auction Agent by 3:30 p.m., New York City time, on the business
day preceding such Auction.
The Auction Agent may terminate its auction agency agreement with the Fund upon
notice to the Fund on a date no earlier than 60 days after such notice. If the
Auction Agent should resign, the Fund will use its best efforts to enter into an
agreement with a successor auction agent containing substantially the same terms
and conditions as the auction agency agreement. The Fund may remove the Auction
Agent provided that prior to such removal the Fund shall have entered into such
an agreement with a successor auction agent.
BROKER-DEALERS. The Auction Agent after each Auction for the Preferred Shares
will pay to each Broker-Dealer, from funds provided by the Fund, a service
charge at the annual rate: (i) in the case of any Auction Date immediately
preceding a Dividend Period other than a Special Dividend Period, the product of
(A) a fraction the numerator of which is the number of days in such Dividend
Period (calculated by counting the date of original issue of such shares to but
excluding the next succeeding dividend payment date of such shares) and the
denominator of which is 360, times (B) 1/4 of 1%, times (C) $25,000 times (D)
the sum of the aggregate number of shares of outstanding Preferred Shares for
which the Auction is conducted and (ii) in the case of any Special Dividend
Period the amount determined by mutual consent of the Trust and any such
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 Preferred Shares will be placed by a
Broker-Dealer if such shares were (a) the subject of hold orders deemed to have
been submitted to the Auction Agent by the Broker-Dealer and were acquired by
such Broker-Dealer for its customers who are beneficial owners
36
or (b) the subject of an order submitted by such Broker-Dealer that is (i) a
submitted bid of an existing holder that resulted in the existing holder
continuing to hold such shares as a result of the Auction or (ii) a submitted
bid of a potential bidder that resulted in the potential holder purchasing such
shares as a result of the Auction or (iii) a valid hold order.
The Fund may request the Auction Agent to terminate one or more Broker-Dealer
agreements at any time, provided that at least one Broker-Dealer agreement is in
effect after such termination.
The Broker-Dealer Agreement provides that a Broker-Dealer (other than an
affiliate of the Fund) may submit orders in Auctions for its own account, unless
the Fund notifies all Broker-Dealers that they may no longer do so, in which
case Broker-Dealers may continue to submit hold orders and sell orders for their
own accounts. Any Broker-Dealer that is an affiliate of the Fund may submit
orders in Auctions, but only if such orders are not for its own account. If a
Broker-Dealer submits an order for its own account in any Auction, it might have
an advantage over other bidders because it would have knowledge of all orders
submitted by it in that Auction; such Broker-Dealer, however, would not have
knowledge of orders submitted by other Broker-Dealers in that Auction.
RATING AGENCY GUIDELINES
The descriptions of Fitch, Inc. ("Fitch") and Moody's Investors Service, Inc.
("Moody's") rating guidelines ("Rating Agency Guidelines") contained in this
statement of additional information do not purport to be complete and are
subject to and qualified in their entireties by reference to the Statement, a
copy of which is attached as Appendix C to this statement of additional
information. A copy of the Statement is filed as an exhibit to the registration
statement of which the prospectus and this statement of additional information
are a part and may be inspected, and copies thereof may be obtained, as
described in the prospectus.
The composition of the Fund's portfolio reflects the Rating Agency Guidelines in
connection with the Fund's receipt of a rating of "Aaa" and "AAA" from Moody's
and Fitch, respectively, for the Preferred Shares. These Rating Agency
Guidelines relate, among other things, to credit quality characteristics of
issuers and diversification requirements and specify various discount factors
for different types of securities (with the level of discount greater as the
rating of a security becomes lower). Under the Rating Agency Guidelines, certain
types of securities in which the Fund may otherwise invest consistent with its
investment strategy are not eligible for inclusion in the calculation of the
discounted value of the Fund's portfolio. Such instruments include, for example,
private placements (other than Rule 144A securities) and other securities not
within the Rating Agency Guidelines. Accordingly, although the Fund reserves the
right to invest in such securities to the extent set forth herein, they have not
and it is anticipated that they will not constitute a significant portion of the
Fund's portfolio.
The Rating Agency Guidelines require that the Fund maintain assets having an
aggregate discounted value, determined on the basis of the Rating Agency
Guidelines, greater than the aggregate liquidation preference of the Preferred
Shares plus specified liabilities, payment obligations and other amounts, as of
periodic valuation dates. The Rating Agency Guidelines also require the Fund to
maintain asset coverage required by the 1940 Act as a condition to paying
dividends or other distributions on the Fund's common shares. The effect of
compliance with the Rating Agency Guidelines may be to cause the Fund to invest
in higher quality assets and/or to maintain relatively substantial balances of
highly liquid assets or to restrict the Fund's ability to make certain
investments that would otherwise be deemed potentially desirable by Pioneer. The
Rating Agency Guidelines are subject to change from time to time with the
consent of the relevant rating agency and would not apply if the Fund in the
future elected not to use financial leverage consisting of senior securities
rated by one or more rating agencies, although other similar arrangements might
apply with respect to other senior securities that the Fund may issue.
The Fund intends to maintain, at specified times, a discounted value for its
portfolio at least equal to the amount specified by each rating agency. Moody's
and Fitch have each established separate guidelines for determining discounted
value. To the extent any particular portfolio holding does not satisfy the
applicable Rating Agency's Guidelines, all or a portion of such holding's value
will not be included in the calculation of discounted value (as defined by such
rating agency). The Rating Agency Guidelines do not impose any limitations on
the percentage of Fund's assets that may be invested in holdings not eligible
for inclusion in the calculation of the discounted value of the Fund's
portfolio. The amount of such assets included in the Fund's portfolio at any
time may vary depending upon the rating, diversification and other
characteristics of the Fund's assets that are eligible for inclusion in the
37
discounted value of the Fund's portfolio under the Rating Agency Guidelines. For
a more detailed description of the Rating Agency Guidelines, see the Statement
which is attached to this Statement of Additional Information as Appendix C.
FEDERAL INCOME TAX MATTERS
The following is a summary discussion of certain U.S. federal income tax
consequences that may be relevant to a shareholder acquiring, holding and
disposing of Preferred Shares of the Fund. This discussion addresses only U.S.
federal income tax consequences to U.S. shareholders who hold their shares as
capital assets and does not address all of the U.S. federal income tax
consequences that may be relevant to particular shareholders in light of their
individual circumstances. This discussion also does not address the tax
consequences to shareholders that are subject to special rules, including,
without limitation, banks and financial institutions, insurance companies,
dealers in securities or foreign currencies, foreign shareholders, tax-exempt or
tax-deferred plans, accounts, or entities, or investors who engage in
constructive sale or conversion transactions. In addition, the discussion does
not address state, local or foreign tax consequences, and it does not address
any tax consequences other than U.S. federal income tax consequences. The
discussion reflects applicable tax laws of the United States as of the date of
this statement of additional information, which tax laws may be changed or
subject to new interpretations by the courts, Treasury or the Internal Revenue
Service (the "IRS") retroactively or prospectively. No attempt is made to
present a detailed explanation of all U.S. federal income tax concerns affecting
the Fund or its shareholders, and the discussion set forth herein does not
constitute tax advice. Investors are urged to consult their own tax advisers to
determine the specific tax consequences to them of investing in the Fund,
including the applicable federal, state, local and foreign tax consequences to
them and the effect of possible changes in tax laws.
The Fund intends to elect to be treated and to qualify each year as a "regulated
investment company" under Subchapter M of the Code and to comply with applicable
distribution requirements so that it generally will not pay U.S. federal income
tax on income of the Fund, including net capital gains distributed to
shareholders. In order to qualify as a regulated investment company under
Subchapter M of the Code, which qualification this discussion assumes, the Fund
must, among other things, derive at least 90% of its gross income for each
taxable year from dividends, interest, payments with respect to securities
loans, gains from the sale or other disposition of stock, securities or foreign
currencies, or other income (including gains from options, futures and forward
contracts) derived with respect to its business of investing in such stock,
securities or currencies (the "90% income test"). In addition to satisfying the
requirements described above, the Fund must satisfy an asset diversification
test in order to qualify as a regulated investment company. Under this test, at
close of each quarter of the Fund's taxable year, at least 50% of the value of
the Fund's assets must consist of cash and cash items (including receivables),
U.S. Government securities, securities of other regulated investment companies,
and securities of other issuers (as to which the Fund must not have invested
more than 5% of the value of the Fund's total assets in securities of any one
such issuer and as to which the Fund must not have held more than 10% of the
outstanding voting securities of any one such issuer), and no more than 25% of
the value of its total assets may be invested in the securities (other than U.S.
Government securities and securities of 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 or similar or related trades or businesses.
The American Jobs Creation Act of 2004 (the "2004 Tax Act"), which the President
recently signed into law, provides that for taxable years of a regulated
investment company beginning after October 22, 2004, net income derived from an
interest in a "qualified publicly traded partnership," as defined in the Code,
will be treated as qualifying income for purposes of the 90% income test, and
for the purposes of the diversification requirements described above, the
outstanding voting securities of any issuer includes the equity securities of a
qualified publicly traded partnership and no more than 25% of the value of a
regulated investment company's total assets may be invested in the securities of
one or more qualified publicly traded partnerships. In addition, the separate
treatment for publicly traded partnerships under the passive loss rules of the
Code applies to a regulated investment company holding an interest in a
qualified publicly traded partnership, with respect to items attributable to
such interest.
If the Fund qualifies as a regulated investment company and, for each taxable
year, it distributes to its shareholders an amount equal to or exceeding the sum
of (i) 90% of its "investment company taxable income" as that term is defined in
the Code (which includes, among other things, dividends, taxable interest, and
the excess of any net short-term capital gains over net long-term capital
losses, as reduced by certain deductible expenses) and (ii) 90% of the excess of
its gross tax-exempt interest, if any, over certain disallowed deductions, the
Fund generally will not be
38
subject to U.S. federal income tax on any income of the Fund, including "net
capital gain" (the excess of net long-term capital gain over net short-term
capital loss), distributed to shareholders. However, if the Fund has met such
distribution requirements but chooses not to retain some portion of its
investment company taxable income or net capital gain, it generally will be
subject to U.S. federal income tax at regular corporate rates on the amount
retained. The Fund intends to distribute at least annually all or substantially
all of its investment company taxable income, net tax-exempt interest, and net
capital gain. If for any taxable year, the Fund did not qualify as a regulated
investment company, it would be treated as a corporation subject to U.S. federal
income tax and all distributions out of earnings and profits would be taxed to
shareholders as ordinary income. In addition, the Fund could be required to
recognize unrealized gains, pay taxes and make distributions (which could be
subject to interest charges) before requalifying as a regulated investment
company.
Under the Code, the Fund will be subject to a nondeductible 4% U.S. federal
excise tax on a portion of its undistributed taxable ordinary income and capital
gains if it fails to meet certain distribution requirements with respect to each
calendar year. The Fund intends to make distributions in a timely manner and
accordingly does not expect to be subject to the excise tax, but as described
below, there can be no assurance that the Fund's distributions will be
sufficient to avoid entirely this tax.
Based in part on the lack of any present intention on the part of the Fund to
redeem or purchase Preferred Shares at any time in the future, the Fund intends
to take the position that under present law the Preferred Shares will constitute
stock of the Fund and distributions with respect to the Preferred Shares (other
than distributions in redemption of the Preferred Shares that are treated as
exchanges under Section 302(b) of the Code) will constitute dividends to the
extent of the Fund's current or accumulated earnings and profits as calculated
for U.S. federal income tax purposes. This view relies in part on a published
ruling of the IRS stating that certain preferred stock, similar in many material
respects to the Preferred Shares, represents equity. It is possible, however,
that the IRS might take a contrary position asserting, for example, that the
Preferred Shares constitute debt of the Fund. If this position were upheld, the
discussion of the treatment of distributions below would not apply. Instead
distributions by the Fund to holders of Preferred Shares would constitute
interest, whether or not such distributions exceeded the earnings and profits of
the Fund, would be included in the income of the recipient, and would be taxed
as ordinary income.
In general, assuming that the Fund has sufficient earnings and profits,
dividends from investment company taxable income are taxable as ordinary income
and distributions from net capital gain, if any, that are designated as capital
gain dividends are taxable as long-term capital gains for U.S. federal income
tax purposes without regard to the length of time the shareholder has held
shares of the Fund. Since the Fund's income is derived primarily from interest,
dividends of the Fund from its investment company taxable income generally will
not constitute "qualified dividend income" for federal income tax purposes and
thus will not be eligible for the favorable federal long-term capital gain tax
rates on qualified dividend income. In addition, the Fund's dividends are not
expected to qualify for any dividends-received deduction that might otherwise be
available for certain dividends received by shareholders that are corporations.
Capital gain dividends distributed by the Fund to individual shareholders
generally will qualify for the maximum 15% U.S. federal tax rate on long-term
capital gains. Under current law, the maximum 15% U.S. federal tax rate on
qualified dividend income and long-term capital gains will cease to apply to
taxable years beginning after December 31, 2008.
Distributions by the Fund in excess of the Fund's current and accumulated
earnings and profits will be treated as a return of capital to the extent of
(and in reduction of) the shareholder's tax basis in its shares and any such
amount in excess of that basis will be treated as gain from the sale of shares,
as discussed below. The U.S. federal income tax status of all distributions will
be reported to shareholders annually.
39
If the Fund retains any net capital gain for a taxable year, the Fund may
designate the retained amount as undistributed capital gains in a notice to
shareholders who, if subject to U.S. federal income tax on long-term capital
gains, (i) will be required to include in income for U.S. federal income tax
purposes, as long-term capital gain, their proportionate shares of such
undistributed amount, and (ii) will be entitled to credit their proportionate
shares of the tax paid by the Fund on the undistributed amount against their
U.S. federal income tax liabilities, if any, and to claim refunds to the extent
the credit exceeds such liabilities.
Although dividends generally will be treated as distributed when paid, any
dividend declared by the Fund as of a record date in October, November or
December and paid during the following January will be treated for U.S. federal
income tax purposes as received by shareholders on December 31 of the calendar
year in which it is declared. In addition, certain other distributions made
after the close of a taxable year of the Fund may be "spilled back" and treated
as paid by the Fund (except for purposes of the 4% excise tax) during such
taxable year. In such case, shareholders generally will be treated as having
received such dividends in the taxable year in which the distributions were
actually made.
If the Fund invests in certain pay-in-kind securities, zero coupon securities,
deferred interest securities or, in general, any other securities with original
issue discount (or with market discount if the Fund elects to include market
discount in income currently), the Fund generally must accrue income on such
investments for each taxable year, which generally will be prior to the receipt
of the corresponding cash payments. However, the Fund must distribute, at least
annually, all or substantially all of its investment company taxable income and
net tax-exempt interest, including such accrued income, to shareholders to
qualify as a regulated investment company under the Code and avoid U.S. federal
income and excise taxes. Therefore, the Fund may have to dispose of its
portfolio securities under disadvantageous circumstances to generate cash, or
may have to borrow the cash, to satisfy distribution requirements.
The Fund may invest significantly in debt obligations that are in the lowest
rating categories or are unrated, including debt obligations of issuers not
currently paying interest or who are in default. Investments in debt obligations
that are at risk of or in default present special tax issues for the Fund. Tax
rules are not entirely clear about issues such as when the Fund may cease to
accrue interest, original issue discount or market discount, when and to what
extent deductions may be taken for bad debts or worthless securities, how
payments received on obligations in default should be allocated between
principal and income and whether exchanges of debt obligations in a workout
context are taxable. These and other issues will be addressed by the Fund, in
the event it invests in such securities, in order to seek to ensure that it
distributes sufficient income to preserve its status as a regulated investment
company and does not become subject to U.S. federal income or excise tax.
If the Fund utilizes leverage through borrowing or issuing preferred shares, a
failure by the Fund to meet the asset coverage requirements imposed by the 1940
Act or by any rating organization that has rated such leverage, or additional
restrictions that may be imposed by certain lenders on the payment of dividends
or distributions potentially could limit or suspend the Fund's ability to make
distributions on its common shares. Such a limitation or suspension or
limitation could prevent the Fund from distributing at least 90% of its
investment company taxable income and net tax-exempt interest as is required
under the Code and therefore might jeopardize the Fund's qualification for
taxation as a regulated investment company under the Code and/or might subject
the Fund to the 4% excise tax discussed above. Upon any failure to meet such
asset coverage requirements, the Fund may, in its sole discretion, purchase or
redeem shares of preferred stock in order to maintain or restore the requisite
asset coverage and avoid the adverse consequences to the Fund and its
shareholders of failing to satisfy the distribution requirement. There can be no
assurance, however, that any such action would achieve these objectives. The
Fund will endeavor to avoid restrictions on its ability to distribute dividends.
For U.S. federal income tax purposes, the Fund is permitted to carry forward an
unused net capital loss for any year to offset its capital gains, if any, for up
to eight years following the year of the loss. To the extent subsequent capital
gains are offset by such losses, they would not result in U.S. federal income
tax liability to the Fund and are not expected to be distributed as such to
shareholders.
At the time of an investor's purchase of Fund shares, a portion of the purchase
price may be attributable to realized or unrealized appreciation in the Fund's
portfolio or undistributed taxable income of the Fund. Consequently, subsequent
distributions by the Fund with respect to these shares from such appreciation or
income may be taxable
40
to such investor even if the trading value of the investor's shares is, as a
result of the distributions, reduced below the investor's cost for such shares
and the distributions economically represent a return of a portion of the
investment.
Foreign exchange gains and losses realized by the Fund in connection with
certain transactions involving foreign currency-denominated debt securities,
certain options and futures contracts relating to foreign currency, foreign
currency forward contracts, foreign currencies, or payables or receivables
denominated in a foreign currency are subject to Section 988 of the Code, which
generally causes such gains and losses to be treated as ordinary income and
losses and may affect the amount, timing and character of distributions to
shareholders. Under Treasury regulations that may be promulgated in the future,
any gains from such transactions that are not directly related to the Fund's
principal business of investing in stock or securities (or its options contracts
or futures contracts with respect to stock or securities) may have to be limited
in order to enable the Fund to satisfy the 90% income test. If the net foreign
exchange loss for a year were to exceed the Fund's investment company taxable
income (computed without regard to such loss), the resulting ordinary loss for
such year would not be deductible by the Fund or its shareholders in future
years.
Sales and other dispositions of Fund shares are taxable events for shareholders
that are subject to tax. Shareholders should consult their own tax advisers with
reference to their individual circumstances to determine whether any particular
transaction in Fund shares is properly treated as a sale for tax purposes, as
the following discussion assumes, and the tax treatment of any gains or losses
recognized in such transactions. In general, if Fund shares are sold, the
shareholder will recognize gain or loss equal to the difference between the
amount realized on the sale and the shareholder's adjusted tax basis in the
shares sold. Such gain or loss will be treated as long-term capital gain or loss
if the shares sold were held for more than one year and otherwise generally will
be treated as short-term capital gain or loss. Any loss realized by a
shareholder upon the sale or other disposition of shares with a tax holding
period of six months or less will be treated as a long-term capital loss to the
extent of any amounts treated as distributions of long-term capital gains with
respect to such shares. Losses on sales or other dispositions of shares may be
disallowed under "wash sale" rules in the event substantially identical shares
of the Fund are purchased (including those made pursuant to reinvestment of
dividends and/or capital gains distributions) within a period of 61 days
beginning 30 days before and ending 30 days after a redemption or other
disposition of shares. In such a case, the disallowed portion of any loss
generally would be included in the U.S. federal tax basis of the shares acquired
in the other investments. The ability to otherwise deduct capital losses may be
subject to other limitations under the Code.
The Fund may, at its option, redeem the Preferred Shares in whole or in part
subject to certain limitations and to the extent permitted under applicable law,
and is required to redeem all or a portion of the Preferred Shares to the extent
required to maintain the Preferred Shares Basic Maintenance Amount and the
Investment Company Act Preferred Share Asset Coverage. Gain or loss, if any,
resulting from a redemption of Preferred Shares generally will be taxed as gain
or loss from the sale of Preferred Shares under Section 302 of the Code rather
than as a dividend, but only if the redemption distribution (a) is deemed not to
be essentially equivalent to a dividend, (b) is in complete redemption of a
shareholder's interest in the Fund, (c) is substantially disproportionate with
respect to the shareholder, or (d) with respect to a non-corporate shareholder,
is in partial liquidation of the shareholder's interest in the Fund. For the
purposes of (a), (b), and (c) above, a shareholder's ownership of common shares
and Preferred Shares will be taken into account and the common shares and
Preferred Shares held by persons who are related to the redeemed shareholder may
also have to be taken into account. If none of the conditions (a) through (d)
are met, the redemption proceeds may be considered to be a dividend distribution
taxable as ordinary income as discussed above. In addition, any declared but
unpaid dividends distributed to shareholders in connection with a redemption
will be taxable to shareholders as dividends as described above.
Under Treasury regulations, if a shareholder recognizes a loss with respect to
shares of $2 million or more for an individual shareholder, or $10 million or
more for a corporate shareholder, in any single taxable year (or a greater
amount over a combination of years), the shareholder must file with the IRS a
disclosure statement on Form 8886. Shareholders who own portfolio securities
directly are in many cases excepted from this reporting requirement but, under
current guidance, shareholders of regulated investment companies are not
excepted. A shareholder who fails to make the required disclosure to the IRS may
be subject to substantial penalties. The fact that a loss is reportable under
these regulations does not affect the legal determination of whether or not the
taxpayer's treatment of the loss is proper. Shareholders should consult with
their tax advisers to determine the applicability of these regulations in light
of their individual circumstances.
41
Options written or purchased and futures contracts entered into by the Fund on
certain securities, indices and foreign currencies, as well as certain forward
foreign currency contracts, may cause the Fund to recognize gains or losses from
marking-to-market even though such options may not have lapsed, been closed out,
or exercised, or such futures and forward contracts may not have been performed
or closed out. The tax rules applicable to these contracts may affect the
characterization of some capital gains and losses realized by the Fund as
long-term or short-term. Certain options, futures and forward contracts relating
to foreign currencies may be subject to Section 988, as described above, and
accordingly may produce ordinary income or loss. Additionally, the Fund may be
required to recognize gain if an option, futures contract, short sale or other
transaction that is not subject to the mark-to-market rules is treated as a
"constructive sale" of an "appreciated financial position" held by the Fund
under Section 1259 of the Code. Any net mark-to-market gains and/or gains from
constructive sales may also have to be distributed to satisfy the distribution
requirements referred to above even though the Fund may receive no corresponding
cash amounts, possibly requiring the disposition of portfolio securities or
borrowing to obtain the necessary cash. Losses on certain options, futures or
forward contracts and/or offsetting positions (portfolio securities or other
positions with respect to which the Fund's risk of loss is substantially
diminished by one or more options, futures or forward contracts) may also be
deferred under the tax straddle rules of the Code, which may also affect the
characterization of capital gains or losses from straddle positions and certain
successor positions as long-term or short-term. Certain tax elections may be
available that would enable the Fund to ameliorate some adverse effects of the
tax rules described in this paragraph. The tax rules applicable to options,
futures, forward contracts and straddles may affect the amount, timing and
character of the Fund's income and gains or losses and hence of its
distributions to shareholders.
The federal income tax treatment of the Fund's investment in transactions
involving swaps, caps, floors, and collars and structured securities is
uncertain and may be subject to recharacterization by the IRS. To the extent the
tax treatment of such securities or transactions differs from the tax treatment
expected by the Fund, the timing or character of income recognized by the Fund
could be affected, requiring the Fund to purchase or sell securities, or
otherwise change its portfolio, in order to comply with the tax rules applicable
to regulated investment companies under the Code.
The IRS has taken the position that if a regulated investment company has two
classes or more of shares, it must designate distributions made to each class in
any year as consisting of no more than such class's proportionate share of
particular types of income, including ordinary income and net capital gain. A
class's proportionate share of a particular type of income is determined
according to the percentage of total dividends paid by the regulated investment
company to such class. Consequently, if both common shares and Preferred Shares
are outstanding, the Fund intends to designate distributions made to the classes
of particular types of income in accordance with the classes' proportionate
shares of such income. Thus, the Fund will designate dividends constituting
capital gain dividends and other taxable dividends in a manner that allocates
such income between the holders of common shares and Preferred Shares in
proportion to the total dividends paid to each class during the taxable year, or
otherwise as required by applicable law.
The Fund may be subject to withholding and other taxes imposed by foreign
countries, including taxes on interest, dividends and capital gains with respect
to its investments in those countries, which would, if imposed, reduce the yield
on or return from those investments. Tax conventions between certain countries
and the U.S. may reduce or eliminate such taxes in some cases. The Fund does not
expect to satisfy the requirements for passing through to its shareholders their
pro rata shares of qualified foreign taxes paid by the Fund, with the general
result that shareholders would not be entitled to any deduction or credit for
such taxes on their own tax returns.
Federal law requires that the Fund withhold (as "backup withholding") 28% of
reportable payments, including dividends, capital gain distributions and the
proceeds of redemptions and exchanges or repurchases of Fund shares, paid to
shareholders who have not complied with IRS regulations. In order to avoid this
withholding requirement, shareholders must certify on their Account
Applications, or on separate IRS Forms W-9, that the Social Security Number or
other Taxpayer Identification Number they provide is their correct number and
that they are not currently subject to backup withholding, or that they are
exempt from backup withholding. The Fund may nevertheless be required to
withhold if it receives notice from the IRS or a broker that the number provided
is incorrect or backup withholding is applicable as a result of previous
underreporting of interest or dividend income.
42
The description of certain U.S. federal tax provisions above relates only to
U.S. federal income tax consequences for shareholders who are U.S. persons,
i.e., U.S. citizens or residents or U.S. corporations, partnerships, trusts or
estates, and who are subject to U.S. federal income tax. Investors other than
U.S. persons may be subject to different U.S. tax treatment, including a
non-resident alien U.S. withholding tax at the rate of 30% or at a lower treaty
rate on amounts treated as ordinary dividends from the Fund and, unless an
effective IRS Form W-8BEN or other authorized withholding certificate is on
file, to backup withholding at the rate of 28% on certain other payments from
the Fund. Under the provisions the 2004 Tax Act, dividends paid by the Fund to
non-U.S. shareholders that are derived from short-term capital gains and
qualifying net interest income (including income from original issue discount
and market discount), and that are properly designated by the Fund as
"interest-related dividends" or "short-term capital gain dividends," will
generally not be subject to U.S. withholding tax, provided that the income would
not be subject to federal income tax if earned directly by the non-U.S.
shareholder. In addition, pursuant to the 2004 Tax Act, distributions of the
Fund attributable to gains from sales or exchanges of "U.S. real property
interests" (as defined in the Code and regulations) (including certain U.S. real
property holding corporations) will generally be subject to U.S. withholding tax
and may give rise to an obligation on the part of the non-U.S. shareholder to
file a United States tax return. The provisions contained in the 2004 Tax Act
relating to distributions to shareholders who are non-U.S. persons generally
will apply to distributions with respect to taxable years of the Fund beginning
after December 31, 2004 and before January 1, 2008. Shareholders should consult
their own tax advisers on these matters and on state, local, foreign and other
applicable tax laws.
PERFORMANCE-RELATED, COMPARATIVE AND OTHER INFORMATION
PERFORMANCE-RELATED INFORMATION. From time to time, in advertisements, in sales
literature or in reports to shareholders, the past performance of the Fund may
be illustrated and/or compared with that of other investment companies with a
similar investment objectives. For example, yield or total return of the Fund's
shares may be compared to averages or rankings prepared by Lipper, Inc., a
widely recognized independent service which monitors mutual fund performance;
the S&P 500 Index; the Russell U.S. Equity Indexes; the Dow Jones Industrial
Average; the Wilshire Total Market Value Index,; or other comparable indices or
investment vehicles. In addition, the performance of the Fund's shares may be
compared to alternative investment or savings vehicles and/or to indices or
indicators of economic activity, e.g., inflation or interest rates. The Fund may
also include securities industry or comparative performance information
generally and in advertising or materials marketing the Fund's shares.
Performance rankings and listings reported in newspapers or national business
and financial publications, such as Barron's, Business Week, Consumers Digest,
Consumer Reports, Financial World, Forbes, Fortune, Investors Business Daily,
Kiplinger's Personal Finance Magazine, Money Magazine, New York Times, Smart
Money, USA Today, U.S. News and World Report, The Wall Street Journal and Worth,
may also be cited (if the Fund is listed in any such publication) or used for
comparison, as well as performance listings and rankings from various other
sources including Bloomberg Financial Markets, CDA/Wiesenberger, Donoghue's
Mutual Fund Almanac, Ibbotson Associates, Investment Company Data, Inc.,
Johnson's Charts, Kanon Bloch Carre and Co., Lipper, Inc., Micropal, Inc.,
Morningstar, Inc., Schabacker Investment Management and Towers Data Systems,
Inc. In addition, from time to time, quotations from articles from financial
publications such as those listed above may be used in advertisements, in sales
literature or in reports to shareholders of the Fund.
The Fund may also present, from time to time, historical information depicting
the value of a hypothetical account in one or more classes of the Fund since
inception.
Past performance is not indicative of future results. At any time in the future,
yields and total return may be higher or lower than past yields and total
return, and there can be no assurance that any historical results will continue.
PIONEER. From time to time, Pioneer or the Fund may use, in advertisements or
information furnished to present or prospective shareholders, information
regarding Pioneer including, without limitation, information regarding Pioneer's
and Highland's investment style, countries of operation, organization,
professional staff, clients (including other registered investment companies),
assets under management and performance record. These materials may refer to
opinions or rankings of Pioneer's and Highland's overall investment management
performance contained in third-party reports or publications. Pioneer's U.S.
mutual fund investment history includes creating in 1928 one of the first mutual
funds. Pioneer has traditionally served a mutual fund and an institutional
clientele.
43
Advertisements for the Fund may make reference to certain other open- or
closed-end investment companies managed by Pioneer.
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The statements of assets and liabilities and operations of the Fund as of [ ],
2005 appearing in this statement of additional information has been audited by
[ ], independent auditors, as set forth in their report thereon appearing
elsewhere herein, and is included in reliance upon such report given upon the
authority of such firm as experts in accounting and auditing. [ ], located at
[ ], provides accounting, auditing and tax preparation services to the Fund.
ADDITIONAL INFORMATION
A Registration Statement on Form N-2 (File No. 811- ), including amendments
thereto, relating to the Preferred Shares offered hereby, has been filed by the
Fund with the SEC, Washington, D.C. The prospectus and this statement of
additional information do not contain all of the information set forth in the
Registration Statement, including any exhibits and schedules thereto. For
further information with respect to the Fund and the Preferred Shares offered
hereby, reference is made to the Registration Statement. Statements contained in
the prospectus and this statement of additional information as to the contents
of any contract or other document referred to are not necessarily complete and
in each instance reference is made to the copy of such contract or other
document filed as an exhibit to the Registration Statement, each such statement
being qualified in all respects by such reference. A copy of the Registration
Statement may be inspected without charge at the SEC's principal office in
Washington, D.C., and copies of all or any part thereof may be obtained from the
SEC upon the payment of certain fees prescribed by the SEC.
44
FINANCIAL STATEMENTS AND REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM
PIONEER FLOATING RATE TRUST
STATEMENT OF ASSETS AND LIABILITIES
[To be included by amendment.]
45
Report of Independent Registered Public Accounting Firm
[To be included by amendment]
46
FINANCIAL HIGHLIGHTS (UNAUDITED)
STATEMENT OF ASSETS AND LIABILITIES (UNAUDITED)
STATEMENT OF OPERATIONS (UNAUDITED)
STATEMENT OF CHANGES (UNAUDITED)
SCHEDULE OF INVESTMENTS (UNAUDITED)
[TO BE FILED BY AMENDMENT]
47
APPENDIX A - DESCRIPTION OF RATINGS(1)
Moody's Prime Rating System
Moody's short-term ratings are opinions of the ability of issuers to honor
senior financial obligations and contracts. Such obligations generally have an
original maturity not exceeding one year, unless explicitly noted.
Moody's employs the following designations, all judged to be investment grade,
to indicate the relative repayment ability of rated issuers:
Prime-1: Issuers rated Prime-1 (or supporting institutions) have a superior
ability for repayment of senior short-term debt obligations. Prime-1 repayment
ability will often be evidenced by many of the following characteristics:
Leading market positions in well-established industries. High rates of return on
funds employed.
Conservative capitalization structure with moderate reliance on debt and ample
asset protection. Broad margins in earnings coverage of fixed financial charges
and high internal cash generation. Well-established access to a range of
financial markets and assured sources of alternate liquidity.
Prime-2: Issuers (or supporting institutions) rated Prime-2 have a strong
ability to repay 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, may be more subject to
variation than is the case for Prime-2 securities. Capitalization
characteristics, while still appropriate, may be more affected by external
conditions. Ample alternate liquidity is maintained.
Prime-3: Issuers (or supporting institutions) rated Prime-3 have an acceptable
ability for repayment of senior short-term obligations. The effect of industry
characteristics and market compositions may be more pronounced. Variability in
earnings and profitability may result in changes in the level of debt-protection
measurements and may require relatively high financial leverage. Adequate
alternate liquidity is maintained.
Not Prime: Issuers rated Not Prime do not fall within any of the Prime rating
categories.
In addition, in certain countries the prime rating may be modified by the
issuer's or guarantor's senior unsecured long-term debt rating.
MOODY'S DEBT RATINGS
Aaa: Bonds and preferred stock, 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 and preferred stock 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 risk appear somewhat larger than
the Aaa securities.
A: Bonds and preferred stock 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 some time in the
future.
Baa: Bonds and preferred stock 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.
A-1
Ba: Bonds and preferred stock 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 and preferred stock 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 and preferred stock 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 and preferred stock 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 and preferred stock 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.
Moody's assigns ratings to individual debt securities issued from medium-term
note ("MTN") programs, in addition to indicating ratings to MTN programs
themselves. Notes issued under MTN programs with such indicated ratings are
rated at issuance at the rating applicable to all pari passu notes issued under
the same program, at the program's relevant indicated rating, provided such
notes do not exhibit any of the characteristics listed below. For notes with any
of the following characteristics, the rating of the individual note may differ
from the indicated rating of the program:
1) Notes containing features which link the cash flow and/or market value to the
credit performance of any third party or parties.
2) Notes allowing for negative coupons, or negative principal.
3) Notes containing any provision which could obligate the investor to make any
additional payments.
Market participants must determine whether any particular note is rated, and if
so, at what rating level.
Note: 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.
STANDARD & POOR'S SHORT-TERM ISSUE CREDIT RATINGS
A-1: A short-term obligation rated A-1 is rated in the highest category by
Standard & Poor's. 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.
A-2
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 Standard & Poor's 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.
STANDARD & POOR'S LONG-TERM ISSUE CREDIT RATINGS
Issue credit ratings are based, in varying degrees, on the following
considerations:
- 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;
- Nature of and provisions of the obligation;
- Protection afforded by, and relative position of, the obligation in
the event of bankruptcy, reorganization, or other arrangement under
the laws of bankruptcy and other laws affecting creditors' rights.
The issue rating 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. (Such differentiation applies when an entity has
both senior and subordinated obligations, secured and unsecured obligations, or
operating company and holding company obligations.) Accordingly, in the case of
junior debt, the rating may not conform exactly with the category definition.
AAA: An obligation rated AAA has the highest rating assigned by Standard &
Poor's. 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 its 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.
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 conditions, the obligor is not likely
to have the capacity to meet its financial commitment on the obligation.
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CC: An obligation rated CC is currently highly vulnerable to nonpayment.
C: A subordinated debt or preferred stock obligation rated C is currently highly
vulnerable to nonpayment. The C rating may be used to cover a situation where a
bankruptcy petition has been filed or similar action taken, but payments on this
obligation are being continued. A C also will be assigned to a preferred stock
issue in arrears on dividends or sinking fund payments, but that is currently
paying.
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 Standard & Poor's 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.
r: This symbol is attached to the ratings of instruments with significant
noncredit risks. It highlights risks to principal or volatility of expected
returns which are not addressed in the credit rating.
N.R.: This indicates that no rating has been requested, that there is
insufficient information on which to base a rating, or that Standard & Poor's
does not rate a particular obligation as a matter of policy.
LOCAL CURRENCY AND FOREIGN CURRENCY RISKS
Country risk considerations are a standard part of Standard & Poor's analysis
for credit ratings on any issuer or issue. Currency of repayment is a key factor
in this analysis. An obligor's capacity to repay foreign currency obligations
may be lower than its capacity to repay obligations in its local currency due to
the sovereign government's own relatively lower capacity to repay external
versus domestic debt. These sovereign risk considerations are incorporated in
the debt ratings assigned to specific issues. Foreign currency issuer ratings
are also distinguished from local currency issuer ratings to identify those
instances where sovereign risks make them different for the same issuer.
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APPENDIX B - PROXY VOTING POLICIES AND PROCEDURES OF PIONEER INVESTMENT
MANAGEMENT, INC.
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TABLE OF CONTENTS
Overview................................................................... B-3
Proxy Voting Procedures.................................................... B-3
Proxy Voting Service.............................................. B-3
Proxy Coordinator................................................. B-3
Referral Items.................................................... B-3
Conflicts of Interest............................................. B-4
Securities Lending................................................ B-4
Share-Blocking.................................................... B-4
Record Keeping.................................................... B-5
Disclosure........................................................ B-5
Proxy Voting Oversight Group...................................... B-5
Proxy Voting Policies...................................................... B-5
Administrative.................................................... B-6
Auditors.......................................................... B-7
Board of Directors................................................ B-7
General Board Issues.............................................. B-7
Elections of Directors............................................ B-8
Capital Structure................................................. B-8
Compensation...................................................... B-9
Corporate Governance............................................. B-11
Mergers and Restructurings....................................... B-11
Mutual Funds..................................................... B-12
Social Issues.................................................... B-12
Takeover-Related Measures................................................. B-12
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OVERVIEW
Pioneer is a fiduciary that owes each of its client's duties of care and loyalty
with respect to all services undertaken on the client's behalf, including proxy
voting. When Pioneer has been delegated proxy-voting authority for a client, the
duty of care requires Pioneer to monitor corporate events and to vote the
proxies. To satisfy its duty of loyalty, Pioneer must cast the proxy votes in a
manner consistent with the best interest of its clients and must place the
client's interests ahead of its own. Pioneer will vote all proxies presented to
it in a timely manner on its behalf.
The Proxy Voting Policies and Procedures are designed to complement Pioneer's
investment policies and procedures regarding its general responsibility to
monitor the performance and/or corporate events of companies that are issuers of
securities held in accounts managed by Pioneer. These Proxy Voting Policies
summarize Pioneer's position on a number of issues solicited by underlying held
companies. The policies are guidelines that provide a general indication on how
Pioneer would vote but do not include all potential voting scenarios.
Pioneer's Proxy Voting Procedures detail monitoring of voting, exception votes,
and review of conflicts of interest and ensure that case-by-case votes are
handled within the context of the overall guidelines (i.e. best interest of
client). The overriding goal is that all proxies for US and non-US companies
that are received promptly will be voted in accordance with Pioneer's policies
or specific client instructions. All shares in a company held by Pioneer-managed
accounts will be voted alike, unless a client has given us specific voting
instructions on an issue or has not delegated authority to us or the Director of
Portfolio Management US determines, after consultation with the Proxy Voting
Oversight Group, that the circumstances justify a different approach.
ANY QUESTIONS ABOUT THESE POLICIES AND PROCEDURES SHOULD BE DIRECTED TO THE
PROXY COORDINATOR.
PROXY VOTING PROCEDURES
PROXY VOTING SERVICE
Pioneer has engaged an independent proxy voting service to assist in the voting
of proxies. The proxy voting service works with custodians to ensure that all
proxy materials are received by the custodians and are processed in a timely
fashion. To the extent applicable, the proxy voting service votes all proxies in
accordance with the proxy voting policies established by Pioneer. The proxy
voting service will refer proxy questions to the Proxy Coordinator (described
below) for instructions under circumstances where: (1) the application of the
proxy voting guidelines is unclear; (2) a particular proxy question is not
covered by the guidelines; or (3) the guidelines call for specific instructions
on a case-by-case basis. The proxy voting service is also requested to call to
the Proxy Coordinator's attention specific proxy questions that, while governed
by a guideline, appear to involve unusual or controversial issues.
PROXY COORDINATOR
Pioneer's Director of Investment Operations (the "Proxy Coordinator")
coordinates the voting, procedures and reporting of proxies on behalf of
Pioneer's clients. The Proxy Coordinator will deal directly with the proxy
voting service and, in the case of proxy questions referred by the proxy voting
service, will solicit voting recommendations and instructions from the Director
of Portfolio Management US. The Proxy Coordinator is responsible for ensuring
that these questions and referrals are responded to in a timely fashion and for
transmitting appropriate voting instructions to the proxy voting service. The
Proxy Coordinator is responsible for verifying with the Compliance Department
whether Pioneer's voting power is subject to any limitations or guidelines
issued by the client (or in the case of an employee benefit plan, the plan's
trustee or other fiduciaries).
REFERRAL ITEMS
From time to time, the proxy voting service will refer proxy questions to the
Proxy Coordinator that are described by Pioneer's policy as to be voted on a
case-by-case basis, that are not covered by Pioneer's guidelines or where
Pioneer's guidelines may be unclear with respect to the matter to be voted on.
Under such certain circumstances, the Proxy Coordinator will seek a written
voting recommendation from the Director of Portfolio Management US. Any such
recommendation will include: (i) the manner in which the proxies should be
voted; (ii) the rationale underlying
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any such decision; and (iii) the disclosure of any contacts or communications
made between Pioneer and any outside parties concerning the proxy proposal prior
to the time that the voting instructions are provided. In addition, the Proxy
Coordinator will ask the Compliance Department to review the question for any
actual or apparent conflicts of interest as described below under "Conflicts of
Interest." The Compliance Department will provide a "Conflicts of Interest
Report," applying the criteria set forth below under "Conflicts of Interest," to
the Proxy Coordinator summarizing the results of its review. In the absence of a
conflict of interest, the Proxy Coordinator will vote in accordance with the
recommendation of the Director of Portfolio Management US.
If the matter presents a conflict of interest for Pioneer, then the Proxy
Coordinator will refer the matter to the Proxy Voting Oversight Group for a
decision. In general, when a conflict of interest is present, Pioneer will vote
according to the recommendation of the Director of Portfolio Management US where
such recommendation would go against Pioneer's interest or where the conflict is
deemed to be immaterial. Pioneer will vote according to the recommendation of
its proxy voting service when the conflict is deemed to be material and the
Pioneer's internal vote recommendation would favor Pioneer's interest, unless a
client specifically requests Pioneer to do otherwise. When making the final
determination as to how to vote a proxy, the Proxy Voting Oversight Group will
review the report from the Director of Portfolio Management US and the Conflicts
of Interest Report issued by the Compliance Department.
CONFLICTS OF INTEREST
Occasionally, Pioneer may have a conflict that can affect how its votes proxies.
The conflict may be actual or perceived and may exist when the matter to be
voted on concerns:
- An affiliate of Pioneer, such as another company belonging to the
UniCredito Italiano S.p.A. banking group;
- An issuer of a security for which Pioneer acts as a sponsor,
adviser, manager, custodian, distributor, underwriter, broker, or
other similar capacity; or
- A person with whom Pioneer (or any of its affiliates) has an
existing, material contract or business relationship that was not
entered into in the ordinary course of Pioneer's business.
Any associate involved in the proxy voting process with knowledge of any
apparent or actual conflict of interest must disclose such conflict to the Proxy
Coordinator and the Compliance Department. The Compliance Department will review
each item referred to Pioneer to determine whether an actual or potential
conflict of interest with Pioneer exists in connection with the proposal(s) to
be voted upon. The review will be conducted by comparing the apparent parties
affected by the proxy proposal being voted upon against the Compliance
Department's internal list of interested persons and, for any matches found,
evaluating the anticipated magnitude and possible probability of any conflict of
interest being present. For each referral item, the determination regarding the
presence or absence of any actual or potential conflict of interest will be
documented in a Conflicts of Interest Report to the Proxy Coordinator
SECURITIES LENDING
Proxies are not available to be voted when the shares are out on loan through
either Pioneer's Lending Program or a client's managed security lending program.
If the Portfolio Manager would like to vote a block of previously lent shares,
the Proxy Coordinator will work with the Portfolio Manager and Investment
Operations to recall the security, to the extent possible, to facilitate the
vote on the entire block of shares.
SHARE-BLOCKING
"Share-blocking" is a market practice whereby shares are sent to a custodian
(which may be different than the account custodian) for record keeping and
voting at the general meeting. The shares are unavailable for sale or delivery
until the end of the blocking period (typically the day after general meeting
date).
Pioneer will vote in those countries with "share-blocking." In the event a
manager would like to sell a security with "share-blocking", the Proxy
Coordinator will work with the Portfolio Manager and Investment Operations
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Department to recall the shares (as allowable within the market time-frame and
practices) and/or communicate with executing brokerage firm. A list of countries
with "share-blocking" is available from the Investment Operations Department
upon request.
RECORD KEEPING
The Proxy Coordinator shall ensure that Pioneer's proxy voting service:
- Retains a copy of the proxy statement received (unless the proxy
statement is available from the SEC's Electronic Data Gathering,
Analysis, and Retrieval (EDGAR) system);
- Retains a record of the vote cast;
- Prepares Form N-PX for filing on behalf of each client that is a
registered investment company; and
- Is able to promptly provide Pioneer with a copy of the voting record
upon its request.
The Proxy Coordinator shall ensure that for those votes that may require
additional documentation (i.e. conflicts of interest, exception votes and
case-by-case votes) the following records are maintained:
- A record memorializing the basis for each referral vote cast;
- A copy of any document created by Pioneer that was material in
making the decision on how to vote the subject proxy; and
- A copy of any conflict notice, conflict consent or any other written
communication (including emails or other electronic communications)
to or from the client (or in the case of an employee benefit plan,
the plan's trustee or other fiduciaries) regarding the subject proxy
vote cast by, or the vote recommendation of, Pioneer.
Pioneer shall maintain the above records in the client's file for a period not
less than six (6) years.
DISCLOSURE
Pioneer shall take reasonable measures to inform its clients of the process or
procedures clients must follow to obtain information regarding how Pioneer voted
with respect to assets held in their accounts. In addition, Pioneer shall
describe to clients its proxy voting policies and procedures and will furnish a
copy of its proxy voting policies and procedures upon request. This information
may be provided to clients through Pioneer's Form ADV (Part II) disclosure, by
separate notice to the client, or by Pioneer's website.
PROXY VOTING OVERSIGHT GROUP
The members of the Proxy Voting Oversight Group are Pioneer's: Director of
Portfolio Management US, Head of Investment Operations, and Director of
Compliance. Other members of Pioneer will be invited to attend meetings and
otherwise participate as necessary.
The Proxy Voting Oversight Group is responsible for developing, evaluating, and
changing (when necessary) Pioneer's Proxy Voting Policies and Procedures. The
group meets at least annually to evaluate and review these policies and
procedures and the services of its third-party proxy voting service. In
addition, the Proxy Voting Oversight Group will meet as necessary to vote on
referral items and address other business as necessary.
PROXY VOTING POLICIES
Pioneer's sole concern in voting proxies is the economic effect of the proposal
on the value of portfolio holdings, considering both the short- and long-term
impact. In many instances, Pioneer believes that supporting the
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company's strategy and voting "for" management's proposals builds portfolio
value. In other cases, however, proposals set forth by management may have a
negative effect on that value, while some shareholder proposals may hold the
best prospects for enhancing it. Pioneer monitors developments in the
proxy-voting arena and will revise this policy as needed.
All proxies for U.S. companies and proxies for non-U.S. companies that are
received promptly will be voted in accordance with the specific policies listed
below. All shares in a company held by Pioneer-managed accounts will be voted
alike, unless a client has given us specific voting instructions on an issue or
has not delegated authority to us. Proxy voting issues will be reviewed by
Pioneer's Proxy Voting Oversight Group, which consists of the Director of
Portfolio Management US, the Director of Investment Operations (the Proxy
Coordinator), and the Director of Compliance.
Pioneer has established Proxy Voting Procedures for identifying and reviewing
conflicts of interest that may arise in the voting of proxies.
Clients may request, at any time, a report on proxy votes for securities held in
their portfolios and Pioneer is happy to discuss our proxy votes with company
management. Pioneer retains a proxy voting service to provide research on proxy
issues and to process proxy votes.
ADMINISTRATIVE
While administrative items appear infrequently in U.S. issuer proxies, they are
quite common in non-U.S. proxies.
We will generally support these and similar management proposals:
- Corporate name change.
- A change of corporate headquarters.
- Stock exchange listing.
- Establishment of time and place of annual meeting.
- Adjournment or postponement of annual meeting.
- Acceptance/approval of financial statements.
- Approval of dividend payments, dividend reinvestment plans and other
dividend-related proposals.
- Approval of minutes and other formalities.
- Authorization of the transferring of reserves and allocation of
income.
- Amendments to authorized signatories.
- Approval of accounting method changes or change in fiscal year-end.
- Acceptance of labor agreements.
- Appointment of internal auditors.
Pioneer will vote on a case-by-case basis on other routine business; however,
Pioneer will oppose any routine business proposal if insufficient information is
presented in advance to allow Pioneer to judge the merit of the proposal.
Pioneer has also instructed its proxy voting service to inform Pioneer of its
analysis of any administrative
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items inconsistent, in its view, with supporting the value of Pioneer portfolio
holdings so that Pioneer may consider and vote on those items on a case-by-case
basis.
AUDITORS
We normally vote for proposals to:
- Ratify the auditors. We will consider a vote against if we are
concerned about the auditors' independence or their past work for
the company. Specifically, we will oppose the ratification of
auditors and withhold votes from audit committee members if
non-audit fees paid by the company to the auditing firm exceed the
sum of audit fees plus audit-related fees plus permissible tax fees
according to the disclosure categories proposed by the Securities
and Exchange Commission.
- Restore shareholder rights to ratify the auditors.
We will normally oppose proposals that require companies to:
- Seek bids from other auditors.
- Rotate auditing firms.
- Indemnify auditors.
- Prohibit auditors from engaging in non-audit services for the
company.
BOARD OF DIRECTORS
On issues related to the board of directors, Pioneer normally supports
management. We will, however, consider a vote against management in instances
where corporate performance has been very poor or where the board appears to
lack independence.
GENERAL BOARD ISSUES
Pioneer will vote for:
- Audit, compensation and nominating committees composed of
independent directors exclusively.
- Indemnification for directors for actions taken in good faith in
accordance with the business judgment rule. We will vote against
proposals for broader indemnification.
- Changes in board size that appear to have a legitimate business
purpose and are not primarily for anti-takeover reasons.
- Election of an honorary director.
We will vote against:
- Separate chairman and CEO positions. We will consider voting with
shareholders on these issues in cases of poor corporate performance.
- Minimum stock ownership by directors.
- Term limits for directors. Companies benefit from experienced
directors, and shareholder control is better achieved through annual
votes.
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- Requirements for union or special interest representation on the
board.
- Requirements to provide two candidates for each board seat.
ELECTIONS OF DIRECTORS
In uncontested elections of directors we will vote against:
- Individual directors with absenteeism above 25% without valid
reason. We support proposals that require disclosure of director
attendance.
- Insider directors and affiliated outsiders who sit on the audit,
compensation, stock option or nominating committees. For the
purposes of our policy, we accept the definition of affiliated
directors provided by our proxy voting service.
We will also vote against directors who:
- Have implemented or renewed a dead-hand or modified dead-hand poison
pill (a "dead-hand poison pill" is a shareholder rights plan that
may be altered only by incumbent or "dead" directors. These plans
prevent a potential acquirer from disabling a poison pill by
obtaining control of the board through a proxy vote).
- Have ignored a shareholder proposal that has been approved by
shareholders for two consecutive years.
- Have failed to act on a takeover offer where the majority of
shareholders have tendered their shares.
- Appear to lack independence or are associated with very poor
corporate performance.
We will vote on a case-by case basis on these issues:
- Contested election of directors.
- Prior to phase-in required by SEC, we would consider supporting
election of a majority of independent directors in cases of poor
performance.
- Mandatory retirement policies.
CAPITAL STRUCTURE
Managements need considerable flexibility in determining the company's financial
structure, and Pioneer normally supports managements' proposals in this area. We
will, however, reject proposals that impose high barriers to potential
takeovers.
Pioneer will vote for:
- Changes in par value.
- Reverse splits, if accompanied by a reduction in number of shares.
- Share repurchase programs, if all shareholders may participate on
equal terms.
- Bond issuance.
- Increases in "ordinary" preferred stock.
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- Proposals to have blank-check common stock placements (other than
shares issued in the normal course of business) submitted for
shareholder approval.
- Cancellation of company treasury shares.
We will vote on a case-by-case basis on the following issues:
- Reverse splits not accompanied by a reduction in number of shares,
considering the risk of delisting.
- Increase in authorized common stock. We will make a determination
considering, among other factors:
- Number of shares currently available for issuance;
- Size of requested increase (we would normally approve increases of
up to 100% of current authorization);
- Proposed use of the additional shares; and
- Potential consequences of a failure to increase the number of
shares outstanding (e.g., delisting or bankruptcy).
- Blank-check preferred. We will normally oppose issuance of a new
class of blank-check preferred, but may approve an increase in a
class already outstanding if the company has demonstrated that it
uses this flexibility appropriately.
- Proposals to submit private placements to shareholder vote.
- Other financing plans.
We will vote against preemptive rights that we believe limit a company's
financing flexibility.
COMPENSATION
Pioneer supports compensation plans that link pay to shareholder returns and
believes that management has the best understanding of the level of compensation
needed to attract and retain qualified people. At the same time, stock-related
compensation plans have a significant economic impact and a direct effect on the
balance sheet. Therefore, while we do not want to micromanage a company's
compensation programs, we will place limits on the potential dilution these
plans may impose.
Pioneer will vote for:
- 401(k) benefit plans.
- Employee stock ownership plans (ESOPs), as long as shares allocated
to ESOPs are less than 5% of outstanding shares. Larger blocks of
stock in ESOPs can serve as a takeover defense. We will support
proposals to submit ESOPs to shareholder vote.
- Various issues related to the Omnibus Budget and Reconciliation Act
of 1993 (OBRA), including:
- Amendments to performance plans to conform with OBRA;
- Caps on annual grants or amendments of administrative
features;
- Adding performance goals; and
- Cash or cash-and-stock bonus plans.
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- Establish a process to link pay, including stock-option grants, to
performance, leaving specifics of implementation to the company.
- Require that option repricings be submitted to shareholders.
- Require the expensing of stock-option awards.
- Require reporting of executive retirement benefits (deferred
compensation, split-dollar life insurance, SERPs, and pension
benefits).
- Employee stock purchase plans where the purchase price is equal to
at least 85% of the market price, where the offering period is no
greater than 27 months and where potential dilution (as defined
below) is no greater than 10%.
We will vote on a case-by-case basis on the following issues:
- Executive and director stock-related compensation plans. We will
consider the following factors when reviewing these plans:
- The program must be of a reasonable size. We will approve
plans where the combined employee and director plans together
would generate less than 15% dilution. We will reject plans
with 15% or more potential dilution.
Dilution = (A + B + C) / (A + B + C + D), where
A = Shares reserved for plan/amendment,
B = Shares available under continuing plans,
C = Shares granted but unexercised and
D = Shares outstanding.
- The plan must not:
- Explicitly permit unlimited option repricing authority
or that have repriced in the past without shareholder
approval.
- Be a self-replenishing "evergreen" plan, plans that
grant discount options and tax offset payments.
- We are generally in favor of proposals that increase
participation beyond executives.
- All other employee stock purchase plans.
- All other compensation-related proposals, including deferred
compensation plans, employment agreements, loan guarantee programs
and retirement plans.
- All other proposals regarding stock compensation plans, including
extending the life of a plan, changing vesting restrictions,
repricing options, lengthening exercise periods or accelerating
distribution of awards and pyramiding and cashless exercise
programs.
We will vote against:
- Limits on executive and director pay.
- Stock in lieu of cash compensation for directors.
- Pensions for non-employee directors. We believe these retirement
plans reduce director objectivity.
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- Elimination of stock option plans.
CORPORATE GOVERNANCE
Pioneer will vote for:
- Confidential Voting.
- Equal access provisions, which allow shareholders to contribute
their opinion to proxy materials.
- Disclosure of beneficial ownership.
We will vote on a case-by-case basis on the following issues:
- Change in the state of incorporation. We will support
reincorporations supported by valid business reasons. We will oppose
those that appear to be solely for the purpose of strengthening
takeover defenses.
- Bundled proposals. We will evaluate the overall impact of the
proposal.
- Adopting or amending the charter, bylaws or articles of association.
- Shareholder appraisal rights, which allow shareholders to demand
judicial review of an acquisition price. We believe that the courts
currently handle this situation adequately without this mechanism.
We will vote against:
- Shareholder advisory committees. While management should solicit
shareholder input, we prefer to leave the method of doing so to
management's discretion.
- Limitations on stock ownership or voting rights.
- Reduction in share ownership disclosure guidelines.
MERGERS AND RESTRUCTURINGS
Pioneer will vote on the following and similar issues on a case-by-case basis:
- Mergers and acquisitions.
- Corporate restructurings, including spin-offs, liquidations, asset
sales, joint ventures, conversions to holding company and
conversions to self-managed REIT structure.
- Debt restructurings.
- Conversion of securities.
- Issuance of shares to facilitate a merger.
- Private placements, warrants, convertible debentures.
- Proposals requiring management to inform shareholders of merger
opportunities.
We will normally vote against shareholder proposals requiring that the company
be put up for sale.
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MUTUAL FUNDS
Many of our portfolios may invest in shares of closed-end mutual funds or
exchange-traded funds. The non-corporate structure of these investments raises
several unique proxy voting issues.
Pioneer will vote for:
- Establishment of new classes or series of shares.
- Establishment of a master-feeder structure.
Pioneer will vote on a case-by-case on:
- Changes in investment policy. We will normally support changes that
do not affect the investment objective or overall risk level of the
Fund. We will examine more fundamental changes on a case-by-case
basis.
- Approval of new or amended advisory contracts.
- Changes from closed-end to open-end format.
- Authorization for, or increase in, preferred shares.
- Disposition of assets, termination, liquidation, or mergers.
SOCIAL ISSUES
Pioneer will abstain on proposals calling for greater disclosure of corporate
activities with regard to social issues. We believe these issues are important
and should receive management attention.
Pioneer will vote against proposals calling for changes in the company's
business. We will also normally vote against proposals with regard to
contributions, believing that management should control the routine disbursement
of funds.
TAKEOVER-RELATED MEASURES
Pioneer is generally opposed to proposals that may discourage takeover attempts.
We believe that the potential for a takeover helps ensure that corporate
performance remains high.
Pioneer will vote for:
- Cumulative voting.
- Increase ability for shareholders to call special meetings.
- Increase ability for shareholders to act by written consent.
- Restrictions on the ability to make greenmail payments.
- Submitting rights plans to shareholder vote.
- Rescinding shareholder rights plans ("poison pills").
- Opting out of the following state takeover statutes:
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- Control share acquisition statutes, which deny large holders voting
rights on holdings over a specified threshold.
- Control share cash-out provisions, which require large holders to
acquire shares from other holders.
- Freeze-out provisions, which impose a waiting period on large
holders before they can attempt to gain control.
- Stakeholder laws, which permit directors to consider interests of
non-shareholder constituencies.
- Disgorgement provisions, which require acquirers to disgorge profits
on purchases made before gaining control.
- Fair price provisions.
- Authorization of shareholder rights plans.
- Labor protection provisions.
- Mandatory classified boards.
We will vote on a case-by-case basis on the following issues:
- Fair price provisions. We will vote against provisions requiring
supermajority votes to approve takeovers. We will also consider
voting against proposals that require a supermajority vote to repeal
or amend the provision. Finally, we will consider the mechanism used
to determine the fair price; we are generally opposed to complicated
formulas or requirements to pay a premium.
- Opting out of state takeover statutes regarding fair price
provisions. We will use the criteria used for fair price provisions
in general to determine our vote on this issue.
- Proposals that allow shareholders to nominate directors.
We will vote against:
- Classified boards.
- Limiting shareholder ability to remove or appoint directors. We will
support proposals to restore shareholder authority in this area. We
will review on a case-by-case basis proposals that authorize the
board to make interim appointments.
- Classes of shares with unequal voting rights.
- Supermajority vote requirements.
- Severance packages ("golden" and "tin" parachutes). We will support
proposals to put these packages to shareholder vote.
- Reimbursement of dissident proxy solicitation expenses. While we
ordinarily support measures that encourage takeover bids, we believe
that management should have full control over corporate funds.
- Extension of advance notice requirements for shareholder proposals.
- Granting board authority normally retained by shareholders (e.g.,
amend charter, set board size).
B-13
- Shareholder rights plans ("poison pills"). These plans generally
allow shareholders to buy additional shares at a below-market price
in the event of a change in control and may deter some bids.
APPENDIX C -- STATEMENT OF PREFERENCES OF AUCTION MARKET PREFERRED SHARES
PIONEER FLOATING RATE TRUST
STATEMENT OF PREFERENCES OF
AUCTION MARKET PREFERRED SHARES
C-1
TABLE OF CONTENTS
PART I........................................................................................................C-32
1. Number of Authorized Shares.................................................................C-32
2. Dividends...................................................................................C-32
3. Designation of Special Dividend Periods.....................................................C-35
4. Voting Rights...............................................................................C-36
5. 1940 Act Preferred Share Asset Coverage.....................................................C-39
6. Preferred Shares Basic Maintenance Amount...................................................C-39
7. Restrictions on Dividends and Other Distributions...........................................C-41
8. Rating Agency Restrictions..................................................................C-42
9. Redemption..................................................................................C-46
10. Liquidation Rights..........................................................................C-49
11. Miscellaneous...............................................................................C-50
PART II.......................................................................................................C-50
1. Orders......................................................................................C-51
2. Submission of Orders by Broker-Dealers to Auction Agent.....................................C-52
3. Determination of Sufficient Clearing Bids, Winning Bids Rate and Applicable Rate............C-53
4. Acceptance and Rejection of Submitted Bids and Submitted Sell Orders and Allocation of
Shares......................................................................................C-55
5. Auction Agent...............................................................................C-57
6. Transfer of Preferred Shares................................................................C-57
7. Global Certificate..........................................................................C-57
8. Force Majeure...............................................................................C-57
C-2
PIONEER FLOATING RATE TRUST, a Delaware statutory trust (the "Trust"),
certifies that:
First: Pursuant to authority expressly vested in the Board of Trustees of
the Trust by Article V of the Trust's Agreement and Declaration of Trust, dated
October 6, 2004 (which, as hereafter restated or amended from time to time is,
together with this Statement, herein called the "Declaration"), the Board of
Trustees adopts this Statement of Preferences of Auction Market Preferred Shares
(the "Statement"), authorizes the establishment, designation and issuance of an
unlimited number of shares of the Trust's Auction Market Preferred Shares,
liquidation preference $25,000 per share, having the designation or designations
set forth in this Statement (the "Auction Market Preferred Shares" or "Preferred
Shares").
Second: The Auction Market Preferred Shares shall be issuable in such
series as are designated from time to time by the Board and shall have the
preferences, voting powers, restrictions, limitations as to dividends,
qualifications, terms and conditions of redemption, and other rights and
limitations set forth in this Statement. As of , 2005, the following series of
Auction Market Preferred Shares are established:
1. Auction Market Preferred Shares, Series [ ]: An unlimited number of
Auction Market Preferred Shares, $0.0001 par value per share, liquidation
preference $25,000 per Auction Market Preferred Share plus accumulated but
unpaid dividends, if any, thereon (whether or not earned or declared), is
hereby designated "Auction Market Preferred Shares, Series [ ] ." Each
Auction Market Preferred Share, Series [ ] (sometimes referred to herein
as "Series [ ] Preferred Shares") may be issued on a date to be determined
by the Board of Trustees of the Trust or pursuant to their delegated
authority; have an Initial Dividend Rate and an Initial Dividend Payment
Date as shall be determined in advance of the issuance thereof by the
Board of Trustees of the Trust or pursuant to their delegated authority
and have such other preferences as provided herein or as may be determined
in advance of the issuance thereof by the Board of Trustees or pursuant to
their delegated authority. The Series [ ] Preferred Shares shall
constitute a separate series of Auction Market Preferred Shares, and each
Series [ ] Preferred Shares shall be identical.
2. Auction Market Preferred Shares, Series [ ]: An unlimited number of
Auction Market Preferred Shares, $0.0001 par value per share, liquidation
preference $25,000 per Auction Market Preferred Share plus accumulated but
unpaid dividends, if any, thereon (whether or not earned or declared), is
hereby designated "Auction Market Preferred Shares, Series [ ] ." Each
Auction Market Preferred Share, Series [ ] (sometimes referred to herein
as "Series [ ] Preferred Shares") may be issued on a date to be determined
by the Board of Trustees of the Trust or pursuant to their delegated
authority; have an Initial Dividend Rate and an Initial Dividend Payment
Date as shall be determined in advance of the issuance thereof by the
Board of Trustees of the Trust or pursuant to their delegated authority
and have such other preferences as provided herein or as may be determined
in advance of the issuance thereof by the Board of Trustees or pursuant to
their delegated authority. The Series [ ] Preferred Shares shall
constitute a separate series of Auction Market Preferred Shares, and each
Series [ ] Preferred Shares shall be identical.
3. Auction Market Preferred Shares, Series [ ]: An unlimited number of
Auction Market Preferred Shares, $0.0001 par value per share, liquidation
preference $25,000 per Auction Market Preferred Share plus accumulated but
unpaid dividends, if any, thereon (whether or not earned or declared), is
hereby designated "Auction Market Preferred Shares, Series [ ] ." Each
Auction Market Preferred Share, Series [ ] (sometimes referred to herein
as "Series [ ] Preferred Shares") may be issued on a date to be determined
by the Board of Trustees of the Trust or pursuant to their delegated
authority; have an Initial Dividend Rate and an Initial Dividend Payment
Date as shall be determined in advance of the issuance thereof by the
Board of Trustees of the Trust or pursuant to their delegated authority
and have such other preferences as provided herein or as may be determined
in advance of the issuance thereof by the Board of Trustees or pursuant to
their delegated authority. The Series [ ] Preferred Shares shall
constitute a separate series of Auction Market Preferred Shares, and each
Series [ ] Preferred Shares shall be identical.
Third: The preferences, voting powers restrictions, limitations as to
dividends, qualifications, terms and conditions of redemption, and other rights
and limitations of the shares of the Series [ ] Preferred Shares, Series [ ]
Preferred Shares, and Series [ ] Preferred Shares, and each other series of
Preferred Shares now or hereafter described in this Statement are or shall be as
set forth in this Statement. No fractional Preferred Shares shall be issued.
C-3
Fourth: That any provisions of the Declaration that conflict with or are
inconsistent with the provisions of this Statement are hereby amended to conform
to the terms of this Statement.
DEFINITIONS
As used in Parts I and II of this Statement, the following terms shall
have the following meanings (with terms defined in the singular having
comparable meanings when used in the plural and vice versa), unless the context
otherwise requires:
"1940 Act" means the Investment Company Act of 1940, as amended from time
to time, and the rules and regulations thereunder.
"1940 Act Cure Date," with respect to the failure by the Trust to maintain
the 1940 Act Preferred Share Asset Coverage (as required by Section 5 of Part I
of this Statement) as of the last Business Day of each month, shall mean the
last Business Day of the following month.
"1940 Act Preferred Share Asset Coverage" shall mean asset coverage, as
defined in Section 18(h) of the 1940 Act, of at least 200% with respect to all
outstanding senior securities of the Trust which are shares of beneficial
interest including all Outstanding Preferred Shares (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 or stock of a
closed-end investment company as a condition of declaring dividends on its
common shares or stock).
"Affected Series" has the meaning set forth in Section 4(c) of Part I of
this Statement.
"Affiliate" means any Person known to the Auction Agent to be controlled
by, in control of, or under common control with, the Trust.
"Agent Member" means a member of, or participant in, the Securities
Depository that will act on behalf of a Beneficial Owner of one or more
Preferred Shares or on behalf of a Potential Beneficial Owner.
"Annual Valuation Date" means the last Friday before the fiscal year end
of the Trust (or if the last Friday is a holiday, then the immediate prior
business day).
"Applicable Percentage" and "Applicable Spread" mean the percentage
determined based on the lower of the credit ratings assigned to the series of
Preferred Shares on such date by Moody's and Fitch (or if Moody's and Fitch are
not making such rating available, the equivalent of such rating by a substitute
rating agency):
Moody's Credit Rating Fitch Credit Rating Applicable Percentage Applicable Spread
--------------------- ------------------- --------------------- -----------------
Aaa AAA 125% 1.25%
Aa3 to Aa1 AA- to AA+ 150% 1.50%
A3 to A1 A- to A+ 200% 2.00%
Baa3 to Baa1 BBB- to BBB+ 250% 2.50%
Ba1 and lower BB+ and lower 300% 3.00%
The Applicable Percentage and the Applicable Spread as so determined shall
be further subject to upward but not downward adjustment in the discretion of
the Board of Trustees of the Trust after consultation with the Broker-Dealers,
provided that immediately following any such increase the Trust would be in
compliance with the Preferred Shares Basic Maintenance Amount. The Trust shall
take all reasonable action necessary to enable Moody's and Fitch to provide a
rating for each series of Preferred Shares. If both Moody's and Fitch shall not
make such a rating available, the Trust shall select another Rating Agency to
act as a Substitute Rating Agency. However, the Trust shall not be required to
have more than one Rating Agency provide a rating for any series of the
Preferred Shares.
C-4
"Applicable Rate" means the rate per annum at which cash dividends are
payable on the Preferred Shares for any Dividend Period.
"Approved Price" means the "fair value" as determined by the Trust in
accordance with the valuation procedures adopted from time to time by the Board
of Trustees of the Trust and for which the Trust receives a marked-to-market
price (which, for the purpose of clarity, shall not mean Market Value) from an
independent source at least semi-annually.
"Auction" means a periodic operation of the Auction Procedures.
"Auction Agent" means [Deutsche Bank Trust Company Americas] unless and
until another commercial bank, trust company or other financial institution
appointed by a resolution of the Board of Trustees of the Trust or a duly
authorized committee thereof enters into an agreement with the Trust 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 Preferred Shares.
"Auction Date" with respect to any Dividend Period shall mean the Business
Day next preceding the first day of such Dividend Period.
"Auction Procedures" means the procedures for conducting Auctions set
forth in Part II of this Statement.
"Auditors' Confirmation" has the meaning set forth in Section 6(c) of Part
I of this Statement.
"Available Preferred Shares" shall have the meaning specified in paragraph
(a) of Section 3 of Part II of this Statement.
"Beneficial Owner" means a customer of a Broker-Dealer who is listed on
the records of that Broker-Dealer (or, if applicable, the Auction Agent) as a
holder of Preferred Shares or a Broker-Dealer that holds Preferred Shares for
its own account.
"Bid" and "Bids" shall have the respective meanings specified in paragraph
(a) of Section 1 of Part II of this Statement.
"Bidder" and "Bidders" shall have the respective meanings specified in
paragraph (a) of Section 1 of Part II of this Statement; provided, however, that
neither the Trust nor any affiliate thereof shall be permitted to be a Bidder in
an Auction, except that any Broker-Dealer that is an affiliate of the Trust may
be a Bidder in an Auction, but only if the Orders placed by such Broker-Dealer
are not for its own account.
"Board of Trustees" means the Board of Trustees of the Trust.
"Broker-Dealer" means any broker-dealer, or other entity permitted by law
to perform the functions required of a Broker-Dealer in Part II of this
Statement, that has been selected by the Trust and has entered into a
Broker-Dealer Agreement with the Auction Agent that remains effective.
"Broker-Dealer Agreement" means an agreement between the Auction Agent and
a Broker-Dealer pursuant to which such Broker-Dealer agrees to follow the
procedures specified in Part II of this Statement.
"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.
"Closing Transaction" has the meaning set forth in Section 8(b)(i) of Part
I of this Statement.
"Code" means the Internal Revenue Code of 1986, as amended from time to
time. Each reference herein to a section of the Code shall be deemed to include
the United States Treasury Regulations in effect thereunder and applicable to
the Preferred Shares or the use of proceeds thereof, and also includes all
applicable amendments or successor provisions unless the context requires
otherwise.
C-5
"Common Shares" means the shares of beneficial interest designated as
common shares, no par value, of the Trust.
"Cure Date" shall mean the Preferred Shares Basic Maintenance Cure Date or
the 1940 Act Cure Date.
"Date of Original Issue" means, with respect to any Preferred Shares, the
date on which the Trust first issues such share.
"Deposit Securities" means cash and portfolio securities 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 Fitch Discount Factor or a Moody's Discount
Factor, as applicable.
"Discounted Value" of any asset of the Trust means the quotient of the
Market Value of an Eligible Asset divided by the applicable Discount Factor.
"Dividend Payment Date," with respect to Preferred Shares, shall mean any
date on which dividends are payable on shares of such series pursuant to the
provisions of paragraph (d) of Section 2 of Part I of this Statement.
"Dividend Period" with respect to shares of a series of Preferred Shares,
shall mean the period from and including the Date of Original Issue of shares of
such series to but excluding the initial Dividend Payment Date for shares of
such series and any period thereafter from and including one Dividend Payment
Date for shares of such series to but excluding the next succeeding Dividend
Payment Date for shares of such series.
"Eligible Asset" means a Fitch Eligible Asset (if Fitch is then rating the
Preferred Shares), a Moody's Eligible Asset (if Moody's is then rating the
Preferred Shares) and/or any asset included in the calculations used by any
Rating Agency then rating the Preferred Shares for purposes of determining such
Rating Agency's rating on the Preferred Shares, as applicable.
"Existing Holder" means a Broker-Dealer, or any such other Person that may
be permitted by the Trust, that is listed as the holder of record of Preferred
Shares in the Share Books.
"Exposure Period" on a Valuation Date means the period commencing on such
date and ending 42 days thereafter for Fitch and 49 days thereafter for Moody's,
as such exposure period may be modified by resolution of the Board of Trustees;
provided, however, that the Trust shall have received confirmation in writing
from each Rating Agency that any such modification shall not adversely affect
such Rating Agency's then-current rating of the Preferred Shares.
"Failure to Deposit," with respect to shares of a series of Preferred
Shares, shall mean a failure by the Trust to pay to the Auction Agent, not later
than 12:00 noon, New York City time, (A) on the Business Day next preceding any
Dividend Payment Date for shares of such series, in funds available on such
Dividend Payment Date in the City of New York, New York, the full amount of any
dividend (whether or not earned or declared) to be paid on such Dividend Payment
Date on any share of such series or (B) on the Business Day next preceding any
redemption date in funds available on such redemption date for shares of such
series in the City of New York, New York, the Redemption Price to be paid on
such redemption date for any share of such Series after Notice of Redemption is
mailed pursuant to paragraph (c) of Section 9 of Part I of this Statement;
provided, however, that the foregoing clause (B) shall not apply to the Trust's
failure to pay the Redemption Price in respect of Preferred Shares when the
related Notice of Redemption provides that redemption of such shares is subject
to one or more conditions precedent and any such condition precedent shall not
have been satisfied at the time or times and in the manner specified in such
Notice of Redemption.
"Fitch" means Fitch Ratings or its successors.
C-6
"Fitch Discount Factor" means, for purposes of determining the Discounted
Value of any Fitch Eligible Asset, the percentage determined as follows. The
Fitch Discount Factor for any Fitch Eligible Asset other than the securities set
forth below will be the percentage provided in writing by Fitch.
(i) Corporate Debt Securities: the Fitch Discount Factor for corporate
debt securities is the percentage determined by reference to the rating on such
asset with reference to the remaining term to maturity of such asset, in
accordance with the table set forth below.
FITCH DISCOUNT FACTORS FOR CORPORATE DEBT SECURITIES INCLUDING NON-INVESTMENT
GRADE BONDS
NOT
Terms to Maturity AAA AA A BBB BB B RATED(1)
----------------- --- --- --- --- --- --- --------
1 year or less ................. 106% 108% 110% 112% 130% 152% 152%
2 years or less (but longer than
1 year) ........................ 106% 108% 110% 112% 130% 152% 152%
3 years or less (but longer than
2 years) ....................... 106% 108% 110% 112% 130% 152% 152%
4 years or less (but longer than
3 years) ....................... 111% 113% 115% 117% 134% 152% 152%
5 years or less (but longer than
4 years) ....................... 111% 113% 115% 117% 134% 152% 152%
7 years or less (but longer than
5 years) ....................... 114% 116% 118% 120% 136% 152% 152%
10 years or less (but longer
than 7 years) .................. 116% 118% 120% 122% 137% 152% 152%
15 years or less (but longer
than (but longer than 10
years) ......................... 120% 122% 124% 124% 139% 152% 152%
30 years or less (but longer
than 15 years) ................. 124% 127% 129% 129% 145% 152% 152%
Greater than 30 years .......... 124% 127% 129% 129% 145% 152% 152%
(1) If a security is not rated by Fitch but is rated by two other Rating
Agencies, then the lower of the ratings on the security from the two other
Rating Agencies will be used to determine the Fitch Discount Factor (e.g., where
the S&P rating is A and the Moody's rating is Baa, a Fitch rating of BBB will be
used). If a security is not rated by Fitch but is rated by only one other Rating
Agency, then the rating on the security from the other Rating Agency will be
used to determine the Fitch Discount Factor (e.g., where the only rating on a
security is an S&P rating of AAA, a Fitch rating of AAA will be used, and where
the only rating on a security is a Moody's rating of Ba, a Fitch rating of BB
will be used). If a security is not rated by any Rating Agency, the Trust will
use the percent set forth under "not rated" in this table. Securities rated
below B by Fitch shall be treated the same as securities not rated by Fitch.
The Fitch Discount Factors presented in the immediately preceding table apply to
corporate debt securities that are performing and have a Market Value determined
by a Pricing Service of an Approved Price. The Fitch Discount Factor noted in
the table above for a debt security rated B by Fitch shall apply to any
non-performing debt security with a price equal to or greater than $0.90. The
Fitch Discount Factor noted in the table above for a debt security rated below B
by Fitch shall apply to any non-performing debt security with a price less than
$0.90 but equal to or greater than $0.20. If a debt security does not have a
Market Value determined by a Pricing Service or an Approved Price, a rating two
rating categories below the actual rating on the debt security will be used
(e.g., where the actual rating is A-, the rating for debt securities rated BB-
will be used). The Fitch Discount Factor for a debt security issued by a limited
partnership that is not a Rule 144A Security shall be the Discount Factor
determined in accordance with the table set forth above multiplied by 105%.
The Fitch Discount Factors presented in the immediately preceding table will
also apply to corporate obligations backed by a guarantee, a letter of credit or
insurance issued by a third party. If the third-party credit rating is the
C-7
basis for the rating on the obligation, then the rating on the third party will
be used to determine the Fitch Discount Factor in the table.
(ii) Preferred stock: the Fitch Discount Factor applied to preferred stock
is the percentage determined by reference to the rating in accordance with the
table set forth below.
PREFERRED STOCK (1) DISCOUNT FACTOR
------------------- ---------------
AAA .................................... 130%
AA ..................................... 133%
A ...................................... 135%
BBB .................................... 139%
BB ..................................... 154%
Not rated or below BB .................. 161%
Investment grade DRD ................... 164%
Note rated or below investment grade DRD 200%
(1) If a security is not rated by Fitch but is rated by two other Rating
Agencies, then the lower of the ratings on the security from the two other
Rating Agencies will be used to determine the Fitch Discount Factor (e.g., where
the S&P rating is A and the Moody's rating is Baa, a Fitch rating of BBB will be
used). If a security is not rated by Fitch but is rated by only one other Rating
Agency, then the rating on the security from the other Rating Agency will be
used to determine the Fitch Discount Factor (e.g., where the only rating on a
security is an S&P rating of AAA, a Fitch rating of AAA will be used, and where
the only rating on a security is a Moody's rating of Ba, a Fitch rating of BB
will be used). If a security is not rated by any Rating Agency, the Trust will
use the percent set forth under "not rated" in this table. Securities rated
below B by Fitch shall be treated the same as securities not rated by Fitch.
(iii) Common stock and warrants: The Fitch Discount Factor applied to
common stock will be:
Large-cap stocks: 200%
Mid-cap stocks: 233%
Small-cap stocks: 286%
Others: 370%
See "Fitch Eligible Assets - common stocks" for definitions of large-cap,
mid-cap and small-cap stocks.
(iv) Convertible securities: the Fitch Discount Factor applied to
convertible securities is (A) 200% for investment grade convertibles and (B)
222% for below investment grade convertibles so long as such convertible debt
securities have neither (x) conversion premium greater than 100% nor (y) have a
yield to maturity or yield to worst of greater than 15% above the relevant
Treasury curve.
The Fitch Discount Factor applied to convertible debt securities which have
conversion premiums of greater than 100% is (A) 152% for investment grade
convertibles and (B) 179% for below investment grade convertibles so long as
such convertible debt securities do not have a yield to maturity or yield to
worse of greater than 15% above the relevant Treasury curve.
The Fitch Discount Factor applied to convertible debt securities which have a
yield to maturity or yield to worse of greater than 15% above the relevant
Treasury curve is 370%.
If a security is not rated by Fitch but is rated by two other Rating Agencies,
then the lower of the ratings on the security from the two other Rating Agencies
will be used to determine the Fitch Discount Factor (e.g., where the S&P rating
is A and the Moody's rating is Baa, a Fitch rating of BBB will be used). If a
security is not rated by Fitch but is rated by only one other Rating Agency,
then the rating on the security from the other Rating Agency will
C-8
be used to determine the Fitch Discount Factor (e.g., where the only rating on
a security is an S&P rating of AAA, a Fitch rating of AAA will be used, and
where the only rating on a security is a Moody's rating of Ba, a Fitch rating of
BB will be used). If a security is not rated by any Rating Agency, the Trust
will treat the security as if it were below investment grade.
(v) U.S. Government Securities:
TIME REMAINING TO MATURITY DISCOUNT FACTOR
-------------------------- ---------------
1 year or less ............................... 101.5%
2 years or less (but longer than 1 year) ..... 103%
3 years or less (but longer than 2 years) .... 105%
4 years or less (but longer than 3 years) .... 107%
5 years or less (but longer than 4 years) .... 109%
7 years or less (but longer than 5 years) .... 112%
10 years or less (but longer than 7 years) ... 114%
15 years or less (but longer than 10 years) .. 122%
20 years or less (but longer than 15 years) .. 130%
25 years or less (but longer than 20 years) .. 146%
Greater than 30 years ........................ 154%
(vi) Short-Term Investments and Cash: the Fitch Discount Factor applied to
short-term portfolio securities, including without limitation Debt Securities,
Short Term Money Market Instruments and Municipal Debt Obligations, will be (A)
100%, so long as such portfolio securities mature or have a demand feature at
part exercisable within the Fitch Exposure Period; (B) 115%, so long as such
portfolio securities mature or have a demand feature at part no exercisable
within the Fitch Exposure Period; and (C) 125%, so long as such portfolio
securities neither mature nor have a demand feature at part exercisable within
the Fitch Exposure Period. A Fitch Discount Factor of 100% will be applied to
cash.
(vii) Rule 144A Securities: the Fitch Discount Factor applied to Rule 144A
Securities shall be the Discount Factor determined in accordance with the table
above under "Corporate Debt Securities" in subsection (i), multiplied by 110%
until such securities are registered under the Securities Act.
(viii) Senior Loans: The Fitch Discount Factor applied to senior, secured
floating rate Loans made to corporate and other business entities ("Senior
Loans") shall be the percentage specified in the table below opposite such Fitch
Loan Category:
Fitch Loan Category Discount Factor
------------------- ---------------
A 115%
B 130%
C 152%
D 370%
Notwithstanding any other provision contained above, for purposes of
determining whether a Fitch Eligible Asset falls within a specific Fitch Loan
Category, to the extent that any Fitch Eligible Asset would fall within more
than one of the Fitch Loan Categories, such Fitch Eligible Asset shall be deemed
to fall into the Fitch Loan Category with the lowest applicable Fitch Discount
Factor.
(ix) Asset-backed and mortgage-backed securities: The percentage
determined by reference to the asset type in accordance with the table set forth
below.
C-9
ASSET TYPE (WITH
TIME REMAINING TO MATURITY, IF APPLICABLE) DISCOUNT FACTOR
------------------------------------------ ---------------
U.S. Treasury/agency securities (10 years or less) 118%
U.S. Treasury/agency securities (greater than 10 years) 127%
U.S. agency sequentials (10 years or less) 128%
U.S. agency sequentials (greater than 10 years) 142%
U.S. agency principal only securities 236%
U.S. agency interest only securities (with Market Value greater than $0.40) 696%
U.S. agency interest only securities (with Market Value less than or equal to $0.40) 214%
AAA LockOut securities, interest only 236%
U.S. agency planned amortization class bonds (10 years or less) 115%
U.S. agency planned amortization class bonds (greater than 10 years) 136%
AAA sequentials (10 years or less) 118%
AAA sequentials (greater than 10 years) 135%
AAA planned amortization class bonds (10 years or less) 115%
AAA planned amortization class bonds (greater than 10 years) 140%
Jumbo mortgage rated AAA(1) 123%
Jumbo mortgage rated AA(1) 130%
Jumbo mortgage rated A(1) 136%
Jumbo mortgage rated BBB(1) 159%
Commercial mortgage-backed securities rated AAA 131%
Commercial mortgage-backed securities rated AA 139%
Commercial mortgage-backed securities rated A 148%
Commercial mortgage-backed securities rated BBB 177%
Commercial mortgage-backed securities rated BB 283%
Commercial mortgage-backed securities rated B 379%
Commercial mortgage-backed securities rated CCC or not rated 950%
(1) Applies to jumbo mortgages, credit cards, auto loans, home equity loans,
manufactured housing and prime mortgage-backed securities not issued by a U.S.
agency or instrumentality.
(x) Futures and call options: for purposes of the Preferred Shares Basic
Maintenance Amount, futures held by the Trust and call options sold by the Trust
shall not be included as Fitch Eligible Assets. However, such assets shall be
valued at Market Value by subtracting the good faith margin and the maximum
daily trading variance as of the Valuation Date. For call options purchased by
the Trust, the Market Value of the call option will be included as a Fitch
Eligible Asset subject to a Fitch Discount Factor mutually agreed to between the
Trust and Fitch based on the characteristics of the option contract such as its
maturity and the underlying security of the contract.
(xi) Securities lending: the Trust may engage in securities lending in an
amount not to exceed 10% [P.43 STATES 15%] of the Trust's total gross assets.
For purposes of calculating the Preferred Shares Basic Maintenance Amount, such
securities lent shall be included as Fitch Eligible Assets with the appropriate
Fitch Discount Factor applied to such lent security. The obligation to return
such collateral shall not be included as an obligation/liability for purposes of
calculating the Preferred Shares Basic Maintenance Amount. However, the Trust
may reinvest cash collateral for securities lent in conformity with its
investment objectives and policies and the provisions of these bylaws. In such
event, to the extent that securities lending collateral received is invested by
the Trust in assets that otherwise would be Fitch Eligible Assets and the value
of such assets exceeds the amount of the Trust's obligation to return the
collateral on a Valuation Date, such excess amount shall be included in the
calculation of Fitch Eligible Assets by applying the applicable Fitch Discount
Factor to this amount and adding the product to total Fitch Eligible Assets.
Conversely, if the value of assets in which securities lending collateral has
been invested is less then the amount of the Trust's obligation to return the
collateral on a Valuation Date, such difference shall be included as an
obligation/liability of the Trust for purposes of calculating the Preferred
Shares Basic Maintenance Amount. Collateral received by the Trust in a
securities lending transaction and maintained by the Trust in the form received
shall not be included as a Fitch Eligible Asset for purposes of calculating the
Preferred Shares Basic Maintenance Amount.
C-10
(xiii) Swaps (including Total Return Swaps and Interest Rate Swaps): Total
Return and Interest Rate Swaps are subject to the following provisions:
If the Trust has an outstanding gain from a swap transaction on a
Valuation Date, the gain will be included as a Fitch Eligible Asset subject to
the Fitch Discount Factor on the counterparty to the swap transaction. At the
time a swap is executed, the Trust will only enter into swap transactions where
the counterparty has at least a Fitch rating of A- or Moody's rating of A3.
(a) Only the cumulative unsettled profit and loss from a Total Return Swap
transaction will be calculated when determining the Preferred Shares Basic
Maintenance Amount. If the Trust has an outstanding liability from a swap
transaction on a Valuation Date, the Trust will count such liability as an
outstanding liability from the total Fitch Eligible Assets in calculating the
Preferred Shares Basic Maintenance Amount.
(b) In addition, for swaps other than Total Return Swaps, the Market Value
of the position (positive or negative) will be included as a Fitch Eligible
Asset. The aggregate notional value of all swaps will not exceed the Liquidation
Preference of the Outstanding Preferred Shares.
(c)(1) The underlying securities subject to a credit default swap sold by
the Trust will be subject to the applicable Fitch Discount Factor for each
security subject to the swap; (2) If the Trust purchases a credit default swap
and holds the underlying security, the Market Value of the credit default swap
and the underlying security will be included as a Fitch Eligible Asset subject
to the Fitch Discount Factor assessed based on the counterparty risk; and (3)
the Trust will not include a credit default swap as a Fitch Eligible Asset
purchase by the Trust without the Trust holding the underlying security or when
the Trust busy a credit default swap for a basket of securities without holding
all the securities in the basket.
(xiv) Municipal Obligations: the Fitch Discount Factor for Municipal
Obligations is 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 Exposure Period, in accordance with the
table set forth below.
RATING CATEGORY
Exposure Period AAA* AA* A* BBB* F1** UNRATED***
--------------- ---- --- -- ---- ---- ----------
7 weeks............................ 151% 159% 166% 173% 136% 225%
8 weeks or less but
greater than 7 weeks............... 154% 161% 168% 176% 137% 231%
9 weeks or less but
greater than 8 weeks............... 158% 163% 170% 177% 138% 240%
----------------
*Fitch rating (or, if not rated by Fitch, see the definition of "Fitch Eligible
Asset" below).
**Municipal Obligations rated F1 by Fitch (or, if not rated by Fitch, see the
definition of "Fitch Eligible Asset" below), which do not mature or have a
demand feature at par exercisable in 30 days and which do not have a long-term
rating.
***Includes Municipal Obligations rated less than BBB by Fitch (or, if not rated
by Fitch, see the definition of "Fitch Eligible Asset" below) and unrated
securities.
Notwithstanding the foregoing, (i) the Fitch Discount Factor for short-term
Municipal Obligations will be 115%, so long as such Municipal Obligations are
rated at least F2 by Fitch (or, if not rated by Fitch, rated MIG-1, VMIG-1 or
P-1 by Moody's or at least A-1+ or SP-1+ by S&P) and mature or have a demand
feature at par exercisable in 30 days or less, and (ii) no Fitch Discount Factor
will be applied to cash or to Receivables for Municipal Obligations Sold.
"Fitch Eligible Assets" means:
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(i) Cash (including interest and dividends due on assets rated (A) BBB or
higher by Fitch or the equivalent by another Rating Agency if the payment date
is within five (5) Business Days of the Valuation Date, (B) A or higher by Fitch
or the equivalent by another Rating Agency if the payment date is within thirty
(30) days of the Valuation Date, and (C) A+ or higher by Fitch or the equivalent
by another Rating Agency if the payment date is within the Fitch Exposure
Period) and receivables for Fitch Eligible Assets sole if the receivable is due
within five (5) Business Days of the Valuation Date, and if the trades which
generated such receivables are settled within five (5) Business Days;
(ii) Short Term Money Market Instruments so long as (A) such securities
are rated at least F1+ by Fitch or the equivalent by another Rating Agency, (B)
in the case of demand deposits, time deposits and overnight funds, the
supporting entity is rated at least A by Fitch or the equivalent by another
Rating Agency, or (C) in all other case, the supporting entity (1) is rated at
least A by Fitch or the equivalent by another Rating Agency and the security
matures within one month, (2) is rated at least A by Fitch or the equivalent by
another Rating Agency and the security matures within three months or (3) is
rated at least AA by Fitch or the equivalent by another Rating Agency and the
security matures within six months;
(iii) U.S. Government Securities;
(iv) Debt securities, if such securities have been registered under the
Securities Act or are restricted as to resale under federal securities laws but
are eligible for resale pursuant to Rule 144A under the Securities Act as
determined by the Trust's investment manager or portfolio manager acting
pursuant to procedures approved by the Board of Trustees of the Trust; and such
securities are issued by (1) a U.S. corporation, limited liability company or
limited partnership, (2) a corporation, limited liability company or limited
partnership domiciled in a member of the European Union, Argentina, Australia,
Brazil, Chile, Japan, Korea, and Mexico or other country if Fitch does not
inform the Trust that including debt securities from such foreign country will
adversely impact Fitch's rating of the Preferred Shares (the "Approved Foreign
Nations"), (3) the government of any Approved Foreign Nation or any of its
agencies, instrumentalities or political subdivisions (the debt securities of
Approved Foreign Nation issuers being referred to collectively as "Foreign
Bonds"), (4) a corporation, limited liability company or limited partnership
domiciled in Canada or (5) the Canadian government or any of its agencies,
instrumentalities or political subdivisions (the debt securities of Canadian
issuers being referred to collectively as "Canadian Bonds"). Foreign Bonds held
by the Trust will qualify as Fitch Eligible Assets only up to a maximum of 20%
of the aggregate Market Value of all assets constituting Fitch Eligible Assets.
Similarly, Canadian Bonds held by the Trust will qualify as Fitch Eligible
Assets only up to a maximum of 20% of the aggregate Market Value of all assets
constituting Fitch Eligible Assets. Notwithstanding the limitations in the two
preceding sentences, Foreign Bonds and Canadian Bonds held by the Trust will
qualify as Fitch Eligible Assets only up to a maximum of 30% of the aggregate
Market Value of all assets constituting Fitch Eligible Assets. All debt
securities satisfying the foregoing requirements and restriction of this
paragraph are herein referred to as "Debt Securities."
(v) Preferred stocks if (1) such securities provide for the periodic
payment of dividends thereon in cash in U.S. dollars or euros and do not provide
for conversion or exchange into, or have warrants attached entitling the holder
to receive equity capital at any time over the respective lives of such
securities, (2) the issuer or such a preferred stock has common stock listed on
either the New York Stock Exchange, the American Stock Exchange or in the
over-the-counter market, and (3) the issuer of such a preferred stock has a
senior debt rating or preferred stock rating from Fitch of BBB- or higher or the
equivalent rating by another Rating Agency. In addition, the preferred stocks
issue must be at least $50 million;
(vi) Rule 144A Securities;
(vii) Interest Rate Swaps entered into according to International Swap
Dealers Association ("ISDA") standards if (1) the counterparty to the swap
transaction has a short-term rating of not less than F1 by Fitch or the
equivalent by another Rating Agency, or, fit he swap counterparty does not have
a short-term rating, the counterparty's senior unsecured long-term debt rating
is AA or higher by Fitch or the equivalent by another Rating Agency and (2) the
originals aggregate notional amount of the Interest Rate Swap transaction or
transactions is not greater than the Liquidation Preference of the Preferred
Shares original issued;
(viii) Swaps, including Total Return Swaps entered into according to ISDA;
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(ix) Financial contracts, as such term is defined in Section
3(c)(2)(B)(ii) of the 1940 Act, not otherwise provided for in this definition
may be included in Fitch Eligible Assets, but, with respect to any financial
contract, only upon receipt by the Trust of a writing from Fitch specifying any
conditions on including such financial contract in Fitch Eligible Assets and
assuring the Trust that including such financial contract in the manner so
specified would not affect the credit rating assigned by Fitch to the Preferred
Shares;
(x) asset-backed and mortgage-backed securities;
(xi) senior loans; and
(xii) Fitch Hedging Transactions.
Financial contracts, as such term is defined in Section 3(c)(2)(B)(ii) of
the Investment Company Act, not otherwise provided for in this definition may be
included in Fitch Eligible Assets, but, with respect to any financial contract,
only upon receipt by the Trust of a writing from Fitch specifying any conditions
on including such financial contract in Fitch Eligible Assets and assuring the
Trust that including such financial contract in the manner so specified would
not affect the credit rating assigned by Fitch to the Preferred Shares.
Where the Trust sells an asset and agrees to repurchase such asset in the
future, the Discounted Value of such asset will constitute a Fitch Eligible
Asset and the amount the Trust is required to pay upon repurchase of such asset
will count as a liability for the purposes of the Preferred Shares Basic
Maintenance Amount. Where the Trust purchases an asset and agrees to sell it to
a third party in the future, cash receivable by the Trust thereby will
constitute a Fitch Eligible Asset if the long-term debt of such other party is
rated at least A- by Fitch or the equivalent by another Rating Agency and such
agreement has a term of 30 days or less; otherwise the Discounted Value of such
purchased asset will constitute a Fitch Eligible Asset.
Notwithstanding the foregoing, an asset will not be considered a Fitch
Eligible Asset to the extent that it has been irrevocably deposited for the
payment of (i)(A) through (i)(E) under the definition of Preferred Shares Basic
Maintenance Amount or to the extent it is subject to any Liens, except for (A)
Liens which are being contested in good faith by appropriate proceedings and
which Fitch has indicated to the Trust will not affect the status of such asset
as a Fitch Eligible Asset, (B) Liens for taxes that are not then due and payable
or that can be paid thereafter without penalty, (C) Liens to secure payment for
services rendered or cash advanced to the Trust by its investment manager or
portfolio manager, the Trust's custodian, transfer agent or registrar or the
Auction Agent and (D) Liens arising by virtue of any repurchase agreement.
Fitch diversification limitations: portfolio holdings as described below
must be within the following diversification and issue size requirements in
order to be included in Fitch's Eligible Assets:
DEBT SECURITIES Maximum Single Maximum Single Minimum Issue Size
RATED AT LEAST Issuer (1) Industry (1)(2) ($ in million)(3)
-------------- ---------- --------------- -----------------
AAA.................................... 100% 100% $100
AA-.................................... 20% 75% $100
A-..................................... 10% 50% $100
BBB-................................... 6% 25% $100
BB-.................................... 4% 16% $50
B-..................................... 3% 12% $50
CCC.................................... 2% 8% $50
(1) Percentages represent both a portion of the aggregate Market Value and
number of outstanding shares of the common stock portfolio.
(2) Industries are determined according to Fitch's Industry Classifications, as
defined herein.
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(3) Preferred stock has a minimum issue size of $50 million, and mortgage pass
through issued by Federal Home Loan Mortgage Corporation ("FHLMC"), the Federal
National Mortgage Association ("FNMA") or the Government National Mortgage
Association ("GNMA"), which has no minimum issue size.
If a security is not rated by Fitch but is rated by two other Rating Agencies,
then the lower of the ratings on the security from the two other Rating Agencies
will be used to determine the Fitch Discount Factor (e.g., where the S&P rating
is A and the Moody's rating is Baa, a Fitch rating of BBB will be used). If a
security is not rated by Fitch but is rated by only one other Rating Agency,
then the rating on the security from the other Rating Agency will be used to
determine the Fitch Discount Factor (e.g., where the only rating on a security
is an S&P rating of AAA, a Fitch rating of AAA will be used, and where the only
rating on a security is a Moody's rating of Ba, a Fitch rating of BB will be
used). If a security is not rated by any Rating Agency, the Trust will treat the
security as if it were below investment grade.
"Fitch Hedging Transactions" has the meaning set forth in Section 8 of
Part I of this Statement.
"Fitch Industry Classifications" means, for the purposes of determining
Fitch Eligible Assets, each of the following industry classifications:
Aerospace & Defense
Automobiles
Banking, Finance & Real Estate
Broadcasting & Media
Building & Materials
Cable
Chemicals
Computers & Electronics
Consumer Products
Energy
Environmental Services
Farming & Agriculture
Food, Beverage & Tobacco
Gaming, Lodging & Restaurants
Healthcare & Pharmaceuticals
Industrial/Manufacturing
Insurance
Leisure & Entertainment
Metals & Mining
Miscellaneous
Packaging and Containers
Paper & Forest Products
Retail
Sovereign
Structured Finance Obligations
Supermarkets & Drugstores
Telecommunications
Textiles & Furniture
Transportation
Utilities
The Trust shall use its discretion in determining which industry
classification is applicable to a particular investment.
"Fitch Loan Category" means the following four categories (and, for
purposes of this categorization, the Market Value of a Fitch Eligible Asset
trading at par is equal to $1.00):
(i) "Fitch Loan Category A" means Performing Bank Loans, which have
a Market Value or an Approved Price greater than or equal to $0.90.
C-14
(ii) "Fitch Loan Category B" means: (A) Performing Bank Loans which
have a Market Value or an Approved Price of greater than or equal to
$0.80 but less than $0.90; and (B) non-Performing Bank Loans which
have a Market Value or an Approved Price greater than or equal to
$0.85.
(iii) "Fitch Loan Category C" means: (A) Performing Bank Loans which
have a Market Value or an Approved Price of greater than or equal to
$0.70 but less than $0.80; (B) non-Performing Bank Loans which have
a Market Value or an Approved Price of greater than or equal to
$0.75 but less than $0.85; and (C) Performing Bank Loans without an
Approved Price rated BB- or higher by Fitch. If a security is not
rated by Fitch but is rated by two other Rating Agencies, then the
lower of the ratings on the security from the two other Rating
Agencies will be used to determine the Fitch Discount Factor (e.g.,
where the S&P rating is A- and the Moody `s rating is Baa1, a Fitch
rating of BBB+ will be used). If a security is not rated by Fitch
but is rated by only one other Rating Agency, then the rating on the
security from the other Rating Agency will be used to determine the
Fitch Discount Factor (e.g., where the only rating on a security is
an S&P rating of AAA, a Fitch rating of AAA will be used, and where
the only rating on a security is a Moody's rating of Ba3, a Fitch
rating of BB- will be used).
(iv) "Fitch Loan Category D" means Bank Loans not described in any
of the foregoing categories.
Notwithstanding any other provision contained above, for purposes of
determining whether a Fitch Eligible Asset falls within a specific Fitch Loan
Category, to the extent that any Fitch Eligible Asset would fall within more
than one of the Fitch Loan Categories, such Fitch Eligible Asset shall be deemed
to fall into the Fitch Loan Category with the lowest applicable Fitch Discount
Factor.
"Forward Commitment" has the meaning set forth in Section 8(a)(vi) of Part
I of this Statement.
"Holder" means a Person identified as a holder of record of Preferred
Shares in the Share Register.
"Hold Order" and "Hold Orders" shall have the respective meanings
specified in paragraph (a) of Section 1 of Part II of this Statement.
"Independent Accountant" means a nationally recognized accountant, or firm
of accountants, that is, with respect to the Trust, an independent public
accountant or firm of independent public accountants under the Securities Act
and serving as such for the Trust.
"Initial Dividend Period," with respect to shares of a series of Preferred
Shares, shall have the meaning specified with respect to shares of such series
in Section 2(d) of Part I of this Statement.
"Late Charge" shall have the meaning specified in subparagraph (e)(i)(B)
of Section 2 of Part I of this Statement.
"LIBOR Dealer" means and such other dealer or dealers as the Trust from
time to time may appoint or, in lieu thereof, their respective affiliates and
successors.
"LIBOR Rate," on any Auction Date, means (i) the rate for deposits in U.S.
dollars for the designated Dividend Period, which appears on display page 3750
of Moneyline's Telerate Service ("Telerate Page 3750") (or such other page as
may replace that page on that service, or such other service as may be selected
by the LIBOR Dealer or its successors that are LIBOR Dealers) as of 11:00 a.m.,
London time, on the day that is the London Business Day preceding the Auction
Date (the "LIBOR Determination Date"), or (ii) if such rate does not appear on
Telerate Page 3750 or such other page as may replace such Telerate Page 3750,
(A) the LIBOR Dealer shall determine the arithmetic mean of the offered
quotations of the Reference Banks to leading banks in the London interbank
market for deposits in U.S. dollars for the designated Dividend Period in an
amount determined by such LIBOR Dealer by reference to requests for quotations
as of approximately 11:00 a.m. (London time) on such date
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made by such LIBOR Dealer to the Reference Banks, (B) if at least two of the
Reference Banks provide such quotations, the LIBOR Rate shall equal such
arithmetic mean of such quotations, (C) if only one or none of the Reference
Banks provide such quotations, the LIBOR Rate shall be deemed to be the
arithmetic mean of the offered quotations that leading banks in The City of New
York selected by the LIBOR Dealer (after obtaining the Trust's approval) are
quoting on the relevant LIBOR Determination Date for deposits in U.S. dollars
for the designated Dividend Period in an amount determined by the LIBOR Dealer
(after obtaining the Trust's approval) that is representative of a single
transaction in such market at such time by reference to the principal London
offices of leading banks in the London interbank market; provided, however, that
if one of the LIBOR Dealers does not quote a rate required to determine the
LIBOR Rate, the LIBOR Rate will be determined on the basis of the quotation or
quotations furnished by any Substitute LIBOR Dealer or Substitute LIBOR Dealers
selected by the Trust to provide such rate or rates not being supplied by the
LIBOR Dealer; provided further, that if the LIBOR Dealer and Substitute LIBOR
Dealers are required but unable to determine a rate in accordance with at least
one of the procedures provided above, the LIBOR Rate shall be the LIBOR Rate as
determined on the previous Auction Date. If the number of Dividend Period days
shall be (i) 7 or more but fewer than 21 days, such rate shall be the seven-day
LIBOR rate; (ii) more than 21 but fewer than 49 days, such rate shall be the
one-month LIBOR rate; (iii) 49 or more but fewer than 77 days, such rate shall
be the two-month LIBOR rate; (iv) 77 or more but fewer than 112 days, such rate
shall be the three-month LIBOR rate; (v) 112 or more but fewer than 140 days,
such rate shall be the four-month LIBOR rate; (vi) 140 or more but fewer than
168 days, such rate shall be the five-month LIBOR rate; (vii) 168 or more but
fewer than 189 days, such rate shall be the six-month LIBOR rate; (viii) 189 or
more but fewer than 217 days, such rate shall be the seven-month LIBOR rate;
(ix) 217 or more but fewer than 252 days, such rate shall be the eight-month
LIBOR rate; (x) 252 or more but fewer than 287 days, such rate shall be the
nine-month LIBOR rate; (xi) 287 or more but fewer than 315 days, such rate shall
be the ten-month LIBOR rate; (xii) 315 or more but fewer than 343 days, such
rate shall be the eleven-month LIBOR rate; and (xiii) 343 or more but fewer than
365 days, such rate shall be the twelve-month LIBOR rate.
"Lien" means any material lien, mortgage, pledge, security interest or
security agreement of any kind.
"Liquidation Preference," with respect to a given number of Preferred
Shares, means $25,000 times that number.
"London Business Day" means any day on which commercial banks are
generally open for business in London.
"Long Term Dividend Period" means a Special Dividend Period consisting of
a specific period of one whole year or more but not greater than five years.
"Market Value" of any asset of the Trust shall be the market value thereof
determined by a Pricing Service. Market Value of any asset shall include any
interest accrued thereon. A Pricing Service shall value portfolio securities at
the quoted bid prices or the mean between the quoted bid and asked price or the
yield equivalent when quotations are not readily available. Securities for which
quotations are not readily available shall be valued at fair value as determined
by a Pricing Service using methods which include consideration of: yields or
prices of securities of comparable quality, type of issue, coupon, maturity and
rating; indications as to value from dealers; and general market conditions. A
Pricing Service may employ electronic data processing techniques and/or a matrix
system to determine valuations. In the event a Pricing Service is unable to
value a security, the security shall be valued at the lower of two dealer bids
obtained by the Trust from dealers who are members of the National Association
of Securities Dealers, Inc. and who make a market in the security, at least one
of which shall be in writing. Futures contracts and options are valued at
closing prices for such instruments established by the exchange or board of
trade on which they are traded, or if market quotations are not readily
available, are valued at fair value on a consistent basis using methods
determined in good faith by the Board of Trustees of the Trust.
"Maximum Applicable Rate" with respect to Preferred Shares for any
Dividend Period will be the higher of the Applicable Percentage of the Reference
Rate or the Reference Rate plus the Applicable Spread. The Reference Rate will
be the LIBOR Rate (for a dividend period of fewer than 365 Days) or the Treasury
Index Rate (for a dividend period of 365 days or more). The Applicable
Percentage and the Applicable Spread for any regular dividend period will be
determined based on the credit ratings assigned to the Preferred Shares by
Moody's and Fitch on the auction date for such period as set forth in the
definition of "Applicable Percentage and Applicable
C-16
Spread". If Moody's and/or Fitch do not make such rating available, the rate
shall be determined by reference to equivalent ratings issued by a Substitute
Rating Agency. In the case of a special rate period, (1) the Maximum Applicable
Rate will be specified by the Trust in the Notice of Special Dividend Period for
such Dividend Payment Period, (2) the Applicable Percentage and Applicable
Spread will be determined on the date two business days before the first day of
such Special Dividend Period, and (3) the Reference Rate will be the LIBOR Rate
(for a Dividend Period of fewer than 365 days) or the Treasury Index Rate (for a
Dividend Period of 365 days or more). 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.
"Minimum Dividend Period" shall mean any Dividend Period of seven (7) days
in the case of Series [ ] Preferred Shares and Series [ ] Preferred Shares, and
days in the case of Series [ ] Preferred Shares.
"Moody's" means Moody's Investors Service, Inc. or its successors.
"Moody's Discount Factor" means, for purposes of determining the
Discounted Value of any Moody's Eligible Asset, the percent determined as
follows. The Moody's Discount Factor for any Moody's Eligible Asset other than
the securities set forth below will be the percentage provided in writing by
Moody's.
(i) Non-Convertible Corporate Debt Securities: the percentage determined
by reference to the rating on such asset with reference to the remaining term to
maturity of such asset, in accordance with the table set forth below:
Moody's Rating Category
Term to Maturity of
Corporate Debt Security (2) Aaa Aa A Baa Ba B Unrated (1)
--------------------------- --- -- - --- -- - -----------
1 year or less................................ 109% 112% 115% 118% 137% 150% 250%
2 years or less (but longer than 1 year)...... 115% 118% 122% 125% 146% 160% 250%
3 years or less (but longer than 2 years)..... 120% 123% 127% 131% 153% 168% 250%
4 years or less (but longer than 3 years)..... 126% 129% 133% 138% 161% 176% 250%
5 years or less (but longer than 4 years)..... 132% 135% 139% 144% 168% 185% 250%
7 years or less (but longer than 5 years)..... 139% 143% 147% 152% 179% 197% 250%
10 years or less (but longer than 7 years).... 145% 150% 155% 160% 189% 208% 250%
15 years or less (but longer than 10 years)... 150% 155% 160% 165% 196% 216% 250%
20 years or less (but longer than 15 years)... 150% 155% 160% 165% 196% 228% 250%
30 years or less (but longer than 20 years)... 150% 155% 160% 165% 196% 229% 250%
Greater than 30 years......................... 165% 173% 181% 189% 205% 240% 250%
(1) Unless conclusions regarding liquidity risk as well as estimates of both the
probability and severity of default for the corporation's assets can be derived
from other sources, securities rated below B by Moody's and unrated securities,
which are securities rated by neither Moody's, S&P nor Fitch, are limited to 10%
of Moody's Eligible Assets. If a corporate debt security is unrated by Moody's,
S&P or Fitch, the Trust will use the percentage set forth under "Unrated" in
this table. Ratings assigned by S&P or Fitch are generally accepted by Moody's
at face value. However, adjustments to face value may be made to particular
categories of credits for which the S&P and/or Fitch rating does not seem to
approximate a Moody's rating equivalent. Split rated securities assigned by S&P
and Fitch will be accepted at the lower of the two ratings.
(2) The Moody's Discount Factors for debt securities shall also be applied to
any interest rate swap or cap, in which case the rating of the counterparty
shall determine the appropriate rating category.
For corporate debt securities that do not pay interest in U.S. dollars, the
Trust sponsor will contact Moody's to obtain the applicable currency conversion
rates.
C-17
(ii) Preferred stock*: The Moody's Discount Factor for taxable preferred
stock shall be:
Aaa............................................... 150%
Aa................................................ 155%
A................................................. 160%
Baa............................................... 165%
Ba................................................ 196%
B................................................. 216%