1933 Act Registration No. 333-
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form N-14AE24
REGISTRATION STATEMENT UNDER THE
SECURITIES ACT OF 1933
[ ] Pre-Effective [ ] Post-Effective
Amendment No. Amendment No.
EVERGREEN EQUITY TRUST
[Exact Name of Registrant as Specified in Charter)
Area Code and Telephone Number: (617) 210-3200
200 Berkeley Street
Boston, Massachusetts 02116
-----------------------------------
(Address of Principal Executive Offices)
Rosemary D. Van Antwerp, Esq.
Keystone Investment Management Company
200 Berkeley Street
Boston, Massachusetts 02116
-----------------------------------------
(Name and Address of Agent for Service)
Copies of All Correspondence to:
Robert N. Hickey, Esq.
Sullivan & Worcester LLP
1025 Connecticut Avenue, N.W.
Washington, D.C. 20036
Approximate date of proposed public offering: As soon as possible after
the effective date of this Registration Statement.
The Registrant has registered an indefinite amount of securities under
the Securities Act of 1933 pursuant to Section 24(f) under the Investment
Company Act of 1940 (File No. 333-37453); accordingly, no fee is payable
herewith. Registrant is filing as an exhibit to this Registration Statement a
copy of an earlier declaration under Rule 24f-2. Pursuant to Rule 429, this
Registration Statement relates to the aforementioned registration on Form N-1A.
A Rule 24f-2 Notice for the Registrant's fiscal year ending September 30, 1998
will be filed with the Commission on or about November 29, 1998.
<PAGE>
It is proposed that this filing will become effective on November 10,
1997 pursuant to Rule 488 of the Securities Act of 1933.
<PAGE>
EVERGREEN EQUITY TRUST
CROSS REFERENCE SHEET
Pursuant to Rule 481(a) under the Securities Act of 1933
Location in
Item of Part A of Form N-14 Prospectus/Proxy
Statement
1. Beginning of Registration Cross Reference Sheet;
Statement and Outside Cover Page
Front Cover Page of
Prospectus
2. Beginning and Outside Table of Contents
Back Cover Page of
Prospectus
3. Fee Table, Synopsis and Comparison of Fees and
Risk Factors Expenses; Summary;
Comparison of Investment
Objectives and Policies;
Risks
4. Information About the Summary; Reasons for the
Transaction Reorganizations;
Comparative Information on
Shareholders' Rights;
Exhibits A-1 and A-2
(Agreements and Plans of
Reorganization)
5. Information about the Cover Page; Summary;
Registrant Risks; Comparison of
Investment Objectives and
Policies; Comparative
Information on
Shareholders' Rights;
Additional Information
<PAGE>
Location in
Item of Part A of Form N-14 Prospectus/Proxy
Statement
6. Information about the Cover Page; Summary;
Company Being Acquired Risks; Comparison of
Investment Objective and
Policies; Comparative
Information on
Shareholders' Rights;
Additional Information
7. Voting Information Cover Page; Summary;
Voting Information
Concerning the Meeting
8. Interest of Certain Financial Statements and
Persons and Experts Experts; Legal Matters
9. Additional Information Inapplicable
Required for Reoffering
by Persons Deemed to be
Underwriters
Item of Part B of Form N-14
10. Cover Page Cover Page
11. Table of Contents Omitted
12. Additional Information Statement of Additional
About the Registrant Information of the
Evergreen Equity Trust -
Evergreen Small Company
Growth Fund dated November
10, 1997
<PAGE>
Location in
Item of Part A of Form N-14 Prospectus/Proxy
Statement
13. Additional Information Statement of Additional
about the Company Being Information of Keystone
Acquired Small Company Growth Fund
II dated August 1,
1997; Statement of
Additional
Information of
Keystone Small
Company Growth Fund
(S-4) dated August 1,
1997
14. Financial Statements Financial Statements dated
May 31, 1997 of Keystone
Small Company Growth Fund
II; Financial Statements
of Keystone Small Company
Growth Fund (S-4) dated
May 31, 1997
Item of Part C of Form N-14
Incorporated by Reference
15. Indemnification to Part A Caption -
"Comparative Information
on Shareholders' Rights -
Liability and
Indemnification of
Trustees"
16. Exhibits Item 16. Exhibits
17. Undertakings Item 17. Undertakings
<PAGE>
KEYSTONE SMALL COMPANY GROWTH FUND II
KEYSTONE SMALL COMPANY GROWTH FUND (S-4)
200 BERKELEY STREET
BOSTON, MASSACHUSETTS 02116
November 14, 1997
Dear Shareholder,
I am writing to shareholders of the Keystone Small Company Growth Fund II and
the Keystone Small Company Growth Fund (S- 4) to inform you of a Special
Shareholders' meeting to be held on January 6, 1998. Before that meeting, I
would like your vote on the important issues affecting your fund as described in
the attached Prospectus/Proxy Statement.
The Prospectus/Proxy Statement includes the proposed reorganization of the
Keystone Small Company Growth Fund II and the Keystone Small Company Growth Fund
(S-4). All of the assets of both funds would be acquired by a new fund, the
Evergreen Small Company Growth Fund. Details about the new fund's investment
objective, portfolio management team, performance, etc. are contained in the
attached Prospectus/Proxy Statement.
The Boards of Trustees have unanimously approved the proposal and recommend that
you vote FOR this proposal.
You will receive shares of the new fund in the same class, with the same letter
designation, the same fees and the same contingent deferred sales charges as the
shares you held prior to the reorganization. This is a non-taxable event for
shareholders.
I realize that this Prospectus/Proxy Statement will take time to review, but
your vote is very important. Please take the time to familiarize yourself with
the proposal presented and sign and return your proxy card(s) in the enclosed
postage-paid envelope today. You may receive more than one proxy card if you own
shares in more than one fund. Please sign and return each card you receive.
If we do not receive your completed proxy card(s) after several weeks, you may
be contacted by our proxy solicitor, Shareholder Communications Corporation.
They will remind you to vote your shares or will record your vote over the phone
if you choose to vote in that manner. You may also call Shareholder
Communications Corporation directly at 800-733- 8481 ext.404 and vote by phone.
<PAGE>
Thank you for taking this matter seriously and participating in this important
process.
Sincerely,
William M. Ennis
Managing Director
Evergreen Funds
<PAGE>
November 1997
IMPORTANT NEWS
FOR EVERGREEN SHAREHOLDERS
We encourage you to read the attached Prospectus/Proxy Statement in full;
however, the following questions and answers represent some typical concerns
that shareholders might have regarding this document.
Q: WHY IS EVERGREEN SENDING ME THIS PROSPECTUS/PROXY
STATEMENT?
Mutual funds are required to get shareholders' votes for certain types of
changes. As a shareholder, you have a right to vote on major policy decisions,
such as those included here.
Q: WHAT ARE THE ISSUES CONTAINED IN THIS PROSPECTUS/PROXY
STATEMENT?
You are being asked to vote to approve a proposal to reorganize the Keystone
Small Company Growth Fund II and the Keystone Small Company Growth Fund (S-4)
into a new fund, called Evergreen Small Company Growth Fund. The new fund's
investment objective is substantially the same as that of the former funds.
Q: HOW WILL THIS CHANGE AFFECT ME AS A FUND SHAREHOLDER?
The reorganization of these funds into the Evergreen Small Company Growth Fund
means that the Keystone Small Company Growth Fund II and the Keystone Small
Company Growth Fund (S- 4) would no longer exist after January 23, 1998.
Shareholders would receive shares of the new fund in the same class, with the
same letter designation, the same fees and the same contingent deferred sales
charges as the shares held prior to the reorganization. This is a non-taxable
event for shareholders.
<PAGE>
Q: WHY IS EVERGREEN PROPOSING THIS CHANGE?
This proposal represents one of the final steps we are undertaking to unify the
Evergreen and Keystone fund families. Shareholders can anticipate the following
benefits:
A comprehensive fund family with a common risk/reward spectrum
The elimination of any overlap or gaps in fund offerings
Reduced confusion surrounding privileges associated with each fund,
specifically regarding exchangeability, letter of intent, and rights of
accumulation.
A user-friendly product line for both shareholders and investment
professionals
A single location for fund information, whether you're looking up funds
in the newspaper or locating a Morningstar report on the Internet.
Q: HOW DO THE BOARD MEMBERS OF MY FUND RECOMMEND THAT I VOTE?
The Board members of each fund recommend that you vote in favor or FOR the
proposal on the enclosed proxy card.
Q: WHOM DO I CALL FOR MORE INFORMATION OR TO PLACE MY VOTE?
Please call Shareholder Communications at 800-733-8481 ext.
404 for additional information. You can vote one of three
ways:
Use the enclosed proxy card to record your vote either FOR, AGAINST or
ABSTAIN, then return the card in the postpaid envelope provided.
or
Complete the enclosed proxy card and FAX to 800-733- 1885.
Call 800-733-8481 ext. 404 and record your vote by
telephone.
Q: WHY ARE MULTIPLE CARDS ENCLOSED?
If you own shares of more than one fund, you will receive a proxy card for each
fund you own. Please sign, date and return each proxy card you receive.
<PAGE>
[SUBJECT TO COMPLETION, OCTOBER 10, 1997 PRELIMINARY COPY]
KEYSTONE SMALL COMPANY GROWTH FUND II
KEYSTONE SMALL COMPANY GROWTH FUND (S-4)
200 BERKELEY STREET
BOSTON, MASSACHUSETTS 02116
NOTICE OF SPECIAL MEETING OF SHAREHOLDERS
TO BE HELD ON JANUARY 6, 1998
Notice is hereby given that a Special Meeting (the "Meeting") of
Shareholders of each of Keystone Small Company Growth Fund II and Keystone Small
Company Growth Fund (S-4) (each a "Fund"), will be held at the offices of the
Evergreen Keystone Funds, 200 Berkeley Street, Boston, Massachusetts 02116 on
January 6, 1998 at 3:00 p.m. for the following purposes:
1. To consider and act upon the Agreement and Plan of Reorganization
(the "Plan") dated as of September 30, 1997, providing for the acquisition of
all of the assets of the Fund by Evergreen Small Company Growth Fund, a series
of Evergreen Equity Trust ("Evergreen Small Company Growth"), in exchange for
shares of Evergreen Small Company Growth and the assumption by Evergreen Small
Company Growth of certain identified liabilities of the Fund. The Plan also
provides for distribution of such shares of Evergreen Small Company Growth to
shareholders of the Fund in liquidation and subsequent termination of the Fund.
A vote in favor of the Plan is a vote in favor of the liquidation and
dissolution of the Fund.
2. To transact any other business which may properly come before the
Meeting or any adjournment or adjournments thereof.
The Trustees of Keystone Small Company Growth Fund II and the Trustees
of Keystone Small Company Growth Fund (S-4) have fixed the close of business on
November 10, 1997 as the record date for the determination of shareholders of
each respective Fund entitled to notice of and to vote at the Meeting or any
adjournment thereof.
IT IS IMPORTANT THAT PROXIES BE RETURNED PROMPTLY. SHAREHOLDERS WHO DO NOT
EXPECT TO ATTEND IN PERSON ARE URGED WITHOUT DELAY TO SIGN AND RETURN THE
ENCLOSED PROXY IN THE ENCLOSED ENVELOPE, WHICH REQUIRES NO POSTAGE, SO THAT
THEIR SHARES MAY BE REPRESENTED AT THE MEETING. YOUR PROMPT
<PAGE>
ATTENTION TO THE ENCLOSED PROXY WILL HELP TO AVOID THE EXPENSE OF FURTHER
SOLICITATION.
By Order of the Boards of Trustees
George O. Martinez
Secretary
November 14, 1997
<PAGE>
INSTRUCTIONS FOR EXECUTING PROXY CARDS
The following general rules for signing proxy cards may be of
assistance to you and may help to avoid the time and expense involved in
validating your vote if you fail to sign your proxy card(s) properly.
1. INDIVIDUAL ACCOUNTS: Sign you name exactly as it
appears in the Registration on the proxy card(s).
2. JOINT ACCOUNTS: Either party may sign, but the name
of the party signing should conform exactly to a name shown in
the Registration on the proxy card(s).
3. ALL OTHER ACCOUNTS: The capacity of the individual signing the proxy
card(s) should be indicated unless it is reflected in the form of Registration.
For example:
REGISTRATION VALID SIGNATURE
CORPORATE
ACCOUNTS
(1) ABC Corp. ABC Corp.
(2) ABC Corp. John Doe, Treasurer
(3) ABC Corp.
c/o John Doe, Treasurer John Doe, Treasurer
(4) ABC Corp. Profit Sharing Plan John Doe, Trustee
TRUST ACCOUNTS
(1) ABC Trust Jane B. Doe, Trustee
(2) Jane B. Doe, Trustee Jane B. Doe
u/t/d 12/28/78
CUSTODIAL OR ESTATE ACCOUNTS
(1) John B. Smith, Cust. John B. Smith
f/b/o John B. Smith, Jr. UGMA
(2) John B. Smith, Jr. John B. Smith, Jr.,
Executor
<PAGE>
PROSPECTUS/PROXY STATEMENT DATED NOVEMBER 14, 1997
Acquisition of Assets of
KEYSTONE SMALL COMPANY GROWTH FUND II
200 Berkeley Street
Boston, Massachusetts 02116
and
KEYSTONE SMALL COMPANY GROWTH FUND (S-4)
200 Berkeley Street
Boston, Massachusetts 02116
By and in Exchange for Shares of
EVERGREEN SMALL COMPANY GROWTH FUND
a series of
Evergreen Equity Trust
200 Berkeley Street
Boston, Massachusetts 02116
This Prospectus/Proxy Statement is being furnished to shareholders of
Keystone Small Company Growth Fund II ("Keystone Small Company Growth II") and
Keystone Small Company Growth Fund (S-4) ("Keystone Small Company Growth (S-
4)") in connection with a proposed Agreement and Plan of Reorganization (the
"Plan") to be submitted to shareholders of each of Keystone Small Company Growth
II and Keystone Small Company Growth (S-4) for consideration at a Special
Meeting of Shareholders to be held on January 6, 1998 at 3:00 p.m. at the
offices of the Evergreen Keystone Funds, 200 Berkeley Street, Boston, MA 02116,
and any adjournments thereof (the "Meeting"). Each Plan provides for all of the
assets of Keystone Small Company Growth II and Keystone Small Company Growth
(S-4), respectively, to be acquired by Evergreen Small Company Growth Fund
("Evergreen Small Company Growth") in exchange for shares of Evergreen Small
Company Growth and the assumption by Evergreen Small Company Growth of certain
identified liabilities of Keystone Small Company Growth II and Keystone Small
Company Growth (S-4), respectively (hereinafter referred to individually as the
"Reorganization" or collectively as the "Reorganizations"). Evergreen Small
Company Growth, Keystone Small Company Growth II and Keystone Small Company
Growth (S-4) are sometimes hereinafter referred to individually as the "Fund"
and collectively as the "Funds." Following the Reorganizations, shares of
Evergreen Small Company Growth will be distributed to shareholders of Keystone
Small Company Growth II and Keystone Small Company Growth (S- 4) in liquidation
of Keystone Small Company Growth II and Keystone Small Company Growth (S-4) and
such Funds will be terminated. Holders of shares of Keystone Small Company
<PAGE>
Growth II will receive shares of the class of Evergreen Small Company Growth
(the "Corresponding Shares") having the same letter designation and the same
distribution-related fees, shareholder servicing-related fees and contingent
deferred sales charges ("CDSCs"), if any as the shares of the class of Keystone
Small Company Growth II held by them prior to the Reorganization. Holders of
shares of Keystone Small Company Growth (S-4) will receive shares of Evergreen
Small Company Growth having the same distribution-related fees, shareholder
servicing-related fees and CDSCs as the shares of Keystone Small Company Growth
(S-4) held by them prior to the Reorganization. As a result of the proposed
Reorganizations, shareholders of Keystone Small Company Growth II will receive
that number of full and fractional Corresponding Shares of Evergreen Small
Company Growth, and shareholders of Keystone Small Company Growth (S-4) will
receive that number of full and fractional shares of Evergreen Small Company
Growth having an aggregate net asset value equal to the aggregate net asset
value of such shareholder's shares of Keystone Small Company Growth II or
Keystone Small Company Growth (S-4). Each Reorganization is being structured as
a tax-free reorganization for federal income tax purposes.
Evergreen Small Company Growth is a separate series of Evergreen Equity
Trust, an open-end management investment company registered under the Investment
Company Act of 1940, as amended (the "1940 Act"). The investment objective of
Evergreen Small Company Growth is to provide shareholders with long-term growth
of capital. Such investment objective is identical to those of Keystone Small
Company Growth II and Keystone Small Company Growth (S-4).
This Prospectus/Proxy Statement, which should be retained for future
reference, sets forth concisely the information about Evergreen Small Company
Growth that shareholders of Keystone Small Company Growth II and Keystone Small
Company Growth (S-4) should know before voting on the Reorganizations. Certain
relevant documents listed below, which have been filed with the Securities and
Exchange Commission ("SEC"), are incorporated in whole or in part by reference.
A Statement of Additional Information dated November 14, 1997, relating to this
Prospectus/Proxy Statement and the Reorganizations incorporating by reference
the financial statements of Keystone Small Company Growth II dated May 31, 1997
and Keystone Small Company Growth (S-4) dated May 31, 1997, has been filed with
the SEC and is incorporated by reference in its entirety into this
Prospectus/Proxy Statement. Evergreen Small Company Growth is a newly created
series of Evergreen Equity Trust and has had no operations to date.
Consequently, there are no current financial statements of Evergreen Small
<PAGE>
Company Growth. A copy of such Statement of Additional Information is available
upon request and without charge by writing to Evergreen Small Company Growth at
200 Berkeley Street, Boston, Massachusetts 02116 or by calling toll-free 1-
800-343-2898.
The two Prospectuses of Evergreen Small Company Growth dated November
10, 1997 are incorporated herein by reference in their entirety. The
Prospectuses, which pertain (i) to Class Y shares and (ii) to Class A, Class B
and Class C shares, differ only insofar as they describe the separate
distribution and shareholder servicing arrangements applicable to the classes.
Shareholders of Keystone Small Company Growth II and Keystone Small Company
Growth (S-4) will receive, with this Prospectus/Proxy Statement, copies of the
Prospectus pertaining to the class of shares of Evergreen Small Company Growth
that they will receive as a result of the consummation of each Reorganization.
Additional information about Evergreen Small Company Growth is contained in its
Statement of Additional Information of the same date which has been filed with
the SEC and which is available upon request and without charge by writing to or
calling Evergreen Small Company Growth at the address or telephone number listed
in the preceding paragraph.
The Prospectus of Keystone Small Company Growth II dated August 1,
1997, as supplemented, and the Prospectus of Keystone Small Company Growth (S-4)
dated August 1, 1997, as supplemented, are incorporated herein in their entirety
by reference. Copies of the Prospectuses and related Statements of Additional
Information dated the same respective dates are available upon request without
charge by writing or calling the Fund of which you are a shareholder at the
address listed in the second preceding paragraph.
Included as Exhibits A-1 and A-2 to this Prospectus/Proxy Statement are
copies of each Plan.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS
THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED
UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS/PROXY STATEMENT. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
The shares offered by this Prospectus/Proxy Statement are not deposits or
obligations of any bank and are not insured or otherwise protected by the U.S.
government, the Federal Deposit Insurance Corporation, the Federal Reserve Board
or
<PAGE>
any other government agency and involve investment risk, including possible loss
of capital.
<PAGE>
TABLE OF CONTENTS
Page
COMPARISON OF FEES AND EXPENSES...................................... 6
SUMMARY.............................................................. 12
Proposed Plans of Reorganization............................ 12
Tax Consequences............................................ 14
Investment Objectives and Policies
of the Funds.............................................. 14
Comparative Performance Information
For Each Fund............................................. 15
Management of the Funds..................................... 16
Investment Adviser ......................................... 16
Portfolio Management........................................ 17
Distribution of Shares...................................... 17
Purchase and Redemption Procedures.......................... 21
Exchange Privileges......................................... 21
Dividend Policy............................................. 21
Risks....................................................... 22
REASONS FOR THE REORGANIZATIONS...................................... 23
Agreements and Plans of Reorganization...................... 27
Federal Income Tax Consequences............................. 30
Pro-forma Capitalization.................................... 32
Shareholder Information..................................... 33
COMPARISON OF INVESTMENT OBJECTIVES AND POLICIES..................... 35
COMPARATIVE INFORMATION ON SHAREHOLDERS' RIGHTS...................... 36
Forms of Organization....................................... 37
Capitalization.............................................. 37
Shareholder Liability....................................... 37
Shareholder Meetings and Voting Rights...................... 38
Liquidation or Dissolution.................................. 39
Liability and Indemnification of Trustees................... 40
ADDITIONAL INFORMATION............................................... 41
VOTING INFORMATION CONCERNING THE MEETING............................ 42
FINANCIAL STATEMENTS AND EXPERTS..................................... 45
LEGAL MATTERS........................................................ 46
OTHER BUSINESS....................................................... 46
<PAGE>
COMPARISON OF FEES AND EXPENSES
It is anticipated that on or about January 9, 1998 Keystone Small
Company Growth (S-4) will become a multiple class fund. As of that date the Fund
will offer Class A, Class B and Class C shares, each of which class of shares
will be similar in all respects to the Class A, Class B and Class C shares of
Evergreen Small Company Growth. It is further anticipated that current
outstanding shares of Keystone Small Company Growth (S-4) will become Class B
shares of the Fund at that time. On or about January 16, 1998, it is anticipated
that any Class B shares of Keystone Small Company Growth (S-4) purchased prior
to January 1, 1994 will be converted to Class A shares of the Fund. Should these
events occur, shareholders of Keystone Small Company Growth (S-4) will receive
on the date of the Reorganization the same class of shares of Evergreen Small
Company Growth held by them in the Fund after January 16, 1998.
The amounts for Class Y, Class A, Class B and Class C shares of
Keystone Small Company Growth II set forth in the following tables and in the
examples are based on the expenses for Keystone Small Company Growth II's fiscal
year ended May 31, 1997. The amounts for shares of Keystone Small Company Growth
(S-4) set forth in the following tables and in the examples are based on the
expenses for Keystone Small Company Growth (S-4)'s fiscal year ended May 31,
1997. The pro forma amounts for Class Y, Class A, Class B and Class C shares of
Evergreen Small Company Growth are based on the estimated expenses of Evergreen
Small Company Growth for the fiscal year ending September 30, 1998.
The following tables show for Keystone Small Company Growth II,
Keystone Small Company Growth (S-4) and Evergreen Small Company Growth pro forma
the shareholder transaction expenses and annual fund operating expenses
associated with an investment in the shares of each Fund.
Comparison of Shares of Evergreen Small Company Growth
With Shares of Keystone Small Company Growth II
and Keystone Small Company Growth (S-4)
Keystone Small Company Growth II
----------------
Shareholder Class Y Class A Class B Class C
Transaction ------- ------- ------- -------
Expenses
<PAGE>
Maximum Sales
Load Imposed on None 4.75% None None
Purchases (as a
percentage of
offering price)
Maximum Sales None None None None
Load Imposed on
Reinvested
Dividends (as a
percentage of
offering price)
Contingent None None 5.00% in 1.00% in
Deferred Sales the first the first
Charge (as a year, year and
percentage of declining 0.00%
original purchase to 1.00% thereafter
price or in the
redemption sixth year
proceeds, and 0.00%
whichever is thereafter
lower)
Exchange Fee None None None None
Annual Fund
Operating
Expenses (as a
percentage of
average daily net
assets)
Management Fee 0.70% 0.70% 0.70% 0.70%
12b-1 Fees (1) None 0.25% 1.00% 1.00%
Other Expenses 1.02% 1.02 1.02 1.03
----- ----- ----- -----
Annual Fund 1.72% 1.97% 2.72% 2.73%
Operating ----- ----- ----- -----
Expenses(3) ----- ----- ----- -----
Keystone Small Company Growth (S-4)
------------------------------------
Shareholder
Transaction Expenses
<PAGE>
Contingent Deferred
Sales Charge (as a 4.00% in the
percentage of original first year,
purchase price or declining to
redemption proceeds, 1.00% in the
whichever is lower) fourth year and
0.00%
thereafter
Exchange Fee None
Annual Fund Operating
Expenses (as a
percentage of average
daily net assets)
Management Fee 0.46%
12b-1 Fees (1) 1.00
Other Expenses 0.29%
-----
Annual Fund Operating 1.75%
Expenses(3) -----
--------
Evergreen Small Company Growth Pro Forma
Shareholder
Transaction Class Y Class A Class B Class C
Expenses ------- ------- ------- -------
Maximum Sales Load None 4.75% None None
Imposed on
Purchases (as a
percentage of
offering price
Maximum Sales Load None None None None
Imposed on
Reinvested
Dividends (as a
percentage of
offering price)
<PAGE>
Contingent Deferred None None 5.00% in 1.00% in
Sales Charge (as a the first the first
percentage of year, year and
original purchase declining 0.00%
price or redemption to 1.00% thereafter
proceeds, whichever in the
is lower) sixth year
and 0.00%
thereafter
(2)
Exchange Fee None None None None
Annual Fund
Operating Expenses
(as a percentage of
average daily net
assets)
Management Fee 0.48% 0.48% 0.48% 0.48%
12b-1 Fees (1) None 0.25% 1.00% 1.00%
Other Expenses 0.27% 0.27% 0.27% 0.27%
------- ------- ------ -----
Annual Fund Operating 0.75% 1.00% 1.75% 1.75% Expenses(3) ------- ------- -----
----- ------- ------- ----- ----- --------------- (1) Class A Shares of
Evergreen Small Company Growth and Keystone Small Company Growth II can pay
up to 0.75% of average daily net assets as a 12b-1 fee. For the foreseeable
future, the Class A 12b-1 fees will be limited to 0.25% of average daily
net assets. For shares of Keystone Small Company Growth (S-4) and for Class
B and Class C shares of Evergreen Small Company Growth and Keystone Small
Company Growth II, a portion of the 12b-1 fees equivalent to 0.25% of
average daily net assets will be shareholder servicing-related.
Distribution-related 12b-1 fees will be limited to 0.75% of average daily
net assets as permitted under the rules of the National Association of
Securities Dealers, Inc.
(2) The contingent deferred sales charge, if any, applicable to shares of
Keystone Small Company Growth II and Keystone Small Company Growth
(S-4) prior to the Reorganizations will carry over to the shares of
<PAGE>
Evergreen Small Company Growth received in the
Reorganizations.
(3) Expense ratios include indirectly paid expenses.
Examples. The following tables show for Keystone Small Company Growth
II and Keystone Small Company Growth (S-4), and for Evergreen Small Company
Growth pro forma, assuming consummation of the Reorganizations, examples of the
cumulative effect of shareholder transaction expenses and annual fund operating
expenses indicated above on a $1,000 investment in each class of shares for the
periods specified, assuming (i) a 5% annual return, and (ii) redemption at the
end of such period, and additionally for Class B and Class C shares of Evergreen
Small Company Growth and Keystone Small Company Growth II and shares of Keystone
Small Company Growth (S-4), no redemption at the end of each period.
Keystone Small Company Growth II
- --------------------------------
One Three Five Ten
Year Years Years Years
---- ----- ----- -----
Class Y $17 $54 $93 $203
Class A $67 $106 $149 $266
Class B $78 $114 $164 $279
(Assuming
redemption
at end of
period)
Class B $28 $84 $144 $279
(Assuming no
redemption
at end of
period)
Class C $38 $85 $144 $306
(Assuming
redemption
at end of
period)
<PAGE>
Class C $28 $85 $144 $306
(Assuming no
redemption
at end of
period)
Keystone Small Company Growth (S-4)
- -----------------------------------
One Three Five Ten
Year Years Years Years
---- ----- ----- -----
(Assuming $58 $75 $95 $206
redemption at
end of
period)
(Assuming no $18 $55 $95 $206
redemption at
end of
period)
Evergreen Small Company Growth - Pro Forma
------------------------------------------
One Three Five Ten
Year Years Years Years
----- ----- ----- -----
Class Y $8 $24 $42 $93
Class A $57 $78 $100 $164
Class B $68 $85 $115 $177
(Assuming
redemption
at end of
period)
Class B $18 $55 $95 $177
(Assuming no
redemption
at end of
period)
<PAGE>
Class C
(Assuming $28 $55 $95 $206
redemption
at end of
period)
Class C $18 $55 $95 $206
(Assuming no
redemption
at end of
period)
The purpose of the foregoing examples is to assist Keystone Small
Company Growth II and Keystone Small Company Growth (S-4) shareholders in
understanding the various costs and expenses that an investor in Evergreen Small
Company Growth as a result of the Reorganizations would bear directly and
indirectly, as compared with the various direct and indirect expenses currently
borne by a shareholder in each Fund. These examples should not be considered a
representation of past or future expenses or annual return. Actual expenses may
be greater or less than those shown.
SUMMARY
This summary is qualified in its entirety by reference to the
additional information contained elsewhere in this Prospectus/Proxy Statement,
and, to the extent not inconsistent with such additional information, the
Prospectuses of Evergreen Small Company Growth dated November 10, 1997 and the
Prospectuses of Keystone Small Company Growth II and Keystone Small Company
Growth (S-4) each dated August 1, 1997, as supplemented, (which are incorporated
herein by reference), and the Plans, forms of which are attached to this
Prospectus/Proxy Statement as Exhibits A-1 and A-2.
Proposed Plans of Reorganization
The Plans provide for the transfer of all of the assets of Keystone
Small Company Growth II and Keystone Small Company Growth (S-4), as applicable,
in exchange for shares of Evergreen Small Company Growth and the assumption by
Evergreen Small Company Growth of certain identified liabilities of each Fund.
The Plans also call for the distribution of shares of Evergreen Small Company
Growth to Keystone Small Company Growth II and Keystone Small Company Growth
(S-4) shareholders in liquidation of those Funds as part of the Reorganizations.
As a result of the Reorganizations, the shareholders of Keystone Small Company
Growth II will become owners of that
<PAGE>
number of full and fractional Corresponding Shares of Evergreen Small Company
Growth and the shareholders of Keystone Small Company Growth (S-4) will become
the owners of that number of full and fractional shares of Evergreen Small
Company Growth having an aggregate net asset value equal to the aggregate net
asset value of the shareholder's respective class of shares of Keystone Small
Company Growth II and Keystone Small Company Growth (S-4), as of the close of
business immediately prior to the date that such Fund's assets are exchanged for
shares of Evergreen Small Company Growth. See "Reasons for the Reorganizations -
Agreements and Plans of Reorganization."
The Trustees of Keystone Small Company Growth II and the Trustees of
Keystone Small Company Growth (S-4), including the Trustees who are not
"interested persons," (the "Trustees") as such term is defined in the 1940 Act
(the "Independent Trustees"), have concluded that the Reorganizations would be
in the best interests of shareholders of Keystone Small Company Growth II and
Keystone Small Company Growth (S-4), respectively, and that the interests of the
shareholders of Keystone Small Company Growth II and Keystone Small Company
Growth (S-4), respectively, will not be diluted as a result of the transactions
contemplated by the Reorganizations. Accordingly, the Trustees have submitted
the Plans for the approval of Keystone Small Company Growth II and Keystone
Small Company Growth (S-4) shareholders.
THE BOARD OF TRUSTEES OF KEYSTONE SMALL COMPANY GROWTH II
RECOMMENDS APPROVAL BY SHAREHOLDERS OF KEYSTONE
SMALL COMPANY GROWTH II OF THE PLAN
EFFECTING THE REORGANIZATION.
THE BOARD OF TRUSTEES OF KEYSTONE SMALL COMPANY GROWTH (S-4)
RECOMMENDS APPROVAL BY SHAREHOLDERS OF KEYSTONE
SMALL COMPANY GROWTH (S-4) OF THE PLAN
EFFECTING THE REORGANIZATION.
The Trustees of Evergreen Equity Trust have also approved
the Plans, and accordingly, Evergreen Small Company Growth's
participation in the Reorganizations.
Approval of a Reorganization on the part of Keystone Small Company
Growth II and Keystone Small Company Growth (S- 4) will require the affirmative
vote of a majority of each Fund's shares present and entitled to vote, with all
classes voting together as a single class at Meetings at which a quorum of each
Fund's shares is present. A majority of the outstanding shares of each Fund
entitled to vote, represented in person or by proxy, is required to constitute a
quorum at
<PAGE>
the Meetings. See "Voting Information Concerning the
Meetings."
The Reorganizations are scheduled to take place on or about January 23,
1998.
If the shareholders of Keystone Small Company Growth II or Keystone
Small Company Growth (S-4) do not vote to approve the Reorganizations, the
Trustees will consider other possible courses of action in the best interests of
shareholders.
Tax Consequences
Prior to or at the completion of a Reorganization, Keystone Small
Company Growth II and Keystone Small Company Growth (S-4) will each have
received an opinion of counsel that the Reorganization has been structured so
that no gain or loss will be recognized by the Fund or its shareholders for
federal income tax purposes as a result of the receipt of shares of Evergreen
Small Company Growth in the Reorganization. The holding period and aggregate tax
basis of shares of Evergreen Small Company Growth that are received by each
Fund's shareholders will be the same as the holding period and aggregate tax
basis of shares of the Fund previously held by such shareholders, provided that
shares of the Fund are held as capital assets. In addition, the holding period
and tax basis of the assets of each Fund in the hands of Evergreen Small Company
Growth as a result of the Reorganization will be the same as in the hands of
each Fund immediately prior to the Reorganization, and no gain or loss will be
recognized by Evergreen Small Company Growth upon the receipt of the assets of
each Fund in exchange for shares of Evergreen Small Company Growth and the
assumption by Evergreen Small Company Growth of certain identified liabilities.
Investment Objectives and Policies of the Funds
The investment objective and policies of each of Evergreen Small
Company Growth, Keystone Small Company Growth II and Keystone Small Company
Growth (S-4) are identical. Each Fund seeks to provide shareholders with
long-term growth of capital. Each Fund will invest at least 65% of its assets in
equity securities of companies with market capitalizations of less than $1
billion ("small cap") at the time of the Fund's investment. While each Fund
focuses on small cap stocks, it may also invest in other types of securities,
without regard to the market capitalization of the issuer and which may be
listed on exchanges or traded over the counter, including other common stocks,
including debt securities convertible into common stocks or having common stock
<PAGE>
characteristics, and rights and warrants to purchase common stocks. Each Fund
may purchase the securities of foreign issuers and certain derivative
securities, including futures and options.
Comparative Performance Information For Each Fund
Discussions of the manner of calculation of total return are contained
in the respective Prospectuses and Statements of Additional Information of the
Funds. Evergreen Small Company Growth, as of the date of this Prospectus/Proxy
Statement, had not commenced operations. The total return of Keystone Small
Company Growth II for the one year period ended August 31, 1997, the total
return of Keystone Small Company Growth (S-4) for the one, five and ten year
periods ended August 31, 1997 and for both Funds for the periods from inception
through August 31, 1997 are set forth in the table below. The calculations of
total return assume the reinvestment of all dividends and capital gains
distributions on the reinvestment date and the deduction of all recurring
expenses (including sales charges) that were charged to shareholders' accounts.
Average Annual Total Return
1 Year 5 Years 10 Years From
Ended Ended Ended Inception
August August August To August Inception
31, 1997 31, 1997 31, 1997 31, 1997 Date
------- ------- -------- --------- ---------
Keystone
Small
Company
Growth II
Class A 8.62% N/A N/A 7.33% 2/20/96
shares
Class B 8.22% N/A N/A 7.43% 2/20/96
shares
Class C 12.22% N/A N/A 9.93% 2/20/96
shares
Class Y N/A N/A N/A 18.17% 1/13/97
shares
<PAGE>
Keystone 12.56% 19.68% 12.69% 10.30% 9/11/35
Small
Company
Growth (S-4)
- --------------
Management of the Funds
The overall management of Evergreen Small Company Growth, of Keystone
Small Company Growth II and of Keystone Small Company Growth (S-4) is the
responsibility of, and is supervised by, the Board of Trustees of Evergreen
Equity Trust, Keystone Small Company Growth II and Keystone Small Company Growth
(S-4), respectively.
Investment Adviser
The investment adviser to Evergreen Small Company Growth, Keystone
Small Company Growth II and Keystone Small Company Growth (S-4) is Keystone
Investment Management Company ("Keystone"). Keystone has provided investment
advisory and management services to investment companies and private accounts
since 1932. Keystone is an indirect wholly-owned subsidiary of First Union
National Bank ("FUNB"). Keystone is located at 200 Berkeley Street, Boston,
Massachusetts 02116- 5034.
FUNB is a subsidiary of First Union Corporation, the sixth largest bank
holding company in the U.S. based on total assets as of June 30, 1997.
Evergreen Small Company Growth, Keystone Small Company Growth II and
Keystone Small Company Growth (S-4) each pay Keystone a fee for its services at
the annual rate below:
Aggregate Net Asset
Value of the Shares
Management Fee of the Fund
0.70% of the first $100,000,000, plus
0.65% of the next $100,000,000, plus
0.60% of the next $100,000,000, plus
0.55% of the next $100,000,000, plus
0.50% of the next $100,000,000, plus
0.45% of the next $500,000,000, plus
0.40% of the next $500,000,000, plus
0.35% of amounts
over $1,500,000,000.
<PAGE>
Keystone's fee is computed as of the close of business each business
day and payable monthly.
Keystone may, at its discretion, also reduce or waive its fee or
reimburse a Fund for certain of its other expenses in order to reduce its
expense ratios. Keystone may reduce or cease these voluntary waivers and
reimbursements at any time.
Portfolio Management
The portfolio manager of both Evergreen Small Company Growth and Keystone
Small Company Growth (S-4) is J. Gary Craven, who joined Keystone in November,
1996. Mr. Craven is currently a Keystone Senior Vice President, Chief Investment
Officer and Group Leader for the small cap equity area. Prior to joining
Keystone, Mr. Craven was a portfolio manager at Invista Capital Management, Inc.
since 1987.
Distribution of Shares
Evergreen Keystone Distributor, Inc. ("EKD"), an affiliate of BISYS
Fund Services, acts as underwriter of Evergreen Small Company Growth's, Keystone
Small Company Growth II's and Keystone Small Company Growth (S-4)'s shares. EKD
distributes each Fund's shares directly or through broker-dealers, banks
(including FUNB), or other financial intermediaries. Evergreen Small Company
Growth and Keystone Small Company Growth II both offer four classes of shares:
Class A, Class B, Class C and Class Y. Keystone Small Company Growth (S-4)
currently offers only one class of shares. However, it is anticipated that on or
about January 9, 1998, Keystone Small Company Growth (S-4) will offer three
classes of shares, Class A, Class B and Class C. Each class has separate
distribution arrangements. (See "Distribution- Related and Shareholder
Servicing-Related Expenses" below.) No class bears the distribution expenses
relating to the shares of any other class.
In the proposed Reorganizations, shareholders of Keystone Small Company
Growth II will receive the corresponding class of shares of Evergreen Small
Company Growth, which they currently hold. The Class A, Class B, Class C and
Class Y shares of Evergreen Small Company Growth have substantially identical
arrangements with respect to the imposition of initial sales charges, CDSCs and
distribution and service fees as the comparable classes of shares of Keystone
Small Company Growth II. Holders of shares of Keystone Small Company Growth
(S-4) will receive Class A and Class B shares of Evergreen Small Company Growth.
As of January 9, 1998, it is anticipated that each class of Evergreen Small
Company Growth,
<PAGE>
Keystone Small Company Growth II and Keystone Small Company Growth (S-4) will
have identical arrangements with respect to CDSCs and distribution and service
fees. Because the Reorganizations will be effected at net asset value without
the imposition of a sales charge, Evergreen Small Company Growth shares acquired
by shareholders of Keystone Small Company Growth II and Keystone Small Company
Growth (S-4) pursuant to the proposed Reorganizations would not be subject to
any initial sales charge or CDSC as a result of the Reorganizations. However,
shares acquired as a result of the Reorganizations would continue to be subject
to a CDSC upon subsequent redemption to the same extent as if shareholders had
continued to hold their shares of Keystone Small Company Growth II and Keystone
Small Company Growth (S-4). The CDSC applicable to a class of shares received in
the Reorganizations will be the CDSC schedule in effect at the time shares of
Keystone Small Company Growth II or Keystone Small Company Growth (S-4) were
originally purchased.
The following is a summary description of charges and fees for each of
the different classes of shares. More detailed descriptions of the distribution
arrangements applicable to the classes of shares are contained in the respective
Evergreen Small Company Growth Prospectuses, the Keystone Small Company Growth
II Prospectus, the Keystone Small Company Growth (S-4) Prospectus and in each
Fund's respective Statement of Additional Information.
Currently, Keystone Small Company Growth (S-4) offers only one class of
shares. Shares are sold without any front-end sales charges, but are subject to
a CDSC which ranges from 4% to 1% if shares are redeemed during the first four
calendar years after purchase. In addition, shares are subject to
distribution-related and shareholder servicing-related fees as described below.
It is anticipated that Keystone Small Company Growth (S-4) will become a
multiple class fund on or about January 9, 1998. Should this occur, the Fund
will offer three classes of shares identical to the Class A, Class B and Class C
shares of Evergreen Small Company Growth and hereafter described, including
identical distribution-related and shareholder servicing-related expenses.
Class Y Shares. Class Y shares are sold at net asset value without any
initial sales charge and are not subject to distribution-related fees. Class Y
shares are only available to certain classes of investors as is more fully
described in the Prospectuses for Evergreen Small Company Growth.
<PAGE>
Class A Shares. Class A shares are sold at net asset value plus an
initial sales charge and, as indicated below, are subject to
distribution-related fees.
Class B Shares. Class B shares are sold without an initial sales charge
but are subject to a CDSC, which ranges from 5% to 1%, if shares are redeemed
during the first six years after the month of purchase. In addition, Class B
shares are subject to distribution-related fees and shareholder
servicing-related fees as described below. Class B shares issued in the
Reorganizations will automatically convert to Class A shares in accordance with
the conversion schedule of Evergreen Small Company Growth in effect at the time
of the Reorganizations. For purposes of determining when Class B shares issued
in the Reorganizations to shareholders of Keystone Small Company Growth II and
Keystone Small Company Growth (S-4) will convert to Class A shares, such shares
will be deemed to have been purchased as of the date the shares of Keystone
Small Company Growth II and Keystone Small Company Growth (S-4) were originally
purchased.
Class B shares are subject to higher distribution-related fees than the
corresponding Class A shares on which a front-end sales charge is imposed (until
they convert to Class A shares). The higher fees mean a higher expense ratio, so
Class B shares pay correspondingly lower dividends and may have a lower net
asset value than Class A shares of the Fund.
Class C Shares. Class C shares are sold without an initial sales charge
but, as indicated below, are subject to distribution and shareholder
servicing-related fees. Class C shares are subject to a 1% CDSC if such shares
are redeemed during the month of purchase and the 12-month period following the
month of purchase. No CDSC is imposed on amounts redeemed thereafter. Class C
shares incur higher distribution and shareholder servicing-related fees than
Class A shares but, unlike Class B shares, do not convert to any other class of
shares.
The amount of the CDSC applicable to redemptions of shares of Keystone
Small Company Growth (S-4), Evergreen Small Company Growth and Keystone Small
Company Growth II is charged as a percentage of the lesser of the then current
net asset value or original cost. The CDSC is deducted from the amount of the
redemption and is paid to the respective Fund's distributor or its predecessor,
as the case may be. Shares of each Fund acquired through dividend or
distribution reinvestment are not subject to a CDSC. For purposes of determining
the schedule of CDSCs, and the time of conversion to Class A shares, applicable
to shares of Evergreen Small
<PAGE>
Company Growth received by Keystone Small Company Growth II's or Keystone Small
Company Growth (S-4)'s shareholders in the Reorganizations, Evergreen Small
Company Growth will treat such shares as having been sold on the date the shares
of Keystone Small Company Growth II or Keystone Small Company Growth (S-4) were
originally purchased by such Fund's shareholder. Additional information
regarding the Classes of shares of each Fund is included in their respective
Prospectus and Statement of Additional Information.
Distribution-Related and Shareholder Servicing-Related Expenses.
Evergreen Small Company Growth and Keystone Small Company Growth II have each
adopted a Rule 12b-1 plan with respect to its Class A shares under which the
class may pay for distribution-related expenses at an annual rate which may not
exceed 0.75% of average daily net assets attributable to the Class. Payments
with respect to Class A shares of Evergreen Small Company Growth and Keystone
Small Company Growth II are currently limited to 0.25% of average daily net
assets attributable to the Class, which amount may be increased to the full plan
rate for such Fund by the Trustees without shareholder approval.
Each of Evergreen Small Company Growth and Keystone Small Company
Growth II has also adopted a Rule 12b-1 plan with respect to its Class B and
Class C shares under which each Class may pay for distribution-related and
shareholder servicing-related expenses at an annual rate which may not exceed
1.00% of average daily net assets attributable to the Class.
The Class B and Class C Rule 12b-1 plans provide, that of the total
1.00% 12b-1 fees, up to 0.25% may be for payment in respect of "shareholder
services." Consistent with the requirements of Rule 12b-1 and the applicable
rules of the National Association of Securities Dealers, Inc. ("NASD"),
following the Reorganizations Evergreen Small Company Growth may make
distribution-related and shareholder servicing- related payments with respect to
Keystone Small Company Growth II and Keystone Small Company Growth (S-4) shares
sold prior to the Reorganizations, including payments to Keystone Small Company
Growth (S-4)'s former underwriter.
Keystone Small Company Growth (S-4) has adopted a Rule 12b-1 plan with
respect to its shares pursuant to which the Fund may pay for
distribution-related and shareholder servicing-related expenses at an annual
rate that may not exceed 1.25% of average daily net assets. The NASD limits the
amount that the Fund may pay annually in distribution costs for the sale of its
shares and shareholder service fees. The
<PAGE>
NASD currently limits such annual expenditures to 1.00% of the aggregate average
daily net asset value of its shares, of which 0.75% may be used to pay
distribution costs and 0.25% may be used to pay shareholder service fees.
Additional information regarding the Rule 12b-1 plans adopted by each
Fund is included in its respective Prospectus and Statement of Additional
Information.
Purchase and Redemption Procedures
Information concerning applicable sales charges, distribution-related
fees and shareholder servicing-related fees are described above. Investments in
the Funds are not insured. The minimum initial purchase requirement for each
Fund is $1,000. There is no minimum for subsequent purchases of shares of any
Fund. Each Fund provides for telephone, mail or wire redemption of shares at net
asset value, less any CDSC, as next determined after receipt of a redemption
request on each day the New York Stock Exchange ("NYSE") is open for trading.
Additional information concerning purchases and redemptions of shares, including
how each Fund's net asset value is determined, is contained in the respective
Prospectus for each Fund. Each Fund may involuntarily redeem shareholders'
accounts that have less than $1,000 of invested funds. All funds invested in
each Fund are invested in full and fractional shares. The Funds reserve the
right to reject any purchase order.
Exchange Privileges
Shares of Keystone Small Company Growth II may be exchanged for a
similar class of shares of any other fund in the Evergreen Keystone fund family
other than any shares of a fund in the Keystone Classic fund family. Exchanges
of shares of Keystone Small Company Growth (S-4) are limited to shares of the
funds in the Keystone Classic fund family and Class K shares of Evergreen Money
Market Fund. Shares of Evergreen Small Company Growth may be exchanged for a
similar class of shares of any fund in the Evergreen Keystone fund family other
than shares of any fund in the Keystone Classic fund family. No sales charge is
imposed on an exchange. An exchange which represents an initial investment in
another fund must amount to at least $1,000. The current exchange privileges,
and the requirements and limitations attendant thereto, are described in each
Fund's respective Prospectus and Statement of Additional Information.
Dividend Policy
<PAGE>
Each Fund distributes its investment company taxable income annually
and net realized capital gains at least annually. Shareholders begin to earn
dividends on the first business day after shares are purchased unless shares
were not paid for, in which case dividends are not earned until the next
business day after payment is received. Dividends and distributions are
reinvested in additional shares of the same class of the respective Fund, or
paid in cash, as a shareholder has elected. See the respective Prospectus of
each Fund for further information concerning dividends and distributions.
After the Reorganizations, shareholders of Keystone Small Company
Growth II and Keystone Small Company Growth (S-4) who have elected to have their
dividends and/or distributions reinvested will have dividends and/or
distributions received from Evergreen Small Company Growth reinvested in shares
of Evergreen Small Company Growth. Shareholders of Keystone Small Company Growth
II and Keystone Small Company Growth (S- 4) who have elected to receive
dividends and/or distributions in cash will receive dividends and/or
distributions from Evergreen Small Company Growth in cash after the
Reorganizations, although they may, after the Reorganizations, elect to have
such dividends and/or distributions reinvested in additional shares of Evergreen
Small Company Growth.
Each of Keystone Small Company Growth II and Keystone Small Company
Growth (S-4) has qualified and intends to continue to qualify, and Evergreen
Small Company Growth intends to qualify, to be treated as a regulated investment
company under the Internal Revenue Code of 1986, as amended (the "Code"). While
so qualified, so long as each Fund distributes all of its investment company
taxable income and any net realized gains to shareholders, it is expected that a
Fund will not be required to pay any federal income taxes on the amounts so
distributed. A 4% nondeductible excise tax will be imposed on amounts not
distributed if a Fund does not meet certain distribution requirements by the end
of each calendar year. Each Fund anticipates meeting such distribution
requirements.
Risks
Since the investment objectives and policies of each Fund are
identical, the risks involved in investing in each Fund's shares are comparable.
Investing in companies with small market capitalizations involves
greater risk than investing in large companies. Their stock prices can rise very
quickly and drop dramatically
<PAGE>
in a short period of time. This volatility results from a number of factors,
including reliance by these companies on limited product lines, markets and
financial and management resources. These and other factors may make small cap
companies more susceptible to setbacks or downturns. These companies may
experience higher rates of bankruptcy or other failures than larger companies.
They may be more likely to be negatively affected by changes in management. In
addition, the stock of small cap companies may be thinly traded.
Each Fund may invest in derivatives. The market values of derivatives
or structured securities may vary depending upon the manner in which the
investments have been structured and may fluctuate much more rapidly and to a
much greater extent. As a result, the values of such investments may change at
rates in excess of the rates at which traditional fixed income securities change
and, depending on the structure of a derivative, would change in a manner
opposite to the change in the market value of a traditional fixed income
security. See each Fund's Prospectus and Statement of Additional Information for
further discussion of the risks inherent in the use of derivatives.
Each Fund may invest in foreign securities. Investing in securities of
foreign issuers generally involves greater risk than investing in securities of
domestic issuers for the following reasons: publicly available information on
issuers and securities may be scarce; many foreign countries do not follow the
same accounting, auditing, and financial reporting standards as are used in the
U.S.; market trading volumes may be smaller, resulting in less liquidity and
more price volatility compared to U.S. securities of comparable quality; there
may be less regulation of securities trading and its participants; the
possibility may exist for expropriation, confiscatory taxation, nationalization,
establishment of exchange controls, political or social instability or negative
diplomatic developments; and dividend or interest withholding may be imposed at
the source.
Fluctuations in foreign exchange rates impose an additional level of
risk, possibly affecting the value of the Fund's foreign investments and
earnings, gains and losses realized through trades, and the unrealized
appreciation or depreciation of investments. Each Fund may also incur costs when
it shifts assets from one country to another.
REASONS FOR THE REORGANIZATIONS
At a regular meeting held on September 17, 1997, the Board of Trustees
of Keystone Small Company Growth Fund II
<PAGE>
considered and approved the Reorganization as in the best interests of
shareholders and determined that the interests of existing shareholders of
Keystone Small Company Growth Fund II will not be diluted as a result of the
transactions contemplated by the Reorganization.
At a regular meeting held on September 17, 1997, the Board of Trustees
of Keystone Small Company Growth (S-4) considered and approved the
Reorganization as in the best interests of shareholders and determined that the
interests of existing shareholders of Keystone Small Company Growth (S-4) will
not be diluted as a result of the transactions contemplated by the
Reorganization.
In approving each Plan, the Trustees reviewed various factors about the
respective Funds and the proposed Reorganizations. The Reorganizations are part
of an overall plan to convert the Evergreen Keystone funds into series of
Delaware business trusts and, to the extent practicable, simplify and make
consistent various investment restrictions and policies. Holders of shares of
beneficial interest in a Massachusetts business trust or a Pennsylvania common
law trust may, under certain circumstances, be held personally liable as
partners for their obligations of the trust. Although provisions of the
Declaration of Trust and other legal documents pertaining to each Fund's affairs
seek to minimize the potential for such liability, some degree of exposure,
however unlikely, continues to exist with respect to the Funds as long as they
are governed by Massachusetts or Pennsylvania law, as applicable. Substantially
all written agreements, obligations, instruments, or undertakings made by
Keystone Small Company Growth II or Keystone Small Company Growth (S-4) must
contain a provision limiting the obligations created by that transaction to the
Fund to which the transaction relates, as well as related provisions to the
effect that the shareholders of the Fund and Trustees of the Trust under which
the Fund operates are not personally liable thereunder. Although the
Declarations of Trust of Keystone Small Company Growth II and Keystone Small
Company Growth (S- 4) provide for indemnification out of the Funds' property of
any shareholder held personally liable for the obligations of a Fund solely by
reason of his or her being or having been a shareholder, a shareholder could
conceivably incur financial loss exceeding any amounts indemnified on account of
shareholder liability if the circumstances were such that the Fund had
insufficient assets or would otherwise be unable to meet its obligations.
As a Delaware business trust, the Evergreen Equity Trust's operations
will be governed by applicable Delaware law
<PAGE>
rather than by applicable Massachusetts or Pennsylvania law. The Delaware
Business Trust Act (the "Delaware Act") provides that a shareholder of a
Delaware business trust shall be entitled to the same limitation of personal
liability extended to stockholders of Delaware corporations. Shareholders of
Delaware corporations do not have personal liability for obligations of the
corporation.
Delaware has obtained a favorable national reputation for its business
laws and business environment. The Delaware courts, which may be called upon to
interpret the Delaware Act, are among the nation's most highly respected and
have an expertise in corporate matters which in part grew out of the fact that
Delaware corporate legal issues are concentrated in the Court of Chancery where
there are no juries and where judges issue written opinions explaining their
decisions. Thus, there is a well established body of precedent which may be
relevant in deciding issues pertaining to a Delaware business trust.
There are other advantages that may be afforded by a Delaware business
trust. Under Delaware law, the Evergreen Equity Trust will have the flexibility
to respond to future business contingencies. For example, the Trustees will have
the power to change the Evergreen Equity Trust to a corporation, to merge or
consolidate it with another entity, to cause each series to become a separate
trust, and to change the Evergreen Equity Trust's domicile without a shareholder
vote. This flexibility could help to assure that the Evergreen Equity Trust
operates under the most advanced form of organization and could reduce the
expense and frequency of future shareholder meetings for non-investment related
issues.
In addition, although it is proposed that Keystone Small Company Growth
II and Keystone Small Company Growth (S-4) each sell all of its assets to
Evergreen Small Company Growth, a newly established series of Evergreen Equity
Trust, an important part of the Reorganizations is that Keystone Small Company
Growth II, for all practical purposes, will be combined with Keystone Small
Company Growth (S-4). The investment objective and policies of Evergreen Small
Company Growth are identical to those of Keystone Small Company Growth (S-4) and
Keystone Small Company Growth II. Consequently, in considering the
Reorganizations, each Fund's Trustees reviewed the Reorganization in the context
of Keystone Small Company Growth II being combined with Keystone Small Company
Growth (S-4).
Keystone Small Company Growth II and Keystone Small Company Growth
(S-4) have identical investment objectives and
<PAGE>
policies and comparable risk profiles. See "Comparison of Investment Objectives
and Policies" below. At the same time, the Boards of Trustees of Keystone Small
Company Growth II and Keystone Small Company Growth (S-4) evaluated the
potential economies of scale associated with larger mutual funds and concluded
that operational efficiencies may be achieved upon the combination of Keystone
Small Company Growth II with another Evergreen Keystone fund with a greater
level of assets. As of August 31, 1997, Keystone Small Company Growth (S-4)'s
net assets were approximately $1,481 million and Keystone Small Company Growth
II's net assets were approximately $41 million.
In addition, assuming that an alternative to the Reorganizations would
be to propose that Keystone Small Company Growth II and Keystone Small Company
Growth (S-4) continue their existences as separate series of Evergreen Equity
Trust, Keystone Small Company II would be offered through common distribution
channels with the substantially identical Keystone Small Company Growth (S-4).
Keystone Small Company Growth II would also have to bear the cost of maintaining
its separate existence. Keystone believes that the prospect of dividing the
resources of the Evergreen Keystone mutual fund organization between two
substantially identical funds could result in each Fund being disadvantaged due
to an inability to achieve optimum size, performance levels and the greatest
possible economies of scale. Accordingly, for the reasons noted above and
recognizing that there can be no assurance that any economies of scale or other
benefits will be realized, Keystone believes that the proposed Reorganizations
would be in the best interests of each Fund and its shareholders.
The Board of Trustees of Keystone Small Company Growth II and the Board
of Trustees of Keystone Small Company Growth (S- 4) met and considered the
recommendation of Keystone, and, in addition, considered among other things, (i)
the disadvantages which apply to operating each Fund as a Massachusetts business
trust or a Pennsylvania common law trust, respectively; (ii) the advantages
which apply to each Fund operating as a series of a Delaware business trust;
(iii) the terms and conditions of the Reorganization; (iv) whether the
Reorganization would result in the dilution of shareholders' interests; (v)
expense ratios, fees and expenses of Keystone Small Company Growth II and
Keystone Small Company Growth (S-4); (vi) the comparative performance records of
each of the Funds; (vii) compatibility of their investment objectives and
policies; (viii) the investment experience, expertise and resources of Keystone;
(ix) service features available to shareholders of the respective Funds and
Evergreen Small Company Growth; (x) the
<PAGE>
fact that FUNB will bear the expenses incurred by Keystone Small Company Growth
II and Keystone Small Company Growth (S- 4) in connection with the
Reorganizations; (xi) the fact that Evergreen Small Company Growth will assume
certain identified liabilities of Keystone Small Company Growth II and Keystone
Small Company Growth (S-4); and (xii) the expected federal income tax
consequences of the Reorganizations.
The Trustees of Keystone Small Company Growth II also considered the
benefits to be derived by shareholders of Keystone Small Company Growth II from
its combination, for all practical purposes, with Keystone Small Company Growth
(S-4). In this regard, the Trustees considered the potential benefits of being
associated with a larger entity and the economies of scale that could be
realized by the participation by shareholders of Keystone Small Company Growth
II.
In addition, the Trustees of Keystone Small Company Growth II and
Keystone Small Company Growth (S-4) considered that there are alternatives
available to shareholders of Keystone Small Company Growth II and Keystone Small
Company Growth (S-4), including the ability to redeem their shares, as well as
the option to vote against the Reorganizations.
During their consideration of the Reorganizations the Trustees met with
Fund counsel and counsel to the Independent Trustees regarding the legal issues
involved. The Trustees of Evergreen Equity Trust on behalf of Evergreen Small
Company Growth also approved at a meeting on September 17, 1997 the
proposed Reorganizations.
THE TRUSTEES OF KEYSTONE SMALL COMPANY GROWTH II RECOMMEND
THAT SHAREHOLDERS APPROVE THE PROPOSED
REORGANIZATION.
THE TRUSTEES OF KEYSTONE SMALL COMPANY GROWTH (S-4)
RECOMMEND THAT SHAREHOLDERS APPROVE THE
PROPOSED REORGANIZATION.
Agreements and Plans of Reorganization
The following summary is qualified in its entirety by reference to the
Plans (Exhibits A-1 and A-2 hereto).
Each Plan provides that Evergreen Small Company Growth will acquire all
of the assets of Keystone Small Company Growth II and Keystone Small Company
Growth (S-4) in exchange for shares of Evergreen Small Company Growth and the
assumption by Evergreen Small Company Growth of certain identified liabilities
of Keystone Small Company Growth II and
<PAGE>
Keystone Small Company Growth (S-4) on or about January 23, 1998 or such other
date as may be agreed upon by the parties (the "Closing Date"). Prior to the
Closing Date, Keystone Small Company Growth II and Keystone Small Company Growth
(S- 4) will endeavor to discharge all of their known liabilities and
obligations. Evergreen Small Company Growth will not assume any liabilities or
obligations of Keystone Small Company Growth II and Keystone Small Company
Growth (S-4) other than those reflected in an unaudited statement of assets and
liabilities of Keystone Small Company Growth II and Keystone Small Company
Growth (S-4) prepared as of the close of regular trading on the NYSE, currently
4:00 p.m. Eastern time, on the business day immediately prior to the Closing
Date. Evergreen Small Company Growth will provide the Trustees of Keystone Small
Company Growth II and Keystone Small Company Growth (S-4) with certain
indemnifications as set forth in each Plan. The number of full and fractional
shares of Evergreen Small Company Growth to be received by the shareholders of
Keystone Small Company Growth II and Keystone Small Company Growth (S-4) will be
as follows: Shareholders of Keystone Small Company Growth (S-4) will receive the
number of shares of each class of Evergreen Small Company Growth equal to the
number of shares of each corresponding class as they currently hold of Keystone
Small Company Growth (S-4). Shareholders of Keystone Small Company Growth II
will receive the number of shares of Evergreen Small Company Growth determined
by multiplying the respective outstanding class of shares of Keystone Small
Company Growth II by a factor which shall be computed by dividing the net asset
value per share of the respective class of Keystone Small Company Growth II by
the net asset value per share of the respective class of Evergreen Small Company
Growth. Such computations will take place as of the close of regular trading on
the NYSE on the business day immediately prior to the Closing Date. The net
asset value per share of each class will be determined by dividing assets, less
liabilities, in each case attributable to the respective class, by the total
number of outstanding shares.
State Street Bank and Trust Company, the custodian for the Funds, will
compute the value of Keystone Small Company Growth II's and Keystone Small
Company Growth (S-4)'s respective portfolio securities. The method of valuation
employed will be consistent with the procedures set forth in the Prospectus and
Statement of Additional Information of Evergreen Small Company Growth, Rule
22c-1 under the 1940 Act, and with the interpretations of such Rule by the SEC's
Division of Investment Management.
<PAGE>
At or prior to the Closing Date, Keystone Small Company Growth II and
Keystone Small Company Growth (S-4) will have declared a dividend or dividends
and distribution or distributions which, together with all previous dividends
and distributions, shall have the effect of distributing to each Fund's
shareholders (in shares of each Fund, or in cash, as the shareholder has
previously elected) all of each Fund's investment company taxable income for the
taxable period ending on the Closing Date (computed without regard to any
deduction for dividends paid) and all of its net capital gains realized in all
taxable periods ending on the Closing Date (after reductions for any capital
loss carryforward).
As soon after the Closing Date as conveniently practicable, Keystone
Small Company Growth II and Keystone Small Company Growth (S-4) will liquidate
and distribute pro rata to shareholders of record as of the close of business on
the Closing Date the full and fractional shares of Evergreen Small Company
Growth received by each Fund. Such liquidation and distribution will be
accomplished by the establishment of accounts in the names of each Fund's
shareholders on the share records of Evergreen Small Company Growth's transfer
agent. Each account will represent the respective pro rata number of full and
fractional shares of Evergreen Small Company Growth due to each Fund's
shareholders. All issued and outstanding shares of each Fund, including those
represented by certificates, will be canceled. The shares of Evergreen Small
Company Growth to be issued will have no preemptive or conversion rights. After
such distributions and the winding up of its affairs, Keystone Small Company
Growth II and Keystone Small Company Growth (S-4) will be terminated. In
connection with such terminations, Keystone Small Company Growth II and Keystone
Small Company Growth (S-4) will file with the SEC applications for termination
as registered investment companies.
The consummation of each Reorganization is subject to the conditions
set forth in the Plan for Keystone Small Company Growth II and the Plan for
Keystone Small Company Growth (S- 4), including approval by each Fund's
shareholders, accuracy of various representations and warranties and receipt of
opinions of counsel, including opinions with respect to those matters referred
to in "Federal Income Tax Consequences" below. Notwithstanding approval of each
Fund's shareholders, each Plan may be terminated (a) by the mutual agreement of
the Fund and Evergreen Small Company Growth; or (b) at or prior to the Closing
Date by either party (i) because of a breach by the other party of any
representation, warranty, or agreement contained therein to be performed at or
prior to the Closing Date if not cured within 30 days, or (ii) because a
condition
<PAGE>
to the obligation of the terminating party has not been met and it reasonably
appears that it cannot be met.
The expenses of Keystone Small Company Growth II and Keystone Small
Company Growth (S-4) in connection with the Reorganizations (including the cost
of any proxy soliciting agent) will be borne by FUNB whether or not the
Reorganizations are consummated.
If the Reorganization is not approved by shareholders of a Fund, the
Board of Trustees of Keystone Small Company Growth II and Keystone Small Company
Growth (S-4), as applicable, will consider other possible courses of action in
the best interests of shareholders.
Federal Income Tax Consequences
Each Reorganization is intended to qualify for federal income tax
purposes as a tax-free reorganization under section 368(a) of the Code. As a
condition to the closing of a Reorganization, Keystone Small Company Growth II
and Keystone Small Company Growth (S-4) will each receive an opinion of counsel
to the effect that, on the basis of the existing provisions of the Code, U.S.
Treasury regulations issued thereunder, current administrative rules,
pronouncements and court decisions, for federal income tax purposes, upon
consummation of the Reorganization:
(1) The transfer of all of the assets of the Fund solely in exchange
for shares of Evergreen Small Company Growth and the assumption by Evergreen
Small Company Growth of certain identified liabilities, followed by the
distribution of Evergreen Small Company Growth's shares by the Fund in
dissolution and liquidation of the Fund, will constitute a "reorganization"
within the meaning of section 368(a)(1)(C) (with respect to Keystone Small
Company Growth II and 368(a)(1)(F) with respect to Keystone Small Company Growth
(S- 4)) of the Code, and Evergreen Small Company Growth and the Fund will each
be a "party to a reorganization" within the meaning of section 368(b) of the
Code;
(2) No gain or loss will be recognized by the Fund on the transfer of
all of its assets to Evergreen Small Company Growth solely in exchange for
Evergreen Small Company Growth's shares and the assumption by Evergreen Small
Company Growth of certain identified liabilities of the Fund or upon the
distribution of Evergreen Small Company Growth's shares to the Fund's
shareholders in exchange for their shares of the Fund;
<PAGE>
(3) The tax basis of the assets transferred will be the same to
Evergreen Small Company Growth as the tax basis of such assets to the Fund
immediately prior to the Reorganization, and the holding period of such assets
in the hands of Evergreen Small Company Growth will include the period during
which the assets were held by the Fund;
(4) No gain or loss will be recognized by Evergreen Small Company
Growth upon the receipt of the assets from the Fund solely in exchange for the
shares of Evergreen Small Company Growth and the assumption by Evergreen Small
Company Growth of certain identified liabilities of the Fund;
(5) No gain or loss will be recognized by the Fund's shareholders upon
the issuance of the shares of Evergreen Small Company Growth to them, provided
they receive solely such shares (including fractional shares) in exchange for
their shares of the Fund; and
(6) The aggregate tax basis of the shares of Evergreen Small Company
Growth, including any fractional shares, received by each of the shareholders of
the Fund pursuant to the Reorganization will be the same as the aggregate tax
basis of the shares of the Fund held by such shareholder immediately prior to
the Reorganization, and the holding period of the shares of Evergreen Small
Company Growth, including fractional shares, received by each such shareholder
will include the period during which the shares of the Fund exchanged therefor
were held by such shareholder (provided that the shares of the Fund were held as
a capital asset on the date of the Reorganization).
Opinions of counsel are not binding upon the Internal Revenue Service
or the courts. If a Reorganization is consummated but does not qualify as a
tax-free reorganization under the Code, shareholders of Keystone Small Company
Growth II and Keystone Small Company Growth (S-4) would recognize a taxable gain
or loss equal to the difference between his or her tax basis in his or her Fund
shares and the fair market value of Evergreen Small Company Growth shares he or
she received. Shareholders of Keystone Small Company Growth II and Keystone
Small Company Growth (S-4) should consult their tax advisers regarding the
effect, if any, of the proposed Reorganization in light of their individual
circumstances. It is not anticipated that the securities of the combined
portfolio will be sold in significant amounts in order to comply with the
policies and investment practices of Evergreen Small Company Growth. Since the
foregoing discussion relates only to the federal income tax consequences of the
Reorganization, shareholders of Keystone Small Company Growth
<PAGE>
II and Keystone Small Company Growth (S-4) should also consult their tax
advisers as to the state and local tax consequences, if any, of the
Reorganization.
Pro-forma Capitalization
The following table sets forth the capitalizations of Keystone Small
Company Growth II and Keystone Small Company Growth (S-4) as of August 31, 1997
and the capitalization of Evergreen Small Company Growth on a pro forma basis as
of that date, giving effect to the proposed acquisitions of assets at net asset
value and the conversion of certain Keystone Small Company Growth (S-4) shares.
As a newly created series of Evergreen Equity Trust, Evergreen Small Company
Growth, immediately preceding the Closing Date, will have nominal assets and
liabilities. The pro forma data reflects an exchange ratio of approximately
1.34, 1.32, 1.32, and 1.34 Class A, Class B, Class C and Class Y shares of
Evergreen Small Company Growth issued for each share of Keystone Small Company
Growth II Class A, Class B, Class C and Class Y, respectively, and an exchange
ratio of approximately 1.00 Class B share of Evergreen Small Company Growth
issued for each share of Keystone Small Company Growth (S-4).
Capitalization of Keystone Small Company Growth II,
Keystone Small Company Growth (S-4) and Evergreen
Small Company Growth (Pro Forma)
Evergreen
Small
Company
Keystone Growth
Small Keystone (After
Company Small Company Reorgani-
Growth II Growth (S-4) zations)
------------ ----------- -----------
Net Assets
Class A............. $11,039,856 N/A $981,741,501
Class B............. $22,239,365 $1,481,308,783 $532,846,503
Class C............. $6,797,412 N/A $6,797,412
Class Y............. $469,283 N/A $469,283
Net Asset Value
Per Share
Class A............. $11.70 N/A $8.76
Class B............. $11.56 $8.76 $8.76
Class C............. $11.56 N/A $8.76
Class Y............. $11.77 N/A $8.76
Shares
Outstanding
<PAGE>
Evergreen
Small
Company
Keystone Growth
Small Keystone (After
Company Small Company Reorgani-
Growth II Growth (S-4) zations)
------------ ----------- -----------
Class A............. 943,337 N/A 112,026,033
Class B............. 1,924,651 169,031,126 60,804,865
Class C............. 588,199 N/A 776,208
Class Y............. 39,863 N/A 53,560
All Classes......... 3,496,050 169,031,126 173,660,667
The table set forth above should not be relied upon to reflect the
number of shares to be received in the Reorganizations; the actual number of
shares to be received will depend upon the net asset value and number of shares
outstanding of each Fund at the time of the Reorganizations.
Shareholder Information
As of November 10, 1997 (the "Record Date"), there were shares of
Keystone Small Company Growth (S-4) outstanding
and Class A, Class B, Class C and Class Y shares (a total of shares) of Keystone
Small Company Growth II outstanding.
As of September 30, 1997, the officers and Trustees of Keystone Small
Company Growth II beneficially owned as a group less than 1% of the outstanding
shares of Keystone Small Company Growth II. To Keystone Small Company Growth
II's knowledge, the following persons owned beneficially or of record more than
5% of Keystone Small Company Growth II's total outstanding shares as of
September 30, 1997:
Percen-
Percen- tage of
tage of Shares of
Shares of Class
Class Outstand-
Before ing After
No. of Reorgani- Reorgani-
Name and Address Class Shares zations zations
- ---------------- ----- ------ --------- ---------
<PAGE>
Merrill Lynch
Pierce Fenner & A 179,857 20.526 0.22
Smith
Attn: Book Entry
4800 Deer Lake
Drive East
3rd Floor
Jacksonville, FL
32246-6484
Merrill Lynch B 607,125 31.30 1.35
Pierce Fenner &
Smith
Attn: Book Entry
4800 Deer Lake
Drive East
3rd Floor
Jacksonville, FL
32246-6484
Merrill Lynch C 390,240 74.48 74.48
Pierce Fenner &
Smith
Attn: Book Entry
4800 Deer Lake
Drive East
3rd Floor
Jacksonville, FL
32246-6484
First Union Y 45,901 98.95 98.95
National Bank
Cash Account
Attn: Trust
Operation Fund
Group
401 S. Tryon
Street
3rd Floor
Charlotte, NC
28288-1151
As of September 30, 1997, the officers and Trustees of Keystone Small
Company Growth (S-4) beneficially owned as a group less than 1% of the
outstanding shares of Keystone Small Company Growth (S-4). To Keystone Small
Company Growth (S- 4)'s knowledge, the following persons owned beneficially or
of record more than 5% of Keystone Small Company Growth (S-4)'s total
outstanding shares as of September 30, 1997:
<PAGE>
Percen- Percentage
tage of of Shares of
Shares of Class
Class Outstanding
Before After
No. of Reorgani- Reorgani-
Name and Address Shares zations zations
- ---------------- ------ --------- ---------
Merrill Lynch Pierce 16,077,034 9.82 9.71 Class A
Fenner & Smith 9.39 Class B
Attn: Book Entry
4800 Deer Lake Drive East
3rd Floor
Jacksonville, FL 32246-
6484
COMPARISON OF INVESTMENT OBJECTIVES AND POLICIES
The following discussion is based upon and qualified in its entirety by
the descriptions of the respective investment objectives, policies and
restrictions set forth in the respective Prospectuses and Statements of
Additional Information of the Funds. The investment objective, policies and
restrictions of Evergreen Small Company Growth can be found in the Prospectuses
of Evergreen Small Company Growth under the caption "Investment Objective and
Policies". The investment objectives, policies and restrictions of Keystone
Small Company Growth II and Keystone Small Company Growth (S- 4) can be found in
the respective Prospectus of each Fund under the caption "Investment Objective
and Policies."
The investment objective and policies of each Fund are identical. Each
Fund seeks to provide shareholders with long-term growth of capital. The
investment objective of Evergreen Small Company Growth can be changed without
shareholder approval. The investment objective of Keystone Small Company Growth
II and Keystone Small Company Growth (S-4) cannot be changed without shareholder
approval.
Each Fund invests at least 65% of its total assets in equity securities
of companies with small market capitalizations. For this purpose, companies with
small market capitalizations are generally those with market capitalization of
less than $1 billion ("small cap") at the time of the Fund's investment.
Companies whose capitalization falls outside this range after the purchase
continue to be considered small company for this purpose.
<PAGE>
While each Fund focuses on small cap stocks, it may also invest in
other types of securities, without regard to the market capitalization of the
issuer and which may be listed on national exchanges or traded over-the-counter,
including other common stocks, debt securities convertible into common stocks or
having common stock characteristics, and rights and warrants to purchase common
stocks.
In addition to its other investment options, each Fund may invest in
limited partnerships, including master limited partnerships and up to 25% of its
assets in foreign securities. Each Fund does not currently intend to invest more
than 5% of its assets in foreign securities.
When market conditions warrant, each Fund may invest up to 100% of its
assets for temporary or defensive purposes in money market instruments.
Each Fund may enter into repurchase and reverse repurchase agreements,
purchase and sell securities and currencies on a when-issued and
delayed-delivery basis and purchase or sell securities on a forward commitment
basis, write covered call and put options and purchase call and put options to
close out existing positions and may employ new investment techniques with
respect to such options. Each Fund may also enter into currency and other
financial futures contracts and engage in related options transactions for
hedging purposes and not for speculation, and may employ new investment
techniques with respect to such futures contracts and related options.
The characteristics of each investment policy and the associated risks
are described in each Fund's respective Prospectus and Statement of Additional
Information. The Funds have other investment policies and restrictions which are
also set forth in the Prospectus and Statement of Additional Information of each
Fund.
COMPARATIVE INFORMATION ON SHAREHOLDERS' RIGHTS
Forms of Organization
Evergreen Equity Trust, Keystone Small Company Growth II and Keystone
Small Company Growth (S-4) are open-end management investment companies
registered with the SEC under the 1940 Act, which continuously offer shares to
the public. Keystone Small Company Growth II and Keystone Small Company Growth
(S-4) are organized as a Massachusetts business trust and a Pennsylvania common
law trust, respectively. Evergreen Equity Trust is organized as a Delaware
business trust. Each
<PAGE>
Trust is governed by a Declaration of Trust, By-Laws and a Board of Trustees.
Each Trust is also governed by applicable Delaware, Massachusetts, Pennsylvania
and federal law. Evergreen Small Company Growth is a series of Evergreen Equity
Trust.
Capitalization
The beneficial interests in Evergreen Small Company Growth are
represented by an unlimited number of transferable shares of beneficial interest
without par value. The beneficial interests in Keystone Small Company Growth II
and Keystone Small Company Growth (S-4) are represented by an unlimited number
of transferable shares of beneficial interest with no par value and a $1.00 par
value per share, respectively. The respective Declaration of Trust under which
each Fund has been established permits the Trustees to allocate shares into an
unlimited number of series, and classes thereof, with rights determined by the
Trustees, all without shareholder approval. Fractional shares may be issued.
Except with respect to Evergreen Small Company Growth where each share of the
Fund is entitled to one vote for each dollar of net asset value applicable to
such share, each Fund's shares have equal voting rights with respect to matters
affecting shareholders of all classes of each Fund and represent equal
proportionate interests in the assets belonging to each class of shares of the
Funds. Shareholders of each Fund are entitled to receive dividends and other
amounts as determined by the Trustees. Shareholders of each Fund vote
separately, by class, as to matters, such as approval of or amendments to Rule
12b-1 distribution plans, that affect only their particular class and by series
as to matters, such as approval of or amendments to investment advisory
agreements or proposed organizations, that affect only their particular series.
Shareholder Liability
Under Massachusetts and Pennsylvania law, shareholders of a business or
common law trust could, under certain circumstances, be held personally liable
for the obligations of the trust. However, the respective Declaration of Trust
under which Keystone Small Company Growth II and Keystone Small Company Growth
(S-4) was established disclaims shareholder liability for acts or obligations of
the series and requires that notice of such disclaimer be given in each
agreement, obligation or instrument entered into or executed by the Fund or the
Trustees. Each Declaration of Trust provides for indemnification out of the
series property for all losses and expenses of any shareholder held personally
<PAGE>
liable for the obligations of the series. Thus, the risk of a shareholder
incurring financial loss on account of shareholder liability is considered
remote since it is limited to circumstances in which a disclaimer is inoperative
and the series or the Trust itself would be unable to meet its obligations. A
substantial number of mutual funds in the United States are organized as
Massachusetts business trusts.
Under Delaware law, shareholders of a Delaware business trust are
entitled to the same limitation of personal liability extended to stockholders
of Delaware corporations. No similar statutory or other authority limiting
business trust shareholder liability exists in any other state. As a result, to
the extent that Evergreen Equity Trust or a shareholder is subject to the
jurisdiction of courts in those states, the courts may not apply Delaware law,
and may thereby subject shareholders of a Delaware trust to liability. To guard
against this risk, the Declaration of Trust of Evergreen Equity Trust: (a)
provides that any written obligation of the Trust may contain a statement that
such obligation may only be enforced against the assets of the Trust or the
particular series in question and the obligation is not binding upon the
shareholders of the Trust; however, the omission of such a disclaimer will not
operate to create personal liability for any shareholder; and (b) provides for
indemnification out of Trust property of any shareholder personally liable for
the obligations of Evergreen Equity Trust. Accordingly, the risk of a
shareholder of the Trust incurring financial loss beyond that shareholder's
investment because of shareholder liability is limited to circumstances in
which: (i) the court refuses to apply Delaware law; (ii) no contractual
limitation of liability was in effect; and (iii) the Trust itself would be
unable to meet its obligations. In light of Delaware law, the nature of the
Trust's business, and the nature of its assets, the risk of personal liability
to a shareholder of Evergreen Equity Trust is remote.
Shareholder Meetings and Voting Rights
Neither Evergreen Equity Trust on behalf of Evergreen Small Company
Growth, Keystone Small Company Growth II nor Keystone Small Company Growth (S-4)
is required to hold annual meetings of shareholders. However, a meeting of
shareholders for the purpose of voting upon the question of removal of a Trustee
must be called when requested in writing by the holders of at least 10% of the
outstanding shares. In addition, each is required to call a meeting of
shareholders for the purpose of electing Trustees if, at any time, less than a
majority of the Trustees then holding office were elected by shareholders. Each
Trust currently does not intend
<PAGE>
to hold regular shareholder meetings. Each Trust does not permit cumulative
voting. Except when a larger quorum is required by applicable law, twenty-five
percent (25%) and, with respect to Keystone Small Company Growth II and Keystone
Small Company Growth (S-4), a majority of the outstanding shares entitled to
vote on a matter, constitutes a quorum for consideration of such matter. For
Evergreen Small Company Growth, a majority of the shares voted and for Keystone
Small Company Growth II and Keystone Small Company Growth (S-4), a majority of
the shares present and entitled to vote is sufficient to act on a matter (unless
otherwise specifically required by the applicable governing documents or other
law, including the 1940 Act).
Under the Declaration of Trust of Evergreen Equity Trust, each share of
Evergreen Small Company Growth is entitled to one vote for each dollar of net
asset value applicable to each share. Under the current voting provisions
governing Keystone Small Company Growth II and Keystone Small Company Growth (S-
4) each share is entitled to one vote. Over time, the net asset values of the
Funds have changed in relation to one another and are expected to continue to do
so in the future. Because of the divergence in net asset values, a given dollar
investment in a Fund with a lower net asset value will purchase more shares, and
under the Funds' current voting provisions, have more votes, than the same
investment in a Fund with a higher net asset value. Under the Declaration of
Trust of Evergreen Equity Trust, voting power is related to the dollar value of
the shareholders' investment rather than to the number of shares held.
Liquidation or Dissolution
In the event of the liquidation of Evergreen Small Company Growth,
Keystone Small Company Growth II and Keystone Small Company Growth (S-4) the
shareholders are entitled to receive, when, and as declared by the Trustees, the
excess of the assets belonging to such Fund or attributable to the class over
the liabilities belonging to the Fund or attributable to the class. In either
case, the assets so distributable to shareholders of the Fund will be
distributed among the shareholders in proportion to the number of shares of a
class of the Fund held by them and recorded on the books of the Fund.
Liability and Indemnification of Trustees
Each of the Declarations of Trust of Keystone Small Company Growth
(S-4) and of Keystone Small Company Growth II provides that a Trustee shall be
liable only for his own
<PAGE>
willful defaults, and that no Trustee shall be protected against any liability
to which he would otherwise be subject by reason of willful misfeasance, bad
faith, gross negligence or reckless disregard of the duties involved in the
conduct of his office. Each of the Declarations of Trust provides that a present
or former Trustee or officer is entitled to indemnification against liabilities
and expenses with respect to claims related to his or her position with the
Fund, unless such Trustee or officer shall have been adjudicated not to have
acted in good faith in the reasonable belief that his or her action was in the
best interest of the Fund, or unless such Trustee or officer is otherwise
subject to liability to the Fund or its shareholders by reason of willful
misfeasance, bad faith, gross negligence or reckless disregard of the duties
involved in the conduct of his office. In the event of settlement, no such
indemnification shall be provided unless there has been a determination that
such Trustee or officer appears to have acted in good faith in the reasonable
belief that his action was in the best interests of the Fund and that such
indemnification would not protect such person against any liability to the Fund
to which such person would otherwise be subject by reason of willful
misfeasance, bad faith, gross negligence, or reckless disregard of the duties
involved in the conduct of his office.
Under the Declaration of Trust of Evergreen Equity Trust, a Trustee is
liable to the Trust and its shareholders only for such Trustee's own willful
misfeasance, bad faith, gross negligence, or reckless disregard of the duties
involved in the conduct of the office of Trustee or the discharge of such
Trustee's functions. As provided in the Declaration of Trust, each Trustee of
the Trust is entitled to be indemnified against all liabilities against him or
her, including the costs of litigation, unless it is determined that the Trustee
(i) did not act in good faith in the reasonable belief that such Trustee's
action was in or not opposed to the best interests of the Trust; (ii) had acted
with willful misfeasance, bad faith, gross negligence or reckless disregard of
such Trustee's duties; and (iii) in a criminal proceeding, had reasonable cause
to believe that such Trustee's conduct was unlawful (collectively, "disabling
conduct"). A determination that the Trustee did not engage in disabling conduct
and is, therefore, entitled to indemnification may be based upon the outcome of
a court action or administrative proceeding or by (a) a vote of a majority of
those Trustees who are neither "interested persons" within the meaning of the
1940 Act nor parties to the proceeding or (b) an independent legal counsel in a
written opinion. The Trust may also advance money for such litigation expenses
provided that the Trustee undertakes to repay the Trust if his or her conduct is
<PAGE>
later determined to preclude indemnification and certain other
conditions are met.
The foregoing is only a summary of certain characteristics of the
operations of the Declarations of Trust, By-Laws, Delaware, Massachusetts and
Pennsylvania law and is not a complete description of those documents or law.
Shareholders should refer to the provisions of such Declarations of Trust,
By-Laws, Delaware, Massachusetts and Pennsylvania law directly for more complete
information.
ADDITIONAL INFORMATION
Evergreen Small Company Growth. Information concerning the operation
and management of Evergreen Small Company Growth is incorporated herein by
reference from the Prospectuses dated November 10, 1997, copies of which are
enclosed, and Statement of Additional Information dated November 10, 1997. A
copy of such Statement of Additional Information is available upon request and
without charge by writing to Evergreen Small Company Growth at the address
listed on the cover page of this Prospectus/Proxy Statement or by calling
toll-free 1-800-343-2898.
Keystone Small Company Growth II. Information about the Fund is
included in its current Prospectuses dated August 1, 1997, as supplemented, and
in the Statement of Additional Information of the same date that have been filed
with the SEC, all of which are incorporated herein by reference. Copies of the
Prospectuses and Statement of Additional Information are available upon request
and without charge by writing to the address listed on the cover page of this
Prospectus/Proxy Statement or by calling toll-free 1-800-343- 2898.
Keystone Small Company Growth (S-4). Information about the Fund is
included in its current Prospectus dated August 1, 1997, as supplemented, and in
the Statement of Additional Information of the same date that has been filed
with the SEC, all of which are incorporated herein by reference. A copy of the
Prospectus and Statement of Additional Information are available upon request
and without charge by writing to the address listed on the cover page of this
Prospectus/Proxy Statement or by calling toll-free 1-800-343-2898.
Evergreen Small Company Growth, Keystone Small Company Growth II and
Keystone Small Company Growth (S-4) are each subject to the informational
requirements of the Securities Exchange Act of 1934 and the 1940 Act, and in
accordance
<PAGE>
therewith file reports and other information including proxy material, and
charter documents with the SEC. These items can be inspected and copies obtained
at the Public Reference Facilities maintained by the SEC at 450 Fifth Street,
N.W., Washington, D.C. 20549, and at the SEC's Regional Offices located at
Northwest Atrium Center, 500 West Madison Street, Chicago, Illinois 60661-2511
and Seven World Trade Center, Suite 1300, New York, New York 10048.
VOTING INFORMATION CONCERNING THE MEETINGS
This Prospectus/Proxy Statement is furnished in connection with a
solicitation of proxies by the Trustees of Keystone Small Company Growth II and
Keystone Small Company Growth (S-4) to be used at each Special Meeting of
Shareholders to be held at 3:00 p.m., January 6, 1998, at the offices of the
Evergreen Keystone Funds, 200 Berkeley Street, Boston, MA 02116 and at any
adjournments thereof. This Prospectus/Proxy Statement, along with a Notice of
the meeting and a proxy card, is first being mailed to shareholders of Keystone
Small Company Growth II and Keystone Small Company Growth (S-4) on or about
November 14, 1997. Only shareholders of record as of the close of business on
the Record Date will be entitled to notice of, and to vote at, the Meeting or
any adjournment thereof. The holders of a majority of the outstanding shares
entitled to vote of each Fund at the close of business on the Record Date
present in person or represented by proxy will constitute a quorum for the
Meeting. If the enclosed form of proxy is properly executed and returned in time
to be voted at the Meeting, the proxies named therein will vote the shares
represented by the proxy in accordance with the instructions marked thereon.
Unmarked proxies will be voted FOR the proposed Reorganization and FOR any other
matters deemed appropriate. Proxies that reflect abstentions and "broker
non-votes" (i.e., shares held by brokers or nominees as to which (i)
instructions have not been received from the beneficial owners or the persons
entitled to vote or (ii) the broker or nominee does not have discretionary
voting power on a particular matter) will be counted as shares that are present
and entitled to vote for purposes of determining the presence of a quorum. Such
proxies will have the effect of being counted as votes against the Plan since
the vote required is a majority of the shares present and entitled to vote. A
proxy may be revoked at any time on or before the Meeting by written notice to
the Secretary of Keystone Small Company Growth II or Keystone Small Company
Growth (S-4), as applicable, 200 Berkeley Street, Boston, Massachusetts 02116.
Unless revoked, all valid proxies will be voted in accordance with the
specifications thereon or, in
<PAGE>
the absence of such specifications, FOR approval of the Plan
and the Reorganization contemplated thereby.
Approval of each Plan will require the affirmative vote of a majority
of the shares present and entitled to vote, with all Classes voting together as
a single class at Meetings at which a quorum of each Fund's shares is present.
Each full share outstanding is entitled to one vote and each fractional share
outstanding is entitled to a proportionate share of one vote.
Proxy solicitations will be made primarily by mail, but proxy
solicitations may also be made by telephone, telegraph or personal solicitations
conducted by officers and employees of FUNB, its affiliates or other
representatives of Keystone Small Company Growth II and Keystone Small Company
Growth (S- 4) (who will not be paid for their soliciting activities).
Shareholders Communications Corp. ("SCC") has been engaged by Keystone Small
Company Growth II and Keystone Small Company Growth (S-4) to assist in
soliciting proxies, and may contact certain shareholders of the Funds over the
telephone. Shareholders who are contacted by SCC may be asked to cast their vote
by telephonic proxy. Such proxies will be recorded in accordance with the
procedures set forth below. Each Fund believes these procedures are reasonably
designed to ensure that the identity of the shareholder casting the vote is
accurately determined and that the voting instructions of the shareholder are
accurately reflected. Keystone Small Company Growth II and Keystone Small
Company Growth (S-4) have received opinions of counsel that address the
validity, under the applicable law of The Commonwealth of Massachusetts and
Pennsylvania, of a proxy given orally. The opinions conclude that a
Massachusetts or Pennsylvania court would find that there is no Massachusetts or
Pennsylvania law or Massachusetts or Pennsylvania public policy against the
acceptance of proxies signed by an orally-authorized agent.
In all cases where a telephonic proxy is solicited, the SCC
representative will ask you for your full name, address, social security or
employer identification number, title (if you are authorized to act on behalf of
an entity, such as a corporation), and number of shares owned. If the
information solicited agrees with the information provided to SCC by each Fund's
transfer agent, then the SCC representative will explain the process, read the
proposals listed on the proxy card and ask for your instructions on each
proposal. The SCC representative, although he or she will answer questions about
the process, will not recommend to the shareholder how he or she should vote,
other than to read any recommendations set forth in the proxy statement. Within
72 hours, SCC will send
<PAGE>
you a letter or mailgram to confirm your vote and asking you to call immediately
if your instructions are not correctly reflected in the confirmation.
If you wish to participate in the Meeting, but do not wish to give your
proxy by telephone, you may still submit the proxy card included with this
Prospectus/Proxy Statement or attend in person. Any proxy given by you, whether
in writing or by telephone, is revocable.
In the event that sufficient votes to approve a Reorganization are not
received by January 6, 1998, the persons named as proxies may propose one or
more adjournments of the Meeting to permit further solicitation of proxies. In
determining whether to adjourn the Meeting, the following factors may be
considered: the percentage of votes actually cast, the percentage of negative
votes actually cast, the nature of any further solicitation and the information
to be provided to shareholders with respect to the reasons for the solicitation.
Any such adjournment will require an affirmative vote by the holders of a
majority of the shares present in person or by proxy and entitled to vote at the
Meeting. The persons named as proxies will vote upon such adjournment after
consideration of all circumstances which may bear upon a decision to adjourn the
Meeting.
A shareholder who objects to a proposed Reorganization will not be
entitled under either Massachusetts or Pennsylvania law or the Declaration of
Trust of Keystone Small Company Growth II or Keystone Small Company Growth
(S-4), as applicable, to demand payment for, or an appraisal of, his or her
shares. However, shareholders should be aware that the Reorganizations as
proposed are not expected to result in recognition of gain or loss to
shareholders for federal income tax purposes and that, if the Reorganizations
are consummated, shareholders will be free to redeem the shares of Evergreen
Small Company Growth which they receive in the transaction at their then-current
net asset value. Shares of Keystone Small Company Growth II and Keystone Small
Company Growth (S-4) may be redeemed at any time prior to the consummation of
the Reorganizations. Shareholders of Keystone Small Company Growth II and
Keystone Small Company Growth (S-4) may wish to consult their tax advisers as to
any differing consequences of redeeming Fund shares prior to the Reorganizations
or exchanging such shares in the Reorganizations.
Keystone Small Company Growth II and Keystone Small Company Growth
(S-4) do not hold annual shareholder meetings. If a Reorganization is not
approved, shareholders wishing to submit proposals for consideration for
inclusion in a proxy
<PAGE>
statement for a subsequent shareholder meeting should send their written
proposals to the Secretary of Keystone Small Company Growth II or Keystone Small
Company Growth (S-4), as applicable, at the address set forth on the cover of
this Prospectus/Proxy Statement such that they will be received by the Funds in
a reasonable period of time prior to any such meeting.
The votes of the shareholders of Evergreen Small Company Growth are not
being solicited by this Prospectus/Proxy Statement and are not required to carry
out the Reorganizations.
NOTICE TO BANKS, BROKER-DEALERS AND VOTING TRUSTEES AND THEIR NOMINEES.
Please advise Keystone Small Company Growth II and Keystone Small Company Growth
(S-4) whether other persons are beneficial owners of shares for which proxies
are being solicited and, if so, the number of copies of this Prospectus/Proxy
Statement needed to supply copies to the beneficial owners of the respective
shares.
FINANCIAL STATEMENTS AND EXPERTS
The financial statements of Keystone Small Company Growth II as of May
31, 1997, and the financial statements and financial highlights for the periods
indicated therein, have been incorporated by reference herein and in the
Registration Statement in reliance upon the report of KPMG Peat Marwick LLP,
independent certified public accountants, incorporated by reference herein, and
upon the authority of said firm as experts in accounting and auditing.
The financial statements of Keystone Small Company Growth (S-4) as of
May 31, 1997, and the financial statements and financial highlights for the
periods indicated therein, have been incorporated by reference herein and in the
Registration Statement in reliance upon the report of KPMG Peat Marwick LLP,
independent certified public accountants, incorporated by reference herein, and
upon the authority of said firm as experts in accounting and auditing.
LEGAL MATTERS
Certain legal matters concerning the issuance of shares of Evergreen
Small Company Growth will be passed upon by Sullivan & Worcester LLP,
Washington, D.C.
OTHER BUSINESS
<PAGE>
The Trustees of Keystone Small Company Growth II and Keystone Small
Company Growth (S-4) do not intend to present any other business at the Meeting.
If, however, any other matters are properly brought before the Meeting, the
persons named in the accompanying form of proxy will vote thereon in accordance
with their judgment.
THE RESPECTIVE TRUSTEES OF KEYSTONE SMALL COMPANY GROWTH II AND
KEYSTONE SMALL COMPANY GROWTH (S-4) RECOMMEND THEIR APPROVAL OF EACH RESPECTIVE
PLAN AND ANY UNMARKED PROXIES WITHOUT INSTRUCTIONS TO THE CONTRARY WILL BE VOTED
IN FAVOR OF APPROVAL OF THE PLANS.
November 14, 1997
<PAGE>
EXHIBIT A-1
AGREEMENT AND PLAN OF REORGANIZATION
THIS AGREEMENT AND PLAN OF REORGANIZATION (the "Agreement") is made as
of this 30th day of September, 1997, by and between the Evergreen Equity Trust,
a Delaware business trust, with its principal place of business at 200 Berkeley
Street, Boston, Massachusetts 02116 (the "Trust"), with respect to its Evergreen
Small Company Growth Fund series (the "Acquiring Fund"), and Keystone Small
Company Growth Fund II, a Massachusetts business trust, with its principal place
of business at 200 Berkeley Street, Boston, Massachusetts 02116 (the "Selling
Fund").
This Agreement is intended to be, and is adopted as, a plan of
reorganization and liquidation within the meaning of Section 368(a)(1)(C) of the
United States Internal Revenue Code of 1986, as amended (the "Code"). The
reorganization (the "Reorganization") will consist of (i) the transfer of all of
the assets of the Selling Fund in exchange solely for Class Y, Class A, Class B
and Class C shares of beneficial interest, without par value, of the Acquiring
Fund (the "Acquiring Fund Shares"); (ii) the assumption by the Acquiring Fund of
certain identified liabilities of the Selling Fund; and (iii) the distribution,
after the Closing Date hereinafter referred to, of the Acquiring Fund Shares to
the shareholders of the Selling Fund in liquidation of the Selling Fund as
provided herein, all upon the terms and conditions hereinafter set forth in this
Agreement.
WHEREAS, the Selling Fund and the Acquiring Fund are a registered
open-end investment company and a separate investment series of an open-end,
registered investment company of the management type, respectively, and the
Selling Fund owns securities that generally are assets of the character in which
the Acquiring Fund is permitted to invest;
WHEREAS, both Funds are authorized to issue their shares
of beneficial interest;
WHEREAS, the Trustees of the Trust have determined that the exchange of
all of the assets of the Selling Fund for Acquiring Fund Shares and the
assumption of certain identified liabilities of the Selling Fund by the
Acquiring Fund on the terms and conditions hereinafter set forth are in the best
interests of the Acquiring Fund's shareholders;
WHEREAS, the Trustees of the Selling Fund have determined that the
Selling Fund should exchange all of its assets and
<PAGE>
certain identified liabilities for Acquiring Fund Shares and that the interests
of the existing shareholders of the Selling Fund will not be diluted as a result
of the transactions contemplated herein;
NOW, THEREFORE, in consideration of the premises and of the covenants
and agreements hereinafter set forth, the parties hereto covenant and agree as
follows:
ARTICLE I
TRANSFER OF ASSETS OF THE SELLING FUND IN EXCHANGE FOR
THE ACQUIRING FUND SHARES AND ASSUMPTION OF SELLING FUND
LIABILITIES AND LIQUIDATION OF THE SELLING FUND
1.1 THE EXCHANGE. Subject to the terms and conditions herein set forth
and on the basis of the representations and warranties contained herein, the
Selling Fund agrees to transfer all of the Selling Fund's assets as set forth in
paragraph 1.2 to the Acquiring Fund. The Acquiring Fund agrees in exchange
therefor (i) to deliver to the Selling Fund the number of Acquiring Fund Shares,
including fractional Acquiring Fund Shares, determined by multiplying the shares
outstanding of each class of the Selling Fund by the ratio computed by dividing
the net asset value per share of each such class of the Selling Fund by the net
asset value per share of the corresponding class of Acquiring Fund Shares
computed in the manner and as of the time and date set forth in paragraph 2.2;
and (ii) to assume certain identified liabilities of the Selling Fund, as set
forth in paragraph 1.3. Such transactions shall take place at the closing
provided for in paragraph 3.1 (the "Closing Date").
1.2 ASSETS TO BE ACQUIRED. The assets of the Selling Fund to be
acquired by the Acquiring Fund shall consist of all property, including, without
limitation, all cash, securities, commodities, and futures interests and
dividends or interest receivables, that is owned by the Selling Fund and any
deferred or prepaid expenses shown as an asset on the books of the Selling Fund
on the Closing Date.
The Selling Fund has provided the Acquiring Fund with its most recent
audited financial statements, which contain a list of all of Selling Fund's
assets as of the date thereof. The Selling Fund hereby represents that as of the
date of the execution of this Agreement there have been no changes in its
financial position as reflected in said financial statements other than those
occurring in the ordinary course of its business in connection with the purchase
and sale of securities and the payment of its normal operating expenses.
<PAGE>
The Selling Fund reserves the right to sell any of such securities, but will
not, without the prior written approval of the Acquiring Fund, acquire any
additional securities other than securities of the type in which the Acquiring
Fund is permitted to invest.
The Acquiring Fund will, within a reasonable time prior to the Closing
Date, furnish the Selling Fund with a statement of the Acquiring Fund's
investment objectives, policies, and restrictions and a list of the securities,
if any, on the Selling Fund's list referred to in the second sentence of this
paragraph that do not conform to the Acquiring Fund's investment objectives,
policies, and restrictions. In the event that the Selling Fund holds any
investments that the Acquiring Fund may not hold, the Selling Fund will dispose
of such securities prior to the Closing Date. In addition, if it is determined
that the Selling Fund and the Acquiring Fund portfolios, when aggregated, would
contain investments exceeding certain percentage limitations imposed upon the
Acquiring Fund with respect to such investments, the Selling Fund if requested
by the Acquiring Fund will dispose of a sufficient amount of such investments as
may be necessary to avoid violating such limitations as of the Closing Date.
1.3 LIABILITIES TO BE ASSUMED. The Selling Fund will endeavor to
discharge all of its known liabilities and obligations prior to the Closing
Date. Except as specifically provided in this paragraph 1.3, the Acquiring Fund
shall assume only those liabilities, expenses, costs, charges and reserves
reflected on a Statement of Assets and Liabilities of the Selling Fund prepared
on behalf of the Selling Fund, as of the Valuation Date (as defined in paragraph
2.1), in accordance with generally accepted accounting principles consistently
applied from the prior audited period. The Acquiring Fund shall assume only
those liabilities of the Selling Fund reflected in such Statement of Assets and
Liabilities and shall not except as specifically provided in this paragraph 1.3
assume any other liabilities, whether absolute or contingent, known or unknown,
accrued or unaccrued, all of which shall remain the obligation of the Selling
Fund. The Acquiring Fund hereby agrees with the Selling Fund and each Trustee of
the Selling Fund: (i) to indemnify each Trustee of the Selling Fund against all
liabilities and expenses referred to in the indemnification provisions of the
Selling Fund's Declaration of Trust and ByLaws, to the extent provided therein,
incurred by any Trustee of the Selling Fund; and (ii) in addition to the
indemnification provided in (i) above, to indemnify each Trustee of the Selling
Fund against all liabilities and expenses and pay the same as they arise and
become due,
<PAGE>
without any exception, limitation or requirement of approval by any person, and
without any right to require repayment thereof by any such Trustee (unless such
Trustee has had the same repaid to him or her) based upon any subsequent or
final disposition or findings made in connection therewith or otherwise, if such
action, suit or other proceeding involves such Trustee's participation in
authorizing or permitting or acquiescing in, directly or indirectly, by action
or inaction, the making of any distribution in any manner of all or any assets
of the Selling Fund without making provision for the payment of any liabilities
of any kind, fixed or contingent, of the Selling Fund, which liabilities were
not actually and consciously personally known to such Trustee to exist at the
time of such Trustee's participation in so authorizing or permitting or
acquiescing in the making of any such distribution.
In addition, upon completion of the Reorganization, for purposes of
calculating the maximum amount permitted to be charged to the Acquiring Fund
under the National Association of Securities Dealers, Inc. Conduct Rule 2830,
minus the amount of the sales charges paid or accrued (including asset based
sales charge), plus permitted interest ("Aggregate NASD Cap"), the Acquiring
Fund will add to its Aggregate NASD Cap immediately prior to the Reorganization
the Aggregate NASD Cap of the Selling Fund immediately prior to the
Reorganization.
1.4 LIQUIDATION AND DISTRIBUTION. On or soon after the Closing Date as
is conveniently practicable (the "Liquidation Date"), (a) the Selling Fund will
liquidate and distribute pro rata to the Selling Fund's shareholders of record,
determined as of the close of business on the Valuation Date (the "Selling Fund
Shareholders"), the Acquiring Fund Shares received by the Selling Fund pursuant
to paragraph 1.1; and (b) the Selling Fund will thereupon proceed to dissolve as
set forth in paragraph 1.8 below. Such liquidation and distribution will be
accomplished by the transfer of the Acquiring Fund Shares then credited to the
account of the Selling Fund on the books of the Acquiring Fund to open accounts
on the share records of the Acquiring Fund in the names of the Selling Fund
Shareholders and representing the respective pro rata number of the Acquiring
Fund Shares due such shareholders. All issued and outstanding shares of the
Selling Fund will simultaneously be canceled on the books of the Selling Fund.
The Acquiring Fund shall not issue certificates representing the Acquiring Fund
Shares in connection with such exchange.
1.5 OWNERSHIP OF SHARES. Ownership of Acquiring Fund Shares will be shown
on the books of the Acquiring Fund's
<PAGE>
transfer agent. Shares of the Acquiring Fund will be issued in the manner
described in the combined Prospectus and Proxy Statement on Form N-14 to be
distributed to shareholders of the Selling Fund as described in paragraph 5.7.
1.6 TRANSFER TAXES. Any transfer taxes payable upon issuance of the
Acquiring Fund Shares in a name other than the registered holder of the Selling
Fund shares on the books of the Selling Fund as of that time shall, as a
condition of such issuance and transfer, be paid by the person to whom such
Acquiring Fund Shares are to be issued and transferred.
1.7 REPORTING RESPONSIBILITY. Any reporting responsibility of the
Selling Fund is and shall remain the responsibility of the Selling Fund up to
and including the Closing Date and such later date on which the Selling Fund is
terminated.
1.8 TERMINATION. The Selling Fund shall be terminated promptly
following the Closing Date and the making of all distributions pursuant to
paragraph 1.4.
ARTICLE II
VALUATION
2.1 VALUATION OF ASSETS. The value of the Selling Fund's assets to be
acquired by the Acquiring Fund hereunder shall be the value of such assets
computed as of the close of business on the New York Stock Exchange on the
business day next preceding the Closing Date (such time and date being
hereinafter called the "Valuation Date"), using the valuation procedures set
forth in the Trust's Declaration of Trust and the Acquiring Fund's then current
prospectus and statement of additional information or such other valuation
procedures as shall be mutually agreed upon by the parties.
2.2 VALUATION OF SHARES. The net asset value per share of the Acquiring
Fund Shares shall be the net asset value per share computed as of the close of
business on the New York Stock Exchange on the Valuation Date, using the
valuation procedures set forth in the Trust's Declaration of Trust and the
Acquiring Fund's then current prospectus and statement of additional
information.
2.3 SHARES TO BE ISSUED. The number of the Acquiring Fund Shares of
each class to be issued (including fractional shares, if any) in exchange for
the Selling Fund's assets shall be determined by multiplying the shares
outstanding of each class of the Selling Fund by the ratio computed by
<PAGE>
dividing the net asset value per share of the Selling Fund attributable to each
of its classes by the net asset value per share of the respective classes of the
Acquiring Fund determined in accordance with paragraph 2.2.
2.4 DETERMINATION OF VALUE. All computations of value shall be made by
State Street Bank and Trust Company in accordance with its regular practice in
pricing the shares and assets of the Acquiring Fund.
ARTICLE III
CLOSING AND CLOSING DATE
3.1 CLOSING DATE. The Closing (the "Closing") shall take place on or
about January 23, 1998 or such other date as the parties may agree to in writing
(the "Closing Date"). All acts taking place at the Closing shall be deemed to
take place simultaneously immediately prior to the opening of business on the
Closing Date unless otherwise provided. The Closing shall be held as of 9:00
a.m. at the offices of the Evergreen Keystone Funds, 200 Berkeley Street,
Boston, MA 02116, or at such other time and/or place as the parties may agree.
3.2 CUSTODIAN'S CERTIFICATE. State Street Bank and Trust Company, as
custodian for the Selling Fund (the "Custodian"), shall deliver at the Closing a
certificate of an authorized officer stating that (a) the Selling Fund's
portfolio securities, cash, and any other assets shall have been delivered in
proper form to the Acquiring Fund on the Closing Date; and (b) all necessary
taxes including all applicable federal and state stock transfer stamps, if any,
shall have been paid, or provision for payment shall have been made, in
conjunction with the delivery of portfolio securities by the Selling Fund.
3.3 EFFECT OF SUSPENSION IN TRADING. In the event that on the Valuation
Date (a) the New York Stock Exchange or another primary trading market for
portfolio securities of the Acquiring Fund or the Selling Fund shall be closed
to trading or trading thereon shall be restricted; or (b) trading or the
reporting of trading on said Exchange or elsewhere shall be disrupted so that
accurate appraisal of the value of the net assets of the Acquiring Fund or the
Selling Fund is impracticable, the Valuation Date shall be postponed until the
first business day after the day when trading shall have been fully resumed and
reporting shall have been restored.
<PAGE>
3.4 TRANSFER AGENT'S CERTIFICATE. Evergreen Keystone Service Company,
as transfer agent for the Selling Fund as of the Closing Date ("EKSC"), shall
deliver at the Closing a certificate of an authorized officer stating that its
records contain the names and addresses of the Selling Fund Shareholders and the
number and percentage ownership of outstanding shares owned by each such
shareholder immediately prior to the Closing. The Acquiring Fund shall issue and
deliver or cause EKSC, its transfer agent as of the Closing Date, to issue and
deliver a confirmation evidencing the Acquiring Fund Shares to be credited on
the Closing Date to the Secretary of the Selling Fund or provide evidence
satisfactory to the Selling Fund that such Acquiring Fund Shares have been
credited to the Selling Fund's account on the books of the Acquiring Fund. At
the Closing, each party shall deliver to the other such bills of sale, checks,
assignments, share certificates, if any, receipts and other documents as such
other party or its counsel may reasonably request.
ARTICLE IV
REPRESENTATIONS AND WARRANTIES
4.1 REPRESENTATIONS OF THE SELLING FUND. The Selling
Fund represents and warrants to the Acquiring Fund as follows:
(a) The Selling Fund is a Massachusetts business trust duly
organized, validly existing, and in good standing under the laws of The
Commonwealth of Massachusetts.
(b) The Selling Fund is a registered investment company
classified as a management company of the open-end type, and its registration
with the Securities and Exchange Commission (the "Commission") as an investment
company under the Investment Company Act of 1940, as amended (the "1940 Act"),
is in full force and effect.
(c) The current prospectuses and statement of additional
information of the Selling Fund conform in all material respects to the
applicable requirements of the Securities Act of 1933, as amended (the "1933
Act"), and the 1940 Act and the rules and regulations of the Commission
thereunder and do not include any untrue statement of a material fact or omit to
state any material fact required to be stated therein or necessary to make the
statements therein, in light of the circumstances under which they were made,
not misleading.
(d) The Selling Fund is not, and the execution,
delivery, and performance of this Agreement (subject to
<PAGE>
shareholder approval) will not result, in violation of any provision of the
Selling Fund's Declaration of Trust or By-Laws or of any material agreement,
indenture, instrument, contract, lease, or other undertaking to which the
Selling Fund is a party or by which it is bound.
(e) The Selling Fund has no material contracts or other
commitments (other than this Agreement) that will be terminated with liability
to it prior to the Closing Date.
(f) Except as otherwise disclosed in writing to and accepted
by the Acquiring Fund, no litigation, administrative proceeding, or
investigation of or before any court or governmental body is presently pending
or to its knowledge threatened against the Selling Fund or any of its properties
or assets, which, if adversely determined, would materially and adversely affect
its financial condition, the conduct of its business, or the ability of the
Selling Fund to carry out the transactions contemplated by this Agreement. The
Selling Fund knows of no facts that might form the basis for the institution of
such proceedings and is not a party to or subject to the provisions of any
order, decree, or judgment of any court or governmental body that materially and
adversely affects its business or its ability to consummate the transactions
herein contemplated.
(g) The financial statements of the Selling Fund at May 31,
1997 are in accordance with generally accepted accounting principles
consistently applied, and such statements (copies of which have been furnished
to the Acquiring Fund) fairly reflect the financial condition of the Selling
Fund as of such date, and there are no known contingent liabilities of the
Selling Fund as of such date not disclosed therein.
(h) Since May 31, 1997 there has not been any material adverse
change in the Selling Fund's financial condition, assets, liabilities, or
business other than changes occurring in the ordinary course of business, or any
incurrence by the Selling Fund of indebtedness maturing more than one year from
the date such indebtedness was incurred, except as otherwise disclosed to and
accepted by the Acquiring Fund. For the purposes of this subparagraph (h), a
decline in the net asset value of the Selling Fund shall not constitute a
material adverse change.
(i) At the Closing Date, all federal and other tax returns and
reports of the Selling Fund required by law to have been filed by such dates
shall have been filed, and all federal and other taxes shown due on said returns
and reports
<PAGE>
shall have been paid, or provision shall have been made for the payment thereof.
To the best of the Selling Fund's knowledge, no such return is currently under
audit, and no assessment has been asserted with respect to such returns.
(j) For each fiscal year of its operation, the Selling Fund
has met the requirements of Subchapter M of the Code for qualification and
treatment as a regulated investment company and has distributed in each such
year all net investment income and realized capital gains.
(k) All issued and outstanding shares of the Selling Fund are,
and at the Closing Date will be, duly and validly issued and outstanding, fully
paid and non-assessable by the Selling Fund (except that, under Massachusetts
law, Selling Fund Shareholders could under certain circumstances be held
personally liable for obligations of the Selling Fund). All of the issued and
outstanding shares of the Selling Fund will, at the time of the Closing Date, be
held by the persons and in the amounts set forth in the records of the transfer
agent as provided in paragraph 3.4. The Selling Fund does not have outstanding
any options, warrants, or other rights to subscribe for or purchase any of the
Selling Fund shares, nor is there outstanding any security convertible into any
of the Selling Fund shares.
(l) At the Closing Date, the Selling Fund will have good and
marketable title to the Selling Fund's assets to be transferred to the Acquiring
Fund pursuant to paragraph 1.2 and full right, power, and authority to sell,
assign, transfer, and deliver such assets hereunder, and, upon delivery and
payment for such assets, the Acquiring Fund will acquire good and marketable
title thereto, subject to no restrictions on the full transfer thereof,
including such restrictions as might arise under the 1933 Act, other than as
disclosed to the Acquiring Fund and accepted by the Acquiring Fund.
(m) The execution, delivery, and performance of this Agreement
have been duly authorized by all necessary action on the part of the Selling
Fund and, subject to approval by the Selling Fund Shareholders, this Agreement
constitutes a valid and binding obligation of the Selling Fund, enforceable in
accordance with its terms, subject as to enforcement, to bankruptcy, insolvency,
reorganization, moratorium, and other laws relating to or affecting creditors'
rights and to general equity principles.
(n) The information to be furnished by the Selling
Fund for use in no-action letters, applications for orders,
<PAGE>
registration statements, proxy materials, and other documents that may be
necessary in connection with the transactions contemplated hereby shall be
accurate and complete in all material respects and shall comply in all material
respects with federal securities and other laws and regulations thereunder
applicable thereto.
(o) The Proxy Statement of the Selling Fund to be included in
the Registration Statement (as defined in paragraph 5.7)(other than information
therein that relates to the Acquiring Fund) will, on the effective date of the
Registration Statement and on the Closing Date, not contain any untrue statement
of a material fact or omit to state a material fact required to be stated
therein or necessary to make the statements therein, in light of the
circumstances under which such statements were made, not misleading.
4.2 REPRESENTATIONS OF THE ACQUIRING FUND. The Acquiring
Fund represents and warrants to the Selling Fund as follows:
(a) The Acquiring Fund is a separate investment series of a
Delaware business trust duly organized, validly existing and in good standing
under the laws of the State of Delaware.
(b) The Acquiring Fund is a separate investment series of a
Delaware business trust that is registered as an investment company classified
as a management company of the open-end type, and its registration with the
Commission as an investment company under the 1940 Act is in full force and
effect.
(c) The current prospectuses and statement of additional
information of the Acquiring Fund conform in all material respects to the
applicable requirements of the 1933 Act and the 1940 Act and the rules and
regulations of the Commission thereunder and do not include any untrue statement
of a material fact or omit to state any material fact required to be stated
therein or necessary to make the statements therein, in light of the
circumstances under which they were made, not misleading.
(d) The Acquiring Fund is not, and the execution, delivery and
performance of this Agreement will not result, in violation of the Trust's
Declaration of Trust or By-Laws or of any material agreement, indenture,
instrument, contract, lease, or other undertaking to which the Acquiring Fund is
a party or by which it is bound.
<PAGE>
(e) Except as otherwise disclosed in writing to the Selling
Fund and accepted by the Selling Fund, no litigation, administrative proceeding
or investigation of or before any court or governmental body is presently
pending or to its knowledge threatened against the Acquiring Fund or any of its
properties or assets, which, if adversely determined, would materially and
adversely affect its financial condition and the conduct of its business or the
ability of the Acquiring Fund to carry out the transactions contemplated by this
Agreement. The Acquiring Fund knows of no facts that might form the basis for
the institution of such proceedings and is not a party to or subject to the
provisions of any order, decree, or judgment of any court or governmental body
that materially and adversely affects its business or its ability to consummate
the transactions contemplated herein.
(f) The Acquiring Fund has no known liabilities of a material
amount, contingent or otherwise.
(g) At the Closing Date, there will not be any material
adverse change in the Acquiring Fund's financial condition, assets, liabilities,
or business other than changes occurring in the ordinary course of business, or
any incurrence by the Acquiring Fund of indebtedness maturing more than one year
from the date such indebtedness was incurred, except as otherwise disclosed to
and accepted by the Selling Fund. For the purposes of this subparagraph (g), a
decline in the net asset value of the Acquiring Fund shall not constitute a
material adverse change.
(h) At the Closing Date, all federal and other tax returns and
reports of the Acquiring Fund required by law then to be filed by such dates
shall have been filed, and all federal and other taxes shown due on said returns
and reports shall have been paid or provision shall have been made for the
payment thereof. To the best of the Acquiring Fund's knowledge, no such return
is currently under audit, and no assessment has been asserted with respect to
such returns.
(i) All issued and outstanding Acquiring Fund Shares are, and
at the Closing Date will be, duly and validly issued and outstanding, fully paid
and non-assessable. The Acquiring Fund does not have outstanding any options,
warrants, or other rights to subscribe for or purchase any Acquiring Fund
Shares, nor is there outstanding any security convertible into any Acquiring
Fund Shares.
(j) The execution, delivery, and performance of this Agreement
have been duly authorized by all necessary action on the part of the Acquiring
Fund, and this Agreement
<PAGE>
constitutes a valid and binding obligation of the Acquiring Fund enforceable in
accordance with its terms, subject as to enforcement, to bankruptcy, insolvency,
reorganization, moratorium, and other laws relating to or affecting creditors'
rights and to general equity principles.
(k) The Acquiring Fund Shares to be issued and delivered to
the Selling Fund, for the account of the Selling Fund Shareholders, pursuant to
the terms of this Agreement will, at the Closing Date, have been duly authorized
and, when so issued and delivered, will be duly and validly issued Acquiring
Fund Shares, and will be fully paid and non-assessable.
(l) The information to be furnished by the Acquiring Fund for
use in no-action letters, applications for orders, registration statements,
proxy materials, and other documents that may be necessary in connection with
the transactions contemplated hereby shall be accurate and complete in all
material respects and shall comply in all material respects with federal
securities and other laws and regulations applicable thereto.
(m) The Prospectus and Proxy Statement (as defined in
paragraph 5.7) to be included in the Registration Statement (only insofar as it
relates to the Acquiring Fund) will, on the effective date of the Registration
Statement and on the Closing Date, not contain any untrue statement of a
material fact or omit to state a material fact required to be stated therein or
necessary to make the statements therein, in light of the circumstances under
which such statements were made, not misleading.
(n) The Acquiring Fund agrees to use all reasonable efforts to
obtain the approvals and authorizations required by the 1933 Act, the 1940 Act,
and such of the state Blue Sky or securities laws as it may deem appropriate in
order to continue its operations after the Closing Date.
ARTICLE V
COVENANTS OF THE ACQUIRING FUND AND THE SELLING FUND
5.1 OPERATION IN ORDINARY COURSE. The Acquiring Fund and the Selling
Fund each will operate its business in the ordinary course between the date
hereof and the Closing Date, it being understood that such ordinary course of
business will include customary dividends and distributions.
<PAGE>
5.2 APPROVAL OF SHAREHOLDERS. The Selling Fund will call a meeting of
its Shareholders to consider and act upon this Agreement and to take all other
action necessary to obtain approval of the transactions contemplated herein.
5.3 INVESTMENT REPRESENTATION. The Selling Fund covenants that the
Acquiring Fund Shares to be issued hereunder are not being acquired for the
purpose of making any distribution thereof other than in accordance with the
terms of this Agreement.
5.4 ADDITIONAL INFORMATION. The Selling Fund will assist the Acquiring
Fund in obtaining such information as the Acquiring Fund reasonably requests
concerning the beneficial ownership of the Selling Fund shares.
5.5 FURTHER ACTION. Subject to the provisions of this Agreement, the
Acquiring Fund and the Selling Fund will each take, or cause to be taken, all
action, and do or cause to be done, all things reasonably necessary, proper or
advisable to consummate and make effective the transactions contemplated by this
Agreement, including any actions required to be taken after the Closing Date.
5.6 STATEMENT OF EARNINGS AND PROFITS. As promptly as practicable, but
in any case within sixty days after the Closing Date, the Selling Fund shall
furnish the Acquiring Fund, in such form as is reasonably satisfactory to the
Acquiring Fund, a statement of the earnings and profits of the Selling Fund for
federal income tax purposes that will be carried over by the Acquiring Fund as a
result of Section 381 of the Code, and which will be reviewed by its independent
auditors and certified by the Selling Fund's President and Treasurer.
5.7 PREPARATION OF FORM N-14 REGISTRATION STATEMENT. The Selling Fund
will provide the Acquiring Fund with information reasonably necessary for the
preparation of a prospectus, which will include the proxy statement, referred to
in paragraph 4.1(o) (the "Prospectus and Proxy Statement"), all to be included
in a Registration Statement on Form N-14 of the Acquiring Fund (the
"Registration Statement"), in compliance with the 1933 Act, the Securities
Exchange Act of 1934, as amended (the "1934 Act"), and the 1940 Act in
connection with the meeting of the Selling Fund Shareholders to consider
approval of this Agreement and the transactions contemplated herein.
ARTICLE VI
<PAGE>
CONDITIONS PRECEDENT TO OBLIGATIONS OF THE SELLING FUND
The obligations of the Selling Fund to consummate the transactions
provided for herein shall be subject, at its election, to the performance by the
Acquiring Fund of all the obligations to be performed by it hereunder on or
before the Closing Date, and, in addition thereto, the following further
conditions:
6.1 All representations, covenants, and warranties of the Acquiring
Fund contained in this Agreement shall be true and correct as of the date hereof
and as of the Closing Date with the same force and effect as if made on and as
of the Closing Date, and the Acquiring Fund shall have delivered to the Selling
Fund a certificate executed in its name by the Trust's President or Vice
President and its Treasurer or Assistant Treasurer, in form and substance
reasonably satisfactory to the Selling Fund and dated as of the Closing Date, to
such effect and as to such other matters as the Selling Fund shall reasonably
request.
6.2 The Selling Fund shall have received on the Closing Date an opinion
from Sullivan & Worcester LLP, counsel to the Acquiring Fund, dated as of the
Closing Date, in a form reasonably satisfactory to the Selling Fund, covering
the following points:
(a) The Acquiring Fund is a separate investment series of a
Delaware business trust duly organized, validly existing and in good standing
under the laws of the State of Delaware and has the power to own all of its
properties and assets and to carry on its business as presently conducted.
(b) The Acquiring Fund is a separate investment series of a
Delaware business trust registered as an investment company under the 1940 Act,
and, to such counsel's knowledge, such registration with the Commission as an
investment company under the 1940 Act is in full force and effect.
(c) This Agreement has been duly authorized, executed, and
delivered by the Acquiring Fund, and, assuming that the Prospectus and Proxy
Statement, and Registration Statement comply with the 1933 Act, the 1934 Act,
and the 1940 Act and the rules and regulations thereunder and, assuming due
authorization, execution and delivery of this Agreement by the Selling Fund, is
a valid and binding obligation of the Acquiring Fund enforceable against the
Acquiring Fund in accordance with its terms, subject as to enforcement, to
bankruptcy, insolvency, reorganization, moratorium, and other
<PAGE>
laws relating to or affecting creditors' rights generally and
to general equity principles.
(d) Assuming that a consideration therefor not less than the
net asset value thereof has been paid, the Acquiring Fund Shares to be issued
and delivered to the Selling Fund on behalf of the Selling Fund Shareholders as
provided by this Agreement are duly authorized and upon such delivery will be
legally issued and outstanding and fully paid and non-assessable, and no
shareholder of the Acquiring Fund has any preemptive rights in respect thereof.
(e) The Registration Statement, to such counsel's knowledge,
has been declared effective by the Commission and no stop order under the 1933
Act pertaining thereto has been issued, and to the knowledge of such counsel, no
consent, approval, authorization or order of any court or governmental authority
of the United States or the State of Delaware is required for consummation by
the Acquiring Fund of the transactions contemplated herein, except such as have
been obtained under the 1933 Act, the 1934 Act and the 1940 Act, and as may be
required under state securities laws.
ARTICLE VII
CONDITIONS PRECEDENT TO OBLIGATIONS OF THE ACQUIRING FUND
The obligations of the Acquiring Fund to complete the transactions
provided for herein shall be subject, at its election, to the performance by the
Selling Fund of all the obligations to be performed by it hereunder on or before
the Closing Date and, in addition thereto, the following conditions:
7.1 All representations, covenants, and warranties of the Selling Fund
contained in this Agreement shall be true and correct as of the date hereof and
as of the Closing Date with the same force and effect as if made on and as of
the Closing Date, and the Selling Fund shall have delivered to the Acquiring
Fund on the Closing Date a certificate executed in its name by the Selling
Fund's President or Vice President and the Treasurer or Assistant Treasurer, in
form and substance satisfactory to the Acquiring Fund and dated as of the
Closing Date, to such effect and as to such other matters as the Acquiring Fund
shall reasonably request.
7.2 The Selling Fund shall have delivered to the Acquiring Fund a
statement of the Selling Fund's assets and liabilities, together with a list of
the Selling Fund's portfolio securities showing the tax costs of such securities
<PAGE>
by lot and the holding periods of such securities, as of the Closing Date,
certified by the Treasurer of the Selling Fund.
7.3 The Acquiring Fund shall have received on the Closing Date an
opinion of Sullivan & Worcester LLP, counsel to the Selling Fund, in a form
satisfactory to the Acquiring Fund covering the following points:
(a) The Selling Fund is a Massachusetts business trust duly
organized, validly existing and in good standing under the laws of The
Commonwealth of Massachusetts and has the power to own all of its properties and
assets and to carry on its business as presently conducted.
(b) The Selling Fund is a Massachusetts business trust
registered as an investment company under the 1940 Act, and, to such counsel's
knowledge, such registration with the Commission as an investment company under
the 1940 Act is in full force and effect.
(c) This Agreement has been duly authorized, executed and
delivered by the Selling Fund, and, assuming that the Prospectus and Proxy
Statement, and Registration Statement comply with the 1933 Act, the 1934 Act,
and the 1940 Act and the rules and regulations thereunder and, assuming due
authorization, execution, and delivery of this Agreement by the Acquiring Fund,
is a valid and binding obligation of the Selling Fund enforceable against the
Selling Fund in accordance with its terms, subject as to enforcement, to
bankruptcy, insolvency, reorganization, moratorium and other laws relating to or
affecting creditors' rights generally and to general equity principles.
(d) To the knowledge of such counsel, no consent, approval,
authorization or order of any court or governmental authority of the United
States or The Commonwealth of Massachusetts is required for consummation by the
Selling Fund of the transactions contemplated herein, except such as have been
obtained under the 1933 Act, the 1934 Act and the 1940 Act, and as may be
required under state securities laws.
ARTICLE VIII
FURTHER CONDITIONS PRECEDENT TO OBLIGATIONS OF THE ACQUIRING
FUND AND THE SELLING FUND
If any of the conditions set forth below do not exist on or before the
Closing Date with respect to the Selling Fund or the Acquiring Fund, the other
party to this Agreement shall,
<PAGE>
at its option, not be required to consummate the transactions
contemplated by this Agreement:
8.1 This Agreement and the transactions contemplated herein shall have
been approved by the requisite vote of the holders of the outstanding shares of
the Selling Fund in accordance with the provisions of the Selling Fund's
Declaration of Trust and By-Laws and certified copies of the resolutions
evidencing such approval shall have been delivered to the Acquiring Fund.
Notwithstanding anything herein to the contrary, neither the Acquiring Fund nor
the Selling Fund may waive the conditions set forth in this paragraph 8.1.
8.2 On the Closing Date, the Commission shall not have issued an
unfavorable report under Section 25(b) of the 1940 Act, nor instituted any
proceeding seeking to enjoin the consummation of the transactions contemplated
by this Agreement under Section 25(c) of the 1940 Act and no action, suit or
other proceeding shall be threatened or pending before any court or governmental
agency in which it is sought to restrain or prohibit, or obtain damages or other
relief in connection with, this Agreement or the transactions contemplated
herein.
8.3 All required consents of other parties and all other consents,
orders, and permits of federal, state and local regulatory authorities
(including those of the Commission and of state Blue Sky securities authorities,
including any necessary "no-action" positions of and exemptive orders from such
federal and state authorities) to permit consummation of the transactions
contemplated hereby shall have been obtained, except where failure to obtain any
such consent, order, or permit would not involve a risk of a material adverse
effect on the assets or properties of the Acquiring Fund or the Selling Fund,
provided that either party hereto may for itself waive any of such conditions.
8.4 The Registration Statement shall have become effective under the
1933 Act, and no stop orders suspending the effectiveness thereof shall have
been issued and, to the best knowledge of the parties hereto, no investigation
or proceeding for that purpose shall have been instituted or be pending,
threatened or contemplated under the 1933 Act.
8.5 The Selling Fund shall have declared a dividend or dividends which,
together with all previous such dividends, shall have the effect of distributing
to the Selling Fund Shareholders all of the Selling Fund's investment company
taxable income for all taxable periods ending on the Closing Date (computed
without regard to any deduction for dividends
<PAGE>
paid) and all of its net capital gains realized in all taxable periods ending on
the Closing Date (after reduction for any capital loss carryforward).
8.6 The parties shall have received a favorable opinion of Sullivan &
Worcester LLP, addressed to the Acquiring Fund and the Selling Fund
substantially to the effect that for federal income tax purposes:
(a) The transfer of all of the Selling Fund assets in exchange
for the Acquiring Fund Shares and the assumption by the Acquiring Fund of
certain stated liabilities of the Selling Fund followed by the distribution of
the Acquiring Fund Shares to the Selling Fund in dissolution and liquidation of
the Selling Fund will constitute a "reorganization" within the meaning of
Section 368(a)(1)(C) of the Code and the Acquiring Fund and the Selling Fund
will each be a "party to a reorganization" within the meaning of Section 368(b)
of the Code.
(b) No gain or loss will be recognized by the Acquiring Fund
upon the receipt of the assets of the Selling Fund solely in exchange for the
Acquiring Fund Shares and the assumption by the Acquiring Fund of certain stated
liabilities of the Selling Fund.
(c) No gain or loss will be recognized by the Selling Fund
upon the transfer of the Selling Fund assets to the Acquiring Fund in exchange
for the Acquiring Fund Shares and the assumption by the Acquiring Fund of
certain stated liabilities of the Selling Fund or upon the distribution (whether
actual or constructive) of the Acquiring Fund Shares to Selling Fund
Shareholders in exchange for their shares of the Selling Fund.
(d) No gain or loss will be recognized by the Selling Fund
Shareholders upon the exchange of their Selling Fund shares for the Acquiring
Fund Shares in liquidation of the Selling Fund.
(e) The aggregate tax basis for the Acquiring Fund Shares
received by each Selling Fund Shareholder pursuant to the Reorganization will be
the same as the aggregate tax basis of the Selling Fund shares held by such
shareholder immediately prior to the Reorganization, and the holding period of
the Acquiring Fund Shares to be received by each Selling Fund Shareholder will
include the period during which the Selling Fund shares exchanged therefor were
held by such shareholder (provided the Selling Fund shares were held as capital
assets on the date of the Reorganization).
<PAGE>
(f) The tax basis of the Selling Fund assets acquired by the
Acquiring Fund will be the same as the tax basis of such assets to the Selling
Fund immediately prior to the Reorganization, and the holding period of the
assets of the Selling Fund in the hands of the Acquiring Fund will include the
period during which those assets were held by the Selling Fund.
Notwithstanding anything herein to the contrary, neither the Acquiring
Fund nor the Selling Fund may waive the conditions set forth in this paragraph
8.6.
8.7 The Acquiring Fund shall have received from KPMG Peat Marwick LLP a
letter addressed to the Acquiring Fund, in form and substance satisfactory to
the Acquiring Fund, to the effect that:
(a) they are independent certified public accountants with
respect to the Selling Fund within the meaning of the 1933 Act and the
applicable published rules and regulations thereunder;
(b) on the basis of limited procedures agreed upon by the
Acquiring Fund and described in such letter (but not an examination in
accordance with generally accepted auditing standards), the Capitalization Table
appearing in the Registration Statement and Prospectus and Proxy Statement has
been obtained from and is consistent with the accounting records of the Selling
Fund;
(c) on the basis of limited procedures agreed upon by the
Acquiring Fund and described in such letter (but not an examination in
accordance with generally accepted auditing standards), the data utilized in the
calculations of the projected expense ratios appearing in the Registration
Statement and Prospectus and Proxy Statement agree with underlying accounting
records of the Selling Fund or to written estimates by Selling Fund's management
and were found to be mathematically correct.
In addition, the Acquiring Fund shall have received from KPMG Peat
Marwick LLP a letter addressed to the Acquiring Fund dated on the Closing Date,
in form and substance satisfactory to the Acquiring Fund, to the effect, that on
the basis of limited procedures agreed upon by the Acquiring Fund (but not an
examination in accordance with generally accepted auditing standards), the
calculation of net asset value per share of the Selling Fund as of the Valuation
Date was determined in accordance with generally accepted accounting practices
and the portfolio valuation practices of the Acquiring Fund.
<PAGE>
8.8 The Selling Fund shall have received from KPMG Peat Marwick LLP a
letter addressed to the Selling Fund, in form and substance satisfactory to the
Selling Fund, to the effect that:
(a) they are independent certified public accountants with
respect to the Acquiring Fund within the meaning of the 1933 Act and the
applicable published rules and regulations thereunder;
(b) on the basis of limited procedures agreed upon by the
Selling Fund and described in such letter (but not an examination in accordance
with generally accepted auditing standards), the Capitalization Table appearing
in the Registration Statement and Prospectus and Proxy Statement has been
obtained from and is consistent with the accounting records of the Acquiring
Fund; and
(c) on the basis of limited procedures agreed upon by the
Selling Fund (but not an examination in accordance with generally accepted
auditing standards), the data utilized in the calculations of the projected
expense ratio appearing in the Registration Statement and Prospectus and Proxy
Statement agree with written estimates by each Fund's management and were found
to be mathematically correct.
8.9 The Acquiring Fund and the Selling Fund shall also have received
from KPMG Peat Marwick LLP a letter addressed to the Acquiring Fund and the
Selling Fund, dated on the Closing Date in form and substance satisfactory to
the Funds, setting forth the federal income tax implications relating to capital
loss carryforwards (if any) of the Selling Fund and the related impact, if any,
of the proposed transfer of all of the assets of the Selling Fund to the
Acquiring Fund and the ultimate dissolution of the Selling Fund, upon the
shareholders of the Selling Fund.
ARTICLE IX
EXPENSES
9.1 Except as otherwise provided for herein, all expenses of the
transactions contemplated by this Agreement incurred by the Selling Fund and the
Acquiring Fund will be borne by First Union National Bank. Such expenses
include, without limitation, (a) expenses incurred in connection with the
entering into and the carrying out of the provisions of this Agreement; (b)
expenses associated with the preparation and filing of the Registration
Statement under the 1933 Act
<PAGE>
covering the Acquiring Fund Shares to be issued pursuant to the provisions of
this Agreement; (c) registration or qualification fees and expenses of preparing
and filing such forms as are necessary under applicable state securities laws to
qualify the Acquiring Fund Shares to be issued in connection herewith in each
state in which the Selling Fund Shareholders are resident as of the date of the
mailing of the Prospectus and Proxy Statement to such shareholders; (d) postage;
(e) printing; (f) accounting fees; (g) legal fees; and (h) solicitation costs of
the transaction. Notwithstanding the foregoing, the Acquiring Fund shall pay its
own federal and state registration fees.
ARTICLE X
ENTIRE AGREEMENT; SURVIVAL OF WARRANTIES
10.1 The Acquiring Fund and the Selling Fund agree that neither party
has made any representation, warranty or covenant not set forth herein and that
this Agreement constitutes the entire agreement between the parties.
10.2 The representations, warranties, and covenants contained in this
Agreement or in any document delivered pursuant hereto or in connection herewith
shall survive the consummation of the transactions contemplated hereunder.
ARTICLE XI
TERMINATION
11.1 This Agreement may be terminated by the mutual agreement of the
Acquiring Fund and the Selling Fund. In addition, either the Acquiring Fund or
the Selling Fund may at its option terminate this Agreement at or prior to the
Closing Date because:
(a) of a breach by the other of any representation, warranty,
or agreement contained herein to be performed at or prior to the Closing Date,
if not cured within 30 days; or
(b) a condition herein expressed to be precedent to the
obligations of the terminating party has not been met and it reasonably appears
that it will not or cannot be met.
11.2 In the event of any such termination, in the absence of willful
default, there shall be no liability for damages on the part of either the
Acquiring Fund, the Selling Fund, the Trust, the respective Trustees or
officers, to the other party or its Trustees or officers.
<PAGE>
ARTICLE XII
AMENDMENTS
This Agreement may be amended, modified, or supplemented in such manner
as may be mutually agreed upon in writing by the authorized officers of the
Selling Fund and the Acquiring Fund; provided, however, that following the
meeting of the Selling Fund Shareholders called by the Selling Fund pursuant to
paragraph 5.2 of this Agreement, no such amendment may have the effect of
changing the provisions for determining the number of the Acquiring Fund Shares
to be issued to the Selling Fund Shareholders under this Agreement to the
detriment of such shareholders without their further approval.
ARTICLE XIII
HEADINGS; COUNTERPARTS; GOVERNING LAW; ASSIGNMENT;
LIMITATION OF LIABILITY
13.1 The Article and paragraph headings contained in this Agreement are
for reference purposes only and shall not affect in any way the meaning or
interpretation of this Agreement.
13.2 This Agreement may be executed in any number of counterparts, each
of which shall be deemed an original.
13.3 This Agreement shall be governed by and construed in accordance
with the laws of the State of Delaware, without giving effect to the conflicts
of laws provisions thereof; provided, however, that the due authorization,
execution and delivery of this Agreement, in the case of the Selling Fund, shall
be governed and construed in accordance with the laws of The Commonwealth of
Massachusetts, without giving effect to the conflicts of laws provisions
thereof.
13.4 This Agreement shall bind and inure to the benefit of the parties
hereto and their respective successors and assigns, but no assignment or
transfer hereof or of any rights or obligations hereunder shall be made by any
party without the written consent of the other party. Nothing herein expressed
or implied is intended or shall be construed to confer upon or give any person,
firm, or corporation, other than the parties hereto and their respective
successors and assigns, any rights or remedies under or by reason of this
Agreement.
13.5 It is expressly agreed that the obligations of the Selling Fund
hereunder shall not be binding upon any of the Trustees, shareholders, nominees,
officers, agents, or
<PAGE>
employees of the Selling Fund personally, but bind only the trust property of
the Selling Fund, as provided in the Declaration of Trust of the Selling Fund.
The execution and delivery of this Agreement have been authorized by the
Trustees of the Selling Fund and signed by authorized officers of the Selling
Fund, acting as such, and neither such authorization by such Trustees nor such
execution and delivery by such officers shall be deemed to have been made by any
of them individually or to impose any liability on any of them personally, but
shall bind only the trust property of the Selling Fund as provided in the
Declaration of Trust of the Selling Fund.
IN WITNESS WHEREOF, the parties have duly executed and sealed this
Agreement, all as of the date first written above.
EVERGREEN EQUITY TRUST
ON BEHALF OF EVERGREEN
SMALL COMPANY GROWTH FUND
By:
Name:
Title:
KEYSTONE SMALL COMPANY GROWTH FUND II
By:
Name:
Title:
<PAGE>
EXHIBIT A-2
AGREEMENT AND PLAN OF REORGANIZATION
THIS AGREEMENT AND PLAN OF REORGANIZATION (the "Agreement") is made as
of this 30th day of September, 1997, by and between the Evergreen Equity Trust,
a Delaware business trust, with its principal place of business at 200 Berkeley
Street, Boston, Massachusetts 02116 (the "Trust"), with respect to its Evergreen
Small Company Growth Fund series (the "Acquiring Fund"), and Keystone Small
Company Growth Fund (S- 4), a Pennsylvania common law trust ("Keystone Trust"),
with its principal place of business at 200 Berkeley Street, Boston,
Massachusetts 02116 with respect to its Keystone Small Company Growth Fund (S-4)
series (the "Selling Fund").
This Agreement is intended to be, and is adopted as a plan of
reorganization and liquidation within the meaning of Section 368(a)(1)(F) of the
United States Internal Revenue Code of 1986, as amended (the "Code"). The
reorganization (the "Reorganization") will consist of (i) the transfer of all of
the assets of the Selling Fund in exchange solely for shares of beneficial
interest, without par value, of the Acquiring Fund (the "Acquiring Fund
Shares"); (ii) the assumption by the Acquiring Fund of certain identified
liabilities of the Selling Fund; and (iii) the distribution, after the Closing
Date hereinafter referred to, of the Acquiring Fund Shares to the shareholders
of the Selling Fund in liquidation of the Selling Fund as provided herein, all
upon the terms and conditions hereinafter set forth in this Agreement.
WHEREAS, the Selling Fund is the sole investment series of, and the
Acquiring Fund is a separate investment series of, an open-end, registered
investment company of the management type, respectively, and the Selling Fund
owns securities that generally are assets of the character in which the
Acquiring Fund is permitted to invest;
WHEREAS, both Funds are authorized to issue their shares
of beneficial interest;
WHEREAS, the Trustees of the Trust have determined that the exchange of
all of the assets of the Selling Fund for Acquiring Fund Shares and the
assumption of certain identified liabilities of the Selling Fund by the
Acquiring Fund on the terms and conditions hereinafter set forth are in the best
interests of the Acquiring Fund's shareholders;
<PAGE>
WHEREAS, the Trustees of Keystone Trust have determined that the
Selling Fund should exchange all of its assets and certain identified
liabilities for Acquiring Fund Shares and that the interests of the existing
shareholders of the Selling Fund will not be diluted as a result of the
transactions contemplated herein;
NOW, THEREFORE, in consideration of the premises and of the covenants
and agreements hereinafter set forth, the parties hereto covenant and agree as
follows:
ARTICLE I
TRANSFER OF ASSETS OF THE SELLING FUND IN EXCHANGE FOR
THE ACQUIRING FUND SHARES AND ASSUMPTION OF SELLING FUND
LIABILITIES AND LIQUIDATION OF THE SELLING FUND
1.1 THE EXCHANGE. Subject to the terms and conditions herein set forth
and on the basis of the representations and warranties contained herein, the
Selling Fund agrees to transfer all of the Selling Fund's assets as set forth in
paragraph 1.2 to the Acquiring Fund. The Acquiring Fund agrees in exchange
therefor (i) to deliver to the Selling Fund the number of Acquiring Fund Shares,
including fractional Acquiring Fund Shares, determined by multiplying the shares
outstanding of each class of the Selling Fund by the ratio computed by dividing
the net asset value per share of each such class of the Selling Fund by the net
asset value per share of the corresponding class of Acquiring Fund Shares
computed in the manner and as of the time and date set forth in paragraph 2.2;
and (ii) to assume certain identified liabilities of the Selling Fund, as set
forth in paragraph 1.3. Such transactions shall take place at the closing
provided for in paragraph 3.1 (the "Closing Date").
1.2 ASSETS TO BE ACQUIRED. The assets of the Selling Fund to be
acquired by the Acquiring Fund shall consist of all property, including, without
limitation, all cash, securities, commodities, and futures interests and
dividends or interest receivables, that is owned by the Selling Fund and any
deferred or prepaid expenses shown as an asset on the books of the Selling Fund
on the Closing Date.
The Selling Fund has provided the Acquiring Fund with its most recent
audited financial statements, which contain a list of all of Selling Fund's
assets as of the date thereof. The Selling Fund hereby represents that as of the
date of the execution of this Agreement there have been no changes in its
financial position as reflected in said financial statements other than those
occurring in the ordinary course of its
<PAGE>
business in connection with the purchase and sale of securities and the payment
of its normal operating expenses. The Selling Fund reserves the right to sell
any of such securities, but will not, without the prior written approval of the
Acquiring Fund, acquire any additional securities other than securities of the
type in which the Acquiring Fund is permitted to invest.
The Acquiring Fund will, within a reasonable time prior to the Closing
Date, furnish the Selling Fund with a statement of the Acquiring Fund's
investment objectives, policies, and restrictions and a list of the securities,
if any, on the Selling Fund's list referred to in the second sentence of this
paragraph that do not conform to the Acquiring Fund's investment objectives,
policies, and restrictions. In the event that the Selling Fund holds any
investments that the Acquiring Fund may not hold, the Selling Fund will dispose
of such securities prior to the Closing Date. In addition, if it is determined
that the Selling Fund and the Acquiring Fund portfolios, when aggregated, would
contain investments exceeding certain percentage limitations imposed upon the
Acquiring Fund with respect to such investments, the Selling Fund if requested
by the Acquiring Fund will dispose of a sufficient amount of such investments as
may be necessary to avoid violating such limitations as of the Closing Date.
1.3 LIABILITIES TO BE ASSUMED. The Selling Fund will endeavor to
discharge all of its known liabilities and obligations prior to the Closing
Date. Except as specifically provided in this paragraph 1.3, the Acquiring Fund
shall assume only those liabilities, expenses, costs, charges and reserves
reflected on a Statement of Assets and Liabilities of the Selling Fund prepared
on behalf of the Selling Fund, as of the Valuation Date (as defined in paragraph
2.1), in accordance with generally accepted accounting principles consistently
applied from the prior audited period. The Acquiring Fund shall assume only
those liabilities of the Selling Fund reflected in such Statement of Assets and
Liabilities and shall not except as specifically provided in this paragraph 1.3
assume any other liabilities, whether absolute or contingent, known or unknown,
accrued or unaccrued, all of which shall remain the obligation of the Selling
Fund. The Acquiring Fund hereby agrees with Keystone Trust and each Trustee of
Keystone Trust: (i) to indemnify each Trustee of Keystone Trust against all
liabilities and expenses referred to in the indemnification provisions of
Keystone Trust's Declaration of Trust and By-Laws, to the extent provided
therein, incurred by any Trustee of Keystone Trust; and (ii) in addition to the
indemnification provided in (i) above, to indemnify each Trustee of Keystone
Trust against
<PAGE>
all liabilities and expenses and pay the same as they arise and become due,
without any exception, limitation or requirement of approval by any person, and
without any right to require repayment thereof by any such Trustee (unless such
Trustee has had the same repaid to him or her) based upon any subsequent or
final disposition or findings made in connection therewith or otherwise, if such
action, suit or other proceeding involves such Trustee's participation in
authorizing or permitting or acquiescing in, directly or indirectly, by action
or inaction, the making of any distribution in any manner of all or any assets
of the Selling Fund without making provision for the payment of any liabilities
of any kind, fixed or contingent, of the Selling Fund, which liabilities were
not actually and consciously personally known to such Trustee to exist at the
time of such Trustee's participation in so authorizing or permitting or
acquiescing in the making of any such distribution.
In addition, upon completion of the Reorganization, for purposes of
calculating the maximum amount permitted to be charged to the Acquiring Fund
under the National Association of Securities Dealers, Inc. Conduct Rule 2830,
minus the amount of the sales charges paid or accrued (including asset based
sales charge), plus permitted interest ("Aggregate NASD Cap"), the Acquiring
Fund will add to its Aggregate NASD Cap immediately prior to the Reorganization
the Aggregate NASD Cap of the Selling Fund immediately prior to the
Reorganization.
1.4 LIQUIDATION AND DISTRIBUTION. On or soon after the Closing Date as
is conveniently practicable (the "Liquidation Date"), (a) the Selling Fund will
liquidate and distribute pro rata to the Selling Fund's shareholders of record,
determined as of the close of business on the Valuation Date (the "Selling Fund
Shareholders"), the Acquiring Fund Shares received by the Selling Fund pursuant
to paragraph 1.1; and (b) the Selling Fund will thereupon proceed to dissolve as
set forth in paragraph 1.8 below. Such liquidation and distribution will be
accomplished by the transfer of the Acquiring Fund Shares then credited to the
account of the Selling Fund on the books of the Acquiring Fund to open accounts
on the share records of the Acquiring Fund in the names of the Selling Fund
Shareholders and representing the respective pro rata number of the Acquiring
Fund Shares due such shareholders. All issued and outstanding shares of the
Selling Fund will simultaneously be canceled on the books of the Selling Fund.
The Acquiring Fund shall not issue certificates representing the Acquiring Fund
Shares in connection with such exchange.
<PAGE>
1.5 OWNERSHIP OF SHARES. Ownership of Acquiring Fund Shares will be
shown on the books of the Acquiring Fund's transfer agent. Shares of the
Acquiring Fund will be issued in the manner described in the combined Prospectus
and Proxy Statement on Form N-14 to be distributed to shareholders of the
Selling Fund as described in paragraph 5.7.
1.6 TRANSFER TAXES. Any transfer taxes payable upon issuance of the
Acquiring Fund Shares in a name other than the registered holder of the Selling
Fund shares on the books of the Selling Fund as of that time shall, as a
condition of such issuance and transfer, be paid by the person to whom such
Acquiring Fund Shares are to be issued and transferred.
1.7 REPORTING RESPONSIBILITY. Any reporting responsibility of the
Selling Fund is and shall remain the responsibility of the Selling Fund up to
and including the Closing Date and such later date on which the Selling Fund is
terminated.
1.8 TERMINATION. The Selling Fund shall be terminated promptly
following the Closing Date and the making of all distributions pursuant to
paragraph 1.4.
ARTICLE II
VALUATION
2.1 VALUATION OF ASSETS. The value of the Selling Fund's assets to be
acquired by the Acquiring Fund hereunder shall be the value of such assets
computed as of the close of business on the New York Stock Exchange on the
business day next preceding the Closing Date (such time and date being
hereinafter called the "Valuation Date"), using the valuation procedures set
forth in the Trust's Declaration of Trust and the Acquiring Fund's then current
prospectus and statement of additional information or such other valuation
procedures as shall be mutually agreed upon by the parties.
2.2 VALUATION OF SHARES. The net asset value per share of the Acquiring
Fund Shares shall be the net asset value per share computed as of the close of
business on the New York Stock Exchange on the Valuation Date, using the
valuation procedures set forth in the Trust's Declaration of Trust and the
Acquiring Fund's then current prospectus and statement of additional
information.
2.3 SHARES TO BE ISSUED. The number of the Acquiring Fund Shares of each
class to be issued (including fractional shares, if any) in exchange for the
Selling Fund's assets
<PAGE>
shall be determined by multiplying the shares outstanding of each class of the
Selling Fund by the ratio computed by dividing the net asset value per share of
the Selling Fund attributable to each of its classes by the net asset value per
share of the respective classes of the Acquiring Fund determined in accordance
with paragraph 2.2.
2.4 DETERMINATION OF VALUE. All computations of value shall be made by
State Street Bank and Trust Company in accordance with its regular practice in
pricing the shares and assets of the Acquiring Fund.
ARTICLE III
CLOSING AND CLOSING DATE
3.1 CLOSING DATE. The Closing (the "Closing") shall take place on or
about January 23, 1998 or such other date as the parties may agree to in writing
(the "Closing Date"). All acts taking place at the Closing shall be deemed to
take place simultaneously immediately prior to the opening of business on the
Closing Date unless otherwise provided. The Closing shall be held as of 9:00
a.m. at the offices of the Evergreen Keystone Funds, 200 Berkeley Street,
Boston, MA 02116, or at such other time and/or place as the parties may agree.
3.2 CUSTODIAN'S CERTIFICATE. State Street Bank and Trust Company, as
custodian for the Selling Fund (the "Custodian"), shall deliver at the Closing a
certificate of an authorized officer stating that (a) the Selling Fund's
portfolio securities, cash, and any other assets shall have been delivered in
proper form to the Acquiring Fund on the Closing Date; and (b) all necessary
taxes including all applicable federal and state stock transfer stamps, if any,
shall have been paid, or provision for payment shall have been made, in
conjunction with the delivery of portfolio securities by the Selling Fund.
3.3 EFFECT OF SUSPENSION IN TRADING. In the event that on the Valuation
Date (a) the New York Stock Exchange or another primary trading market for
portfolio securities of the Acquiring Fund or the Selling Fund shall be closed
to trading or trading thereon shall be restricted; or (b) trading or the
reporting of trading on said Exchange or elsewhere shall be disrupted so that
accurate appraisal of the value of the net assets of the Acquiring Fund or the
Selling Fund is impracticable, the Valuation Date shall be postponed until the
first business day after the day when trading shall have been fully resumed and
reporting shall have been restored.
<PAGE>
3.4 TRANSFER AGENT'S CERTIFICATE. Evergreen Keystone Service Company,
as transfer agent for the Selling Fund as of the Closing Date ("EKSC"), shall
deliver at the Closing a certificate of an authorized officer stating that its
records contain the names and addresses of the Selling Fund Shareholders and the
number and percentage ownership of outstanding shares owned by each such
shareholder immediately prior to the Closing. The Acquiring Fund shall issue and
deliver or cause EKSC, its transfer agent as of the Closing Date, to issue and
deliver a confirmation evidencing the Acquiring Fund Shares to be credited on
the Closing Date to the Secretary of Keystone Trust or provide evidence
satisfactory to the Selling Fund that such Acquiring Fund Shares have been
credited to the Selling Fund's account on the books of the Acquiring Fund. At
the Closing, each party shall deliver to the other such bills of sale, checks,
assignments, share certificates, if any, receipts and other documents as such
other party or its counsel may reasonably request.
ARTICLE IV
REPRESENTATIONS AND WARRANTIES
4.1 REPRESENTATIONS OF THE SELLING FUND. The Selling
Fund represents and warrants to the Acquiring Fund as follows:
(a) The Selling Fund is the sole investment series of a
Pennsylvania common law trust duly organized, validly existing, and in good
standing under the laws of The Commonwealth of Pennsylvania.
(b) The Selling Fund is the sole investment series of a
Pennsylvania common law trust that is registered as an investment company
classified as a management company of the open-end type, and its registration
with the Securities and Exchange Commission (the "Commission") as an investment
company under the Investment Company Act of 1940, as amended (the "1940 Act"),
is in full force and effect.
(c) The current prospectus and statement of additional
information of the Selling Fund conform in all material respects to the
applicable requirements of the Securities Act of 1933, as amended (the "1933
Act"), and the 1940 Act and the rules and regulations of the Commission
thereunder and do not include any untrue statement of a material fact or omit to
state any material fact required to be stated therein or necessary to make the
statements therein, in light of the circumstances under which they were made,
not misleading.
<PAGE>
(d) The Selling Fund is not, and the execution, delivery, and
performance of this Agreement (subject to shareholder approval) will not result,
in violation of any provision of Keystone Trust's Declaration of Trust or
By-Laws or of any material agreement, indenture, instrument, contract, lease, or
other undertaking to which the Selling Fund is a party or by which it is bound.
(e) The Selling Fund has no material contracts or other
commitments (other than this Agreement) that will be terminated with liability
to it prior to the Closing Date.
(f) Except as otherwise disclosed in writing to and accepted
by the Acquiring Fund, no litigation, administrative proceeding, or
investigation of or before any court or governmental body is presently pending
or to its knowledge threatened against the Selling Fund or any of its properties
or assets, which, if adversely determined, would materially and adversely affect
its financial condition, the conduct of its business, or the ability of the
Selling Fund to carry out the transactions contemplated by this Agreement. The
Selling Fund knows of no facts that might form the basis for the institution of
such proceedings and is not a party to or subject to the provisions of any
order, decree, or judgment of any court or governmental body that materially and
adversely affects its business or its ability to consummate the transactions
herein contemplated.
(g) The financial statements of the Selling Fund at May 31,
1997 are in accordance with generally accepted accounting principles
consistently applied, and such statements (copies of which have been furnished
to the Acquiring Fund) fairly reflect the financial condition of the Selling
Fund as of such date, and there are no known contingent liabilities of the
Selling Fund as of such date not disclosed therein.
(h) Since May 31, 1997 there has not been any material adverse
change in the Selling Fund's financial condition, assets, liabilities, or
business other than changes occurring in the ordinary course of business, or any
incurrence by the Selling Fund of indebtedness maturing more than one year from
the date such indebtedness was incurred, except as otherwise disclosed to and
accepted by the Acquiring Fund. For the purposes of this subparagraph (h), a
decline in the net asset value of the Selling Fund shall not constitute a
material adverse change.
(i) At the Closing Date, all federal and other tax returns and reports of
the Selling Fund required by law to
<PAGE>
have been filed by such dates shall have been filed, and all federal and other
taxes shown due on said returns and reports shall have been paid, or provision
shall have been made for the payment thereof. To the best of the Selling Fund's
knowledge, no such return is currently under audit, and no assessment has been
asserted with respect to such returns.
(j) For each fiscal year of its operation, the Selling Fund
has met the requirements of Subchapter M of the Code for qualification and
treatment as a regulated investment company and has distributed in each such
year all net investment income and realized capital gains.
(k) All issued and outstanding shares of the Selling Fund are,
and at the Closing Date will be, duly and validly issued and outstanding, fully
paid and non-assessable by the Selling Fund (except that, under Pennsylvania
law, Selling Fund Shareholders could under certain circumstances be held
personally liable for obligations of the Selling Fund). All of the issued and
outstanding shares of the Selling Fund will, at the time of the Closing Date, be
held by the persons and in the amounts set forth in the records of the transfer
agent as provided in paragraph 3.4. The Selling Fund does not have outstanding
any options, warrants, or other rights to subscribe for or purchase any of the
Selling Fund shares, nor is there outstanding any security convertible into any
of the Selling Fund shares.
(l) At the Closing Date, the Selling Fund will have good and
marketable title to the Selling Fund's assets to be transferred to the Acquiring
Fund pursuant to paragraph 1.2 and full right, power, and authority to sell,
assign, transfer, and deliver such assets hereunder, and, upon delivery and
payment for such assets, the Acquiring Fund will acquire good and marketable
title thereto, subject to no restrictions on the full transfer thereof,
including such restrictions as might arise under the 1933 Act, other than as
disclosed to the Acquiring Fund and accepted by the Acquiring Fund.
(m) The execution, delivery, and performance of this Agreement
have been duly authorized by all necessary action on the part of the Selling
Fund and, subject to approval by the Selling Fund Shareholders, this Agreement
constitutes a valid and binding obligation of the Selling Fund, enforceable in
accordance with its terms, subject as to enforcement, to bankruptcy, insolvency,
reorganization, moratorium, and other laws relating to or affecting creditors'
rights and to general equity principles.
<PAGE>
(n) The information to be furnished by the Selling Fund for
use in no-action letters, applications for orders, registration statements,
proxy materials, and other documents that may be necessary in connection with
the transactions contemplated hereby shall be accurate and complete in all
material respects and shall comply in all material respects with federal
securities and other laws and regulations thereunder applicable thereto.
(o) The Proxy Statement of the Selling Fund to be included in
the Registration Statement (as defined in paragraph 5.7)(other than information
therein that relates to the Acquiring Fund) will, on the effective date of the
Registration Statement and on the Closing Date, not contain any untrue statement
of a material fact or omit to state a material fact required to be stated
therein or necessary to make the statements therein, in light of the
circumstances under which such statements were made, not misleading.
4.2 REPRESENTATIONS OF THE ACQUIRING FUND. The Acquiring
Fund represents and warrants to the Selling Fund as follows:
(a) The Acquiring Fund is a separate investment series of a
Delaware business trust duly organized, validly existing and in good standing
under the laws of the State of Delaware.
(b) The Acquiring Fund is a separate investment series of a
Delaware business trust that is registered as an investment company classified
as a management company of the open-end type, and its registration with the
Commission as an investment company under the 1940 Act is in full force and
effect.
(c) The current prospectuses and statement of additional
information of the Acquiring Fund conform in all material respects to the
applicable requirements of the 1933 Act and the 1940 Act and the rules and
regulations of the Commission thereunder and do not include any untrue statement
of a material fact or omit to state any material fact required to be stated
therein or necessary to make the statements therein, in light of the
circumstances under which they were made, not misleading.
(d) The Acquiring Fund is not, and the execution, delivery and
performance of this Agreement will not result, in violation of the Trust's
Declaration of Trust or By-Laws or of any material agreement, indenture,
instrument, contract, lease, or other undertaking to which the Acquiring Fund is
a party or by which it is bound.
<PAGE>
(e) Except as otherwise disclosed in writing to the Selling
Fund and accepted by the Selling Fund, no litigation, administrative proceeding
or investigation of or before any court or governmental body is presently
pending or to its knowledge threatened against the Acquiring Fund or any of its
properties or assets, which, if adversely determined, would materially and
adversely affect its financial condition and the conduct of its business or the
ability of the Acquiring Fund to carry out the transactions contemplated by this
Agreement. The Acquiring Fund knows of no facts that might form the basis for
the institution of such proceedings and is not a party to or subject to the
provisions of any order, decree, or judgment of any court or governmental body
that materially and adversely affects its business or its ability to consummate
the transactions contemplated herein.
(f) The Acquiring Fund has no known liabilities of a material
amount, contingent or otherwise.
(g) At the Closing Date, there will not be any material
adverse change in the Acquiring Fund's financial condition, assets, liabilities,
or business other than changes occurring in the ordinary course of business, or
any incurrence by the Acquiring Fund of indebtedness maturing more than one year
from the date such indebtedness was incurred, except as otherwise disclosed to
and accepted by the Selling Fund. For the purposes of this subparagraph (g), a
decline in the net asset value of the Acquiring Fund shall not constitute a
material adverse change.
(h) At the Closing Date, all federal and other tax returns and
reports of the Acquiring Fund required by law then to be filed by such dates
shall have been filed, and all federal and other taxes shown due on said returns
and reports shall have been paid or provision shall have been made for the
payment thereof. To the best of the Acquiring Fund's knowledge, no such return
is currently under audit, and no assessment has been asserted with respect to
such returns.
(i) All issued and outstanding Acquiring Fund Shares are, and
at the Closing Date will be, duly and validly issued and outstanding, fully paid
and non-assessable. The Acquiring Fund does not have outstanding any options,
warrants, or other rights to subscribe for or purchase any Acquiring Fund
Shares, nor is there outstanding any security convertible into any Acquiring
Fund Shares.
(j) The execution, delivery, and performance of this Agreement
have been duly authorized by all necessary action on the part of the Acquiring
Fund, and this Agreement
<PAGE>
constitutes a valid and binding obligation of the Acquiring Fund enforceable in
accordance with its terms, subject as to enforcement, to bankruptcy, insolvency,
reorganization, moratorium, and other laws relating to or affecting creditors'
rights and to general equity principles.
(k) The Acquiring Fund Shares to be issued and delivered to
the Selling Fund, for the account of the Selling Fund Shareholders, pursuant to
the terms of this Agreement will, at the Closing Date, have been duly authorized
and, when so issued and delivered, will be duly and validly issued Acquiring
Fund Shares, and will be fully paid and non-assessable.
(l) The information to be furnished by the Acquiring Fund for
use in no-action letters, applications for orders, registration statements,
proxy materials, and other documents that may be necessary in connection with
the transactions contemplated hereby shall be accurate and complete in all
material respects and shall comply in all material respects with federal
securities and other laws and regulations applicable thereto.
(m) The Prospectus and Proxy Statement (as defined in
paragraph 5.7) to be included in the Registration Statement (only insofar as it
relates to the Acquiring Fund) will, on the effective date of the Registration
Statement and on the Closing Date, not contain any untrue statement of a
material fact or omit to state a material fact required to be stated therein or
necessary to make the statements therein, in light of the circumstances under
which such statements were made, not misleading.
(n) The Acquiring Fund agrees to use all reasonable efforts to
obtain the approvals and authorizations required by the 1933 Act, the 1940 Act,
and such of the state Blue Sky or securities laws as it may deem appropriate in
order to continue its operations after the Closing Date.
ARTICLE V
COVENANTS OF THE ACQUIRING FUND AND THE SELLING FUND
5.1 OPERATION IN ORDINARY COURSE. The Acquiring Fund and the Selling
Fund each will operate its business in the ordinary course between the date
hereof and the Closing Date, it being understood that such ordinary course of
business will include customary dividends and distributions.
<PAGE>
5.2 APPROVAL OF SHAREHOLDERS. Keystone Trust will call a meeting of the
Selling Fund Shareholders to consider and act upon this Agreement and to take
all other action necessary to obtain approval of the transactions contemplated
herein.
5.3 INVESTMENT REPRESENTATION. The Selling Fund covenants that the
Acquiring Fund Shares to be issued hereunder are not being acquired for the
purpose of making any distribution thereof other than in accordance with the
terms of this Agreement.
5.4 ADDITIONAL INFORMATION. The Selling Fund will assist the Acquiring
Fund in obtaining such information as the Acquiring Fund reasonably requests
concerning the beneficial ownership of the Selling Fund shares.
5.5 FURTHER ACTION. Subject to the provisions of this Agreement, the
Acquiring Fund and the Selling Fund will each take, or cause to be taken, all
action, and do or cause to be done, all things reasonably necessary, proper or
advisable to consummate and make effective the transactions contemplated by this
Agreement, including any actions required to be taken after the Closing Date.
5.6 STATEMENT OF EARNINGS AND PROFITS. As promptly as practicable, but
in any case within sixty days after the Closing Date, the Selling Fund shall
furnish the Acquiring Fund, in such form as is reasonably satisfactory to the
Acquiring Fund, a statement of the earnings and profits of the Selling Fund for
federal income tax purposes that will be carried over by the Acquiring Fund as a
result of Section 381 of the Code, and which will be reviewed by its independent
auditors and certified by Keystone Trust's President and Treasurer.
5.7 PREPARATION OF FORM N-14 REGISTRATION STATEMENT. The Selling Fund
will provide the Acquiring Fund with information reasonably necessary for the
preparation of a prospectus, which will include the proxy statement, referred to
in paragraph 4.1(o) (the "Prospectus and Proxy Statement"), all to be included
in a Registration Statement on Form N-14 of the Acquiring Fund (the
"Registration Statement"), in compliance with the 1933 Act, the Securities
Exchange Act of 1934, as amended (the "1934 Act"), and the 1940 Act in
connection with the meeting of the Selling Fund Shareholders to consider
approval of this Agreement and the transactions contemplated herein.
ARTICLE VI
<PAGE>
CONDITIONS PRECEDENT TO OBLIGATIONS OF THE SELLING FUND
The obligations of the Selling Fund to consummate the transactions
provided for herein shall be subject, at its election, to the performance by the
Acquiring Fund of all the obligations to be performed by it hereunder on or
before the Closing Date, and, in addition thereto, the following further
conditions:
6.1 All representations, covenants, and warranties of the Acquiring
Fund contained in this Agreement shall be true and correct as of the date hereof
and as of the Closing Date with the same force and effect as if made on and as
of the Closing Date, and the Acquiring Fund shall have delivered to the Selling
Fund a certificate executed in its name by the Trust's President or Vice
President and its Treasurer or Assistant Treasurer, in form and substance
reasonably satisfactory to the Selling Fund and dated as of the Closing Date, to
such effect and as to such other matters as the Selling Fund shall reasonably
request.
6.2 The Selling Fund shall have received on the Closing Date an opinion
from Sullivan & Worcester LLP, counsel to the Acquiring Fund, dated as of the
Closing Date, in a form reasonably satisfactory to the Selling Fund, covering
the following points:
(a) The Acquiring Fund is a separate investment series of a
Delaware business trust duly organized, validly existing and in good standing
under the laws of the State of Delaware and has the power to own all of its
properties and assets and to carry on its business as presently conducted.
(b) The Acquiring Fund is a separate investment series of a
Delaware business trust registered as an investment company under the 1940 Act,
and, to such counsel's knowledge, such registration with the Commission as an
investment company under the 1940 Act is in full force and effect.
(c) This Agreement has been duly authorized, executed, and
delivered by the Acquiring Fund, and, assuming that the Prospectus and Proxy
Statement, and Registration Statement comply with the 1933 Act, the 1934 Act,
and the 1940 Act and the rules and regulations thereunder and, assuming due
authorization, execution and delivery of this Agreement by the Selling Fund, is
a valid and binding obligation of the Acquiring Fund enforceable against the
Acquiring Fund in accordance with its terms, subject as to enforcement, to
bankruptcy, insolvency, reorganization, moratorium, and other
<PAGE>
laws relating to or affecting creditors' rights generally and
to general equity principles.
(d) Assuming that a consideration therefor not less than the
net asset value thereof has been paid, the Acquiring Fund Shares to be issued
and delivered to the Selling Fund on behalf of the Selling Fund Shareholders as
provided by this Agreement are duly authorized and upon such delivery will be
legally issued and outstanding and fully paid and non-assessable, and no
shareholder of the Acquiring Fund has any preemptive rights in respect thereof.
(e) The Registration Statement, to such counsel's knowledge,
has been declared effective by the Commission and no stop order under the 1933
Act pertaining thereto has been issued, and to the knowledge of such counsel, no
consent, approval, authorization or order of any court or governmental authority
of the United States or the State of Delaware is required for consummation by
the Acquiring Fund of the transactions contemplated herein, except such as have
been obtained under the 1933 Act, the 1934 Act and the 1940 Act, and as may be
required under state securities laws.
ARTICLE VII
CONDITIONS PRECEDENT TO OBLIGATIONS OF THE ACQUIRING FUND
The obligations of the Acquiring Fund to complete the transactions
provided for herein shall be subject, at its election, to the performance by the
Selling Fund of all the obligations to be performed by it hereunder on or before
the Closing Date and, in addition thereto, the following conditions:
7.1 All representations, covenants, and warranties of the Selling Fund
contained in this Agreement shall be true and correct as of the date hereof and
as of the Closing Date with the same force and effect as if made on and as of
the Closing Date, and the Selling Fund shall have delivered to the Acquiring
Fund on the Closing Date a certificate executed in its name by Keystone Trust's
President or Vice President and the Treasurer or Assistant Treasurer, in form
and substance satisfactory to the Acquiring Fund and dated as of the Closing
Date, to such effect and as to such other matters as the Acquiring Fund shall
reasonably request.
7.2 The Selling Fund shall have delivered to the Acquiring Fund a
statement of the Selling Fund's assets and liabilities, together with a list of
the Selling Fund's portfolio securities showing the tax costs of such securities
<PAGE>
by lot and the holding periods of such securities, as of the Closing Date,
certified by the Treasurer of Keystone Trust.
7.3 The Acquiring Fund shall have received on the Closing Date an
opinion of Sullivan & Worcester LLP, counsel to the Selling Fund, in a form
satisfactory to the Acquiring Fund covering the following points:
(a) The Selling Fund is the sole investment series of a
Pennsylvania common law trust duly organized, validly existing and in good
standing under the laws of The Commonwealth of Massachusetts and has the power
to own all of its properties and assets and to carry on its business as
presently conducted.
(b) The Selling Fund is the sole investment series of a
Pennsylvania common law trust registered as an investment company under the 1940
Act, and, to such counsel's knowledge, such registration with the Commission as
an investment company under the 1940 Act is in full force and effect.
(c) This Agreement has been duly authorized, executed and
delivered by the Selling Fund, and, assuming that the Prospectus and Proxy
Statement, and Registration Statement comply with the 1933 Act, the 1934 Act,
and the 1940 Act and the rules and regulations thereunder and, assuming due
authorization, execution, and delivery of this Agreement by the Acquiring Fund,
is a valid and binding obligation of the Selling Fund enforceable against the
Selling Fund in accordance with its terms, subject as to enforcement, to
bankruptcy, insolvency, reorganization, moratorium and other laws relating to or
affecting creditors' rights generally and to general equity principles.
(d) To the knowledge of such counsel, no consent, approval,
authorization or order of any court or governmental authority of the United
States or The Commonwealth of Pennsylvania is required for consummation by the
Selling Fund of the transactions contemplated herein, except such as have been
obtained under the 1933 Act, the 1934 Act and the 1940 Act, and as may be
required under state securities laws.
ARTICLE VIII
FURTHER CONDITIONS PRECEDENT TO OBLIGATIONS OF THE ACQUIRING
FUND AND THE SELLING FUND
If any of the conditions set forth below do not exist on or before the
Closing Date with respect to the Selling Fund or the Acquiring Fund, the other
party to this Agreement shall,
<PAGE>
at its option, not be required to consummate the transactions
contemplated by this Agreement:
8.1 This Agreement and the transactions contemplated herein shall have
been approved by the requisite vote of the holders of the outstanding shares of
the Selling Fund in accordance with the provisions of Keystone Trust's
Declaration of Trust and By-Laws and certified copies of the resolutions
evidencing such approval shall have been delivered to the Acquiring Fund.
Notwithstanding anything herein to the contrary, neither the Acquiring Fund nor
the Selling Fund may waive the conditions set forth in this paragraph 8.1.
8.2 On the Closing Date, the Commission shall not have issued an
unfavorable report under Section 25(b) of the 1940 Act, nor instituted any
proceeding seeking to enjoin the consummation of the transactions contemplated
by this Agreement under Section 25(c) of the 1940 Act and no action, suit or
other proceeding shall be threatened or pending before any court or governmental
agency in which it is sought to restrain or prohibit, or obtain damages or other
relief in connection with, this Agreement or the transactions contemplated
herein.
8.3 All required consents of other parties and all other consents,
orders, and permits of federal, state and local regulatory authorities
(including those of the Commission and of state Blue Sky securities authorities,
including any necessary "no-action" positions of and exemptive orders from such
federal and state authorities) to permit consummation of the transactions
contemplated hereby shall have been obtained, except where failure to obtain any
such consent, order, or permit would not involve a risk of a material adverse
effect on the assets or properties of the Acquiring Fund or the Selling Fund,
provided that either party hereto may for itself waive any of such conditions.
8.4 The Registration Statement shall have become effective under the
1933 Act, and no stop orders suspending the effectiveness thereof shall have
been issued and, to the best knowledge of the parties hereto, no investigation
or proceeding for that purpose shall have been instituted or be pending,
threatened or contemplated under the 1933 Act.
8.5 The Selling Fund shall have declared a dividend or dividends which,
together with all previous such dividends, shall have the effect of distributing
to the Selling Fund Shareholders all of the Selling Fund's investment company
taxable income for all taxable periods ending on the Closing Date (computed
without regard to any deduction for dividends
<PAGE>
paid) and all of its net capital gains realized in all taxable periods ending on
the Closing Date (after reduction for any capital loss carryforward).
8.6 The parties shall have received a favorable opinion of Sullivan &
Worcester LLP, addressed to the Acquiring Fund and the Selling Fund
substantially to the effect that for federal income tax purposes:
(a) The transfer of all of the Selling Fund assets in exchange
for the Acquiring Fund Shares and the assumption by the Acquiring Fund of
certain stated liabilities of the Selling Fund followed by the distribution of
the Acquiring Fund Shares to the Selling Fund in dissolution and liquidation of
the Selling Fund will constitute a "reorganization" within the meaning of
Section 368(a)(1)(F) of the Code and the Acquiring Fund and the Selling Fund
will each be a "party to a reorganization" within the meaning of Section 368(b)
of the Code.
(b) No gain or loss will be recognized by the Acquiring Fund
upon the receipt of the assets of the Selling Fund solely in exchange for the
Acquiring Fund Shares and the assumption by the Acquiring Fund of certain stated
liabilities of the Selling Fund.
(c) No gain or loss will be recognized by the Selling Fund
upon the transfer of the Selling Fund assets to the Acquiring Fund in exchange
for the Acquiring Fund Shares and the assumption by the Acquiring Fund of
certain stated liabilities of the Selling Fund or upon the distribution (whether
actual or constructive) of the Acquiring Fund Shares to Selling Fund
Shareholders in exchange for their shares of the Selling Fund.
(d) No gain or loss will be recognized by the Selling Fund
Shareholders upon the exchange of their Selling Fund shares for the Acquiring
Fund Shares in liquidation of the Selling Fund.
(e) The aggregate tax basis for the Acquiring Fund Shares
received by each Selling Fund Shareholder pursuant to the Reorganization will be
the same as the aggregate tax basis of the Selling Fund shares held by such
shareholder immediately prior to the Reorganization, and the holding period of
the Acquiring Fund Shares to be received by each Selling Fund Shareholder will
include the period during which the Selling Fund shares exchanged therefor were
held by such shareholder (provided the Selling Fund shares were held as capital
assets on the date of the Reorganization).
<PAGE>
(f) The tax basis of the Selling Fund assets acquired by the
Acquiring Fund will be the same as the tax basis of such assets to the Selling
Fund immediately prior to the Reorganization, and the holding period of the
assets of the Selling Fund in the hands of the Acquiring Fund will include the
period during which those assets were held by the Selling Fund.
Notwithstanding anything herein to the contrary, neither the Acquiring
Fund nor the Selling Fund may waive the conditions set forth in this paragraph
8.6.
8.7 The Acquiring Fund shall have received from KPMG Peat Marwick LLP a
letter addressed to the Acquiring Fund, in form and substance satisfactory to
the Acquiring Fund, to the effect that:
(a) they are independent certified public accountants with
respect to the Selling Fund within the meaning of the 1933 Act and the
applicable published rules and regulations thereunder;
(b) on the basis of limited procedures agreed upon by the
Acquiring Fund and described in such letter (but not an examination in
accordance with generally accepted auditing standards), the Capitalization Table
appearing in the Registration Statement and Prospectus and Proxy Statement has
been obtained from and is consistent with the accounting records of the Selling
Fund;
(c) on the basis of limited procedures agreed upon by the
Acquiring Fund and described in such letter (but not an examination in
accordance with generally accepted auditing standards), the data utilized in the
calculations of the projected expense ratios appearing in the Registration
Statement and Prospectus and Proxy Statement agree with underlying accounting
records of the Selling Fund or to written estimates by Selling Fund's management
and were found to be mathematically correct.
In addition, the Acquiring Fund shall have received from KPMG Peat
Marwick LLP a letter addressed to the Acquiring Fund dated on the Closing Date,
in form and substance satisfactory to the Acquiring Fund, to the effect, that on
the basis of limited procedures agreed upon by the Acquiring Fund (but not an
examination in accordance with generally accepted auditing standards), the
calculation of net asset value per share of the Selling Fund as of the Valuation
Date was determined in accordance with generally accepted accounting practices
and the portfolio valuation practices of the Acquiring Fund.
<PAGE>
8.8 The Selling Fund shall have received from KPMG Peat Marwick LLP a
letter addressed to the Selling Fund, in form and substance satisfactory to the
Selling Fund, to the effect that:
(a) they are independent certified public accountants with
respect to the Acquiring Fund within the meaning of the 1933 Act and the
applicable published rules and regulations thereunder;
(b) on the basis of limited procedures agreed upon by the
Selling Fund and described in such letter (but not an examination in accordance
with generally accepted auditing standards), the Capitalization Table appearing
in the Registration Statement and Prospectus and Proxy Statement has been
obtained from and is consistent with the accounting records of the Acquiring
Fund; and
(c) on the basis of limited procedures agreed upon by the
Selling Fund (but not an examination in accordance with generally accepted
auditing standards), the data utilized in the calculations of the projected
expense ratio appearing in the Registration Statement and Prospectus and Proxy
Statement agree with written estimates by each Fund's management and were found
to be mathematically correct.
8.9 The Acquiring Fund and the Selling Fund shall also have received
from KPMG Peat Marwick LLP a letter addressed to the Acquiring Fund and the
Selling Fund, dated on the Closing Date in form and substance satisfactory to
the Funds, setting forth the federal income tax implications relating to capital
loss carryforwards (if any) of the Selling Fund and the related impact, if any,
of the proposed transfer of all of the assets of the Selling Fund to the
Acquiring Fund and the ultimate dissolution of the Selling Fund, upon the
shareholders of the Selling Fund.
ARTICLE IX
EXPENSES
9.1 Except as otherwise provided for herein, all expenses of the
transactions contemplated by this Agreement incurred by the Selling Fund and the
Acquiring Fund will be borne by First Union National Bank. Such expenses
include, without limitation, (a) expenses incurred in connection with the
entering into and the carrying out of the provisions of this Agreement; (b)
expenses associated with the preparation and filing of the Registration
Statement under the 1933 Act covering the Acquiring Fund Shares to be issued
pursuant to
<PAGE>
the provisions of this Agreement; (c) registration or qualification fees and
expenses of preparing and filing such forms as are necessary under applicable
state securities laws to qualify the Acquiring Fund Shares to be issued in
connection herewith in each state in which the Selling Fund Shareholders are
resident as of the date of the mailing of the Prospectus and Proxy Statement to
such shareholders; (d) postage; (e) printing; (f) accounting fees; (g) legal
fees; and (h) solicitation costs of the transaction. Notwithstanding the
foregoing, the Acquiring Fund shall pay its own federal and state registration
fees.
ARTICLE X
ENTIRE AGREEMENT; SURVIVAL OF WARRANTIES
10.1 The Acquiring Fund and the Selling Fund agree that neither party
has made any representation, warranty or covenant not set forth herein and that
this Agreement constitutes the entire agreement between the parties.
10.2 The representations, warranties, and covenants contained in this
Agreement or in any document delivered pursuant hereto or in connection herewith
shall survive the consummation of the transactions contemplated hereunder.
ARTICLE XI
TERMINATION
11.1 This Agreement may be terminated by the mutual agreement of the
Acquiring Fund and the Selling Fund. In addition, either the Acquiring Fund or
the Selling Fund may at its option terminate this Agreement at or prior to the
Closing Date because:
(a) of a breach by the other of any representation, warranty,
or agreement contained herein to be performed at or prior to the Closing Date,
if not cured within 30 days; or
(b) a condition herein expressed to be precedent to the
obligations of the terminating party has not been met and it reasonably appears
that it will not or cannot be met.
11.2 In the event of any such termination, in the absence of willful
default, there shall be no liability for damages on the part of either the
Acquiring Fund, the Selling Fund, Keystone Trust, the Trust, the respective
Trustees or officers, to the other party or its Trustees or officers.
<PAGE>
ARTICLE XII
AMENDMENTS
This Agreement may be amended, modified, or supplemented in such manner
as may be mutually agreed upon in writing by the authorized officers of the
Selling Fund and the Acquiring Fund; provided, however, that following the
meeting of the Selling Fund Shareholders called by the Selling Fund pursuant to
paragraph 5.2 of this Agreement, no such amendment may have the effect of
changing the provisions for determining the number of the Acquiring Fund Shares
to be issued to the Selling Fund Shareholders under this Agreement to the
detriment of such shareholders without their further approval.
ARTICLE XIII
HEADINGS; COUNTERPARTS; GOVERNING LAW; ASSIGNMENT;
LIMITATION OF LIABILITY
13.1 The Article and paragraph headings contained in this Agreement are
for reference purposes only and shall not affect in any way the meaning or
interpretation of this Agreement.
13.2 This Agreement may be executed in any number of counterparts, each
of which shall be deemed an original.
13.3 This Agreement shall be governed by and construed in accordance
with the laws of the State of Delaware, without giving effect to the conflicts
of laws provisions thereof; provided, however, that the due authorization,
execution and delivery of this Agreement, in the case of Keystone Trust, shall
be governed and construed in accordance with the laws of The Commonwealth of
Pennsylvania, without giving effect to the conflicts of laws provisions thereof.
13.4 This Agreement shall bind and inure to the benefit of the parties
hereto and their respective successors and assigns, but no assignment or
transfer hereof or of any rights or obligations hereunder shall be made by any
party without the written consent of the other party. Nothing herein expressed
or implied is intended or shall be construed to confer upon or give any person,
firm, or corporation, other than the parties hereto and their respective
successors and assigns, any rights or remedies under or by reason of this
Agreement.
13.5 It is expressly agreed that the obligations of the Selling Fund
hereunder shall not be binding upon any of the Trustees, shareholders, nominees,
officers, agents, or
<PAGE>
employees of Keystone Trust personally, but bind only the trust property of the
Selling Fund, as provided in the Declaration of Trust of Keystone Trust. The
execution and delivery of this Agreement have been authorized by the Trustees of
Keystone Trust and signed by authorized officers of Keystone Trust, acting as
such, and neither such authorization by such Trustees nor such execution and
delivery by such officers shall be deemed to have been made by any of them
individually or to impose any liability on any of them personally, but shall
bind only the trust property of the Selling Fund as provided in the Declaration
of Trust of Keystone Trust.
IN WITNESS WHEREOF, the parties have duly executed and sealed this
Agreement, all as of the date first written above.
EVERGREEN EQUITY TRUST
ON BEHALF OF EVERGREEN
SMALL COMPANY GROWTH FUND
By:
Name:
Title:
KEYSTONE SMALL COMPANY GROWTH FUND (S-4)
By:
Name:
Title:
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
Acquisition of the Assets of
KEYSTONE SMALL COMPANY GROWTH FUND II
200 Berkeley Street
Boston, Massachusetts 02116
(800) 343-2898
and
KEYSTONE SMALL COMPANY GROWTH FUND (S-4)
200 Berkeley Street
Boston, Massachusetts 02116
(800) 343-2898
By and In Exchange For Shares of
EVERGREEN SMALL COMPANY GROWTH FUND
a Series of
EVERGREEN EQUITY TRUST
200 Berkeley Street
Boston, Massachusetts 02116
(800) 343-2898
This Statement of Additional Information, relating specifically to the
proposed transfer of the assets and liabilities of Keystone Small Company Growth
Fund II, ("Keystone Small Company Growth II"), and Keystone Small Company Growth
Fund (S-4) ("Keystone Small Company Growth (S- 4)"), to Evergreen Small Company
Growth Fund ("Evergreen Small Company Growth"), a series of the Evergreen Equity
Trust, in exchange, as applicable, for Class Y, Class A, Class B and Class C
shares of beneficial interest, no par value, of Evergreen Small Company Growth,
consists of this cover page and the following described documents, each of which
is attached hereto and incorporated by reference herein:
(1) The Statement of Additional Information of Keystone
Small Company Growth II dated August 1, 1997;
(2) The Statement of Additional Information of Keystone
Small Company Growth (S-4) dated August 1, 1997;
(3) Annual Report of Keystone Small Company Growth II for the year
ended May 31, 1997; and
<PAGE>
(4) Annual Report of Keystone Small Company Growth (S-4) for the
year ended May 31, 1997.
This Statement of Additional Information, which is not a prospectus,
supplements, and should be read in conjunction with, the Prospectus/Proxy
Statement of Evergreen Small Company Growth, Keystone Small Company Growth II
and Keystone Small Company Growth (S-4) dated November 14, 1997. A copy of the
Prospectus/Proxy Statement may be obtained without charge by calling or writing
to Evergreen Small Company Growth, Keystone Small Company Growth II or Keystone
Small Company Growth (S-4) at the telephone numbers or addresses set forth
above.
The date of this Statement of Additional Information is November 14,
1997.
<PAGE>
KEYSTONE SMALL COMPANY GROWTH FUND II
PART B
STATEMENT OF ADDITIONAL INFORMATION
<PAGE>
KEYSTONE SMALL COMPANY GROWTH FUND II
STATEMENT OF ADDITIONAL INFORMATION
AUGUST 1, 1997
This statement of additional information pertains to all classes of
shares of Keystone Small Company Growth Fund II (the "Fund"). It is not a
prospectus, but relates to, and should be read in conjunction with, either the
prospectus offering Class A, B and C shares dated August 1, 1997, or the
separate prospectus offering Class Y shares dated August 1, 1997. You may obtain
a copy of either prospectus from the Fund's principal underwriter, Evergreen
Keystone Distributor, Inc., or your broker-dealer.
TABLE OF CONTENTS
Page
The Fund .....................................................................2
Service Providers.............................................................2
Investment Restrictions.......................................................3
Distributions and Taxes.......................................................5
Valuation of Securities.......................................................5
Brokerage.....................................................................6
Sales Charges.................................................................7
Distribution Plans...........................................................11
Trustees and Officers........................................................13
Investment Adviser...........................................................16
Principal Underwriter........................................................18
Sub-administrator............................................................19
Declaration of Trust.........................................................20
Expenses.....................................................................21
Standardized Total Return and Yield Quotations...............................22
Financial Statements.........................................................23
Additional Information...................................................... 24
Appendix .................................................................A - 1
THE FUND
The Fund is an open-end, diversified management investment company,
commonly known as a mutual fund. The Fund's investment objective is to provide
shareholders with long-term growth of capital.
Certain information about the Fund is contained in its prospectuses.
This statement of additional information ("SAI")provides additional information
about the Fund that may be of interest to some investors.
SERVICE PROVIDERS
SERVICE PROVIDER
Investment adviser (referred to Keystone Investment Management
in this SAI as "Keystone")
Company, 200 Berkeley
Street, Boston, Massachusetts 02116.
Keystone is a wholly-owned
subsidiary of First Union
Keystone, Inc. ("First
Union Keystone") (formerly
Keystone Investments, Inc.),
also located at 200
Berkeley Street, Boston,
Massachusetts 02116
Principal underwriter (referred Evergreen Keystone Distributor, Inc.
to in this SAI as "EKD") (formerly Evergreen Funds Distributor,
Inc.), 125 W.
55th Street, New York, New York 10019
Marketing services agent and Evergreen Keystone Investment Services, Inc.
predecessor to EKD (referred (formerly Keystone Investment Distributors
to in this SAI as "EKIS") Company), 200 Berkeley Street, Boston,
Massachusetts 02116
Sub-administrator (referred to BISYS Fund Services, 3435 Stelzer Road,
in this SAI as ("BISYS") Columbus, Ohio 43219
Transfer and dividend Evergreen Keystone Service Company,
disbursing agent(referred to (formerly Keystone Investor Resource Center,
Inc.), in this SAI as"EKSC") 200 Berkeley
Street, Boston, Massachusetts 02116 (EKSC
is a wholly-owned subsidiary of Keystone)
Independent auditors KPMG Peat Marwick LLP, 99 High Street, Boston,
Massachusetts 02110, Certified Public
Accountants
Custodian State Street Bank and Trust Company, 225
Franklin
Street, Boston, Massachusetts 02110
INVESTMENT RESTRICTIONS
FUNDAMENTAL INVESTMENT RESTRICTIONS
The investment restrictions set forth below are fundamental and may not
be changed without the vote of a majority of the Fund's outstanding shares (as
defined in the Investment Company Act of 1940 (the "1940 Act")). Unless
otherwise stated, all references to Fund's assets are in terms of current market
value.
The Fund may not do the following:
(1) with respect to 75% of its total assets, invest more than 5% of the
value of its total assets, determined at market or other fair value at the time
of purchase, in the securities of any one issuer, or invest in more than 10% of
the outstanding voting securities of any one issuer, all as determined
immediately after such investment; provided that these limitations do not apply
to investments in securities issued or guaranteed by the United States ("U.S.")
government or its agencies or instrumentalities;
(2) concentrate its investments in the securities of issuers in any one
industry other than securities issued or guaranteed by the U.S. government or
its agencies or instrumentalities;
(3) borrow, except from banks for temporary or emergency purposes, provided
that, immediately after any such borrowing there is asset coverage of at least
300% for all such borrowings, and the Fund may enter into reverse repurchase
agreements;
(4) issue senior securities, except that the Fund may (a) make permitted
borrowings of money; (b) enter into firm commitment agreements and collateral
arrangements with respect to the writing of options on securities and engage in
permitted transactions in futures and options thereon and forward contracts; and
(c) issue shares of any additional permitted classes or series;
(5) engage in the business of underwriting securities issued by other
persons, except insofar as the Fund may be deemed to be an underwriter in
connection with the disposition of its portfolio investments;
(6) invest in real estate or commodities, except that the Fund may (a)
invest in securities directly or indirectly secured by real estate and interests
therein and securities of companies that invest in real estate and interests
therein, including mortgages and other liens; and (b) enter into financial
futures contracts and options thereon for hedging purposes and enter into
forward contracts; or
(7) make loans, except that the Fund may make, purchase, or hold publicly
and nonpublicly offered debt securities (including convertible securities) and
other debt investments, including loans, consistent with its investment
objective; (b) lend its portfolio securities to broker-dealers; and (c) enter
into repurchase agreements.
OTHER FUNDAMENTAL POLICIES
Notwithstanding any other investment policy or restriction, the Fund
may invest all of its assets in the securities of a single open-end management
investment company with substantially the same fundamental investment objective,
policies and restrictions as the Fund.
NON-FUNDAMENTAL INVESTMENT RESTRICTIONS
The Fund has adopted the non-fundamental policies set forth below,
which may be changed without shareholder approval.
The Fund may not do the following:
(1) borrow money except for temporary or emergency purposes (not for
leveraging or investment), and it will not purchase any security while
borrowings representing more than 5% of its total assets are outstanding;
(2) (a) sell securities short (except by selling futures contracts or
writing covered options), unless it owns, or by virtue of ownership of other
securities has the right to obtain without additional consideration securities
identical in kind and amount to the securities sold short; or (b) purchase
securities on margin, except for such short-term credits as are necessary for
the clearance of transactions, and provided that the Fund may make initial and
variation so-called "margin" payments in connection with purchases or sales of
futures contracts or of options on futures contracts or forwards or other
similar instruments;
(3) pledge, mortgage, or hypothecate its assets, except that the Fund
may pledge not more than one-third of its total assets (taken at current value)
to secure borrowings made in accordance with its investment restrictions on
borrowings, and provided that the Fund may make initial and variation margin
payments in connection with purchases or sales of futures contracts or of
options on futures contracts or forwards or other similar instruments;
(4) purchase the securities of any other investment company, except by
purchase in the open market subject only to customary broker's commissions and
provided that any such purchase will not result in duplication of sales charges
or management fees, and except in connection with any merger, consolidation, or
reorganization;
(5) invest in oil, gas, or other mineral leases or development programs
(except the Fund may invest in companies that own or invest in such interests);
(6) invest in real estate limited partnerships; or
(7) (a) write covered options, unless the securities underlying such
options are listed on a national securities exchange and the options are issued
by the Options Clearing Corporation; provided, however, that the securities
underlying such options may be traded on an automated quotations system
("NASDAQ") of the National Association of Securities Dealers, Inc. ("NASD") if
and to the extent permitted by applicable state regulations; or (b) purchase
warrants, valued at the lower of cost or market, in excess of 5% of the value of
the Fund's net assets; included within that amount, but not to exceed 2% of the
value of the Fund's net assets, may be warrants that are not listed on the New
York or American Stock Exchanges; warrants acquired by the Fund at any time in
units or attached to securities are not subject to this restriction.
OTHER NON-FUNDAMENTAL POLICIES
If a percentage limit is satisfied at the time of investment or
borrowing, a later increase or decrease resulting from a change in asset value
is not a violation of the limit.
DISTRIBUTIONS AND TAXES
The Fund distributes to its shareholders dividends from net investment
income and net realized securities gains, if any, at least annually in shares
or, at the option of the shareholder, in cash. Distributions are taxable whether
received in cash or additional shares. (Distributions of ordinary income may be
eligible in whole or in part for the corporate 70% dividends received
deduction.) Shareholders who have not opted, prior to the record date for any
distribution, to receive cash will have the number of distributed shares
determined on the basis of the Fund's net asset value per share per class
computed at the end of the ex-dividend date after adjustment for the
distribution. Net asset value is used in computing the number of shares in both
gains and income distribution reinvestments. Account statements and/or checks,
as appropriate, will be mailed to shareholders by the 15th day of the
appropriate month. Unless the Fund receives instructions to the contrary from a
shareholder before the record date, it will assume that the shareholder wishes
to receive that distribution and future gains and income distributions in
shares. Instructions continue in effect until changed in writing.
Capital gains dividends are generally taxable to shareholders as net
long-term capital gains regardless of how long the shareholder has held Fund
shares. If such shares are held less than six months and disposed at a loss,
however, the shareholder will recognize a long-term capital loss on such shares
to the extent of the long-term capital gain distribution received in connection
with such shares. If the net asset value of the Fund's shares is reduced below a
shareholder's cost by a capital gains dividend, such distribution, to the extent
of the reduction, would be a return of investment though taxable as stated
above. Since capital gain dividends depend upon profits actually realized from
the sale of securities by the Fund, they may or may not occur. The foregoing
comments relating to the taxation of dividends and distributions paid on the
Fund's shares relate solely to federal income taxation. Such dividends and
distributions may also be subject to state and local taxes.
When the Fund makes a distribution, it intends to distribute only the
Fund's net capital gains and such income as has been predetermined, to the best
of the Fund's ability, to be taxable as ordinary income. Shareholders of the
Fund will be advised annually of the federal income tax status of distributions.
VALUATION OF SECURITIES
Current values for the Fund's securities are generally determined as
follows:
(1) securities that are traded on a national securities exchange or the
over-the-counter National Market System ("NMS") are valued on the basis of the
last sales price on the exchange where primarily traded or NMS prior to the time
of the valuation, provided that a sale has occurred and that this price reflects
current market value according to procedures established by the Fund's Board of
Trustees;
(2) securities traded in the over-the-counter market, other than NMS,
for which market quotations are readily available, are valued at the mean of the
bid and asked prices at the time of valuation;
(3) short-term investments purchased with maturities of more than sixty
days for which market quotations are readily available, are valued at current
market value;
(4) short-term investments with initial or remaining maturities of
sixty days or less (including all master demand notes) are valued at amortized
cost (original purchase cost as adjusted for amortization of premium or
accretion of discount), which, when combined with accrued interest, approximates
market; and
(5) the following securities are valued at prices deemed in good faith
to be fair under procedures established by the Board of Trustees: (a)
securities, including restricted securities, for which complete quotations are
not readily available; (b) listed securities or those on NMS if, in Keystone's
opinion, the last sales price does not reflect a current market value or if no
sale occurred; and (c) other assets.
Foreign securities for which market quotations are not readily
available are valued on the basis of valuations provided by a pricing service,
approved by the Fund's Board of Trustees, which uses information with respect to
transactions in such securities, quotations from broker-dealers, market
transactions in comparable securities and various relationships between
securities and yield to maturity in determining value.
BROKERAGE
SELECTION OF BROKERS
In effecting transactions in portfolio securities for the Fund,
Keystone seeks the best execution of orders at the most favorable prices.
Keystone determines whether a broker has provided the Fund with best execution
and price in the execution of a securities transaction by evaluating, among
other things:
1. overall direct net economic result to the Fund;
2. the efficiency with which the transaction is effected;
3. the broker's ability to effect the transaction where a large block is
involved;
4. the broker's readiness to execute potentially difficult transactions in
the future;
5. the financial strength and stability of the broker; and
6. the receipt of research services, such as analyses and reports
concerning issuers, industries, securities, economic factors and trends and
other statistical and factual information ("research services").
The Fund's management weighs these considerations in determining the
overall reasonableness of the brokerage commissions paid.
Should the Fund or Keystone receive research services from a broker,
the Fund would consider such services to be in addition to, and not in lieu of,
the services Keystone is required to perform under the Advisory Agreement (as
defined below). Keystone believes that the cost, value and specific application
of such information are indeterminable and cannot be practically allocated
between the Fund and its other clients who may indirectly benefit from the
availability of such information. Similarly, the Fund may indirectly benefit
from information made available as a result of transactions effected for
Keystone's other clients. Under the Advisory Agreement, Keystone is permitted to
pay higher brokerage commissions for brokerage and research services in
accordance with Section 28(e) of the Securities Exchange Act of 1934. In the
event Keystone follows such a practice, it will do so on a basis that is fair
and equitable to the Fund.
The Fund's Board of Trustees has determined that the Fund may consider
sales of Fund shares as a factor in the selection of brokers to execute
portfolio transactions, subject to the requirements of best execution described
above.
BROKERAGE COMMISSIONS
Generally, the Fund expects to purchase and sell its securities through
brokerage transactions for which commissions are payable. Purchases from
underwriters will include the underwriting commission or concession, and
purchases from dealers serving as market makers will include a dealer's mark-up
or reflect a dealer's mark-down. Where transactions are made in the
over-the-counter market, the Fund will deal with primary market makers unless
more favorable prices are otherwise obtainable.
GENERAL BROKERAGE POLICIES
In order to take advantage of the availability of lower purchase
prices, the Fund may participate, if and when practicable, in group bidding for
the direct purchase from an issuer of certain securities.
Keystone makes investment decisions for the Fund independently from
those of its other clients. It may frequently develop, however, that Keystone
will make the same investment decision for more than one client. Simultaneous
transactions are inevitable when the same security is suitable for the
investment objective of more than one account. When two or more of its clients
are engaged in the purchase or sale of the same security, Keystone will allocate
the transactions according to a formula that is equitable to each of its
clients. Although, in some cases, this system could have a detrimental effect on
the price or volume of the Fund's securities, the Fund believes that in other
cases its ability to participate in volume transactions will produce better
executions.
The Fund does not purchase portfolio securities from or sell portfolio
securities to Keystone, EKD, or any of their affiliated persons, as defined in
the 1940 Act.
The Board of Trustees will, from time to time, review the Fund's
brokerage policy. In the event of further regulatory developments affecting the
securities exchanges and brokerage practices generally, the Board of Trustees
may change, modify or eliminate any of the foregoing practices.
SALES CHARGES
The Fund offers four classes of shares that differ primarily with respect
to sales charges and distribution fees. As described below, depending upon the
class of shares that you purchase, the Fund will impose a sales charge when you
purchase Fund shares, a contingent deferred sales charge (a "CDSC") when you
redeem Fund shares or no sales charges at all. The Fund charges a CDSC as
reimbursement for certain expenses, such as commissions or shareholder servicing
fees, that it has incurred in connection with the sale of its shares (see
"Distribution Plans"). If imposed, the Fund deducts CDSCs from the redemption
proceeds you would otherwise receive. CDSCs attributable to your shares are, to
the extent permitted by the NASD, paid to EKD or its predecessor. See the
prospectus for additional information on a particular class.
CLASS DISTINCTIONS
CLASS A SHARES
With certain exceptions, when you purchase Class A shares, you will pay
a maximum sales charge of 4.75%, payable at the time of purchase. (The
prospectus for Class A, Class B and Class C shares contains a complete table of
applicable sales charges and a discussion of sales charge reductions or waivers
that may apply to purchases.) If you purchase Class A shares in the amount of $1
million or more, without an initial sales charge, the Fund will charge a CDSC of
1.00% if you redeem during the month of your purchase and the 12-month period
following the month of your purchase. See "Calculation of Contingent Deferred
Sales Charge" below.
CLASS B SHARES
The Fund offers Class B shares at net asset value (without an initial
sales charge). With respect to Class B shares, the Fund charges a CDSC on shares
redeemed as follows:
REDEMPTION TIMING CDSC RATE
Month of purchase and the first twelve-month
period following the month of purchase..............................5.00%
Second twelve-month
period following the month of purchase..............................4.00%
Third twelve-month
period following the month of purchase..............................3.00%
Fourth twelve-month
period following the month of purchase..............................3.00%
Fifth twelve-month
period following the month of purchase..............................2.00%
Sixth twelve-month
period following the month of purchase..............................1.00%
Thereafter...............................................................0.00%
Class B shares that have been outstanding for seven years after the month
of purchase will automatically convert to Class A shares without imposition of a
front-end sales charge. (Conversion of Class B shares represented by stock
certificates will require the return of the stock certificate to EKSC. See
"Calculation of Contingent Deferred Sales Charge" below.
CLASS C SHARES
Class C shares are available only through broker-dealers who have entered
into special distribution agreements with EKD. The Fund offers Class C shares at
net asset value (without an initial sales charge). With certain exceptions,
however, the Fund will charge a CDSC of 1.00% if you redeem during the month of
your purchase and the 12-month period following the month of your purchase. See
"Calculation of Contingent Deferred Sales Charge" below.
CLASS Y SHARES
No CDSC is imposed on the redemption of Class Y shares. Class Y shares
are not offered to the general public and are available only to (i) persons who
at or prior to December 31, 1994 owned shares in a mutual fund advised by
Evergreen Asset Management Corp. ("Evergreen Asset"), (ii) certain institutional
investors and (iii) investment advisory clients of The Capital Management Group
of First Union National Bank ("CMG"), Evergreen Asset, Keystone, or their
affiliates. Class Y shares are offered at net asset value without a front-end or
back-end sales charge and do not bear any Rule 12b-1 distribution expenses.
CALCULATION OF CONTINGENT DEFERRED SALES CHARGE
Any CDSC imposed upon the redemption of Class A, Class B or Class C
shares is a percentage of the lesser of (1) the net asset value of the shares
redeemed or (2) the net cost of such shares. Upon request for redemption, the
Fund will redeem shares not subject to a CDSC first. Thereafter, the Fund will
redeem first shares held the longest.
SHARES THAT ARE NOT SUBJECT TO A SALES CHARGE OR CDSC
EXCHANGES
The Fund does not charge a CDSC when you exchange your shares for the
shares of the same class of another Evergreen Keystone fund. (See "Additional
Information" for descriptions of the Evergreen Keystone funds.) However, if you
are exchanging shares that are still subject to a CDSC, the CDSC will carry over
to the shares you acquire by the exchange. Moreover, the Fund will compute any
future CDSC based upon the date you originally purchased the shares you tendered
for exchange.
WAIVER OF SALES CHARGES
The Fund may sell its shares at net asset value without an initial
sales charge to:
1. purchasers buying Class A shares in the amount of $1 million or more;
2. a corporate or certain other qualified retirement plan or a
non-qualified deferred compensation plan or a Title 1 tax sheltered annuity or
TSA plan sponsored by an organization having 100 or more eligible employees (a
"Qualifying Plan") or a TSA plan sponsored by a public educational entity having
5,000 or more eligible employees (an "Educational TSA Plan");
3. institutional investors, which may include bank trust departments and
registered investment advisers;
4. investment advisers, consultants or financial planners who place trades
for their own accounts or the accounts of their clients and who charge such
clients a management, consulting, advisory or other fee;
5. clients of investment advisers or financial planners who place trades
for their own accounts if the accounts are linked to the master account of such
investment advisers or financial planners on the books of the broker-dealer
through whom shares are purchased;
6. institutional clients of broker-dealers, including retirement and
deferred compensation plans and the trusts used to fund these plans, that place
trades through an omnibus account maintained with the Fund by the broker-dealer;
7. employees of First Union National Bank and its affiliates, EKD and any
broker-dealer with whom EKD has entered into an agreement to sell shares of the
Fund, and members of the immediate families of such employees;
8. certain Directors, Trustees, officers employees of the Fund, Keystone,
EKD or their affiliates and to the immediate families of such persons; or
9. a bank or trust company in a single account in the name of such bank or
trust company as trustee if the initial investment in shares of the Fund or any
fund in the Evergreen Keystone funds purchased pursuant to this waiver is at
least $500,000 and any commission paid at the time of such purchase is not more
than 1% of the amount invested.
With respect to items 8 and 9 above, the Fund will only sell shares to
these parties upon the purchasers written assurance that he or she is buying the
shares for investment purposes only. Such purchasers may not resell the
securities except through redemption by the Fund. In addition, the Fund will not
charge a CDSC on redemptions by such purchasers.
WAIVER OF CDSCS
The Fund does not impose a CDSC when the shares you are redeeming
represent:
1. an increase in the value of the shares you redeem above the net cost of
such shares;
2. certain shares for which the Fund did not pay a commission on issuance,
including shares acquired through reinvestment of dividend income and capital
gains distributions;
3. shares that are in the accounts of a shareholder who has died or become
disabled;
4. a lump-sum distribution from a 401(k) plan or other benefit plan
qualified under the Employee Retirement Income Security Act of 1974 ("ERISA");
5. automatic withdrawals from the ERISA plan of a shareholder who is a
least 59 1/2 years old;
6. shares in an account that we have closed because the account has an
aggregate net asset value of less than $1,000;
7. automatic withdrawals under a Systematic Withdrawal Plan of up to 1.00%
per month of your initial account balance;
8. withdrawals consisting of loan proceeds to a retirement plan
participant;
9. financial hardship withdrawals made by a retirement plan participant;
10. withdrawals consisting of returns of excess contributions or excess
deferral amounts made to a retirement plan; or
11. a redemption by an individual participant in a Qualifying Plan that
purchased Class C shares (this waiver is not available in the event a Qualifying
Plan, as a whole, redeems substantially all of its assets).
DISTRIBUTION PLANS
Rule 12b-1 under the 1940 Act permits investment companies, such as the
Fund, to use their assets to bear expenses of distributing their shares if they
comply with various conditions, including adoption of a distribution plan
containing certain provisions set forth in Rule 12b-1 (a "Distribution Plan").
The Fund's Class A, Class B, and Class C Distribution Plans have been
approved by the Fund's Board of Trustees, including a majority of the Trustees
who are not interested persons of the Fund, as defined in the 1940 Act, and who
have no direct or indirect financial interest in the Distribution Plans or any
agreement related thereto (the "Independent Trustees"). The Fund's Class Y
shares have not adopted a Distribution Plan and incur no Distribution Plan
expenses.
The NASD limits the amount that the Fund may pay annually in
distribution costs for sales of its shares and shareholder service fees to 1.00%
of the aggregate average daily net asset value of its shares, of which 0.75% may
be used to pay such distribution costs and 0.25% may be used to pay shareholder
service fees. The NASD also limits the aggregate amount that the Fund may pay
for such distribution costs to 6.25% of gross share sales since the inception of
the Distribution Plan, plus interest at the prime rate plus 1% on such amounts
(less any CDSCs paid by shareholders to EKD) remaining unpaid from time to time.
CLASS A DISTRIBUTION PLAN
The Class A Distribution Plan provides that the Fund may expend daily
amounts at an annual rate, which is currently limited to 0.25% of the Fund's
average daily net asset value attributable to Class A shares, to finance any
activity that is primarily intended to result in the sale of Class A shares,
including, without limitation, expenditures consisting of payments to EKD of the
Fund to enable EKD to pay or to have paid to others who sell Class A shares a
service or other fee, at any such intervals as EKD may determine, in respect of
Class A shares maintained by any such recipient and outstanding on the books of
the Fund for specified periods.
Amounts paid by the Fund under the Class A Distribution Plan are
currently used to pay others, such as broker-dealers, service fees at an annual
rate of up to 0.25% of the average net asset value of Class A shares maintained
by such others and outstanding on the books of the Fund for specified periods.
CLASS B DISTRIBUTION PLAN
The Class B Distribution Plans provide that the Fund may expend daily
amounts at an annual rate of up to 1.00% of the Fund's average daily net asset
value attributable to Class B shares to finance any activity that is primarily
intended to result in the sale of Class B shares, including, without limitation,
expenditures consisting of payments to EKD and/or its predecessor. Payments are
made to EKD (1) to enable EKD to pay to others (broker-dealers) commissions in
respect of Class B shares sold since inception of the Distribution Plans; (2) to
enable EKD to pay or to have paid to others a service fee,at such intervals as
EKD may determine, in respect of Class B shares maintained by any such recipient
and outstanding on the books of the Fund for specified periods; and (3) as
interest.
EKD generally reallows to broker-dealers or others a commission equal
to 4.00% of the price paid for each Class B share sold. The broker-dealer or
other party may also receive service fees at an annual rate of 0.25% of the
average daily net asset value of such Class B share maintained by the recipient
and outstanding on the books of the Fund for specified periods.
EKD intends, but is not obligated, to continue to pay or accrue
distribution charges incurred in connection with the Class B Distribution Plans
that exceed current annual payments permitted to be received by EKD from the
Fund ("Advances"). EKD intends to seek full reimbursement of such Advances from
the Fund (together with annual interest thereon at the prime rate plus 1%) at
such time in the future as, and to the extent that, payment thereof by the Fund
would be within the permitted limits. If the Fund's Independent Trustees
authorize such reimbursements of Advances, the effect would be to extend the
period of time during which the Fund incurs the maximum amount of costs allowed
by the Class B Distribution Plans.
In connection with financing its distribution costs, including
commission advances to broker-dealers and others, EKIS, the predecessor to EKD,
sold to a financial institution substantially all of its 12b-1 fee collection
rights and CDSC collection rights in respect of Class B shares sold during the
period beginning with the Fund's initial public offering through November 30,
1996. The Fund has agreed not to reduce the rate of payment of 12b-1 fees in
respect of such Class B shares unless it terminates such shares' Distribution
Plan completely. If it terminates such Distribution Plan, the Fund may be
subject to adverse distribution consequences.
The financing of payments made by EKD to compensate broker-dealers or
other persons for distributing shares of the Fund will be provided by FUNB or
its affiliates.
CLASS C DISTRIBUTION PLAN
The Class C Distribution Plan provides that the Fund may expend daily
amounts at an annual rate of up to 1.00% of the Fund's average daily net asset
value attributable to Class C shares to finance any activity that is primarily
intended to result in the sale of Class C shares, including, without limitation,
expenditures consisting of payments to EKD and/or its predecessor. Payments are
made to EKD (1) to enable EKD to pay to others (broker-dealers) commissions in
respect of Class C shares sold since inception of the Distribution Plan; (2) to
enable EKD to pay or to have paid to others a service fee, at such intervals as
EKD may determine, in respect of Class C shares maintained by any such recipient
and outstanding on the books of the Fund for specified periods; and (3) as
interest.
EKD generally reallows to broker-dealers or others a commission in the
amount of 0.75% of the price paid for each Class C share sold plus the first
year's service fee in advance in the amount of 0.25% of the price paid for each
Class C share sold. Beginning approximately fifteen months after purchase,
broker-dealers or others receive a commission at an annual rate of 0.75%
(subject to NASD rules) plus service fees at the annual rate of 0.25%,
respectively, of the average daily net asset value of each Class C share
maintained by the recipient and outstanding on the books of the Fund for
specified periods.
DISTRIBUTION PLANS - GENERAL
The total amounts paid by the Fund under the foregoing arrangements may not
exceed the maximum Distribution Plan limits specified above. The amounts and
purposes of expenditures under a Distribution Plan must be reported to the
Independent Trustees quarterly. The Independent Trustees may require or approve
changes in the implementation or operation of a Distribution Plan, and may also
require that total expenditures by the Fund under a Distribution Plan be kept
within limits lower than the maximum amount permitted by such Distribution Plan
as stated above.
Each of the Distribution Plans may be terminated at any time by a vote
of the Independent Trustees, or by vote of a majority of the outstanding voting
shares of the respective class of Fund shares. If the Class B Distribution Plans
are terminated, EKD and EKIS will ask the Independent Trustees to take whatever
action they deem appropriate under the circumstances with respect to payment of
Advances.
Any change in a Distribution Plan that would materially increase the
distribution expenses of the Fund provided for in a Distribution Plan requires
shareholder approval. Otherwise, a Distribution Plan may be amended by votes of
the majority of both (1) the Fund's Trustees and (2) the Independent Trustees
cast in person at a meeting called for the purpose of voting on each amendment.
While a Distribution Plan is in effect, the Fund will be required to
commit the selection and nomination of candidates for Independent Trustees to
the discretion of the Independent Trustees.
The Independent Trustees of the Fund have determined that the sales of
the Fund's shares resulting from payments under the Distribution Plans have
benefited the Fund.
TRUSTEES AND OFFICERS
The Trustees and officers of the Fund, their principal occupations and
some of their affiliations over the last five years are as follows:
FREDERICK AMLING: Trustee of the Fund; Trustee or Trustee of all other funds in
the Keystone Families of Funds; Professor, Finance Department, George Washington
University; President, Amling & Company (investment advice); and former Member,
Board of Advisers, Cre dito Emilano (banking).
LAURENCE B. ASHKIN: Trustee of the Fund; Trustee or Director of all other funds
in the Keystone Families of Funds; Trustee or Director of all funds in the
Evergreen Family of Funds other than Evergreen Investment Trust and Evergreen
Variable Trust; real estate developer and construction consultant; and President
of Centrum Equities and Centrum Properties, Inc.
CHARLES A. AUSTIN III: Trustee of the Fund; Trustee or Director of all other
funds in the Keystone Families of Funds; Investment Counselor to Appleton
Partners, Inc.; and former Managing Director, Seaward Management Corporation
(investment advice).
FOSTER BAM: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; Trustee or Director of all the funds in the
Evergreen Family of Funds other than Evergreen Investment Trust and Evergreen
Variable Trust; Partner in the law firm of Cummings & Lockwood; Director,
Symmetrix, Inc. (sulphur company) and Pet Practice, Inc. (veterinary services);
and former Director, Chartwell Group Ltd. (manufacturer of office furnishings
and accessories), Waste Disposal Equipment Acquisition Corporation and
Rehabilitation Corporation of America (rehabilitation hospitals).
*GEORGE S. BISSELL: Chief Executive Officer of the Fund and each of the other
funds in the Keystone Families of Funds; Chairman of the Board and Trustee of
the Fund; Chairman of the Board and Trustee or Director of all other funds in
the Keystone Families of Funds; Chairman of the Board and Trustee of Anatolia
College; Trustee of University Hospital (and Chairman of its Investment
Committee); former Director and Chairman of the Board of Hartwell Keystone
Advisers, Inc.; and former Chairman of the Board, Director and Chief Executive
Officer of Keystone Investments, Inc..
EDWIN D. CAMPBELL: Trustee of the Fund; Trustee or Director of all other funds
in the Keystone Families of Funds; Principal, Padanaram Associates, Inc.; and
former Executive Director, Coalition of Essential Schools, Brown University.
CHARLES F. CHAPIN: Trustee of the Fund; Trustee or Director of all other funds
in the Keystone Families of Funds; and former Director, Peoples Bank (Charlotte,
NC).
K. DUN GIFFORD: Trustee of the Fund; Trustee or Director of all other funds in
the Keystone Families of Funds; Trustee, Treasurer and Chairman of the Finance
Committee, Cambridge College; Chairman Emeritus and Director, American Institute
of Food and Wine; Chairman and President, Oldways Preservation and Exchange
Trust (education); former Chairman of the Board, Director, and Executive Vice
Presi dent, The London Harness Company; former Managing Partner, Roscommon
Capital Corp.; former Chief Executive Officer, Gifford Gifts of Fine Foods;
former Chairman, Gifford, Drescher & Asso ciates (environmental consulting); and
former Director, Keystone Investments, Inc. and Keystone.
JAMES S. HOWELL: Trustee of the Fund; Trustee or Director of all other funds in
the Keystone Families of Funds; Chairman and Trustee or Director of all the
funds in the Evergreen Family of Funds; former Chairman of the Distribution
Foundation for the Carolinas; and former Vice President of Lance Inc. (food
manufacturing).
LEROY KEITH, JR.: Trustee of the Fund; Trustee or Director of all other funds in
the Keystone Families of Funds; Chairman of the Board and Chief Executive
Officer, Carson Products Company; Director of Phoenix Total Return Fund and
Equifax, Inc.; Trustee of Phoenix Series Fund, Phoenix Multi-Portfolio Fund, and
The Phoenix Big Edge Series Fund; and former President, Morehouse College.
F. RAY KEYSER, JR.: Trustee of the Fund; Trustee or Director of all other funds
in the Keystone Families of Funds; Chairman and Of Counsel, Keyser, Crowley &
Meub, P.C.; Member, Governor's (VT) Council of Eco nomic Advisers; Chairman of
the Board and Director, Central Vermont Public Service Corporation and Lahey
Hitchcock Clinic; Director, Vermont Yankee Nuclear Power Corporation, Grand
Trunk Corporation, Grand Trunk Western Railroad, Union Mutual Fire Insurance
Company, New England Guaranty Insurance Com pany, Inc., and the Investment
Company Institute; former Director and President, Associated Industries of
Vermont; former Director of Keystone, Central Vermont Railway, Inc., S.K.I.
Ltd., and Arrow Financial Corp.; and former Director and Chairman of the Board,
Proctor Bank and Green Mountain Bank.
GERALD M. MCDONNELL: Trustee of the Fund; Trustee or Director of all other funds
in the Keystone Families of Funds; Trustee or Director of all of the funds in
the Evergreen Family of Funds; and Sales Representative with Nucor-Yamoto, Inc.
(steel producer).
THOMAS L. MCVERRY: Trustee of the Fund; Trustee or Director of all other funds
in the Keystone Families of Funds; Trustee or Director of all the funds in the
Evergreen Family of Funds except Evergreen Variable Trust; former Vice President
and Director of Rexham Corporation; and former Director of Carolina Cooperative
Federal Credit Union.
*WILLIAM WALT PETTIT: Trustee of the Fund; Trustee or Director of all other
funds in the Keystone Families of Funds; Trustee or Director of all the funds in
the Evergreen Family of Funds except Evergreen Variable Trust; and Partner in
the law firm of Holcomb and Pettit, P.A.
DAVID M. RICHARDSON: Trustee of the Fund; Trustee or Director of all other funds
in the Keystone Families of Funds; Vice Chair and former Executive Vice
President, DHR International, Inc. (executive recruitment); former Senior Vice
President, Boyden International Inc. (executive recruit ment); and Director,
Commerce and Industry Association of New Jersey, 411 International, Inc., and
J&M Cumming Paper Co.
RUSSELL A. SALTON, III MD: Trustee of the Fund; Trustee or Director of all other
funds in the Keystone Families of Funds; Trustee or Director of all the funds in
the Evergreen Family of Funds; Medical Director, U.S. Health Care/Aetna Health
Services; and former Managed Health Care Consultant; former President, Primary
Physician Care.
MICHAEL S. SCOFIELD: Trustee of the Fund; Trustee or Director of all other funds
in the Keystone Families of Funds; Trustee or Director of all the funds in the
Evergreen Family of Funds; and Attorney, Law Offices of Michael S. Scofield.
RICHARD J. SHIMA: Trustee of the Fund; Trustee or Director of all other funds in
the Keystone Families of Funds; Chairman, Environmental Warranty, Inc.
(insurance agency); Executive Consultant, Drake Beam Morin, Inc. (executive
outplacement); Director of Connecticut Natural Gas Corporation, Hartford
Hospital, Old State House Association, Middlesex Mutual Assurance Company, and
Enhance Financial Services, Inc.; Chairman, Board of Trustees, Hartford Graduate
Center; Trustee, Greater Hartford YMCA; former Director, Vice Chairman and Chief
Investment Officer, The Travelers Corpora tion; former Trustee, Kingswood-Oxford
School; and former Managing Director and Consultant, Russell Miller, Inc.
ANDREW J. SIMONS: Trustee of the Fund; Trustee or Director of all other funds in
the Keystone Families of Funds; Partner, Farrell, Fritz, Caemmerer, Cleary,
Barnosky & Armentano, P.C.; Adjunct Professor of Law and former Associate Dean,
St. John's University School of Law; Adjunct Professor of Law, Touro College
School of Law; and former President, Nassau County Bar Association.
JOHN J. PILEGGI: President and Treasurer of the Fund; President and Treasurer of
all other funds in the Evergreen Keystone Family of Funds; Senior Managing
Director, Furman Selz LLC since 1992; Managing Director from 1984 to 1992;
Consultant, BISYS Fund Services since 1996; 230 Park Avenue, Suite 910, New
York, NY.
GEORGE O. MARTINEZ: Secretary of the Fund; Secretary of all other funds in the
Evergreen Keystone Family of Funds; Senior Vice President and Director of
Administration and Regulatory Services, BISYS Fund Services since 1995; Vice
President/Assistant General Counsel, Alliance Capital Management from 1988 to
1995; 3435 Stelzer Road, Columbus, Ohio.
* This Trustee may be considered an "interested person" of the Fund within
the meaning of the 1940 Act.
The Fund does not pay any direct remuneration to any officer or Trustee
who is an "affiliated person" of Keystone or any of its affiliates. See
"Investment Adviser." During the fiscal year ended May 31, 1997, none of the
unaffiliated Trustees received retainers or fees from the Fund. For the year
ended December 31, 1996, aggregate compensation received by Independent Trustees
on a fund complex wide basis (which includes over 30 mutual funds) was $411,000.
As of June 30, 1997, the Trustees and officers beneficially owned less than
1.00% of the Fund's then outstanding shares.
No Trustee received aggregate compensation from the Evergreen Keystone
Funds in excess of $60,000 for the fiscal period of June 1, 1996 through May 31,
1997.
Except as set forth above, the address of all of the Fund's Trustees
and the address of the Fund is 200 Berkeley Street, Boston, Massachusetts
02116-5034.
INVESTMENT ADVISER
INVESTMENT ADVISER
Subject to the general supervision of the Fund's Board of Trustees,
Keystone provides investment advice, management and administrative services to
the Fund.
On December 11, 1996, the predecessor corporation to First Union
Keystone, Keystone Investments, Inc. ("Keystone Investments") and indirectly
each subsidiary of Keystone Investments, including Keystone, were acquired (the
"Acquisition") by First Union National Bank ("FUNB"), a wholly-owned subsidiary
of First Union Corporation ("First Union"). Keystone Investments was acquired by
FUNB by merger into a wholly-owned subsidiary of FUNB, which entity then assumed
the First Union Keystone name and succeeded to the business of the predecessor
corporation. Contemporaneously with the Acquisition, the Fund entered into a new
investment advisory agreement with Keystone and into a principal underwriting
agreement with EKD, an indirect wholly-owned subsidiary of BISYS. The new
investment advisory agreement (the "Advisory Agreement") was approved by the
shareholders of the Fund on December 9, 1996, and became effective on December
11, 1996.
First Union Keystone and each of its subsidiaries, including Keystone,
are now indirectly owned by First Union. First Union is headquartered in
Charlotte, North Carolina, and had $143 billion in consolidated assets as of
June 30, 1997. First Union and its subsidiaries provide a broad range of
financial services to individuals and businesses throughout the United States.
CMG, Keystone and Evergreen Asset Management Corp., a wholly-owned subsidiary of
FUNB, manage or otherwise oversee the investment of over $66 billion in assets
as of June 30, 1997 belonging to a wide range of clients, including the
Evergreen Keystone funds.
Pursuant to the Advisory Agreement and subject to the supervision of
the Fund's Board of Trustees, Keystone furnishes to the Fund investment
advisory, management and administrative services, office facilities, and
equipment in connection with its services for managing the investment and
reinvestment of the Fund's assets. Keystone pays for all of the expenses
incurred in connection with the provision of its services.
The Fund pays for all charges and expenses, other than those
specifically referred to as being borne by Keystone, including, but not limited
to (1) custodian charges and expenses; (2) bookkeeping and auditors' charges and
expenses; (3) transfer agent charges and expenses; (4) fees and expenses of
Independent Trustees; (5) brokerage commissions, brokers' fees and expenses; (6)
issue and transfer taxes; (7) costs and expenses under the Distribution Plan;
(8) taxes and trust fees payable to governmental agencies; (9) the cost of share
certificates; (10) fees and expenses of the registration and qualification of
the Fund and its shares with the Securities and Exchange Commission ("SEC") or
under state or other securities laws; (11) expenses of preparing, printing and
mailing prospectuses, statements of additional information, notices, reports and
proxy materials to shareholders of the Fund; (12) expenses of shareholders' and
Trustees' meetings; (13) charges and expenses of legal counsel for the Fund and
for the Independent Trustees of the Fund on matters relating to the Fund; and
(14) charges and expenses of filing annual and other reports with the SEC and
other authorities, and all extraordinary charges and expenses of the Fund.
The Fund pays Keystone a fee for its services at the annual rate set
forth below:
Aggregate Net
Asset Value of
Management Fee Fund Shares
- --------------------------------------------------------------------------------
0.70% of the first $100,000,000, plus
0.65% of the next $100,000,000, plus
0.60% of the next $100,000,000, plus
0.55% of the next $100,000,000, plus
0.50% of the next $100,000,000, plus
0.45% of the next $500,000,000, plus
0.40% of the next $500,000,000, plus
0.35% of amounts over $1,500,000,000
Keystone's fee is computed as of the close of business each business day and
payable daily.
Keystone has voluntarily agreed to limit the expenses of the Fund's
Class A, Class B, Class C and Class Y shares to 1.95%, 2.70%, 2.70% and 1.70%,
respectively, of each such Class's average daily net assets. These voluntary
expense limitations are continued on a calendar month-by-month basis and may be
modified or terminated in the future. Keystone will not be required to make any
such reimbursement to the extent it would result in the Fund's inability to
qualify as a regulated investment company under the provisions of the Internal
Revenue Code.
Under the Advisory Agreement, any liability of Keystone in connection
with rendering services thereunder is limited to situations involving its
willful misfeasance, bad faith, gross negligence or reckless disregard of its
duties.
The Advisory Agreement continues in effect for two years from its
effective date and, thereafter, from year to year only if approved at least
annually by the Board of Trustees of the Fund or by a vote of a majority of the
Fund's outstanding shares (as defined in the 1940 Act). In either case, the
terms of the Advisory Agreement and continuance thereof must be approved by the
vote of a majority of the Independent Trustees cast in person at a meeting
called for the purpose of voting on such approval. The Advisory Agreement may be
terminated, without penalty, on 60 days' written notice by the Fund's Board of
Trustees or by a vote of a majority of outstanding shares. The Advisory
Agreement will terminate automatically upon its "assignment" as that term is
defined in the 1940 Act.
PRINCIPAL UNDERWRITER
The Fund has entered into Principal Underwriting Agreements (each an
"Underwriting Agreement") with EKD with respect to each class. EKD, which is not
affiliated with First Union, replaces EKIS as the Fund's principal underwriter.
EKIS may no longer act as principal underwriter of the Fund due to regulatory
restrictions imposed by the Glass-Steagall Act upon national banks such as FUNB
and their affiliates, that prohibit such entities from acting as the
underwriters of mutual fund shares. While EKIS may no longer act as principal
underwriter of the Fund as discussed above, EKIS may continue to receive
compensation from the Fund or EKD in respect of underwriting and distribution
services performed prior to the termination of EKIS as principal underwriter. In
addition, EKIS may also be compensated by EKD for the provision of certain
marketing support services to EKD at an annual rate of up to 0.75% of the
average daily net assets of the Fund, subject to certain restrictions.
EKD, as agent, has agreed to use its best efforts to find purchasers
for the shares. EKD may retain and employ representatives to promote
distribution of the shares and may obtain orders from broker-dealers, and
others, acting as principals, for sales of shares to them. The Underwriting
Agreements provide that EKD will bear the expense of preparing, printing, and
distributing advertising and sales literature and prospectuses used by it. In
its capacity as principal underwriter, EKD or EKIS, its predecessor, may receive
payments from the Fund pursuant to the Fund's Distribution Plans.
All subscriptions and sales of shares by EKD are at the public offering
price of the shares, which is determined in accordance with the provisions of
the Fund's Declaration of Trust, By-Laws, current prospectuses and statement of
additional information. All orders are subject to acceptance by the Fund and the
Fund reserves the right, in its sole discretion, to reject any order received.
Under the Underwriting Agreements, the Fund is not liable to anyone for failure
to accept any order.
The Fund has agreed under the Underwriting Agreements to pay all
expenses in connection with the registration of its shares with the SEC and
auditing and filing fees in connection with the registration of its shares under
the various state "blue-sky" laws.
EKD has agreed that it will, in all respects, duly conform with all
state and federal laws applicable to the sale of the shares. EKD has also agreed
that it will indemnify and hold harmless the Fund and each person who has been,
is, or may be a Trustee or officer of the Fund against expenses reasonably
incurred by any of them in connection with any claim, action, suit, or
proceeding to which any of them may be a party that arises out of or is alleged
to arise out of any misrepresentation or omission to state a material fact on
the part of EKD or any other person for whose acts EKD is responsible or is
alleged to be responsible, unless such misrepresentation or omission was made in
reliance upon written information furnished by the Fund.
Each Underwriting Agreement provides that it will remain in effect as
long as its terms and continuance are approved annually (1) by a vote of a
majority of the Fund's Independent Trustees, and (2) by vote of a majority of
the Fund's Trustees, in each case, cast in person at a meeting called for that
purpose.
Each Underwriting Agreement may be terminated, without penalty, on 60
days' written notice by the Fund's Board of Trustees or by a vote of a majority
of outstanding shares subject to such agreement. Each Underwriting Agreement
will terminate automatically upon its "assignment," as that term is defined in
the 1940 Act.
From time to time, if, in EKD's judgment, it could benefit the sales of
Fund shares, EKD may provide to selected broker-dealers promotional materials
and selling aids, including, but not limited to, personal computers, related
software, and Fund data files.
SUB-ADMINISTRATOR
BISYS provides personnel to serve as officers of the Fund, and provides
certain administrative services to the Fund pursuant to a sub-administrator
agreement. For its services under that agreement, BISYS receives from Keystone a
fee based on the aggregate average daily net assets of the Fund at a rate based
on the total assets of all mutual funds administered by BISYS for which FUNB
affiliates also serve as investment adviser. The sub-administrator fee is
calculated in accordance with the following schedule:
Aggregate Average Daily Net Assets Of Mutual Funds
Sub-Administrator Administered By BISYS For Which Any Affiliate Of
Fee FUNB Serves As Investment Adviser
- --------------------------------------------------------------------------------
0.0100% on the first $7 billion
0.0075% on the next $3 billion
0.0050% on the next $15 billion
0.0040% on assets in excess of $25 billion
The total assets of the mutual funds for which FUNB affiliates also
serve as investment advisers were approximately $30.5 billion as of June 30,
1997.
DECLARATION OF TRUST
MASSACHUSETTS BUSINESS TRUST
The Fund is a Massachusetts business trust established under a
Declaration of Trust dated December 13, 1995, as later amended (the "Declaration
of Trust"). The Fund is similar in most respects to a business corporation. The
principal distinction between the Fund and a corporation relates to the
shareholder liability. A copy of the Declaration of Trust is on file as an
exhibit to the Registration Statement of which this statement of additional
information is a part. This summary is qualified in its entirety by reference to
the Declaration of Trust.
DESCRIPTION OF SHARES
The Declaration of Trust authorizes the issuance of an unlimited number
of shares of beneficial interest of classes of shares. Each share of the Fund
represents an equal proportionate interest with each other share of that class.
Upon liquidation, shares are entitled to a pro rata share of the Fund based on
the relative net assets of each class. Shareholders have no preemptive or
conversion rights. Shares are redeemable and transferable. The Fund is
authorized to issue additional classes or series of shares. The Fund currently
issues Class A, Class B, Class C and Class Y shares, but may issue additional
classes or series of shares.
SHAREHOLDER LIABILITY
Pursuant to certain decisions of the Supreme Judicial Court of
Massachusetts, shareholders of a Massachusetts business trust may, under certain
circumstances, be held personally liable as partners for the obligations of the
trust. If the Fund was held to be a partnership, the possibility of the
shareholders incurring financial loss for that reason appears remote because the
Fund's Declaration of Trust (1) contains an express disclaimer of shareholder
liability for obligations of the Fund; (2) requires that notice of such
disclaimer be given in each agreement, obligation, or instrument entered into or
executed by the Fund or the Trustees; and (3) provides for indemnification out
of the Fund's property for any shareholder held personally liable for the
obligations of the Fund.
VOTING RIGHTS
Under the terms of the Declaration of Trust, the Fund does not hold
annual meetings. At meetings called for the initial election of Trustees or to
consider other matters, shares are entitled to one vote per share. Shares
generally vote together as one class on all matters. Classes of shares of the
Fund have equal voting rights except that each class of shares has exclusive
voting rights with respect to its respective Distribution Plan. No amendment may
be made to the Declaration of Trust that adversely affects any class of shares
without the approval of a majority of the shares of that class. Shares have
non-cumulative voting rights, which means that the holders of more than 50% of
the shares voting for the election of Trustees can elect 100% of the Trustees to
be elected at a meeting and, in such event, the holders of the remaining 50% or
less of the shares voting will not be able to elect any Trustees.
After the initial meeting as described above, no further meetings of
shareholders for the purpose of electing Trustees will be held, unless required
by law, unless and until such time as less than a majority of the Trustees
holding office have been elected by shareholders, at which time, the Trustees
then in office will call a shareholders' meeting for the election of Trustees.
Except as set forth above, the Trustees shall continue to hold office
indefinitely, unless otherwise required by law, and may appoint successor
Trustees. A Trustee may be removed from or cease to hold office (as the case may
be) (1) at any time by two-thirds vote of the remaining Trustees; (2) when such
Trustee becomes mentally or physically incapacitated; or (3) at a special
meeting of shareholders by a two-thirds vote of the Fund's outstanding shares.
Any Trustee may voluntarily resign from office.
LIMITATION OF TRUSTEES' LIABILITY
The Declaration of Trust provides that a Trustee shall be liable only
for his own willful defaults and, if reasonable care has been exercised in the
selection of officers, agents, employees or investment advisers, shall not be
liable for any neglect or wrongdoing of any such person; provided, however, that
nothing in the Declaration of Trust shall protect a Trustee against any
liability for his willful misfeasance, bad faith, gross negligence or reckless
disregard of his duties.
The Trustees have absolute and exclusive control over the management
and disposition of all assets of the Fund and may perform such acts as in their
sole judgment and discretion are necessary and proper for conducting the
business and affairs of the Fund or promoting the interests of the Fund and the
shareholders.
- --------------------------------------------------------------------------------
EXPENSES
- --------------------------------------------------------------------------------
INVESTMENT ADVISORY FEES
For the Fund's last fiscal year and the period from February 21, 1996
(commencement of operations) to May 31, 1996, the table below lists the total
dollar amounts paid by the Fund to Keystone for investment advisory services
rendered. For more information, see "Investment Adviser."
Percent of Fund's
Average Net Assets
Fiscal Period Fee Paid to Keystone represented by
Ended May 31, Advisory Agreement Keystone's Fee
- ------------------------- -------------------- --------------------
1997 $297,833 0.70%
1996 $21,221 0.70%
DISTRIBUTION PLAN EXPENSES
Listed below are the amounts paid by each class of shares under its
respective Distribution Plan to EKD and/or its predecessor for the fiscal year
ended May 31, 1997. For more information, see "Distribution Plans."
Class A Shares Class B Shares Class C Shares
- ---------------------- ----------------------------- ---------------
$30,858 $211,893 $90,225
UNDERWRITING COMMISSIONS
For the Fund's last fiscal year and the period from February 21, 1996
(commencement of operations) to May 31, 1996, the table below lists the
aggregate dollar amounts of underwriting commissions (front-end sales charges,
plus distribution fees, plus CDSCs) paid to EKD or EKIS with respect to the
public distribution of the Fund's shares. The table also indicates the aggregate
dollar amount of underwriting commissions retained by EKD or EKIS. For more
information, see "Principal Underwriter" and "Sales Charges.
Aggregate Dollar Amount of
Fiscal Period Aggregate Dollar Amount of Underwriting Commissions
Ended May 31, Underwriting Commissions Paid Retained
- -------------- ------------------------------ -------------------------
1997 $945,753 ($329,634)
1996 $404,493 ($553,309)
BROKERAGE COMMISSIONS
Fiscal Period
Ended May 31, Brokerage Commissions Paid
- ------------------------- --------------------------------------
1997 $100,457
1996 $33,494
STANDARDIZED TOTAL RETURN AND YIELD QUOTATIONS
Total return quotations for a class of shares of the Fund, as they may
appear from time to time in advertisements, are calculated by finding the
average annual compounded rates of return over one, five and ten years periods,
or the time periods for which such class of shares has been effective, whichever
is relevant, on a hypothetical $1,000 investment that would equate the initial
amount invested in the class to the ending redeemable value. To the initial
investment all dividends and distributions are added and, if applicable, the
maximum sales charge and all recurring fees charged to all shareholder accounts
are deducted. The ending redeemable value assumes a complete redemption at the
end of the relevant periods.
The cumulative total returns for the period from February 21, 1996
(commencement of operations) to May 31, 1997 were -2.50%, -1.40% and -1.40% for
the Fund's Class A, Class B and Class C shares, respectively. The cumulative
total return for the period from May 28, 1997 (commencement of investment
operations) to May 31, 1997 was -2.64% for the Fund's Class Y shares.
The compounded average annual rates of return for the one year period
ended May 31, 1997, were -8.07%, -8.81% and -8.81% for the Fund's Class A, Class
B and Class C shares, respectively. The compounded average annual rates of
return for the one year period ended May 31, 1997 (including CDSCs) were
- -12.44%, -13.37% and -9.72% for the Fund's Class A, Class B and Class C shares.
The compounded average annual rates of return for the one year period ended May
31, 1997 (without CDSCs) were -8.07%, -8.81% and -8.81% for the Fund's Class A,
Class B and Class C shares.
FINANCIAL STATEMENTS
The following financial statements of the Fund are incorporated by
reference herein from the Fund's Annual Report, as filed with the SEC:
Schedule of Investments as of May 31, 1997;
Financial Highlights for the fiscal year ended May 31, 1997 and the
period from February 21, 1996 (commencement of operations) to May 31,
1996 for Class A, Class B and Class C shares;
Financial Highlights for the period from January 13, 1997 (date of
initial public offering) to May 31, 1997 for Class Y shares;
Statement of Assets and Liabilities as of May 31, 1997;
Statement of Operations for the year ended May 31, 1997;
Statements of Changes in Net Assets for the fiscal year ended May 31,
1997 and the period from February 21, 1996 (commencement of operations)
to May 31, 1996;
Notes to Financial Statements; and
Independent Auditors' Report dated June 27, 1997.
A copy of the Fund's Annual Report will be furnished upon request and
without charge. Requests may be made in writing to EKSC, P.O. Box 2121, Boston,
Massachusetts 02106-2121, or by calling EKSC toll free at 1-800-343-2898.
ADDITIONAL INFORMATION
As of June 30, 1997, Merrill Lynch Pierce Fenner & Smith, Attn: Book
Entry, 4800 Deer Lake Dr. E, 3rd Floor, Jacksonville, FL 32246-6484, owned
21.28% of the outstanding Class A shares of the Fund.
As of June 30, 1997, Merrill Lynch Pierce Fenner & Smith, Attn: Book
Entry, 4800 Deer Lake Dr. E, 3rd Floor, Jacksonville, FL 32246-6484, owned
20.29% of the outstanding Class A shares of the Fund.
As of June 30, 1997, Merrill Lynch Pierce Fenner & Smith, Attn: Book
Entry, 4800 Deer Lake Dr. E, 3rd Floor, Jacksonville, FL 32246-6484, owned
31.66% of the outstanding Class B shares of the Fund.
As of June 30, 1997, Merrill Lynch Pierce Fenner & Smith, Attn: Book
Entry, 4800 Deer Lake Dr. E, 3rd Floor, Jacksonville, FL 32246-6484, owned
60.74% of the outstanding Class C shares of the Fund.
As of June 30, 1997, PaineWebber FBO, LD Hancock Foundation Inc., P.O.
Box 2203, Tupelo, MS 38803-2203, owned 12.21% of the outstanding Class C shares
of the Fund.
As of June 30, 1997, Cowen & Co. FBO, 4G-55109-0, Financial Square, New
York, NY 10005 owned 6.80% of the outstanding Class C shares of the Fund.
As of June 30, 1997, Darrel E. Schafer and Rita M. Schafer Jt Ten, 1217
Lory Street, Fort Collins, CO 80524-3905 owned 100% of the outstanding Class Y
shares of the Fund.
Except as otherwise stated in its prospectuses or required by law, the
Fund reserves the right to change the terms of the offer stated in its
prospectuses without shareholder approval, including the right to impose or
change fees for services provided.
If conditions arise that would make it undesirable for the Fund to pay for
all redemptions in cash, the Fund may authorize payment to be made in portfolio
securities or other property. The Fund has obligated itself, however, under the
1940 Act, to redeem for cash all shares presented for redemption by any one
shareholder up to the lesser of $250,000 or 1.00% of the Fund's net assets in
any 90-day period. Securities delivered in payment of redemptions would be
valued at the same value assigned to them in computing the net asset value per
share and would, to the extent permitted by law, be readily marketable.
Shareholders receiving such securities would incur brokerage costs upon the sale
of securities.
No dealer, salesman or other person is authorized to give any
information or to make any representation not contained in the Fund's
prospectuses, this SAI or in supplemental sales literature issued by the Fund or
EKD, and no person is entitled to rely on any information or representation not
contained therein.
The Fund's prospectuses and this SAI omit certain information contained
in the registration statement filed with the SEC, which may be obtained from the
SEC's principal office in Washington, D.C. upon payment of the fee prescribed by
the rules and regulations promulgated by the SEC.
A - 1
APPENDIX
COMMON AND PREFERRED STOCK RATINGS
S&P'S EARNINGS AND DIVIDEND RANKINGS FOR COMMON STOCKS
Because the investment process involves assessment of various factors,
such as product and industry position, corporate resources and financial policy,
with results that make some common stocks more highly esteemed than others,
Standard & Poor's Ratings Group (S&P) believes that earnings and dividend
performance is the end result of the interplay of these factors and that, over
the long run, the record of this performance has a considerable bearing on
relative quality. S&P rankings, however, do not reflect all of the factors,
tangible or intangible, that bear on stock quality.
Growth and stability of earnings and dividends are deemed key elements
in establishing S&P earnings and dividend rankings for common stocks, which
capsulize the nature of this record in a single symbol.
S&P has established a computerized scoring system based on per share
earnings and dividend records of the most recent ten years, a period deemed long
enough to measure a company's perfor mance under varying economic conditions.
S&P measures growth, stability within the trend line and cyclicity. The ranking
system also makes allowances for company size, since large companies have
certain inherent advantages over small ones. From these, scores for earnings and
dividends are determined.
The final score for each stock is measured against a scoring matrix
determined by analysis of the scores of a large and representative sample which
is reviewed and sometimes modified with the following ladder of rankings:
A+ Highest B+ Average C Lowest
A High B Below Average D In Reorganization
A- Above Average B- Lower
S&P believes its rankings are not a forecast of future market price
performance, but are basically an appraisal of past performance of earnings and
dividends, and relative current standing.
MOODY'S COMMON STOCK RANKINGS
Moody's Investors Service ("Moody's") presents a concise statement of the
important characteristics of a company and an evaluation of the grade (quality)
of its common stock. Data presented includes: (a) capsule stock information
which reveals short and long-term growth and yield afforded by the indicated
dividend, based on a recent price; (b) a long-term price chart which shows
patterns of monthly stock price movements and monthly trading volumes; (c) a
breakdown of a company's capital account which aids in determining the degree of
conservatism or financial leverage in a company's balance sheet; (d) interim
earnings for the current year to date, plus three previous years; (e) dividend
information; (f) company background; (g) recent corporate developments; (h)
prospects for a company in the immediate future and the next few years; and (i)
a ten year comparative statistical analysis.
This information provides investors with information on what a company
does, how it has performed in the past, how it is performing currently and what
its future performance prospects appear to be.
These characteristics are then evaluated and result in a grading, or
indication of quality. The grade is based on an analysis of each company's
financial strength, stability of earnings and record of dividend payments. Other
considerations include conservativeness of capitalization, depth and caliber of
management, accounting practices, technological capabilities and industry
position.
Evaluation is represented by the following grades:
(1) High Grade
(2) Investment Grade
(3) Medium Grade
(4) Speculative Grade
MOODY'S PREFERRED STOCK RATINGS
Preferred stock ratings and their definitions are as follows:
1. AAA: An issue which is rated "AAA" is considered to be a top-quality
preferred stock. This rating indicates good asset protection and the least risk
of dividend impairment within the universe of preferred stocks.
2. AA: An issue which is rated "AA" is considered a high-grade preferred
stock. This rating indicates that there is a reasonable assurance that earnings
and asset protection will remain relatively well maintained in the foreseeable
future.
3. A: An issue which is rated "A" is considered to be an upper-medium grade
preferred stock. While risks are judged to be somewhat greater then in the "AAA"
and "AA" classification, earnings and asset protection are, nevertheless,
expected to be maintained at adequate levels.
4. BAA: An issue which is rated "BAA" is considered to be a medium-grade
preferred stock, neither highly protected nor poorly secured. Earnings and asset
protection appear adequate at present but may be questionable over any great
length of time.
5. BA: An issue which is rated "BA" is considered to have speculative
elements and its future cannot be considered well assured. Earnings and asset
protection may be very moderate and not well safeguarded during adverse periods.
Uncertainty of position characterizes preferred stocks in this class.
6. B: An issue which is rated "B" generally lacks the characteristics of a
desirable investment. Assurance of dividend payments and maintenance of other
terms of the issue over any long period of time may be small.
7. CAA: An issue which is rated "CAA" is likely to be in arrears on
dividend payments. This rating designation does not purport to indicate the
future status of payments.
8. CA: An issue which is rated "CA" is speculative in a high degree and is
likely to be in arrears on dividends with little likelihood of eventual
payments.
9. C: This is the lowest rated class of preferred or preference stock.
Issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
Moody's applies numerical modifiers 1, 2 and 3 in each rating
classification: the modifier 1 indicates that the security ranks in the higher
end of its generic rating category, the modifier 2 indicates a mid-range ranking
and the modifier 3 indicates that the issue ranks in the lower end of its
generic rating category.
CORPORATE BOND RATINGS
S&P CORPORATE BOND RATINGS
An S&P corporate bond rating is a current assessment of the
creditworthiness of an obligor, including obligors outside the United States,
with respect to a specific obligation. This assessment may take into
consideration obligors such as guarantors, insurers, or lessees. Ratings of
foreign obligors do not take into account currency exchange and related
uncertainties. The ratings are based on current information furnished by the
issuer or obtained by S&P from other sources it considers reliable.
The ratings are based, in varying degrees, on the following
considerations:
a. Likelihood of default - capacity and willingness of the obligor as to
the timely payment of interest and repayment of principal in accordance with the
terms of the obligation;
b. Nature of and provisions of the obligation; and
c. 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.
PLUS (+) OR MINUS (-): To provide more detailed indications of credit
quality, ratings from "AA" to "A" may be modified by the addition of a plus or
minus sign to show relative standing within the major rating categories.
Bond ratings are as follows:
1. AAA - Debt rated AAA has the highest rating assigned by S&P. Capacity to
pay interest and repay principal is extremely strong.
2. AA - Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from the higher rated issues only in small degree.
3. A - Debt rated A has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher rated
categories.
4. BBB - Debt rated BBB is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
5. BB, B, CCC, CC AND C - Debt rated BB, B, CCC, CC AND C is regarded, on
balance, as predominantly speculative with respect to capacity to pay interest
and repay principal in accordance with the terms of the obligation. BB indicates
the lowest degree of speculation and C the highest degree of speculation. While
such debt will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major risk exposures to adverse
conditions.
MOODY'S CORPORATE BOND RATINGS
Moody's ratings are as follows:
1. AAA - Bonds which are rated AAA are judged to be of the best
quality. They carry the smallest degree of investment risk and are generally
referred to as "gilt-edge." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of such issues.
2. AA - Bonds which are rated AA are judged to be of high quality by
all standards. Together with the AAA group they comprise what are generally
known as high grade bonds. They are rated lower than the best bonds because
margins of protection may not be as large as in AAA securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long term risks appear somewhat larger than in AAA
securities.
3. A - Bonds which are rated A possess many favorable investment
attributes and are to be considered as upper medium grade obligations. Factors
giving security to principal and interest are considered adequate but elements
may be present which suggest a susceptibility to impairment sometime in the
future.
4. BAA - Bonds which are rated BAA are considered as medium grade
obligations, i.e., they are neither highly protected nor poorly secured.
Interest payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
5. BA - Bonds which are rated BA are judged to have speculative
elements. Their future cannot be considered as well assured. Often the
protection of interest and principal payments may be very moderate and thereby
not well safeguarded during both good and bad times over the future.
Uncertainty of position characterizes bonds in this class.
6. B - Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time may be
small.
Moody's applies numerical modifiers 1, 2 and 3 in each generic rating
classification from AA through B in its corporate bond rating system. The
modifier 1 indicates that the security ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking; and the modifier
3 indicates that the issue ranks in the lower end of its generic rating
category.
MONEY MARKET INSTRUMENTS
The Fund's investments in commercial paper are limited to those rated
A-1 by S&P, PRIME-1 by Moody's or F-1 by Fitch Investors Service L.P. These
ratings and other money market instruments are described as follows:
COMMERCIAL PAPER RATINGS
Commercial paper rated A-1 by S&P has the following characteristics:
Liquidity ratios are adequate to meet cash requirements. The issuer's long-term
senior debt is rated "A" or better, although in some cases "BBB" credits may be
allowed. The issuer has access to at least two additional channels of borrowing.
Basic earnings and cash flow have an upward trend with allowance made for
unusual circumstances. Typically, the issuer's industry is well established and
the issuer has a strong position within the industry.
The rating PRIME-1 is the highest commercial paper rating assigned by
Moody's. Among the factors considered by Moody's in assigning ratings are the
following: (1) evaluation of the management of the issuer; (2) economic
evaluation of the issuer's industry or industries and an appraisal of
speculative-type risks which may be inherent in certain areas; (3) evaluation of
the issuer's products in relation to competition and customer acceptance; (4)
liquidity; (5) amount and quality of long-term debt; (6) trend of earnings over
a period of ten years; (7) financial strength of a parent company and the
relationships which exist with the issuer; and (8) recognition by the management
of obligations which may be present or may arise as a result of public
preparations to meet such obligations. Relative strength or weakness of the
above factors determines how the issuer's commercial paper is rated within
various categories.
The rating F-1 is the highest rating assigned by Fitch. Among the
factors considered by Fitch in assigning this rating are: (1) the issuer's
liquidity; (2) its standing in the industry; (3) the size of its debt; (4) its
ability to service its debt; (5) its profitability; (6) its return on equity;
(7) its alternative sources of financing; and (8) its ability to access the
capital markets. Analysis of the relative strength or weakness of these factors
and others determines whether an issuer's commercial paper is rated F-1.
UNITED STATES GOVERNMENT SECURITIES
Securities issued or guaranteed by the U.S. government include a
variety of Treasury securities that differ only in their interest rates,
maturities and dates of issuance. Treasury bills have maturities of one year or
less. Treasury notes have maturities of one to ten years and Treasury bonds
generally have maturities of greater than ten years at the date of issuance.
Securities issued or guaranteed by the U.S. government or its agencies or
instrumentalities include direct obligations of the U.S. Treasury and securities
issued or guaranteed by the Federal Housing Administration, Farmers Home
Administration, Export-Import Bank of the United States, Small Business
Administration, Government National Mortgage Association, General Services
Administration, Central Bank for Cooperatives, Federal Home Loan Banks, Federal
Loan Mortgage Corporation, Federal Intermediate Credit Banks, Federal Land
Banks, Maritime Administration, The Tennessee Valley Authority, District of
Columbia Armory Board and Federal National Mortgage Association.
Some obligations of U.S. government agencies and instrumentalities,
such as Treasury bills and Government National Mortgage Association pass-through
certificates, are supported by the full faith and credit of the United States;
others, such as securities of Federal Home Loan Banks, by the right of the
issuer to borrow from the Treasury; still others, such as bonds issued by the
Federal National Mortgage Association, a private corporation, are supported only
by the credit of the instrumentality. Because the U.S. government is not
obligated by law to provide support to an instrumentality it sponsors, the Fund
will invest in the securities issued by such an instrumentality only when
Keystone determines that the credit risk with respect to the instrumentality
does not make its securities unsuitable investments. U.S. government securities
will not include international agencies or instrumentalities in which the U.S.
government, its agencies or instrumentalities participate, such as the World
Bank, the Asian Development Bank or the Inter-American Development Bank, or
issues insured by the Federal Deposit Insurance Corporation.
OPTIONS TRANSACTIONS
The Fund is authorized to write (i.e., sell) covered call options and
to purchase call options to close out covered call options previously written. A
call option obligates a writer to sell, and gives a purchaser the right to buy,
the underlying security at the stated exercise price at any time until the
stated expiration date.
The Fund will only write call options which are covered, which means
that the Fund will own the underlying security (or other securities, such as
convertible securities, which are acceptable for escrow) when it writes the call
option and until the Fund's obligation to sell the underlying security is
extinguished by exercise or expiration of the call option or the purchase of a
call option covering the same underlying security and having the same exercise
price and expiration date. The Fund will receive a premium for writing a call
option, but will give up, until the expiration date, the opportunity to profit
from an increase in the underlying security's price above the exercise price.
The Fund will retain the risk of loss from a decrease in the price of the
underlying security. The writing of covered call options is a conservative
investment technique believed to involve relatively little risk (in contrast to
the writing of naked options which the Fund will not do) but capable of
enhancing the Fund's total returns.
The premium received by the Fund for writing a covered call option will
be recorded as a liability in the Fund's statement of assets and liabilities.
This liability will be adjusted daily to the option's current market value,
which will be the latest sale price at the time as of which the net asset value
per share of the Fund is computed (the close of the New York Stock Exchange),
or, in the absence of such sale, at the latest bid quotation. The liability will
be extinguished upon expiration of the option, the purchase of an identical
option in a closing transaction or delivery of the underlying security upon
exercise of the option.
Many options are traded on registered securities exchanges. Options
traded on such exchanges are issued by the Options Clearing Corporation
("OCC"),a clearing corporation which assumes responsibility for the completion
of options transactions.
The Fund will purchase call options only to close out a covered call
option it has written. When it appears that a covered call option written by the
Fund is likely to be exercised, the Fund may consider it appropriate to avoid
having to sell the underlying security. Or, the Fund may wish to extinguish a
covered call option which it has written in order to be free to sell the
underlying security to realize a profit on the previously written call option or
to write another covered call option on the underlying security. In all such
instances, the Fund can close out the previously written call option by
purchasing a call option on the same underlying security with the same exercise
price and expiration date. (The Fund may, under certain circumstances, also be
able to transfer a previously written call option.) The Fund will realize a
short-term capital gain if the amount paid to purchase the call option plus
transaction costs is less than the premium received for writing the covered call
option. The Fund will realize a short-term capital loss if the amount paid to
purchase the call option plus transaction costs is greater than the premium
received for writing the covered call option.
A previously written call option can be closed out by purchasing an
identical call option only in a secondary market for the call option. Although
the Fund will generally write only those options for which there appears to be
an active secondary market, there is no assurance that a liquid secondary market
will exist for any particular option at any particular time, and for some
options no secondary market may exist. In such event it might not be possible to
effect a closing transaction in a particular option. If the Fund as a covered
call option writer is unable to effect a closing purchase transaction, it will
not be able to sell the underlying securities until the option expires or it
delivers the underlying securities upon exercise.
If a substantial number of the call options written by the Fund are
exercised, the Fund's rate of portfolio turnover may exceed historical levels.
This would result in higher transaction costs, including brokerage commissions.
The Fund will pay brokerage commissions in connection with the writing of
covered call options and the purchase of call options to close out previously
written options. Such brokerage commissions are normally higher than those
applicable to purchases and sales of portfolio securities.
In the past the Fund has qualified for, and elected to receive, the
special tax treatment afforded regulated investment companies under Subchapter M
of the Internal Revenue Code of 1986, as amended (the "Code"). Although the Fund
intends to continue to qualify for such tax treatment, in order to do so it
must, among other things, derive less than 30% of its gross income from gains
from the sale or other disposition of securities held for less than three
months. Because of this, the Fund may be restricted in the writing of call
options where the underlying securities have been held less than three months,
in the writing of covered call options which expire in less than three months,
and in effecting closing purchases with respect to options which were written
less than three months earlier. As a result, the Fund may elect to forego
otherwise favorable investment opportunities and may elect to avoid or delay
effecting closing purchases or selling portfolio securities, with the risk that
a potential loss may be increased or a potential gain may be reduced or turned
into a loss.
Under the Code, gain or loss attributable to a closing transaction and
premiums received by the Fund for writing a covered call option which is not
exercised may constitute short-term capital gain or loss. Under provisions of
the Tax Reform Act of 1986, effective for taxable years beginning after October
22, 1986, a gain on an option transaction which qualifies as a "designated
hedge" transaction under Treasury regulations may be offset by realized or
unrealized losses on such designated transaction. The netting of gain against
such losses could result in a reduction in gross income from options
transactions for purposes of the 30 percent test.
FUTURES CONTRACTS AND RELATED OPTIONS TRANSACTIONS
The Fund intends to enter into currency and other financial futures
contracts as a hedge against changes in prevailing levels of interest or
currency exchange rates to seek relative stability of principal and to establish
more definitely the effective return on securities held or intended to be
acquired by the Fund or as a hedge against changes in the prices of securities
or currencies held by the Fund or to be acquired by the Fund. The Fund's hedging
may include sales of futures as an offset against the effect of expected
increases in interest or currency exchange rates or securities prices and
purchases of futures as an offset against the effect of expected declines in
interest or currency exchange rates.
For example, when the Fund anticipates a significant market or market
sector advance, it will purchase a stock index futures contract as a hedge
against not participating in such advance at a time when the Fund is not fully
invested. The purchase of a futures contract serves as a temporary substitute
for the purchase of individual securities which may then be purchased in an
orderly fashion. As such purchases are made, an equivalent amount of index based
futures contracts would be terminated by offsetting sales. In contrast, the Fund
would sell stock index futures contracts in anticipation of or in a general
market or market sector decline that may adversely affect the market value of
the Fund's portfolio. To the extent that the Fund's portfolio changes in value
in correlation with a given index, the sale of futures contracts on that index
would substantially reduce the risk to the portfolio of a market decline or
change in interest rates, and, by doing so, provide an alternative to the
liquidation of the Fund's securities positions and the resulting transaction
costs.
The Fund intends to engage in options transactions which are related to
currency or other financial futures contracts for the hedging purposes and in
connection with the hedging strategies described above.
Although techniques other than sales and purchases of futures contracts
and related options transactions could be used to reduce the Fund's exposure to
interest rate and/or market fluctuations, the Fund may be able to hedge its
exposure more effectively and perhaps at a lower cost through using futures
contracts and related options transactions. While the Fund does not intend to
take delivery of the instruments underlying futures contracts it holds, the Fund
does not intend to engage in such futures contracts for speculation.
FUTURES CONTRACTS
Futures contracts are transactions in the commodities markets rather
than in the securities markets. A futures contract creates an obligation by the
seller to deliver to the buyer the commodity specified in the contract at a
specified future time for a specified price. The futures contract creates an
obligation by the buyer to accept delivery from the seller of the commodity
specified at the specified future time for the specified price. In contrast, a
spot transaction creates an immediate obligation for the seller to deliver and
the buyer to accept delivery of and pay for an identified commodity. In general,
futures contracts involve transactions in fungible goods such as wheat, coffee
and soybeans. However, in the last decade an increasing number of futures
contracts have been developed which specify currencies, financial instruments or
financially based indexes as the underlying commodity.
U.S. futures contracts are traded only on national futures exchanges and
are standardized as to maturity date and underlying financial instrument. The
principal financial futures exchanges in the United States are The Board of
Trade of the City of Chicago, the Chicago Mercantile Exchange, the International
Monetary Market (a division of the Chicago Mercantile Exchange), the New York
Futures Exchange and the Kansas City Board of Trade. Each exchange guarantees
performancE under contract provisions through a clearing corporation, a
nonprofit organization managed by the exchange membership, which is also
responsible for handling daily accounting of deposits or withdrawals of margin.
A futures commission merchant (Broker) effects each transaction in connection
with futures contracts for a commission. Futures exchanges and trading are
regulated under the Commodity Exchange Act by the Commodity Futures Trading
Commission ("CFTC") and National Futures Association ("NFA").
INTEREST RATE FUTURES CONTRACTS
The sale of an interest rate futures contract creates an obligation by
the Fund, as seller, to deliver the type of financial instrument specified in
the contract at a specified future time for a specified price. The purchase of
an interest rate futures contract creates an obligation by the Fund, as
purchaser, to accept delivery of the type of financial instrument specified at a
specified future time for a specified price. The specific securities delivered
or accepted, respectively, at settlement date, are not determined until at or
near that date. The determination is in accordance with the rules of the
exchange on which the futures contract sale or purchase was made.
Currently, interest rate futures contracts can be purchased or sold on
90-day U.S. Treasury bills, U.S. Treasury bonds, U.S. Treasury notes with
maturities between 6 1/2 and 10 years, Government National Mortgage Association
("GNMA") certificates, 90-day domestic bank certificates of deposit, 90-day
commercial paper, and 90-day Eurodollar certificates of deposit. It is expected
that futures contracts trading in additional financial instruments will be
authorized. The standard contract size is $100,000 for futures contracts in U.S.
Treasury bonds, U.S. Treasury notes and GNMA certificates, and $1,000,000 for
the other designated contracts. While U.S. Treasury bonds, U.S. Treasury bills
and U.S. Treasury notes are backed by the full faith and credit of the U.S.
government and GNMA certificates are guaranteed by a U.S. government agency, the
futures contracts in U.S.
government securities are not obligations of the U.S. Treasury.
INDEX BASED FUTURES CONTRACTS
A. STOCK INDEX FUTURES CONTRACTS
A stock index assigns relative values to the common stocks included in
the index. The index fluctuates with changes in the market values of the common
stocks so included. A stock index futures contract is a bilateral agreement by
which two parties agree to take or make delivery of an amount of cash equal to a
specified dollar amount times the difference between the closing value of the
stock index on the expiration date of the contract and the price at which the
futures contract is originally made. No physical delivery of the underlying
stocks in the index is made.
Currently, stock index futures contracts can be purchased or sold on
the Standard and Poor's Corporation (S&P) Index of 500 Stocks, the S&P Index of
100 Stocks, the New York Stock Exchange Composite Index, the Value Line Index
and the Major Market Index. It is expected that futures contracts trading in
additional stock indices will be authorized. The standard contract size is $500
times the value of the index.
The Fund does not believe that differences between existing stock
indices will create any differences in the price movements of the stock index
futures contracts in relation to the movements in such indices. However, such
differences in the indices may result in differences in correlation of the
futures with movements in the value of the securities being hedged.
B. OTHER INDEX BASED FUTURES CONTRACTS
It is expected that bond index and other financially based index
futures contracts will be developed in the future. It is anticipated that such
index based futures contracts will be structured in the same way as stock index
futures contracts but will be measured by changes in interest rates, related
indexes or other measures, such as the consumer price index. In the event that
such futures contracts are developed the Fund will sell interest rate index and
other index based futures contracts to hedge against changes which are expected
to affect the Fund's portfolio.
The purchase or sale of a futures contract differs from the purchase or
sale of a security, in that no price or premium is paid or received. Instead, to
initiate trading an amount of cash, cash equivalents, money market instruments,
or U.S. Treasury bills equal to approximately 1 1/2% (up to 5%) of the contract
amount must be deposited by the Fund with the Broker. This amount is known as
initial margin. The nature of initial margin in futures transactions is
different from that of margin in security transactions. Futures contract margin
does not involve the borrowing of funds by the customer to finance the
transactions. Rather, the initial margin is in the nature of a performance bond
or good faith deposit on the contract which is returned to the Fund upon
termination of the futures contract assuming all contractual obligations have
been satisfied. The margin required for a particular futures contract is set by
the exchange on which the contract is traded, and may be significantly modified
from time to time by the exchange during the term of the contract.
Subsequent payments, called variation margin, to the Broker and from
the Broker, are made on a daily basis as the value of the underlying instrument
or index fluctuates, making the long and short positions in the futures contract
more or less valuable, a process known as mark-to-market. For example, when the
Fund has purchased a futures contract and the price of the underlying financial
instrument or index has risen, that position will have increased in value and
the Fund will receive from the Broker a variation margin payment equal to that
increase in value. Conversely, where the Fund has purchased a futures contract
and the price of the underlying financial instrument or index has declined, the
position would be less valuable and the Fund would be required to make a
variation margin payment to the Broker. At any time prior to expiration of the
futures contract, the Fund may elect to close the position. A final
determination of variation margin is then made, additional cash is required to
be paid to or released by the Broker, and the Fund realizes a loss or gain.
The Fund intends to enter into arrangements with its custodian and with
Brokers to enable its initial margin and any variation margin to be held in a
segregated account by its custodian on behalf of the Broker.
Although interest rate futures contracts by their terms call for actual
delivery or acceptance of financial instruments and index based futures
contracts call for the delivery of cash equal to the difference between the
closing value of the index on the expiration date of the contract and the price
at which the futures contract is originally made, in most cases such futures
contracts are closed out before the settlement date without the making or taking
of delivery. Closing out a futures contract sale is effected by an offsetting
transaction in which the Fund enters into a futures contract purchase for the
same aggregate amount of the specific type of financial instrument or index and
same delivery date. If the price in the sale exceeds the price in the offsetting
purchase, the Fund is paid the difference and thus realizes a gain. If the
offsetting purchase price exceeds the sale price, the Fund pays the difference
and realizes a loss. Similarly, the closing out of a futures contract purchase
is effected by an offsetting transaction in which the Fund enters into a futures
contract sale. If the offsetting sale price exceeds the purchase price, the Fund
realizes a gain. If the purchase price exceeds the offsetting sale price the
Fund realizes a loss. The amount of the Fund's gain or loss on any transaction
is reduced or increased, respectively, by the amount of any transaction costs
incurred by the Fund.
As an example of an offsetting transaction, the contractual obligations
arising from the sale of one contract of September U.S. Treasury bills on an
exchange may be fulfilled at any time before delivery of the contract is
required (i.e. on a specified date in September, the "delivery month") by the
purchase of one contract of September U.S. Treasury bills on the same exchange.
In such instance the difference between the price at which the futures contract
was sold and the price paid for the offsetting purchase after allowance for
transaction costs, represents the profit or loss to the Fund.
There can be no assurance, however, that the Fund will be able to enter
into an offsetting transaction with respect to a particular contract at a
particular time. If the Fund is not able to enter into an offsetting
transaction, the Fund will continue to be required to maintain the margin
deposits on the contract and to complete the contract according to its terms.
OPTIONS ON CURRENCY AND OTHER FINANCIAL FUTURES
The Fund intends to purchase call and put options on currency and other
financial futures contracts and sell such options to terminate an existing
position. Options on currency or other financial futures contracts are similar
to options on stocks except that an option on a currency financial futures
contract gives the purchaser the right, in return for the premium paid, to
assume a position in a futures contract (a long position if the option is a call
and a short position if the option is a put) rather than to purchase or sell
currency or other instruments making up a financial futures index, at a
specified exercise price at any time during the period of the option. Upon
exercise of the option, the delivery of the futures position by the writer of
the option to the holder of the option will be accompanied by delivery of the
accumulated balance in the writer's futures margin account. This amount
represents the amount by which the market price of the futures contract at
exercise exceeds, in the case of a call, or is less than, in the case of a put,
the exercise price of the option on the futures contract. If an option is
exercised on the last trading day prior to the expiration date of the option,
the settlement will be made entirely in cash equal to the difference between the
exercise price of the option and value of the futures contract.
The Fund intends to use options on currency or other financial futures
contracts in connection with hedging strategies. In the future the Fund may use
such options for other purposes.
PURCHASE OF PUT OPTIONS ON FUTURES CONTRACTS
The purchase of protective put options on currency or other financial
futures contracts is analogous to the purchase of protective puts on individual
stocks, where an absolute level of protection is sought below which no
additional economic loss would be incurred by the Fund. Put options may be
purchased to hedge a portfolio of stocks or debt instruments or a position in
the futures contract upon which the put option is based.
PURCHASE OF CALL OPTIONS ON FUTURES CONTRACTS
The purchase of a call option on a currency or other financial futures
contract represents a means of obtaining temporary exposure to market
appreciation at limited risk. It is analogous to the purchase of a call option
on an individual stock, which can be used as a substitute for a position in the
stock itself. Depending on the pricing of the option compared to either the
futures contract upon which it is based, or upon the price of the underlying
financial instrument or index itself, purchase of a call option may be less
risky than the ownership of the interest rate or index based futures contract or
the underlying securities. Call options on futures contracts may be purchased to
hedge against an interest rate increase or a market advance when the Fund is not
fully invested.
USE OF NEW INVESTMENT TECHNIQUES INVOLVING CURRENCY AND OTHER FINANCIAL FUTURES
CONTRACTS OR RELATED OPTIONS
The Fund may employ new investment techniques involving currency and
other financial futures contracts and related options. The Fund intends to take
advantage of new techniques in these areas which may be developed from time to
time and which are consistent with the Fund's investment objective. The Fund
believes that no additional techniques have been identified for employment by
the Fund in the foreseeable future other than those described herein.
LIMITATIONS ON PURCHASE AND SALE OF FUTURES CONTRACTS AND RELATED OPTIONS
ON SUCH FUTURES CONTRACTS
The Fund will not enter into a futures contract if, as a result
thereof, more than 5% of the Fund's total assets (taken at market value at the
time of entering into the contract) would be committed to margin deposits on
such futures contracts.
The Fund intends that its futures contracts and related options
transactions will be entered into for traditional hedging purposes. That is,
futures contracts will be sold to protect against a decline in the price of
securities that the Fund owns, or futures contracts will be purchased to protect
the Fund against an increase in the price of securities it intends to purchase.
The Fund does not intend to enter into futures contracts for speculation.
FOREIGN CURRENCY TRANSACTIONS
As discussed above, the Fund may invest in securities of foreign
issuers. When the Fund invests in foreign securities they usually will be
denominated in foreign currencies and the Fund temporarily may hold funds in
foreign currencies. Thus, the Fund's share value will be affected by changes in
exchange rates.
FORWARD CURRENCY CONTRACTS
As one way of managing exchange rate risk, the Fund may engage in forward
currency exchange contracts (agreements to purchase or sell currencies at a
specified price and date). Under the contract, the exchange rate for the
transaction (the amount of currency the Fund will deliver or receive when the
contract is completed) is fixed when the Fund enters into the contract. The Fund
usually will enter into these contracts to stabilize the U.S. dollar value of a
security it has agreed to buy or sell. The Fund also may use these contracts to
hedge the U.S. dollar value of a security it already owns, particularly if the
Fund expects a decrease in the value of the currency in which the foreign
security is denominated. Although the Fund will attempt to benefit from using
forward contracts, the success of its hedging strategy will depend on Keystone's
ability to predict accurately the future exchange rate between foreign
currencies and the U.S. dollar. The value of the Fund's investments denominated
in foreign currencies will depend on the relative strength of those currencies
and the U.S. dollar, and the Fund may be affected favorably or unfavorably by
changes in the exchange rates or exchange control regulations between foreign
currencies and the dollar. Changes in foreign currency exchange rates also may
affect the value of dividends and interest earned, gains and losses realized on
the sale of securities and net investment income and gains, if any, to be
distributed to shareholders by the Fund.
CURRENCY FUTURES CONTRACTS
Currency futures contracts are bilateral agreements under which two
parties agree to take or make delivery of a specified amount of a currency at a
specified future time for a specified price. Trading of currency futures
contracts in the United States is regulated under the Commodity Exchange Act by
the CFTC and NFA. Currently the only national futures exchange on which currency
futures are traded is the International Monetary Market of the Chicago
Mercantile Exchange. Foreign currency futures trading is conducted in the same
manner and subject to the same regulations as trading in interest rate and index
based futures. The Fund intends to engage in currency futures contracts only for
hedging purposes, and not for speculation. The Fund may enter into currency
futures contracts for other purposes if authorized to do so by its Board of
Trustees. The hedging strategies which will be used by the Fund in connection
with foreign currency futures contracts are similar to those described above for
forward foreign currency exchange contracts.
Currently, currency futures contracts for the British Pound Sterling,
Canadian Dollar, Dutch Guilder, Deutsche Mark, Japanese Yen, Mexican Peso, Swiss
Franc, and French Franc can be purchased or sold for U.S. dollars through the
International Monetary Market. It is expected that futures contracts trading in
additional currencies will be authorized. The standard contract sizes are
L125,000 for the Pound, 125,000 for the Guilder, Mark, French Francs and Swiss
Francs, C$100,000 for the Canadian Dollar, Y12,500,000 for the Yen, and
1,000,000 for the Peso. In contrast to forward currency exchange contracts which
can be traded at any time, only four value dates per year are available, the
third Wednesday of March, June, September and December.
FOREIGN CURRENCY OPTIONS TRANSACTIONS
Foreign currency options (as opposed to futures) are traded in a
variety of currencies in both the United States and Europe. On the Philadelphia
Stock Exchange, for example, contracts for half the size of the corresponding
futures contracts on the Chicago Board - Options Exchange are traded with up to
nine months maturity in marks, sterling, yen, Swiss francs, French francs and
Canadian dollars. Options can be exercised at any time during the contract life,
and require a deposit subject to normal margin requirements. Since a futures
contract must be exercised, the Fund must continually make up the margin
balance. As a result, a wrong price move could result in the Fund losing more
than the original investment, as it cannot walk away from the futures contract
as it can an option contract.
The Fund will purchase call and put options and sell such options to
terminate an existing position. Options on foreign currency are similar to
options on stocks except that an option on an interest rate and/or index based
futures contract gives the purchaser the right, in return for the premium paid,
to purchase or sell foreign currency, rather than to purchase or sell stock, at
a specified exercise price at any time during the period of the option.
The Fund intends to use foreign currency option transactions in
connection with hedging strategies.
PURCHASE OF PUT OPTIONS ON FOREIGN CURRENCIES
The purchase of protective put options on a foreign currency is
analogous to the purchase of protective puts on individual stocks, where an
absolute level of protection is sought below which no additional economic loss
would be incurred by the Fund. Put options may be purchased to hedge a portfolio
of foreign stocks or foreign debt instruments or a position in the foreign
currency upon which the put option is based.
PURCHASE OF CALL OPTIONS ON FOREIGN CURRENCIES
The purchase of a call option on foreign currency represents a means of
obtaining temporary exposure to market appreciation at limited risk. It is
analogous to the purchase of a call option on an individual stock, which can be
used as a substitute for a position in the stock itself. Depending on the
pricing of the option compared to either the foreign currency upon which it is
based, or upon the price of the foreign stock or foreign debt instruments,
purchase of a call option may be less risky than the ownership of the foreign
currency or the foreign securities. The Fund would purchase a call option on a
foreign currency to hedge against an increase in the foreign currency or a
foreign market advance when the Fund is not fully invested.
The Fund may employ new investment techniques involving forward foreign
currency exchange contracts, foreign currency futures contracts and options on
foreign currencies in order to take advantage of new techniques in these areas
which may be developed from time to time and which are consistent with the
Fund's investment objective. The Fund believes that no additional techniques
have been identified for employment by the Fund in the foreseeable future other
than those described above.
CURRENCY TRADING RISKS
Currency exchange trading may involve significant risks. The four major
types of risk the Fund faces are exchange rate risk, interest rate risk, credit
risk and country risk.
EXCHANGE RATE RISK
Exchange rate risk results from the movement up and down of foreign
currency values in response to shifting market supply and demand. When the Fund
buys or sells a foreign currency, an exposure called an open position is
created. Until the time that position can be "covered" by selling or buying an
equivalent amount of the same currency, the Fund is exposed to the risk that the
exchange rate might move against it. Since exchange rate changes can readily
move in one direction, a position carried overnight or over a number of days
involves greater risk than one carried a few minutes or hours. Techniques such
as foreign currency forward and futures contracts and options on foreign
currency are intended to be used by the Fund to reduce exchange rate risk.
MATURITY GAPS AND INTEREST RATE RISK
Interest rate risk arises whenever there are mismatches or gaps in the
maturity structure of the Fund's foreign exchange currency holdings, which is
the total of its outstanding spot and forward or futures contracts.
Foreign currency transactions often involve borrowing short term and
lending longer term to benefit from the normal tendency of interest rates to be
higher for longer maturities. However in foreign exchange trading, while the
maturity pattern of interest rates for one currency is important, it is the
differential between interest rates for two currencies that is decisive.
CREDIT RISK
Whenever the Fund enters into a foreign exchange contract, it faces a
risk, however small, that the counterparty will not perform under the contract.
As a result there is a credit risk, although no extension of "credit" is
intended. To limit credit risk, the Fund intends to evaluate the
creditworthiness of each other party. The Fund does not intend to trade more
than 5% of its net assets under foreign exchange contracts with one party.
Credit risk exists because the Fund's counterparty may be unable or
unwilling to fulfill its contractual obligations as a result of bankruptcy or
insolvency or when foreign exchange controls prohibit payment. In any foreign
exchange transaction, each party agrees to deliver a certain amount of currency
to the other on a particular date. In establishing its hedges a Fund relies on
each contract being completed. If the contract is not performed, then the Fund's
hedge is eliminated, and the Fund is exposed to any changes in exchange rates
since the contract was originated. To put itself in the same position it would
have been in had the contract been performed, the Fund must arrange a new
transaction. However, the new transaction may have to be arranged at an adverse
exchange rate. The trustee for a bankrupt company may elect to perform those
contracts which are advantageous to the company but disclaim those contracts
which are disadvantageous, resulting in losses to the Fund.
Another form of credit risk stems from the time zone difference between
the U.S. and foreign nations. If the Fund sells sterling it generally must pay
pounds to a counterparty earlier in the day than it will be credited with
dollars in New York. In the intervening hours, the buyer can go into bankruptcy
or can be declared insolvent. Thus, the dollars may never be credited to the
Fund.
COUNTRY RISK
At one time or another, virtually every country has interfered with
international transactions in its currency. Interference has taken the form of
regulation of the local exchange market, restrictions on foreign investment by
residents, or limits on inflows of investment funds from abroad. Governments
take such measures for example to improve control over the domestic banking
system, or to influence the pattern of receipts and payments between residents
and foreigners. In those cases, restrictions on the exchange market or on
international transactions are intended to affect the level or movement of the
exchange rate. Occasionally a serious foreign exchange shortage may lead to
payments interruptions or debt servicing delays, as well as interference in the
exchange market. It has become increasingly difficult to distinguish foreign
exchange or credit risk from country risk.
Changes in regulations or restrictions usually do have an important
exchange market impact. Most disruptive are changes in rules which interfere
with the normal payments mechanism. If government regulations change and a
counterparty is either forbidden to perform or is required to do something
extra, then the Fund might be left with an unintended open position or an
unintended maturity mismatch. Dealing with such unintended long or short
positions could result in unanticipated costs to the Fund.
Other changes in official regulations influence international
investment transactions. If one of the factors affecting the buying or selling
of a currency changes, the exchange rate is likely to respond. Changes in such
controls often are unpredictable and can create a significant exchange rate
response.
Many major countries have moved toward liberalization of exchange and
payments restrictions in recent years, or accepted the principle that
restrictions should be relaxed. A few industrial countries have moved in the
other direction. Important liberalizations were carried out by Switzerland, the
United Kingdom and Japan. They dismantled mechanisms for restricting either
foreign exchange inflows (Switzerland), outflows (Britain), or elements of both
(Japan). By contrast, France and Mexico have recently tightened foreign exchange
controls.
Overall, many exchange markets are still heavily restricted. Several
countries limit access to the forward market to companies financing documented
export or import transactions in an effort to insulate the market from purely
speculative activities. Some of these countries permit local traders to enter
into forward contracts with residents but prohibit certain forward transactions
with nonresidents. By comparison, other countries have strict controls on
exchange transactions by residents, but permit free exchange transactions
between local traders and non-residents. A few countries have established tiered
markets, funneling commercial transactions through one market and financial
transactions through another. Outside the major industrial countries, relatively
free foreign exchange markets are rare and control on foreign currency
transactions are extensive.
Another aspect of country risk has to do with the possibility that the
Fund may be dealing with a foreign trader whose home country is facing a
payments problem. Even though the foreign trader intends to perform on its
foreign exchange contracts, the contracts are tied to other external liabilities
the country has incurred. As a result performance may be delayed, and can result
in unanticipated cost to the Fund. This aspect of country risk is a major
element in the Fund's credit judgment as to with whom it will deal and in what
amounts.
ADDITIONAL INFORMATION REGARDING DERIVATIVE INSTRUMENTS
Derivatives have been variously defined to include forwards, futures,
options, mortgage-backed securities, other asset-backed securities and
structured securities, such as interest rate swaps, equity swaps, index swaps,
currency swaps and caps and floors. These basic vehicles can also be combined to
create more complex products, called hybrid derivatives. Options, futures and
forwards are discussed elsewhere in the Fund's prospectus and statement of
additional information. The following discussion addresses mortgage backed and
other asset-backed securities, structured securities and other instruments.
EQUITY SWAP CONTRACTS
The counterparty to an equity swap contract would typically be a bank,
investment banking firm or broker/dealer. For example, the counterparty would
generally agree to pay the Fund the amount, if any, by which the notional amount
of the equity swap contract would have increased in value if such notional
amount had been invested in the stocks comprising the S&P 500 Index in
proportion to the composition of the Index, plus the dividends that would have
been received on those stocks. The Fund would agree to pay to the counterparty a
floating rate of interest (typically the London Inter Bank Offered Rate) on the
notional amount of the equity swap contract plus the amount, if any, by which
that notional amount would have decreased in value had it been invested in such
index stocks. Therefore, the return to the Fund on any equity swap contract
should be the gain or loss on the notional amount plus dividends on the stocks
comprising the S&P 500 Index less the interest paid by the Fund on the notional
amount. If permitted by its investment policies, the Fund will only enter into
equity swap contracts on a net basis, I.E., the two parties' obligations are
netted out, with the Fund paying or receiving, as the case may be, only the net
amount of any payments. Payments under equity swap contracts may be made at the
conclusion of the contract or periodically during its term.
If permitted by its investment policies, the Fund may also from time to
time enter into the opposite side of equity swap contracts (I.E., where the Fund
is obligated to pay the increase (net of interest) or received the decrease
(plus interest) on the contract) to reduce the amount of the Fund's equity
market exposure consistent with the Fund's investment objective(s) and policies.
These positions are sometimes referred to as "reverse equity swap contracts."
Equity swap contracts will not be used to leverage the Fund. Since the
SEC considers equity swap contracts and reverse equity swap contracts to be
illiquid securities, the Fund will not invest in equity swap contracts or
reverse equity swap contracts if the total value of such investments together
with that of all other illiquid securities that the Fund owns would exceed the
Fund's limitations on investments in illiquid securities.
The Fund does not believe that its obligations under equity swap
contracts or reverse equity swap contracts are senior securities and,
accordingly, the Fund will not treat them as being subject to its borrowing
restrictions. However, the net amount of the excess, if any, of the Fund's
obligations over its respective entitlement with respect to each equity swap
contract and each reverse equity swap contract will be accrued on a daily basis
and an amount of cash, U. S. government securities or other liquid high quality
debt securities having an aggregate market value at lease equal to the accrued
excess will be maintained in a segregated account by the Fund's custodian.
CURRENCY SWAPS, INDEX SWAPS AND CAPS AND FLOORS
A currency swap is an agreement to exchange cash flows on a notional
amount of two or more currencies based on the relative value differential among
them. An index swap is an agreement to swap cash flows on a notional amount
based on changes in the values of reference indices. The purchase of an interest
rate cap entitles the purchaser, to the extent that a specified index exceeds an
agree-upon interest rate, to receive payments of interest on a notional
principal amount from the party selling such interest rate cap. The purchase of
an interest rate floor entitles the purchaser to receive payments of interest on
a notional principal amount from the party selling such interest rate floor. If
permitted by the Fund's investment policies, the investment adviser expects to
enter into these types of transactions on behalf of the Fund 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 rather than for speculative purposes.
Accordingly, if permitted by the Fund's investment policies, the Fund intends to
use these transactions as hedges and not as speculative investments and will not
sell interest rate caps or floors unless it owns securities or other instruments
providing the income stream the Fund may be obligated to pay. Caps and floors
require segregation of assets with a value equal to the Fund's net obligation,
if any.
SPECIAL RISKS OF SWAPS, CAPS AND FLOORS
As with futures, options, forward contracts, and mortgage backed and
other asset-backed securities, the use of swap, cap and floor contracts exposes
the Fund to additional investment risk and transaction costs. These risks
include operational risk, market risk and credit risk.
Operational risk includes, among others, the risks that the investment
adviser will incorrectly analyze market conditions or will not employ
appropriate strategies and monitoring with respect to these instruments or will
be forced to defer closing out certain hedged positions to avoid adverse tax
consequences.
Market risk includes, among others, the risks of imperfect correlations
between the expected values of the contracts, or their underlying bases, and
movements in the prices of the securities or currencies being hedged, and the
possible absence of a liquid secondary market for any particular instrument at
any time. 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 more illiquid. Nevertheless, a secondary market for swaps
is never assured, and caps and floors, which are more recent innovations for
which standardized documentation has not yet been fully developed, are much less
liquid than swaps.
Credit risk is primarily the risk that counterparties may be
financially unable to fulfill their contracts on a timely basis, if at all. If
there is a default by the counterparty to any such contract, the Fund will be
limited to contractual remedies pursuant to the agreements related to the
transaction. There is no assurance that contract counterparties will be able to
meet contract obligations or that, in the event of default, the Fund will
succeed in pursuing contractual remedies. The Fund thus assumes the risk that it
may be delayed in or prevented from obtaining payments owed to it pursuant to
such contracts. The Fund will closely monitor the credit of swap counterparties
in order to minimize this risk. The Fund will not enter into any equity swap
contract or reverse equity swap contract unless, at the time of entering into
such transaction, the unsecured senior debt of the counterparty is rated at
least A by Moody's or S&P.
<PAGE>
KEYSTONE SMALL COMPANY GROWTH FUND (S-4)
PART B
STATEMENT OF ADDITIONAL INFORMATION
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
KEYSTONE SMALL COMPANY GROWTH FUND (S-4)
August 1, 1997
This statement of additional information is not a prospectus, but relates
to, and should be read in conjunction with, the prospectus of Keystone Small
Company Growth Fund (S-4)(the "Fund") dated August 1, 1997, as supplemented
from time to time. You may obtain a copy of the prospectus from the Fund's
principal underwriter, Evergreen Keystone Distributor, Inc., or your
broker-dealer.
TABLE OF CONTENTS
Page
The Fund 2
Service Providers 2
Investment Restrictions 3
Distributions and Taxes 4
Valuation of Securities 5
Brokerage 5
Sales Charge 7
Distribution Plan 8
Trustees and Officers 10
The Trust Agreement 14
Investment Adviser 15
Principal Underwriter 16
Sub-administrator 17
Expenses 18
Standardized Total Return
and Yield Quotations 19
Financial Statements 19
Additional Information 20
Appendix A-1
THE FUND
The Fund is an open-end, diversified management investment company commonly
known as a mutual fund. The Fund's investment objective is to provide
shareholders with long-term growth of capital. It is the Fund's policy to invest
its assets as fully as practicable. Keystone Investment Management Company
("Keystone") serves as the Fund's investment adviser.
Certain information about the Fund is contained in its prospectus. This
statement of additional information ("SAI") provides additional information
about the Fund that may be of interest to some investors.
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SERVICE PROVIDERS
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Service Provider
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Investment adviser (referred to Keystone Investment Management Company, 200 Berkeley
in this SAI as "Keystone") Street, Boston, Massachusetts 02116 (Keystone is a wholly-
owned subsidiary of First Union Keystone, Inc. ("First
Union Keystone"), also located at 200 Berkeley Street,
Boston, Massachusetts 02116)
Principal underwriter( referred
to in this SAI as "EKD") Evergreen Keystone Distributor, Inc. (formerly Evergreen
Funds Distributor, Inc.), 125 W. 55th Street, New York,
New York 10019
Predecessor to EKD (referred to Evergreen Keystone Investment Services, Inc. (formerly
in this SAI as "EKIS") Keystone Investment Distributors Company), 200 Berkeley
Street, Boston, Massachusetts 02116
Sub-administrator (referred to in BISYS Fund Services, 3435 Stelzer Road, Columbus, Ohio
this SAI as "BISYS") 43219
Transfer and dividend disbursing Evergreen Keystone Service Company (formerly Keystone
agent (referred to in this SAI as Investor Resource Center, Inc.), 200 Berkeley Street,
"EKSC") Boston, Massachusetts 02116 (EKSC is a wholly-owned
subsidiary of Keystone)
Independent auditors KPMG Peat Marwick LLP, 99 High Street, Boston,
Massachusetts 02110, Certified Public Accountants
Custodian State Street Bank and Trust Company, 225 Franklin Street,
Boston, Massachusetts 02110
</TABLE>
INVESTMENT RESTRICTIONS
Fundamental Investment Restrictions
The Fund has adopted the fundamental investment restrictions set forth
below, which may not be changed without the vote of majority of the Fund's
outstanding voting shares (as defined in the Investment Company Act of 1940 (the
"1940 Act")). Unless otherwise stated, all references to Fund assets are in
terms of current market value.
The Fund may not do any of the following:
(1) with respect to 75% of its total assets, invest more than 5% of the
value of its total assets, determined at market or other fair value at the time
of purchase, in the securities of any one issuer, or invest in more than 10% of
the outstanding voting securities of any one issuer, all as determined
immediately after such investment; provided that these limitations do not apply
to investments in securities issued or guaranteed by the United States ("U.S.")
government or its agencies or instrumentalities;
(2) invest more than 5% of the value of its total assets in companies which
have been in operation for less than three years;
(3) borrow money, except that the Fund may (a) borrow money from banks for
temporary or emergency purposes in aggregate amounts up to 10% of the value of
the Fund's net assets (computed at cost); or (b) enter into reverse repurchase
agreements;
(4) underwrite securities, except that the Fund may purchase securities
from issuers thereof or others and dispose of such securities in a manner
consistent with its other investment policies; in the disposition of restricted
securities the Fund may be deemed to be an underwriter, as defined in the
Securities Act of 1933 (the "1933 Act");
(5) purchase or sell real estate or interests in real estate, except that
it may purchase and sell securities secured by real estate and securities of
companies which invest in real estate, or purchase or sell commodities or
commodity contracts, except that the Fund may engage in currency or other
financial futures contracts and related options transactions;
(6) invest for the primary purpose of exercising control over, or
management of, any issuer;
(7) make margin purchases or short sales of securities;
(8) make loans, except that the Fund may purchase money market securities,
enter into repurchase agreements, buy publicly and privately distributed debt
securities and lend limited amounts of its portfolio securities to
broker-dealers; all such investments must be consistent with the Fund's
investment objective and policies;
(9) invest more than 25% of its total assets in the securities of issuers
in any single industry, other than securities issued or guaranteed by the U.S.
government, its agencies or instrumentalities; and
(10) purchase the securities of any other investment company except in the
open market and at customary brokerage rates and in no event more than 3% of the
voting securities of any investment company.
If a percentage limit is satisfied at the time of investment or borrowing,
a later increase or decrease resulting from a change in the value of a security
or a decrease in Fund assets is not a violation of the limit.
The Fund has no current intention of attempting to increase its net income
by borrowing and intends to repay any borrowings made in accordance with third
third investment restriction enumerated above before it makes any additional
investments.
Non-Fundamental Investment Restrictions
Additional restrictions adopted by the Fund, which may be changed by the
Fund's Board of Trustees, stipulate that the Fund may not purchase or retain
securities of an issuer if, to the knowledge of the Fund, any officer, Trustee
or Director of the Fund or Keystone Investment Management Company ("Keystone"),
each owning beneficially more than 1/2of 1% of the securities of such issuer,
own, in the aggregate, more than 5% of the securities of such issuer, or such
persons or management personnel of the Fund or Keystone have a substantial
beneficial interest in the securities of such issuer. Portfolio securities of
the Fund may not be purchased from or sold or loaned to Keystone or any
affiliate thereof or any of their Directors, officers or employees.
DISTRIBUTIONS AND TAXES
The Fund will make distributions to its shareholders of dividends from net
investment income and net realized capital gains, if any, at least annually in
shares or, at the option of the shareholder, in cash. (Distributions of ordinary
income may be eligible in whole or in part for the corporate 70% dividends
received deduction.) Distributions are taxable whether received in cash or
additional shares. Shareholders who have not opted, prior to the record date for
any distribution, to receive cash will have the number of distributed shares
determined on the basis of the Fund's net asset value per share computed at the
end of the day on the record date after adjustment for the distribution. Net
asset value is used in computing the number of shares in both gains and income
distribution reinvestments. Account statements and/or checks, as appropriate,
will be mailed to shareholders by the 15th of the appropriate month. Unless the
Fund receives instructions to the contrary from a shareholder before the record
date, it will assume that the shareholder wishes to receive that distribution
and future gains and income distributions in shares. Instructions continue in
effect until changed in writing.
Distributed long-term capital gains are taxable as such to the shareholder
regardless of the period of time Fund shares have been held by the shareholder.
However, if such shares are held less than six months and redeemed at a loss,
the shareholder will recognize a long-term capital loss on such shares to the
extent of the long-term capital gain distribution received in connection with
such shares. If the net asset value of the Fund's shares is reduced below a
shareholder's cost by a capital gains distribution, such distribution, to the
extent of the reduction, would be a return of investment though taxable as
stated above. Since distributions of capital gains depend upon profits actually
realized from the sale of securities by the Fund, they may or may not occur. The
foregoing comments relating to the taxation of dividends and distributions paid
on the Fund's shares relate solely to federal income taxation. Such dividends
and distributions may also be subject to state and local taxes.
When the Fund makes a distribution, it intends to distribute only its net
capital gains and such income as has been predetermined, to the best of the
Fund's ability, to be taxable as ordinary income. Shareholders of the Fund will
be advised annually of the federal income tax status of distributions.
VALUATION OF SECURITIES
Current value for the Fund's portfolio securities is determined as follows:
(1) Securities traded on an established exchange are valued on the basis of
the last sales price on the exchange where the securities are primarily traded
prior to the time of the valuation;
(2) Securities traded in the over-the-counter market, for which complete
quotations are readily available, are valued at the mean of the bid and asked
prices at the time of valuation;
(3) Short-term investments maturing in sixty days or less are valued at
amortized cost (original purchase cost as adjusted for amortization of premium
or accretion of discount), which, when combined with accrued interest,
approximates market;
(4) Short-term investments maturing in more than sixty days are valued at
market value;
(5) Short-term investments maturing in more than sixty days when purchased
that are held on the sixtieth day prior to maturity are valued at amortized cost
(market value on the sixtieth day adjusted for amortization of premium or
accretion of discount), which, when combined with accrued interest, approximates
market; and
(6) The Fund's Board of Trustees values the following securities at prices
it deems in good faith to be fair: (a) securities, including restricted
securities, for which complete quotations are not readily available; (b) listed
securities if, in the Board's opinion, the last sales price does not reflect a
current market value or if no sale occurred; and (c) other assets.
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BROKERAGE
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Selection of Brokers
In effecting transactions in portfolio securities for the Fund, Keystone
seeks the best execution of orders at the most favorable prices. Keystone
determines whether a broker has provided the Fund with best execution and price
in the execution of a securities transaction by evaluating, among other things:
1. overall direct net economic result to the Fund;
2. the efficiency with which the transaction is effected;
3. the broker's ability to effect the transaction where a large block is
involved;
4. the broker's readiness to execute potentially difficult transactions in
the future;
5. the financial strength and stability of the broker; and
6. the receipt of research services, such as analyses and reports
concerning issuers, industries, securities, economic factors and trends and
other statistical and factual information ("research services").
The Fund's management weighs these considerations in determining the
overall reasonableness of the brokerage commissions paid.
Should the Fund or Keystone receive research services from a broker, the
Fund would consider such services to be in addition to, and not in lieu of, the
services Keystone is required to perform under the Advisory Agreement (as
defined below). Keystone believes that the cost, value and specific application
of such information are generally indeterminable and cannot be practically
allocated between the Fund and its other clients who may indirectly benefit from
the availability of such information. Similarly, the Fund may indirectly benefit
from information made available as a result of transactions effected for
Keystone's other clients. Under the Advisory Agreement, Keystone is permitted to
pay higher brokerage commissions for brokerage and research services in
accordance with Section 28(e) of the Securities Exchange Act of 1934. In the
event Keystone follows such a practice, it will do so on a basis that is fair
and equitable to the Fund.
The Fund's Board of Trustees has determined that the Fund may consider
sales of Fund shares as a factor when selecting brokers to execute portfolio
transactions, subject to the requirements of best execution described above.
Brokerage Commissions
Generally, the Fund expects to purchase and sell its securities through
brokerage transactions for which commissions are payable. Purchases from
underwriters will include the underwriting commission or concession, and
purchases from dealers serving as market makers will include a dealer's mark-up
or reflect a dealer's mark-down. Where transactions are made in the
over-the-counter market, the Fund will deal with primary market makers, unless
more favorable prices are otherwise obtainable.
General Brokerage Policies
In order to take advantage of the availability of lower purchase prices,
the Fund may participate, if and when practicable, in group bidding for the
direct purchase from an issuer of certain securities.
Keystone makes investment decisions for the Fund independently from those
of its other clients. It may frequently develop, however, that Keystone will
make the same investment decision for more than one client. Simultaneous
transactions are inevitable when the same security is suitable for the
investment objective of more than one account. When two or more of its clients
are engaged in the purchase or sale of the same security, Keystone will allocate
the transactions according to a formula that is equitable to each of its
clients. Although, in some cases, this system could have a detrimental effect on
the price or volume of the Fund's securities, the Fund believes that in other
cases its ability to participate in volume transactions will produce better
executions.
The Fund does not purchase portfolio securities from or sell portfolio
securities to Keystone, EKD, or any of their affiliated persons, as defined in
the 1940 Act.
The Board of Trustees will, from time to time, review the Fund's brokerage
policy. In the event of further regulatory developments affecting the securities
exchanges and brokerage practices generally, the Board of Trustees may change,
modify or eliminate any of the foregoing practices.
SALES CHARGE
The Fund may charge a contingent deferred sales charge (a "CDSC") when you
redeem certain of its shares within four calendar years after the month in which
you purchase the shares. The Fund charges a CDSC as reimbursement for certain
expenses, such as commissions or shareholder servicing fees, that it has
incurred in connection with the sale of its shares (see "Distribution Plan"). If
imposed, the Fund deducts the CDSC from the redemption proceeds you would
otherwise receive. CDSCs attributable to your shares are, to the extent
permitted by the National Association of Securities Dealers, Inc. ("NASD"), paid
to EKD or its predecessor.
Calculating the CDSC
The CDSC is a declining percentage of the lesser of (1) the net asset value
of the shares you redeemed, or (2) the net asset value at time of purchase of
such shares. The CDSC is calculated according to the following schedule:
Redemption Timing CDSC
During the calendar year of purchase.............................4.00%
During the first calendar year after the
year of purchase............................................3.00%
During the second calendar
year after the year of purchase.............................2.00%
During the third calendar year
after the year of purchase..................................1.00%
Thereafter.......................................................0.00%
In determining whether a CDSC is payable and, if so, the percentage charge
applicable, the Fund will first redeem shares not subject to a CDSC and will
then redeem shares you have held the longest.
CDSC Waivers. The Fund does not impose a CDSC when the amount you are
redeeming represents:
1. an increase in the value of the shares redeemed above the total cost of
such shares due to increases in the net asset value per share of the Fund;
2. certain shares for which the Fund did not pay a commission on issuance,
including shares acquired through reinvestment of dividend income and capital
gains distributions;
3. shares you have held for all or part of more than four consecutive
calendar years;
4. shares that are held in the accounts of a shareholder who has died or
become disabled;
5. a lump-sum distribution from a 401(k) plan or other benefit plan
qualified under the Employee Retirement Income Security Act of 1974 ("ERISA");
6. automatic withdrawals from the ERISA plan of a shareholder who is a
least 59 1/2 years old;
7. shares in an account that the Fund has closed because the account has an
aggregate net asset value of less than $1,000;
8. automatic withdrawals under a Systematic Withdrawal Plan of up to 1% per
month of your initial account balance;
9. withdrawals consisting of loan proceeds to a retirement plan
participant;
10. financial hardship withdrawals made by a retirement plan participant;
11. withdrawals consisting of returns of excess contributions or excess
deferral amounts made to a retirement plan;
12. shares purchased by a bank or trust company in a single account in the
name of such bank or trust company as trustee if the initial investment in
shares of the Fund, any other Keystone Classic Fund and/or any Evergreen
Keystone Fund, is at least $500,000 and any commission paid by the Fund and such
other fund at the time of such purchase is not more than 1% of the amount
invested;
13. shares purchased by certain Directors, Trustees, officers and employees
of the Fund, Keystone and certain of their affiliates; and
14. shares purchased by registered representatives of firms with dealer
agreements with EKD.
Exchanges. The Fund does not charge a CDSC on exchanges of shares between
funds in the Keystone Classic Fund Family that have adopted distribution plans
pursuant to Rule 12b-1 under the 1940 Act. If you do exchange shares of one such
fund for shares of another such fund, the Fund will deem the calendar year of
the purchase, for purposes of any future CDSC, to be the year the shares
tendered for exchange were originally purchased.
DISTRIBUTION PLAN
Rule 12b-1 under the 1940 Act permits investment companies, such as the
Fund, to use their assets to bear the expenses of distributing their shares if
they comply with various conditions, including the adoption of a distribution
plan containing certain provisions set forth in Rule 12b-1. The Fund bears some
of the costs of selling its shares under a Distribution Plan adopted pursuant to
Rule 12b-1 (the "Distribution Plan").
The Fund's Distribution Plan provides that the Fund may expend up to
0.3125% quarterly (approximately 1.25% annually) of the average daily net asset
value of its shares to pay distribution costs for sales of its shares and to pay
shareholder service fees. The NASD limits such annual expenditures to 1.0%, of
which 0.75% may be used to pay such distribution costs and 0.25% may be used to
pay shareholder service fees. The NASD also limits the aggregate amount that the
Fund may pay for such distribution costs to 6.25% of gross share sales since the
inception of the Fund's Distribution Plan plus interest at the prime rate plus
1% on unpaid amounts thereof (less any CDSC paid by shareholders to EKD).
Payments under the Distribution Plan are currently made to EKD or its
predecessor, which may reallow all or part to others, such as broker-dealers(1)
as commissions for Fund shares sold and (2) as shareholder service fees in
respect of shares maintained by the recipient and outstanding on the Fund's
books for specific periods. Amounts paid or accrued to EKD under (1) and (2) in
the aggregate may not exceed the limitation referred to above. EKD generally
reallows to broker-dealers or others a commission equal to 4% of the price paid
for each Fund share sold as well as a shareholder service fee at a rate of 0.25%
per annum of the net asset value of shares maintained by such recipient and
outstanding on the books of the Fund for specified periods.
If the Fund is unable to pay EKD a commission on a new sale because the
annual maximum (0.75% of average daily net assets) has been reached, EKD
intends, but is not obligated, to continue to accept new orders for the purchase
of Fund shares and to pay commissions and service fees to broker- dealers in
excess of the amount it currently receives from the Fund. While the Fund is
under no contractual obligation to pay EKD for advances made by EKD in excess of
the Distribution Plan limitation, EKD intends to seek full payment of such
amounts from the Fund (together with interest at the prime rate plus 1%) at such
time in the future as, and to the extent that, payment thereof by the Fund would
be within permitted limits. If the Fund's disinterested Trustees (as defined in
the 1940 Act) (the "Independent Trustees") authorize such payments, the effect
will be to extend the period of time during which the Fund incurs the maximum
amount of costs allowed by the Distribution Plan. If the Distribution Plan is
terminated, EKD will ask the Independent Trustees to take whatever action they
deem appropriate under the circumstances with respect to payment of such
amounts.
The total amounts paid by the Fund under the foregoing arrangements may not
exceed the maximum Distribution Plan limit specified above, and the amounts and
purposes of expenditures under the Distribution Plan must be reported to the
Fund's Independent Trustees quarterly. The Fund's Independent Trustees may
require or approve changes in the implementation or operation of the
Distribution Plan and may require that total expenditures by the Fund under the
Distribution Plan be kept within limits lower than the maximum amount permitted
by the Distribution Plan as stated above. If such costs are not limited by the
Independent Trustees, such costs could, for some period of time, be higher than
such costs permitted by most other plans presently adopted by other investment
companies.
The Distribution Plan may be terminated at any time by vote of the
Independent Trustees or by vote of a majority of the outstanding voting
securities of the Fund.
Any change in the Distribution Plan that would materially increase the
distribution expenses of the Fund provided for in the Distribution Plan requires
shareholder approval. Otherwise, the Distribution Plan may be amended by votes
of the majority of both (1) the Fund's Trustees and (2) the Independent Trustees
cast in person at a meeting called for the purpose of voting on such amendment.
While the Distribution Plan is in effect, the Fund is required to commit
the selection and nomination of candidates for Independent Trustees to the
discretion of the Independent Trustees.
The Independent Trustees of the Fund have determined that the sales of the
Fund's shares resulting from payments under the Distribution Plan have benefited
the Fund.
TRUSTEES AND OFFICERS
The Trustees and officers of the Fund, their principal occupations and some
of their affiliations over the last five years are as follows:
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FREDERICK AMLING: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; Professor, Finance Department,
George Washington University; President, Amling & Company
(investment advice); and former Member, Board of Advisers, Cre
dito Emilano (banking).
LAURENCE B. ASHKIN: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; Trustee or Director of all funds in the
Evergreen Family of Funds other than Evergreen Investment
Trust and Evergreen Variable Trust; real estate developer and
construction consultant; and President of Centrum Equities and
Centrum Properties, Inc.
CHARLES A. AUSTIN III: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; Investment Counselor to Appleton
Partners, Inc.; and former Managing Director, Seaward
Management Corporation (investment advice).
FOSTER BAM: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; Trustee or Director of all the funds in
the Evergreen Family of Funds other than Evergreen Investment
Trust and Evergreen Variable Trust; Partner in the law firm of
Cummings & Lockwood; Director, Symmetrix, Inc. (sulphur
company) and Pet Practice, Inc. (veterinary services); and former
Director, Chartwell Group Ltd. (manufacturer of office furnishings
and accessories), Waste Disposal Equipment Acquisition
Corporation and Rehabilitation Corporation of America
(rehabilitation hospitals).
*GEORGE S. BISSELL: Chief Executive Officer of the Fund and each of the other funds in
the Keystone Families of Funds; Chairman of the Board and
Trustee of the Fund; Chairman of the Board and Trustee or
Director of all other funds in the Keystone Families of Funds;
Chairman of the Board and Trustee of Anatolia College; Trustee of
University Hospital (and Chairman of its Investment Committee);
former Director and Chairman of the Board of Hartwell Keystone
Advisers, Inc.; and former Chairman of the Board, Director and
Chief Executive Officer of Keystone Investments, Inc.
EDWIN D. CAMPBELL: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; Principal, Padanaram Associates, Inc.;
and former Executive Director, Coalition of Essential Schools,
Brown University.
CHARLES F. CHAPIN: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; and former Director, Peoples Bank
(Charlotte, NC).
K. DUN GIFFORD: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; Trustee, Treasurer and Chairman of
the Finance Committee, Cambridge College; Chairman Emeritus
and Director, American Institute of Food and Wine; Chairman and
President, Oldways Preservation and Exchange Trust (education);
former Chairman of the Board, Director, and Executive Vice Presi
dent, The London Harness Company; former Managing Partner,
Roscommon Capital Corp.; former Chief Executive Officer, Gifford
Gifts of Fine Foods; former Chairman, Gifford, Drescher & Asso
ciates (environmental consulting); and former Director, Keystone
Investments, Inc. and Keystone.
JAMES S. HOWELL: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; Chairman and Trustee or Director of
all the funds in the Evergreen Family of Funds; former Chairman
of the Distribution Foundation for the Carolinas; and former Vice
President of Lance Inc. (food manufacturing).
LEROY KEITH, JR.: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; Chairman of the Board and Chief
Executive Officer, Carson Products Company; Director of Phoenix
Total Return Fund and Equifax, Inc.; Trustee of Phoenix Series
Fund, Phoenix Multi-Portfolio Fund, and The Phoenix Big Edge
Series Fund; and former President, Morehouse College.
F. RAY KEYSER, JR.: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; Chairman and Of Counsel, Keyser,
Crowley & Meub, P.C.; Member, Governor's (VT) Council of Eco
nomic Advisers; Chairman of the Board and Director, Central
Vermont Public Service Corporation and Lahey Hitchcock Clinic;
Director, Vermont Yankee Nuclear Power Corporation, Grand
Trunk Corporation, Grand Trunk Western Railroad, Union Mutual
Fire Insurance Company, New England Guaranty Insurance Com
pany, Inc., and the Investment Company Institute; former Director
and President, Associated Industries of Vermont; former Director
of Keystone, Central Vermont Railway, Inc., S.K.I. Ltd., and Arrow
Financial Corp.; and former Director and Chairman of the Board,
Proctor Bank and Green Mountain Bank.
GERALD M. MCDONNELL: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; Trustee or Director of all of the funds
in the Evergreen Family of Funds; and Sales Representative with
Nucor-Yamoto, Inc. (steel producer).
THOMAS L. MCVERRY: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; Trustee or Director of all of the funds
in the Evergreen Family of Funds; former Vice President and
Director of Rexham Corporation; and former Director of Carolina
Cooperative Federal Credit Union.
*WILLIAM WALT PETTIT: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; Trustee or Director of all the funds in
the Evergreen Family of Funds; and Partner in the law firm of
Holcomb and Pettit, P.A.
DAVID M. RICHARDSON: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; Vice Chair and former Executive Vice
President, DHR International, Inc. (executive recruitment); former
Senior Vice President, Boyden International Inc. (executive recruit
ment); and Director, Commerce and Industry Association of New
Jersey, 411 International, Inc., and J&M Cumming Paper Co.
RUSSELL A. SALTON, III MD: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; Trustee or Director of all the funds in
the Evergreen Family of Funds; Medical Director, U.S. Health
Care/Aetna Health Services; and former Managed Health Care
Consultant; former President, Primary Physician Care.
MICHAEL S. SCOFIELD: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; Trustee or Director of all the funds in
the Evergreen Family of Funds; and Attorney, Law Offices of
Michael S. Scofield.
RICHARD J. SHIMA: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; Chairman, Environmental Warranty,
Inc. (insurance agency); Executive Consultant, Drake Beam Morin,
Inc. (executive outplacement); Director of Connecticut Natural Gas
Corporation, Hartford Hospital, Old State House Association,
Middlesex Mutual Assurance Company, and Enhance Financial
Services, Inc.; Chairman, Board of Trustees, Hartford Graduate
Center; Trustee, Greater Hartford YMCA; former Director, Vice
Chairman and Chief Investment Officer, The Travelers Corpora
tion; former Trustee, Kingswood-Oxford School; and former
Managing Director and Consultant, Russell Miller, Inc.
ANDREW J. SIMONS: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; Partner, Farrell, Fritz, Caemmerer,
Cleary, Barnosky & Armentano, P.C.; Adjunct Professor of Law and
former Associate Dean, St. John's University School of Law;
Adjunct Professor of Law, Touro College School of Law; and former
President, Nassau County Bar Association.
JOHN J. PILEGGI: President and Treasurer of the Fund; President and Treasurer of
all other funds in the Evergreen Keystone Family of Funds; Senior
Managing Director, Furman Selz LLC since 1992; Managing
Director from 1984 to 1992; Consultant, BISYS Fund Services since
1996; 230 Park Avenue, Suite 910, New York, NY.
GEORGE O. MARTINEZ: Secretary of the Fund; Secretary of all other funds in the
Evergreen Keystone Family of Funds; Senior Vice President and
Director of Administration and Regulatory Services, BISYS Fund
Services since 1995; Vice President/Assistant General Counsel,
Alliance Capital Management from 1988 to 1995; 3435 Stelzer
Road, Columbus, Ohio.
</TABLE>
* This Trustee may be considered an "interested person" of the Fund within
the meaning of the 1940 Act.
The Fund does not pay any direct remuneration to any officer or Trustee who
is an "affiliated person" of Keystone or any of its affiliates. See "Investment
Adviser." During the fiscal year ended May 31, 1997, the unaffiliated Trustees
received retainers or fees totaling $58,980 from the Fund. For the fiscal year
ended May 31, 1997, aggregate compensation received by the Fund's Trustees on a
fund complex wide basis (which includes over 70 mutual funds) was $963,988. As
of July 1, 1997, the Trustees and officers beneficially owned less than 1.00% of
the Fund's then outstanding shares.
Except as set forth above, the address of all of the Fund's Trustees and
the address of the Fund is 200 Berkeley Street, Boston, Massachusetts
02116-5034.
Set forth below for each of the Trustees receiving in excess of $60,000 for
the fiscal period June 1, 1996 through May 31, 1997 is the total compensation
paid to such Trustee by the Evergreen Keystone Funds:
Total
Compensation
From Registrant
and Fund Complex
Name Pd. To Trustees
James S. Howell $76,875
Gerald M. McDonnell $65,550
Thomas L. McVerry $71,375
William Walt Pettit $69,375
Russell A Salton, III M.D. $71,325
Michael S. Scofield $71,325
THE TRUST AGREEMENT
Trust Agreement
The Fund is a Pennsylvania common law trust established under a Trust
Agreement dated July 15, 1935, as restated and amended (the "Trust Agreement").
The Trust Agreement restructured the Fund so that its operation would be
substantially similar to that of most other mutual funds. The Trust Agreement
provides for a Board of Trustees and enables the Fund to enter into an agreement
with an investment manager and/or adviser to provide the Fund with investment
advisory, management, and administrative services. A copy of the Trust Agreement
is on file as an exhibit to the Fund's Registration Statement, of which this
statement of additional information is a part. This summary is qualified in its
entirety by reference to the Trust Agreement.
Description of Shares
The Trust Agreement authorizes the issuance of an unlimited number of
shares of beneficial interest and the creation of additional series and/or
classes of series of Fund shares. Each share represents an equal proportionate
interest in the Fund with each other share of that class. Upon liquidation,
shares are entitled to a pro rata share in the net assets of their class of Fund
shares. Shareholders shall have no preemptive or conversion rights. Shares are
transferable. The Fund currently intends to issue only one class of shares.
Shareholder Liability
Pursuant to court decisions or other theories of law, shareholders of a
Pennsylvania common law trust could possibly be held personally liable for the
obligations of the trust. The possibility of Fund shareholders incurring
financial loss under such circumstances appears to be remote, however, because
the Trust Agreement (1) contains an express disclaimer of shareholder liability
for obligations of the Fund; (2) requires that notice of such disclaimer be
given in each agreement, obligation or instrument entered into or executed by
the Fund or the Trustees; and (3) provides for indemnification out of Fund
property for any shareholder held personally liable for the obligations of the
Fund.
Voting Rights
Under the terms of the Trust Agreement, the Fund does not hold annual
meetings. At meetings called for the initial election of Trustees or to consider
other matters, shares are entitled to one vote for each full share owned and
fractional votes for fractional shares. Shares generally vote together as one
class on all matters. No amendment may be made to the Trust Agreement that
adversely affects any class of shares without the approval of a majority of the
shares of that class. There shall be no cumulative voting in the election of
Trustees.
After a meeting as described above, no further meetings of shareholders for
the purpose of electing Trustees will be held, unless required by law, or until
such time as less than a majority of the Trustees holding office have been
elected by shareholders, at which time, the Trustees then in office will call a
shareholders' meeting for the election of Trustees.
Except as set forth above, the Trustees shall continue to hold office
indefinitely unless otherwise required by law and may appoint successor
Trustees. A Trustee may cease to hold office or may be removed from office (as
the case may be)
(1) at any time by a two-thirds vote of the remaining Trustees;
(2) when such Trustee becomes mentally or physically incapacitated; or
(3) at a special meeting of shareholders by a two-thirds vote of the
outstanding shares. Any Trustee may voluntarily resign from office.
Limitation of Trustees' Liability
The Trust Agreement provides that a Trustee shall be liable only for his
own willful defaults and, if reasonable care has been exercised in the selection
of officers, agents, employees, or investment advisers, shall not be liable for
any neglect or wrongdoing of any such person; provided, however, that nothing in
the Trust Agreement shall protect a Trustee against any liability for his
willful misfeasance, bad faith, gross negligence or reckless disregard of his
duties.
The Trustees have absolute and exclusive control over the management and
disposition of all assets of the Fund and may perform such acts as in their sole
judgment and discretion are necessary and proper for conducting the business and
affairs of the Fund or promoting the interests of the Fund and the shareholders.
INVESTMENT ADVISER
Investment Adviser
Subject to the general supervision of the Fund's Board of Trustees,
Keystone provides investment advice, management and administrative services to
the Fund.
On December 11, 1996, the predecessor corporation to First Union Keystone,
Keystone Investments, Inc. ("Keystone Investments") and indirectly each
subsidiary of Keystone Investments, including Keystone, were acquired (the
"Acquisition") by First Union National Bank ("FUNB"), a wholly- owned subsidiary
of First Union Corporation ("First Union"). Keystone Investments was acquired by
FUNB by merger into a wholly-owned subsidiary of FUNB, which entity then assumed
the First Union Keystone name and succeeded to the business of the predecessor
corporation. Contemporaneously with the Acquisition, the Fund entered into a new
investment advisory agreement with Keystone and into a principal underwriting
agreement with EKD, an indirect wholly-owned subsidiary of BISYS. The new
investment advisory agreement (the "Advisory Agreement") was approved by the
shareholders of the Fund on December 9, 1996, and became effective on December
11, 1996.
First Union Keystone and each of its subsidiaries, including Keystone, are
now indirectly owned by First Union. First Union is headquartered in Charlotte,
North Carolina, and had $143 billion in consolidated assets as of June 30, 1997.
First Union and its subsidiaries provide a broad range of financial services to
individuals and businesses throughout the United States. The Capital Management
Group of FUNB, Keystone and Evergreen Asset Management Corp., a wholly-owned
subsidiary of FUNB, manage or otherwise oversee the investment of over $66
billion in assets as of June 30, 1997 belonging to a wide range of clients,
including the Evergreen Keystone Family of Funds.
Pursuant to the Advisory Agreement and subject to the supervision of the
Fund's Board of Trustees, Keystone furnishes to the Fund investment advisory,
management and administrative services, office facilities, and equipment in
connection with its services for managing the investment and reinvestment of the
Fund's assets. Keystone pays for all of the expenses incurred in connection with
the provision of its services.
The Fund pays for all charges and expenses, other than those specifically
referred to as being borne by Keystone, including, but not limited to (1)
custodian charges and expenses; (2) bookkeeping and auditors' charges and
expenses; (3) transfer agent charges and expenses; (4)fees and expenses of
Independent Trustees; (5) brokerage commissions, brokers' fees and expenses; (6)
issue and transfer taxes; (7) costs and expenses under the Distribution Plan;
(8) taxes and trust fees payable to governmental agencies; (9) the cost of share
certificates; (10) fees and expenses of the registration and qualification of
the Fund and its shares with the Securities and Exchange Commission ("SEC") or
under state or other securities laws; (11) expenses of preparing, printing and
mailing prospectuses, statements of additional information, notices, reports and
proxy materials to shareholders of the Fund; (12) expenses of shareholders' and
Trustees' meetings; (13) charges and expenses of legal counsel for the Fund and
for the Independent Trustees of the Fund on matters relating to the Fund; and
(14) charges and expenses of filing annual and other reports with the SEC and
other authorities, and all extraordinary charges and expenses of the Fund.
The Fund pays Keystone a fee for its services at the annual rate set forth
below:
Aggregate Net
Asset Value of
Management Fee Fund Shares
- --------------------------------------------------------------------------------
0.70% of the first $100,000,000, plus
0.65% of the next $100,000,000, plus
0.60% of the next $100,000,000, plus
0.55% of the next $100,000,000, plus
0.50% of the next $100,000,000, plus
0.45% of the next $500,000,000, plus
0.40% of the next $500,000,000, plus
0.35% of amounts over $1,500,000,000
Keystone's fee is computed as of the close of business each business day
and payable monthly.
The Advisory Agreement continues in effect for two years from its effective
date and, thereafter, from year to year only if approved at least annually by
the Board of Trustees of the Fund or by a vote of a majority of the Fund's
outstanding shares (as defined in the 1940 Act). In either case, the terms of
the Advisory Agreement and continuance thereof must be approved by the vote of a
majority of the Independent Trustees cast in person at a meeting called for the
purpose of voting on such approval. The Advisory Agreement may be terminated,
without penalty, on 60 days' written notice by the Fund's Board of Trustees or
by a vote of a majority of outstanding shares. The Advisory Agreement will
terminate automatically upon its assignment.
PRINCIPAL UNDERWRITER
The Fund has entered into a Principal Underwriting Agreement (the
"Underwriting Agreement") with EKD. EKD, which is not affiliated with First
Union, replaces EKIS as the Fund's principal underwriter. EKIS may no longer
serve as principal underwriter of the Fund due to regulatory restrictions
imposed by the Glass-Steagall Act upon national banks such as FUNB and their
affiliates, that prohibit such entities from acting as the underwriters of
mutual fund shares. While EKIS may nolonger serve as principal underwriter of
the Fund as discussed above, EKIS may continue to receive compensation from the
Fund or EKD in respect of underwriting and distribution services performed prior
to the termination of EKIS as principal underwriter. In addition, EKIS may also
be compensated by EKD for the provision of certain marketing support services to
EKD at an annual rate of up to 0.75% of the average daily net assets of the
Fund, subject to certain restrictions.
EKD, as agent, has agreed to use its best efforts to find purchasers for
the shares. EKD may retain and employ representatives to promote distribution of
the shares and may obtain orders from broker-dealers and others, acting as
principals, for sales of shares to them. The Underwriting Agreement provides
that EKD will bear the expense of preparing, printing, and distributing
advertising and sales literature and prospectuses used by it. In its capacity as
principal underwriter, EKD or EKIS, its predecessor, may receive payments from
the Fund pursuant to the Fund's Distribution Plan.
The Underwriting Agreement provides that it will remain in effect as long
as its terms and continuance are approved annually (1) by a vote of a majority
of the Independent Trustees, and (2) by vote of a majority of the Trustees, in
each case, cast in person at a meeting called for that purpose.
The Underwriting Agreement may be terminated, without penalty, on 60 days'
written notice by the Board of Trustees or by a vote of a majority of
outstanding shares. The Underwriting Agreement will terminate automatically upon
its assignment.
From time to time, if, in EKD's judgment, it could benefit the sales of
Fund shares, EKD may provide to selected broker-dealers promotional materials
and selling aids, including, but not limited to, personal computers, related
software, and Fund data files.
- --------------------------------------------------------------------------------
SUB-ADMINISTRATOR
- --------------------------------------------------------------------------------
BISYS provides personnel to serve as officers of the Fund, and provides
certain administrative services to the Fund pursuant to a sub-administrator
agreement. For its services under that agreement, BISYS receives from Keystone a
fee based on the aggregate average daily net assets of the Fund at a rate based
on the total assets of all mutual funds administered by BISYS for which FUNB
affiliates also serve as investment adviser. The sub-administrator fee is
calculated in accordance with the following schedule:
Aggregate Average Daily Net Assets Of Mutual Funds
Sub-Administrator Administered By BISYS For Which Any Affiliate Of
Fee FUNB Serves As Investment Adviser
________________________________________________________________________________
0.0100% on the first $7 billion
0.0075% on the next $3 billion
0.0050% on the next $15 billion
0.0040% on assets in excess of $25 billion
The total assets of the mutual funds for which FUNB affiliates also serve
as investment advisers were approximately $30.5 billion as of June 30, 1997.
- --------------------------------------------------------------------------------
EXPENSES
- --------------------------------------------------------------------------------
Investment Advisory Fee
For each of the Fund's last three fiscal years, the table below lists the
total dollar amounts paid by the Fund to Keystone for investment advisory
services rendered. For more information, see "Investment Adviser."
Percent of Fund's Fee Paid to
Average Net Assets Keystone under
represented by the Advisory
Fiscal Year Ended Keystone's Fee Agreement
- ------------------------- ---------------------- ---------------------
May 31, 1997 0.46% $7,788,033
May 31, 1996 0.46% $8,473,139
May 31, 1995 0.50% $6,037,504
Distribution Plan Expenses
For the fiscal year ended May 31, 1997, the Fund paid $16,641,755 to EKD or
EKIS under its Distribution Plan. For more information, see "Distribution Plan."
Underwriting Commissions
For each of the Fund's last three fiscal years, the table below lists the
aggregate dollar amounts of underwriting commissions (distribution fees, plus
CDSCs) paid to EKD or EKIS with respect to the public distribution of the Fund's
shares. The table also indicates the aggregate dollar amount of underwriting
commissions retained by EKD or EKIS. For more information, see "Principal
Underwriter" and "Sales Charges."
<TABLE>
<CAPTION>
<S> <C> <C>
Aggregate Dollar Amount of
Aggregate Dollar Amount of Underwriting Commissions
Fiscal Year Ended Underwriting Commissions Paid Retained
- -------------------------- ---------------------------------------- ---------------------------
May 31, 1997 $17,885,604 $13,187,854
May 31, 1996 $15,690,812 ($5,933,719)
May 31, 1995 $10,076,379 $2,257,795
</TABLE>
Nomura Securities Co., Ltd. ("Nomura"), located at 1-9-1 Nihonbashi Tohri,
Chuo-ku, Tokyo, Japan, acts as an underwriter of the Fund's shares offered for
sale in Japan. Kokusai Securities Co., Ltd.("Kokusai"), located at Shinjuku
Nomura Building, 26-2 Hishishinjuku 1-Chrone, Shinjuku, Japan, acts as a
co-underwriter of the Fund's shares offered for sale in Japan. For the fiscal
year ended May 31, 1997, Nomura and Kokusai received service fees in the amounts
of $ 155,465 and $324,080, respectively. For the fiscal year ended May 31, 1996,
Nomura and Kokusai received service fees in the amounts of $97,894 and $516,864,
respectively. For the fiscal year ended May 31, 1995, Nomura and Kokusai
received service fees in the amounts of $71,026 and $371,638, respectively.
Brokerage Commissions
Fiscal Year Ended Brokerage Commissions Paid
- ------------------------- --------------------------------------
May 31, 1997 $1,891,397
May 31, 1996 $2,853,950
May 31, 1995 $1,445,066
STANDARDIZED TOTAL RETURN AND YIELD QUOTATIONS
Total return quotations for the Fund as they may appear, from time to time,
in advertisements are calculated by finding the average annual compounded rates
of return over one, five, and ten year periods on a hypothetical $1,000
investment that would equate the initial amount invested to the ending
redeemable value. To the initial investment, all dividends and distributions are
added, and all recurring fees charged to all shareholder accounts are deducted.
The ending redeemable value assumes a complete redemption at the end of the one,
five or ten year periods.
The cumulative total returns of the Fund for the one, five and ten year
periods ended May 31, 1997 were -11.06% (including CDSCs), 106.86%, and 208.05%,
respectively. The compounded average annual rates of return for the one, five,
and ten year periods ended May 31, 1997 were -11.06% (including CDSCs), 15.63%
and 11.91%, respectively.
Current yield quotations as they may appear, from time to time, in
advertisements will consist of a quotation based on a 30-day period ended on the
date of the most recent balance sheet of the Fund, computed by dividing the net
investment income per share earned during the period by the maximum offering
price per share on the last day of the base period. The Fund presently does not
intend to advertise current yield.
Any given total return or current yield quotations should not be considered
representative of the Fund's total return or current yield for any future
period.
- --------------------------------------------------------------------------------
FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
The following financial statements of the Fund are incorporated by
reference herein from the Fund's Annual Report, as filed with the SEC:
Schedule of Investments as of May 31, 1997;
Financial Highlights for each of the years in the ten-year period ended May
31, 1997;
Statement of Assets and Liabilities as of May 31, 1997;
Statement of Operations for the year ended May 31, 1997;
Statements of Changes in Net Assets for each of the years in the two-year
period ended May 31, 1997;
Notes to Financial Statements; and
Independent Auditors' Report dated June 27, 1997.
A copy of the Fund's Annual Report will be furnished upon request and
without charge. Requests may be made in writing to EKSC, P.O. Box 2121, Boston,
Massachusetts 02106-2121, or by calling EKSC toll free at 1-800-343-2898.
- --------------------------------------------------------------------------------
ADDITIONAL INFORMATION
- --------------------------------------------------------------------------------
To the best of the Fund's knowledge, as of June 30, 1997, the following
were the only shareholders of record who owned 5% or more the Fund's outstanding
shares:
As of June 30, 1997, Merrill Lynch Pierce Fenner & Smith, Attn: Book Entry,
4800 Deer Lake Dr. E 3rd Floor, Jacksonville, FL 32246-6484, owned of record
10.03% of the Fund's outstanding shares.
As of June 30, 1997, Rofe & Co., c/o State Street Bank & Trust Company, Sub
Account Kokusai Securities Co., Ltd., P.O. Box 5061, Boston, MA 02206-0001 owned
of record 7.15% of the Fund's outstanding shares.
Except as otherwise stated in its prospectus or required by law, the Fund
reserves the right to change the terms of the offer stated in its prospectus
without shareholder approval, including the right to impose or change fees for
services provided.
If conditions arise that would make it undesirable for the Fund to pay for
all redemptions in cash, the Fund may authorize payment to be made in portfolio
securities or other property. The Fund has obligated itself, however, under the
1940 Act, to redeem for cash all shares presented for redemption by any one
shareholder up to the lesser of $250,000 or 1.00% of the Fund's net assets in
any 90-day period. Securities delivered in payment of redemptions would be
valued at the same value assigned to them in computing the net asset value per
share and would, to the extent permitted by law, be readily marketable.
Shareholders receiving such securities would incur brokerage costs upon the sale
of securities.
No dealer, salesman or other person is authorized to give any information
or to make any representation not contained in the Fund's prospectus, this SAI
or in supplemental sales literature issued by the Fund or EKD, and no person is
entitled to rely on any information or representation not contained therein.
The Fund's prospectus and this SAI omit certain information contained in
the registration statement filed with the SEC, which may be obtained from the
SEC's principal office in Washington, D.C. upon payment of the fee prescribed by
the rules and regulations promulgated by the SEC.
APPENDIX
COMMON AND PREFERRED STOCK RATINGS
S&P's Earnings and Dividend Rankings for Common Stocks
Because the investment process involves assessment of various factors, such
as product and industry position, corporate resources and financial policy, with
results that make some common stocks more highly esteemed than others, Standard
& Poor's Ratings Group ("S&P") believes that earnings and dividend performance
is the end result of the interplay of these factors and that, over the long run,
the record of this performance has a considerable bearing on relative quality.
S&P rankings, however, do not reflect all of the factors, tangible or
intangible, that bear on stock quality.
Growth and stability of earnings and dividends are deemed key elements in
establishing S&P earnings and dividend rankings for common stocks, which
capsulize the nature of this record in a single symbol.
S&P has established a computerized scoring system based on per share
earnings and dividend records of the most recent ten years, a period deemed long
enough to measure a company's performance under varying economic conditions. S&P
measures growth, stability within the trend line and cyclicity. The ranking
system also makes allowances for company size, since large companies have
certain inherent advantages over small ones. From these, scores for earnings and
dividends are determined.
The final score for each stock is measured against a scoring matrix
determined by analysis of the scores of a large and representative sample which
is reviewed and sometimes modified with the following ladder of rankings:
A+ Highest B+ Average C Lowest
A High B Below Average D In Reorganization
A- Above Average B- Lower
S&P believes its rankings are not a forecast of future market price
performance, but are basically an appraisal of past performance of earnings and
dividends, and relative current standing.
Moody's Common Stock Rankings
Moody's Investor's Service ("Moody's")presents a concise statement of the
important char acteristics of a company and an evaluation of the grade (quality)
of its common stock. Data presented includes: (a) capsule stock information
which reveals short and long-term growth and yield afforded by the indicated
dividend, based on a recent price; (b) a long-term price chart which shows
patterns of monthly stock price movements and monthly trading volumes; (c) a
breakdown of a company's capital account which aids in determining the degree of
conservatism or financial leverage in a company's balance sheet; (d) interim
earnings for the current year to date, plus three previous years; (e) dividend
information; (f) company background; (g) recent corporate developments; (h)
prospects for a company in the immediate future and the next few years; and (i)
a ten year comparative statistical analysis.
This information provides investors with information on what a company
does, how it has performed in the past, how it is performing currently and what
its future performance prospects appear to be.
These characteristics are then evaluated and result in a grading, or
indication of quality. The grade is based on an analysis of each company's
financial strength, stability of earnings and record of dividend payments. Other
considerations include conservativeness of capitalization, depth and caliber of
management, accounting practices, technological capabilities and industry
position. Evaluation is represented by the following grades:
(1) High Grade
(2) Investment Grade
(3) Medium Grade
(4) Speculative Grade
Moody's Preferred Stock Ratings
Preferred stock ratings and their definitions are as follows:
1. aaa: An issue which is rated "aaa" is considered to be a top-quality
preferred stock. This rating indicates good asset protection and the least risk
of dividend impairment within the universe of preferred stocks.
2. aa: An issue which is rated "aa" is considered a high-grade preferred
stock. This rating indicates that there is a reasonable assurance that earnings
and asset protection will remain relatively well maintained in the foreseeable
future.
3. a: An issue which is rated "a" is considered to be an upper-medium grade
preferred stock. While risks are judged to be somewhat greater then in the "aaa"
and "aa" classification, earnings and asset protection are, nevertheless,
expected to be maintained at adequate levels.
4. baa: An issue which is rated "baa" is considered to be a medium-grade
preferred stock, neither highly protected nor poorly secured. Earnings and asset
protection appear adequate at present but may be questionable over any great
length of time.
5. ba: An issue which is rated "ba" is considered to have speculative
elements and its future cannot be considered well assured. Earnings and asset
protection may be very moderate and not well safeguarded during adverse periods.
Uncertainty of position characterizes preferred stocks in this class.
6. b: An issue which is rated "b" generally lacks the characteristics of a
desirable investment. Assurance of dividend payments and maintenance of other
terms of the issue over any long period of time may be small.
7. caa: An issue which is rated "caa" is likely to be in arrears on
dividend payments. This rating designation does not purport to indicate the
future status of payments.
8. ca: An issue which is rated "ca" is speculative in a high degree and is
likely to be in arrears on dividends with little likelihood of eventual
payments.
9. c: This is the lowest rated class of preferred or preference stock.
Issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
Moody's applies numerical modifiers 1, 2 and 3 in each rating
classification: the modifier 1 indicates that the security ranks in the higher
end of its generic rating category, the modifier 2 indicates a mid-range ranking
and the modifier 3 indicates that the issue ranks in the lower end of its
generic rating category.
CORPORATE BOND RATINGS
S&P Corporate Bond Ratings
An S&P corporate bond rating is a current assessment of the
creditworthiness of an obligor, including obligors outside the United States,
with respect to a specific obligation. This assessment may take into
consideration obligors such as guarantors, insurers, or lessees. Ratings of
foreign obligors do not take into account currency exchange and related
uncertainties. The ratings are based on current information furnished by the
issuer or obtained by S&P from other sources it considers reliable.
The ratings are based, in varying degrees, on the following considerations:
a. Likelihood of default-capacity and willingness of the obligor as to
the timely payment of interest and repayment of principal in accordance with the
terms of the obligation;
b. Nature of and provisions of the obligation; and
c. 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.
PLUS (+) OR MINUS (-): To provide more detailed indications of credit
quality, ratings from "AA" to "A" may be modified by the addition of a plus or
minus sign to show relative standing within the major rating categories.
Bond ratings are as follows:
1. AAA - Debt rated AAA has the highest rating assigned by S&P. Capacity to
pay interest and repay principal is extremely strong.
2. AA - Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from the higher rated issues only in small degree.
3. A - Debt rated A has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher rated
categories.
4. BBB - Debt rated BBB is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
5. BB, B, CCC, CC and C - Debt rated BB, B, CCC, CC and C is regarded, on
balance, as predominantly speculative with respect to capacity to pay interest
and repay principal in accordance with the terms of the obligation. BB
indicates the lowest degree of speculation and C the highest degree of
speculation. While such debt will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or major risk
exposures to adverse conditions.
Moody's ratings are as follows:
1. Aaa - Bonds which are rated Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally referred to
as "gilt-edge." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of such issues.
2. Aa - Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise
what are generally known as high grade bonds. They are rated lower than the
best bonds because margins of protection may not be as large as in Aaa
securities or fluctuation of protective elements may be of greater amplitude or
there may be other elements present which make the long term risks appear
somewhat larger than in Aaa securities.
3. A - Bonds which are rated A possess many favorable investment attributes
and are to be considered as upper medium grade obligations. Factors giving
security to principal and interest are considered adequate but elements may be
present which suggest a susceptibility to impairment sometime in the future.
4. Baa - Bonds which are rated Baa are considered as medium grade
obligations, i.e., they are neither highly protected nor poorly secured.
Interest payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
5. Ba - Bonds which are rated Ba are judged to have speculative elements.
Their future cannot be considered as well assured. Often the protection of
interest and principal payments may be very moderate and thereby not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
6. B - Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time may be
small.
Moody's applies numerical modifiers 1, 2 and 3 in each generic rating
classification from Aa through B in its corporate bond rating system. The
modifier 1 indicates that the security ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking; and the modifier
3 indicates that the issue ranks in the lower end of its generic rating
category.
MONEY MARKET INSTRUMENTS
The Fund's investments in commercial paper are limited to those rated A-1
by S&P, Prime-1 by Moody's or F-1 by Fitch Investors Service L.P. ("Fitch").
These ratings and other money market instruments are described as follows:
Commercial Paper Ratings
Commercial paper rated A-1 by S&P's has the following characteristics:
Liquidity ratios are adequate to meet cash requirements. The issuer's long-term
senior debt is rated "A" or better, although in some cases "BBB" credits may be
allowed. The issuer has access to at least two additional channels of borrowing.
Basic earnings and cash flow have an upward trend with allowance made for
unusual circumstances. Typically, the issuer's industry is well established and
the issuer has a strong position within the industry.
The rating Prime-1 is the highest commercial paper rating assigned by
Moody's. Among the factors considered by Moody's in assigning ratings are the
following: (1) evaluation of the management of the issuer; (2) economic
evaluation of the issuer's industry or industries and an appraisal of
speculative- type risks which may be inherent in certain areas; (3) evaluation
of the issuer's products in relation to competition and customer acceptance; (4)
liquidity; (5) amount and quality of long-term debt; (6) trend of earnings over
a period of ten years; (7) financial strength of a parent company and the
relationships which exist with the issuer; and (8) recognition by the management
of obligations which may be present or may arise as a result of public
preparations to meet such obligations. Relative strength or weakness of the
above factors determines how the issuer's commercial paper is rated within
various categories.
The rating F-1 is the highest rating assigned by Fitch. Among the factors
considered by Fitch in assigning this rating are: (1) the issuer's liquidity;
(2) its standing in the industry; (3) the size of its debt; (4) its ability to
service its debt; (5) its profitability; (6) its return on equity; (7) its
alternative sources of financing; and (8) its ability to access the capital
markets. Analysis of the relative strength or weakness of these factors and
others determines whether an issuer's commercial paper is rated F-1.
United States Government Securities
Securities issued or guaranteed by the United States government include a
variety of Treasury securities that differ only in their interest rates,
maturities and dates of issuance. Treasury bills have maturities of one year or
less. Treasury notes have maturities of one to ten years and Treasury bonds
generally have maturities of greater than ten years at the date of issuance.
Securities issued or guaranteed by the United States government or its
agencies or instrumentalities include direct obligations of the United States
Treasury and securities issued or guaranteed by the Federal Housing
Administration, Farmers Home Administration, Export-Import Bank of the United
States, Small Business Administration, Government National Mortgage Association,
General Services Administration, Central Bank for Cooperatives, Federal Home
Loan Banks, Federal Loan Mortgage Corporation, Federal Intermediate Credit
Banks, Federal Land Banks, Maritime Administration, The Tennessee Valley
Authority, District of Columbia Armory Board and Federal National Mortgage
Association.
Some obligations of United States government agencies and
instrumentalities, such as Treasury bills and Government National Mortgage
Association pass-through certificates, are supported by the full faith and
credit of the United States; others, such as securities of Federal Home Loan
Banks, by the right of the issuer to borrow from the Treasury; still others,
such as bonds issued by the Federal National Mortgage Association, a private
corporation, are supported only by the credit of the instrumentality. Because
the United States government is not obligated by law to provide support to an
instrumentality it sponsors, the Fund will invest in the securities issued by
such an instrumentality only when Keystone determines that the credit risk with
respect to the instrumentality does not make its securities unsuitable
investments. United States government securities will not include international
agencies or instrumental-ities in which the United States government, its
agencies or instrumentalities participate, such as the World Bank, the Asian
Development Bank or the Inter-American Development Bank, or issues insured by
the Federal Deposit Insurance Corporation.
OPTIONS TRANSACTIONS
The Fund is authorized to write (i.e., sell) covered call options and to
purchase call options to close out covered call options previously written. A
call option obligates a writer to sell, and gives a purchaser the right to buy,
the underlying security at the stated exercise price at any time until the
stated expiration date.
The Fund will only write call options which are covered, which means that
the Fund will own the underlying security (or other securities, such as
convertible securities, which are acceptable for escrow) when it writes the call
option and until the Fund's obligation to sell the underlying security is
extinguished by exercise or expiration of the call option or the purchase of a
call option covering the same underlying security and having the same exercise
price and expiration date. The Fund will receive a premium for writing a call
option, but will give up, until the expiration date, the opportunity to profit
from an increase in the underlying security's price above the exercise price.
The Fund will retain the risk of loss from a decrease in the price of the
underlying security. The writing of covered call options is a conservative
investment technique believed to involve relatively little risk (in contrast to
the writing of naked options which the Fund will not do) but capable of
enhancing the Fund's total returns.
The premium received by the Fund for writing a covered call option will be
recorded as a liability in the Fund's statement of assets and liabilities. This
liability will be adjusted daily to the option's current market value, which
will be the latest sale price at the time as of which the net asset value per
share of the Fund is computed (the close of the New York Stock Exchange), or, in
the absence of such sale, at the latest bid quotation. The liability will be
extinguished upon expiration of the option, the purchase of an identical option
in a closing transaction or delivery of the underlying security upon exercise of
the option.
Many options are traded on registered securities exchanges. Options traded
on such exchanges are issued by the Options Clearing Corporation ("OCC"),a
clearing corporation which assumes responsi bility for the completion of options
transactions.
The Fund will purchase call options only to close out a covered call option
it has written. When it appears that a covered call option written by the Fund
is likely to be exercised, the Fund may consider it appropriate to avoid having
to sell the underlying security. Or, the Fund may wish to extinguish a covered
call option which it has written in order to be free to sell the underlying
security to realize a profit on the previously written call option or to write
another covered call option on the underlying security. In all such instances,
the Fund can close out the previously written call option by purchasing a call
option on the same underlying security with the same exercise price and
expiration date. (The Fund may, under certain circumstances, also be able to
transfer a previously written call option.) The Fund will realize a short-term
capital gain if the amount paid to purchase the call option plus transaction
costs is less than the premium received for writing the covered call option.
The Fund will realize a short-term capital loss if the amount paid to purchase
the call option plus transaction costs is greater than the premium received for
writing the covered call option.
A previously written call option can be closed out by purchasing an
identical call option only in a secondary market for the call option. Although
the Fund will generally write only those options for which there appears to be
an active secondary market, there is no assurance that a liquid secondary market
will exist for any particular option at any particular time, and for some
options no secondary market may exist. In such event it might not be possible to
effect a closing transaction in a particular option. If the Fund as a covered
call option writer is unable to effect a closing purchase transaction, it will
not be able to sell the underlying securities until the option expires or it
delivers the underlying securities upon exercise.
If a substantial number of the call options written by the Fund are
exercised, the Fund's rate of portfolio turnover may exceed historical levels.
This would result in higher transaction costs, including brokerage commissions.
The Fund will pay brokerage commissions in connection with the writing of
covered call options and the purchase of call options to close out previously
written options. Such brokerage commissions are normally higher than those
applicable to purchases and sales of portfolio securities.
In the past the Fund has qualified for, and elected to receive, the special
tax treatment afforded regulated investment companies under Subchapter M of the
Internal Revenue Code of 1986, as amended. Although the Fund intends to continue
to qualify for such tax treatment, in order to do so it must, among other
things, derive less than 30% of its gross income from gains from the sale or
other disposition of securities held for less than three months. Because of
this, the Fund may be restricted in the writing of call options where the
underlying securities have been held less than three months, in the writing of
covered call options which expire in less than three months, and in effecting
closing purchases with respect to options which were written less than three
months earlier. As a result, the Fund may elect to forego otherwise favorable
investment opportunities and may elect to avoid or delay effecting closing
purchases or selling portfolio securities, with the risk that a potential loss
may be increased or a potential gain may be reduced or turned into a loss.
Under the Internal Revenue Code of 1954, as amended, gain or loss
attributable to a closing transaction and premiums received by the Fund for
writing a covered call option which is not exercised may constitute short-term
capital gain or loss. Under provisions of the Tax Reform Act of 1986, effective
for taxable years beginning after October 22, 1986, a gain on an option
transaction which qualifies as a "designated hedge" transaction under Treasury
regulations may be offset by realized or unrealized losses on such designated
transaction. The netting of gain against such losses could result in a reduction
in gross income from options transactions for purposes of the 30 percent test.
FUTURES CONTRACTS AND RELATED OPTIONS TRANSACTIONS
The Fund intends to enter into currency and other financial futures
contracts as a hedge against changes in prevailing levels of interest or
currency exchange rates to seek relative stability of principal and to establish
more definitely the effective return on securities held or intended to be
acquired by the Fund or as a hedge against changes in the prices of securities
or currencies held by the Fund or to be acquired by the Fund. The Fund's hedging
may include sales of futures as an offset against the effect of expected
increases in interest or currency exchange rates or securities prices and
purchases of futures as an offset against the effect of expected declines in
interest or currency exchange rates.
For example, when the Fund anticipates a significant market or market
sector advance, it will purchase a stock index futures contract as a hedge
against not participating in such advance at a time when the Fund is not fully
invested. The purchase of a futures contract serves as a temporary substitute
for the purchase of individual securities which may then be purchased in an
orderly fashion. As such purchases are made, an equivalent amount of index based
futures contracts would be terminated by offsetting sales. In contrast, the Fund
would sell stock index futures contracts in anticipation of or in a general
market or market sector decline that may adversely affect the market value of
the Fund's portfolio. To the extent that the Fund's portfolio changes in value
in correlation with a given index, the sale of futures contracts on that index
would substantially reduce the risk to the portfolio of a market decline or
change in interest rates, and, by doing so, provide an alternative to the
liquidation of the Fund's securities positions and the resulting transaction
costs.
The Fund intends to engage in options transactions which are related to
currency or other financial futures contracts for the hedging purposes and in
connection with the hedging strategies described above.
Although techniques other than sales and purchases of futures contracts and
related options transactions could be used to reduce the Fund's exposure to
interest rate and/or market fluctuations, the Fund may be able to hedge its
exposure more effectively and perhaps at a lower cost through using futures
contracts and related options transactions. While the Fund does not intend to
take delivery of the instruments underlying futures contracts it holds, the Fund
does not intend to engage in such futures contracts for speculation.
Futures Contracts
Futures contracts are transactions in the commodities markets rather than
in the securities markets. A futures contract creates an obligation by the
seller to deliver to the buyer the commodity specified in the contract at a
specified future time for a specified price. The futures contract creates an
obligation by the buyer to accept delivery from the seller of the commodity
specified at the specified future time for the specified price. In contrast, a
spot transaction creates an immediate obligation for the seller to deliver and
the buyer to accept delivery of and pay for an identified commodity. In general,
futures contracts involve transactions in fungible goods such as wheat, coffee
and soybeans. However, in the last decade an increasing number of futures
contracts have been developed which specify currencies, financial instruments or
financially based indexes as the underlying commodity.
U.S. futures contracts are traded only on national futures exchanges and
are standardized as to maturity date and underlying financial instrument. The
principal financial futures exchanges in the United States are The Board of
Trade of the City of Chicago, the Chicago Mercantile Exchange, the International
Monetary Market (a division of the Chicago Mercantile Exchange), the New York
Futures Exchange and the Kansas City Board of Trade. Each exchange guarantees
performance under contract provisions through a clearing corporation, a
nonprofit organization managed by the exchange membership, which is also
responsible for handling daily accounting of deposits or withdrawals of margin.
A futures commission merchant ("Broker") effects each transaction in connection
with futures contracts for a commission. Futures exchanges and trading are
regulated under the Commodity Exchange Act by the Commodity Futures Trading
Commission ("CFTC") and National Futures Association ("NFA").
Interest Rate Futures Contracts
The sale of an interest rate futures contract creates an obligation by the
Fund, as seller, to deliver the type of financial instrument specified in the
contract at a specified future time for a specified price. The purchase of an
interest rate futures contract creates an obligation by the Fund, as purchaser,
to accept delivery of the type of financial instrument specified at a specified
future time for a specified price. The specific securities delivered or
accepted, respectively, at settlement date, are not determined until at or near
that date. The determination is in accordance with the rules of the exchange on
which the futures contract sale or purchase was made.
Currently, interest rate futures contracts can be purchased or sold on
90-day U.S. Treasury bills, U.S. Treasury bonds, U.S. Treasury notes with
maturities between 6 1/2 and 10 years, Government National Mortgage Association
("GNMA") certificates, 90-day domestic bank certificates of deposit, 90-day
commercial paper, and 90-day Eurodollar certificates of deposit. It is expected
that futures contracts trading in additional financial instruments will be
authorized. The standard contract size is $100,000 for futures contracts in U.S.
Treasury bonds, U.S. Treasury notes and GNMA certificates, and $1,000,000 for
the other designated contracts. While U.S. Treasury bonds, U.S. Treasury bills
and U.S. Treasury notes are backed by the full faith and credit of the U.S.
government and GNMA certificates are guaranteed by a U.S. government agency, the
futures contracts in U.S. government securities are not obligations of the U.S.
Treasury.
Index Based Futures Contracts
a. Stock Index Futures Contracts
A stock index assigns relative values to the common stocks included in the
index. The index fluctuates with changes in the market values of the common
stocks so included. A stock index futures contract is a bilateral agreement by
which two parties agree to take or make delivery of an amount of cash equal to a
specified dollar amount times the difference between the closing value of the
stock index on the expiration date of the contract and the price at which the
futures contract is originally made. No physical delivery of the underlying
stocks in the index is made.
Currently, stock index futures contracts can be purchased or sold on the
Standard and Poor's Corporation (S&P) Index of 500 Stocks, the S&P Index of 100
Stocks, the New York Stock Exchange Composite Index, the Value Line Index and
the Major Market Index. It is expected that futures contracts trading in
additional stock indices will be authorized. The standard contract size is $500
times the value of the index.
The Fund does not believe that differences between existing stock indices
will create any differences in the price movements of the stock index futures
contracts in relation to the movements in such indices. However, such
differences in the indices may result in differences in correlation of the
futures with movements in the value of the securities being hedged.
b. Other Index Based Futures Contracts
It is expected that bond index and other financially based index futures
contracts will be developed in the future. It is anticipated that such index
based futures contracts will be structured in the same way as stock index
futures contracts but will be measured by changes in interest rates, related
indexes or other measures, such as the consumer price index. In the event that
such futures contracts are developed the Fund will sell interest rate index and
other index based futures contracts to hedge against changes which are expected
to affect the Fund's portfolio.
The purchase or sale of a futures contract differs from the purchase or
sale of a security, in that no price or premium is paid or received. Instead, to
initiate trading an amount of cash, cash equivalents, money market instruments,
or U.S. Treasury bills equal to approximately 1 1/2% (up to 5%) of the contract
amount must be deposited by the Fund with the Broker. This amount is known as
initial margin. The nature of initial margin in futures transactions is
different from that of margin in security transactions. Futures contract margin
does not involve the borrowing of funds by the customer to finance the
transactions. Rather, the initial margin is in the nature of a performance bond
or good faith deposit on the contract which is returned to the Fund upon
termination of the futures contract assuming all contractual obligations have
been satisfied. The margin required for a particular futures contract is set by
the exchange on which the contract is traded, and may be significantly modified
from time to time by the exchange during the term of the contract.
Subsequent payments, called variation margin, to the Broker and from the
Broker, are made on a daily basis as the value of the underlying instrument or
index fluctuates, making the long and short positions in the futures contract
more or less valuable, a process known as mark-to-market. For example, when the
Fund has purchased a futures contract and the price of the underlying financial
instrument or index has risen, that position will have increased in value and
the Fund will receive from the Broker a variation margin payment equal to that
increase in value. Conversely, where the Fund has purchased a futures contract
and the price of the underlying financial instrument or index has declined, the
position would be less valuable and the Fund would be required to make a
variation margin payment to the Broker. At any time prior to expiration of the
futures contract, the Fund may elect to close the position. A final
determination of variation margin is then made, additional cash is required to
be paid to or released by the Broker, and the Fund realizes a loss or gain.
The Fund intends to enter into arrangements with its custodian and with
Brokers to enable its initial margin and any variation margin to be held in a
segregated account by its custodian on behalf of the Broker.
Although interest rate futures contracts by their terms call for actual
delivery or acceptance of financial instruments and index based futures
contracts call for the delivery of cash equal to the difference between the
closing value of the index on the expiration date of the contract and the price
at which the futures contract is originally made, in most cases such futures
contracts are closed out before the settlement date without the making or taking
of delivery. Closing out a futures contract sale is effected by an offsetting
transaction in which the Fund enters into a futures contract purchase for the
same aggregate amount of the specific type of financial instrument or index and
same delivery date. If the price in the sale exceeds the price in the offsetting
purchase, the Fund is paid the difference and thus realizes a gain. If the
offsetting purchase price exceeds the sale price, the Fund pays the difference
and realizes a loss. Similarly, the closing out of a futures contract purchase
is effected by an offsetting transaction in which the Fund enters into a futures
contract sale. If the offsetting sale price exceeds the purchase price, the Fund
realizes a gain. If the purchase price exceeds the offsetting sale price the
Fund realizes a loss. The amount of the Fund's gain or loss on any transaction
is reduced or increased, respectively, by the amount of any transaction costs
incurred by the Fund.
As an example of an offsetting transaction, the contractual obligations
arising from the sale of one contract of September U.S. Treasury bills on an
exchange may be fulfilled at any time before delivery of the contract is
required (i.e. on a specified date in September, the "delivery month") by the
purchase of one contract of September U.S. Treasury bills on the same exchange.
In such instance the difference between the price at which the futures contract
was sold and the price paid for the offsetting purchase after allowance for
transaction costs, represents the profit or loss to the Fund.
There can be no assurance, however, that the Fund will be able to enter
into an offsetting transaction with respect to a particular contract at a
particular time. If the Fund is not able to enter into an offsetting
transaction, the Fund will continue to be required to maintain the margin
deposits on the contract and to complete the contract according to its terms.
Options on Currency and Other Financial Futures
The Fund intends to purchase call and put options on currency and other
financial futures contracts and sell such options to terminate an existing
position. Options on currency or other financial futures contracts are similar
to options on stocks except that an option on a currency financial futures
contract gives the purchaser the right, in return for the premium paid, to
assume a position in a futures contract (a long position if the option is a call
and a short position if the option is a put) rather than to purchase or sell
currency or other instruments making up a financial futures index, at a
specified exercise price at any time during the period of the option. Upon
exercise of the option, the delivery of the futures position by the writer of
the option to the holder of the option will be accompanied by delivery of the
accumulated balance in the writer's futures margin account. This amount
represents the amount by which the market price of the futures contract at
exercise exceeds, in the case of a call, or is less than, in the case of a put,
the exercise price of the option on the futures contract. If an option is
exercised on the last trading day prior to the expiration date of the option,
the settlement will be made entirely in cash equal to the difference between the
exercise price of the option and value of the futures contract.
The Fund intends to use options on currency or other financial futures
contracts in connection with hedging strategies. In the future the Fund may use
such options for other purposes.
Purchase of Put Options on Futures Contracts
The purchase of protective put options on currency or other financial
futures contracts is analagous to the purchase of protective puts on individual
stocks, where an absolute level of protection is sought below which no
additional economic loss would be incurred by the Fund. Put options may be
purchased to hedge a portfolio of stocks or debt instruments or a position in
the futures contract upon which the put option is based.
Purchase of Call Options on Futures Contracts
The purchase of a call option on a currency or other financial futures
contract represents a means of obtaining temporary exposure to market
appreciation at limited risk. It is analogous to the purchase of a call option
on an individual stock, which can be used as a substitute for a position in the
stock itself. Depending on the pricing of the option compared to either the
futures contract upon which it is based, or upon the price of the underlying
financial instrument or index itself, purchase of a call option may be less
risky than the ownership of the interest rate or index based futures contract or
the underlying securities. Call options on futures contracts may be purchased to
hedge against an interest rate increase or a market advance when the Fund is not
fully invested.
Use of New Investment Techniques Involving Currency and Other Financial
Futures Contracts or Related Options
The Fund may employ new investment techniques involving currency and other
financial futures contracts and related options. The Fund intends to take
advantage of new techniques in these areas which may be developed from time to
time and which are consistent with the Fund's investment objective. The Fund
believes that no additional techniques have been identified for employment by
the Fund in the foreseeable future other than those described herein.
Limitations on Purchase and Sale of Futures Contracts and Related Options
on Such Futures Contracts
The Fund will not enter into a futures contract if, as a result thereof,
more than 5% of the Fund's total assets (taken at market value at the time of
entering into the contract) would be committed to margin deposits on such
futures contracts.
The Fund intends that its futures contracts and related options
transactions will be entered into for traditional hedging purposes. That is,
futures contracts will be sold to protect against a decline in the price of
securities that the Fund owns, or futures contracts will be purchased to protect
the Fund against an increase in the price of securities it intends to purchase.
The Fund does not intend to enter into futures contracts for speculation.
FOREIGN CURRENCY TRANSACTIONS
As discussed above, the Fund may invest in securities of foreign issuers.
When the Fund invests in foreign securities they usually will be denominated in
foreign currencies and the Fund temporarily may hold funds in foreign
currencies. Thus, the Fund's share value will be affected by changes in exchange
rates.
Forward Currency Contracts
As one way of managing exchange rate risk, the Fund may engage in forward
currency exchange contracts (agreements to purchase or sell currencies at a
specified price and date). Under the contract, the exchange rate for the
transaction (the amount of currency the Fund will deliver or receive when the
contract is completed) is fixed when the Fund enters into the contract. The Fund
usually will enter into these contracts to stabilize the U.S. dollar value of a
security it has agreed to buy or sell. The Fund also may use these contracts to
hedge the U.S. dollar value of a security it already owns, particularly if the
Fund expects a decrease in the value of the currency in which the foreign
security is denominated. Although the Fund will attempt to benefit from using
forward contracts, the success of its hedging strategy will depend on Keystone's
ability to predict accurately the future exchange rate between foreign
currencies and the U.S. dollar. The value of the Fund's investments denominated
in foreign currencies will depend on the relative strength of those currencies
and the U.S. dollar, and the Fund may be affected favorably or unfavorably by
changes in the exchange rates or exchange control regulations between foreign
currencies and the dollar. Changes in foreign currency exchange rates also may
affect the value of dividends and interest earned, gains and losses realized on
the sale of securities and net investment income and gains, if any, to be
distributed to shareholders by the Fund.
Currency Futures Contracts
Currency futures contracts are bilateral agreements under which two parties
agree to take or make delivery of a specified amount of a currency at a
specified future time for a specified price. Trading of currency futures
contracts in the United States is regulated under the Commodity Exchange Act by
the CFTC and NFA. Currently the only national futures exchange on which currency
futures are traded is the International Monetary Market of the Chicago
Mercantile Exchange. Foreign currency futures trading is conducted in the same
manner and subject to the same regulations as trading in interest rate and index
based futures. The Fund intends to engage in currency futures contracts only for
hedging purposes, and not for speculation. The Fund may enter into currency
futures contracts for other purposes if authorized to do so by the Board. The
hedging strategies which will be used by the Fund in connection with foreign
currency futures contracts are similar to those described above for forward
foreign currency exchange contracts.
Currently, currency futures contracts for the British Pound Sterling,
Canadian Dollar, Dutch Guilder, Deutsche Mark, Japanese Yen, Mexican Peso, Swiss
Franc, and French Franc can be purchased or sold for U.S. dollars through the
International Monetary Market. It is expected that futures contracts trading in
additional currencies will be authorized. The standard contract sizes are
L125,000 for the Pound, 125,000 for the Guilder, Mark, French Francs and Swiss
Francs, C$100,000 for the Canadian Dollar, Y12,500,000 for the Yen, and
1,000,000 for the Peso. In contrast to forward currency exchange contracts which
can be traded at any time, only four value dates per year are available, the
third Wednesday of March, June, September and December.
Foreign Currency Options Transactions
Foreign currency options (as opposed to futures) are traded in a variety of
currencies in both the United States and Europe. On the Philadelphia Stock
Exchange, for example, contracts for half the size of the corresponding futures
contracts on the Chicago Board - Options Exchange are traded with up to nine
months maturity in marks, sterling, yen, Swiss francs, French francs and
Canadian dollars. Options can be exercised at any time during the contract life,
and require a deposit subject to normal margin requirements. Since a futures
contract must be exercised, the Fund must continually make up the margin
balance. As a result, a wrong price move could result in the Fund losing more
than the original investment, as it cannot walk away from the futures contract
as it can an option contract.
The Fund will purchase call and put options and sell such options to
terminate an existing position. Options on foreign currency are similar to
options on stocks except that an option on an interest rate and/or index based
futures contract gives the purchaser the right, in return for the premium paid,
to purchase or sell foreign currency, rather than to purchase or sell stock, at
a specified exercise price at any time during the period of the option.
The Fund intends to use foreign currency option transactions in connection
with hedging strategies.
Purchase of Put Options on Foreign Currencies
The purchase of protective put options on a foreign currency is analagous
to the purchase of protective puts on individual stocks, where an absolute level
of protection is sought below which no additional economic loss would be
incurred by the Fund. Put options may be purchased to hedge a portfolio of
foreign stocks or foreign debt instruments or a position in the foreign currency
upon which the put option is based.
Purchase of Call Options on Foreign Currencies
The purchase of a call option on foreign currency represents a means of
obtaining temporary exposure to market appreciation at limited risk. It is
analogous to the purchase of a call option on an individual stock, which can be
used as a substitute for a position in the stock itself. Depending on the
pricing of the option compared to either the foreign currency upon which it is
based, or upon the price of the foreign stock or foreign debt instruments,
purchase of a call option may be less risky than the ownership of the foreign
currency or the foreign securities. The Fund would purchase a call option on a
foreign currency to hedge against an increase in the foreign currency or a
foreign market advance when the Fund is not fully invested.
The Fund may employ new investment techniques involving forward foreign
currency exchange contracts, foreign currency futures contracts and options on
foreign currencies in order to take advantage of new techniques in these areas
which may be developed from time to time and which are consistent with the
Fund's investment objective. The Fund believes that no additional techniques
have been identified for employment by the Fund in the foreseeable future other
than those described above.
Currency Trading Risks
Currency exchange trading may involve significant risks. The four major
types of risk the Fund faces are exchange rate risk, interest rate risk, credit
risk and country risk.
Exchange Rate Risk
Exchange rate risk results from the movement up and down of foreign
currency values in response to shifting market supply and demand. When the Fund
buys or sells a foreign currency, an exposure called an open position is
created. Until the time that position can be "covered" by selling or buying an
equivalent amount of the same currency, the Fund is exposed to the risk that the
exchange rate might move against it. Since exchange rate changes can readily
move in one direction, a position carried overnight or over a number of days
involves greater risk than one carried a few minutes or hours. Techniques such
as foreign currency forward and futures contracts and options on foreign
currency are intended to be used by the Fund to reduce exchange rate risk.
Maturity Gaps and Interest Rate Risk
Interest rate risk arises whenever there are mismatches or gaps in the
maturity structure of the Fund's foreign exchange currency holdings, which is
the total of its outstanding spot and forward or futures contracts.
Foreign currency transactions often involve borrowing short term and
lending longer term to benefit from the normal tendency of interest rates to be
higher for longer maturities. However in foreign exchange trading, while the
maturity pattern of interest rates for one currency is important, it is the
differential between interest rates for two currencies that is decisive.
Credit Risk
Whenever the Fund enters into a foreign exchange contract, it faces a risk,
however small, that the counterparty will not perform under the contract. As a
result there is a credit risk, although no extension of "credit" is intended. To
limit credit risk, the Fund intends to evaluate the creditworthiness of each
other party. The Fund does not intend to trade more than 5% of its net assets
under foreign exchange contracts with one party.
Credit risk exists because the Fund's counterparty may be unable or
unwilling to fulfill its contractual obligations as a result of bankruptcy or
insolvency or when foreign exchange controls prohibit payment. In any foreign
exchange transaction, each party agrees to deliver a certain amount of currency
to the other on a particular date. In establishing its hedges a Fund relies on
each contract being completed. If the contract is not performed, then the Fund's
hedge is eliminated, and the Fund is exposed to any changes in exchange rates
since the contract was originated. To put itself in the same position it would
have been in had the contract been performed, the Fund must arrange a new
transaction. However, the new transaction may have to be arranged at an adverse
exchange rate. The trustee for a bankrupt company may elect to perform those
contracts which are advantageous to the company but disclaim those contracts
which are disadvantageous, resulting in losses to the Fund.
Another form of credit risk stems from the time zone difference between the
U.S. and foreign nations. If the Fund sells small sterling it generally must pay
pounds to a counterparty earlier in the day than it will be credited with
dollars in New York. In the intervening hours, the buyer can go into bankruptcy
or can be declared insolvent. Thus, the dollars may never be credited to the
Fund.
Country Risk
At one time or another, virtually every country has interfered with
international transactions in its currency. Interference has taken the form of
regulation of the local exchange market, restrictions on foreign investment by
residents, or limits on inflows of investment funds from abroad. Governments
take such measures for example to improve control over the domestic banking
system, or to influence the pattern of receipts and payments between residents
and foreigners. In those cases, restrictions on the exchange market or on
international transactions are intended to affect the level or movement of the
exchange rate. Occasionally a serious foreign exchange shortage may lead to
payments interruptions or debt servicing delays, as well as interference in the
exchange market. It has become increasingly difficult to distinguish foreign
exchange or credit risk from country risk.
Changes in regulations or restrictions usually do have an important
exchange market impact. Most disruptive are changes in rules which interfere
with the normal payments mechanism. If government regulations change and a
counterparty is either forbidden to perform or is required to do something
extra, then the Fund might be left with an unintended open position or an
unintended maturity mismatch. Dealing with such unintended long or short
positions could result in unanticipated costs to the Fund.
Other changes in official regulations influence international investment
transactions. If one of the factors affecting the buying or selling of a
currency changes, the exchange rate is likely to respond. Changes in such
controls often are unpredictable and can create a significant exchange rate
response.
Many major countries have moved toward liberalization of exchange and
payments restrictions in recent years, or accepted the principle that
restrictions should be relaxed. A few industrial countries have moved in the
other direction. Important liberal-izations were carried out by Switzerland, the
United Kingdom and Japan. They dismantled mechanisms for restricting either
foreign exchange inflows (Switzerland), outflows (Britain), or elements of both
(Japan). By contrast, France and Mexico have recently tightened foreign exchange
controls.
Overall, many exchange markets are still heavily restricted. Several
countries limit access to the forward market to companies financing documented
export or import transactions in an effort to insulate the market from purely
speculative activities. Some of these countries permit local traders to enter
into forward contracts with residents but prohibit certain forward transactions
with nonresidents. By comparison, other countries have strict controls on
exchange transactions by residents, but permit free exchange transactions
between local traders and non-residents. A few countries have established tiered
markets, funneling commercial transactions through one market and financial
transactions through another. Outside the major industrial countries, relatively
free foreign exchange markets are rare and control on foreign currency
transactions are extensive.
Another aspect of country risk has to do with the possibility that the Fund
may be dealing with a foreign trader whose home country is facing a payments
problem. Even though the foreign trader intends to perform on its foreign
exchange contracts, the contracts are tied to other external liabilities the
country has incurred. As a result performance may be delayed, and can result in
unanticipated cost to the Fund. This aspect of country risk is a major element
in the Fund's credit judgment as to with whom it will deal and in what amounts.
ADDITIONAL INFORMATION REGARDING DERIVATIVE INSTRUMENTS
Derivatives have been variously defined to include forwards, futures,
options, mortgage-backed securities, other asset-backed securities and
structured securities, such as interest rate swaps, equity swaps, index swaps,
currency swaps and caps and floors. These basic vehicles can also be combined to
create more complex products, called hybrid derivatives. Options, fututes and
forwards are discussed elsewhere in the Fund's prospectus and statement of
additional information. The following discussion addresses mortgage backed and
other asset-backed securities, structured securities and other instruments.
INTEREST-RATE SWAP CONTRACTS
Interest rate swaps are over-the-counter ("OTC") agreements between parties
and counterparties to make periodic payments to each other for a stated time,
generally entered into for the purpose of changing the nature or amount of
interest being received on debt securities held by one or both parties. The
calculation of these payments is based on an agreed-upon amount called the
"notional amount." The notional amount is not typically exchanged in swaps
(except in currency swaps). The periodic payments may be fixed or floating.
Floating payments change (positively or inversely) with fluctuations in interest
or currency rates or equity or commodity prices, depending on the swap
contract's terms.
Swaps may be used to hedge against adverse changes in interest rates, for
instance. Thus, if permitted by its investment policies, the Fund may have a
portfolio of debt instruments (ARM's, for instance) the floating interest rates
of which adjust frequently because they are tied positively to changes in market
interest rates. The Fund would then be exposed to interest rate risk because a
decline in interest rates would reduce the interest receipts on its portfolio.
If the investment adviser believed interest rates would decline, the Fund, if
permitted by its investment policies, could enter into an interest rate swap
with another financial institution to hedge the interest rate risk. In the swap
contract, the Fund would agree to make payments based on a floating interest
rate in exchange for receiving payments based on a fixed interest rate.
Thereafter, if interest rates declined, the Fund's fixed rate receipts on the
swap would offset the reduction in its portfolio receipts. If interest rates
rose, the higher rates the Fund could obtain from new portfolio investments
(assuming sale of existing investments) would offset the higher rates it paid
under the swap agreement.
EQUITY SWAP CONTRACTS
The counterparty to an equity swap contract would typically be a bank,
investment banking firm or broker/dealer. For example, the counterparty would
generally agree to pay the Fund the amount, if any, by which the notional amount
of the equity swap contract would have increased in value if such notional
amount had been invested in the stocks comprising the S&P 500 Index in
proportion to the composition of the Index, plus the dividends that would have
been received on those stocks. The Fund would agree to pay to the counterparty a
floating rate of interest (typically the London Inter Bank Offered Rate) on the
notional amount of the equity swap contract plus the amount, if any, by which
that notional amount would have decreased in value had it been invested in such
index stocks. Therefore, the return to the Fund on any equity swap contract
should be the gain or loss on the notional amount plus dividends on the stocks
comprising the S&P 500 Index less the interest paid by the Fund on the notional
amount. If permitted by its investment policies, the Fund will only enter into
equity swap contracts on a net basis, i.e., the two parties' obligations are
netted out, with the Fund paying or receiving, as the case may be, only the net
amount of any payments. Payments under equity swap contracts may be made at the
conclusion of the contract or periodically during its term.
If permitted by its investment policies, the Fund may also from time to
time enter into the opposite side of equity swap contracts (i.e., where the Fund
is obligated to pay the increase (net of interest) or received the decrease
(plus interest) on the contract) to reduce the amount of the Fund's equity
market exposure consistent with the Fund's investment objective(s) and policies.
These positions are sometimes referred to as "reverse equity swap contracts."
Equity swap contracts will not be used to leverage the Fund. Since the SEC
considers equity swap contracts and reverse equity swap contracts to be illiquid
securities, the Fund will not invest in equity swap contracts or reverse equity
swap contracts if the total value of such investments together with that of all
other illiquid securities that the Fund owns would exceed the Fund's limitations
on investments in illiquid securities.
The Fund does not believe that its obligations under equity swap contracts
or reverse equity swap contracts are senior securities and, accordingly, the
Fund will not treat them as being subject to its borrowing restrictions.
However, the net amount of the excess, if any, of the Fund's obligations over
its respective entitlement with respect to each equity swap contract and each
reverse equity swap contract will be accrued on a daily basis and an amount of
cash, U. S. Government Securities or other liquid high quality debt securities
having an aggregate market value at lease equal to the accrued excess will be
maintained in a segregated account by the Fund's Custodian.
CURRENCY SWAPS, INDEX SWAPS AND CAPS AND FLOORS
A currency swap is an agreement to exchange cash flows on a notional amount
of two or more currencies based on the relative value differential among them.
An index swap is an agreement to swap cash flows on a notional amount based on
changes in the values of reference indices. The purchase of an interest rate cap
entitles the purchaser, to the extent that a specified index exceeds an
agree-upon interest rate, to receive payments of interest on a notional
principal amount from the party selling such interest rate cap. The purchase of
an interest rate floor entitles the purchaser to receive payments of interest on
a notional principal amount from the party selling such interest rate floor. If
permitted by the Fund's investment policies, the investment adviser expects to
enter into these types of transactions on behalf of the Fund 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 rather than for speculative purposes.
Accordingly, if permitted by the Fund's investment policies, the Fund intends to
use these transactions as hedges and not as speculative investments and will not
sell interest rate caps or floors unless it owns securities or other instruments
providing the income stream the Fund may be obligated to pay. Caps and floors
require segregation of assets with a value equal to the Fund's net obligation,
if any.
SPECIAL RISKS OF SWAPS, CAPS AND FLOORS
As with futures, options, forward contracts, and mortgage backed and other
asset-backed securities, the use of swap, cap and floor contracts exposes the
Fund to additional investment risk and transaction costs. These risks include
operational risk, market risk and credit risk.
Operational risk includes, among others, the risks that the investment
adviser will incorrectly analyze market conditions or will not employ
appropriate strategies and monitoring with respect to these instruments or will
be forced to defer closing out certain hedged positions to avoid adverse tax
consequences.
Market risk includes, among others, the risks of imperfect correlations
between the expected values of the contracts, or their underlying bases, and
movements in the prices of the securities or currencies being hedged, and the
possible absence of a liquid secondary market for any particular instrument at
any time. 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 more illiquid. Nevertheless, a secondary market for swaps
is never assured, and caps and floors, which are more recent innovations for
which standardized documentation has not yet been fully developed, are much less
liquid than swaps.
Credit risk is primarily the risk that counterparties may be financially
unable to fulfill their contracts on a timely basis, if at all. If there is a
default by the counterparty to any such contract, the Fund will be limited to
contractual remedies pursuant to the agreements related to the transaction.
There is no assurance that contract counterparties will be able to meet contract
obligations or that, in the event of default, the Fund will succeed in pursuing
contractual remedies. The Fund thus assumes the risk that it may be delayed in
or prevented from obtaining payments owed to it pursuant to such contracts. The
Fund will closely monitor the credit of swap counterparties in order to minimize
this risk. The Fund will not enter into any equity swap contract or reverse
equity swap contract unless, at the time of entering into such transaction, the
unsecured senior debt of the counterparty is rated at least A by Moody's or S&P.
<PAGE>
PAGE 1
KEYSTONE SMALL COMPANY GROWTH FUND II
SEEKS LONG-TERM GROWTH OF CAPITAL BY INVESTING IN EMERGING GROWTH COMPANIES.
Dear Shareholder:
We are pleased to report to you on the activities of Keystone Small Company
Growth Fund II for the twelve-month period that ended May 31, l997. Following
this letter, we have included an interview with the Fund's management team
members.
PERFORMANCE
For the twelve-month period, which ended May 31, l997, your Fund produced the
following returns, exclusive of maximum sales charges:
A shares returned -8.07%
B shares returned -8.81%
C shares returned -8.81%
Y shares, which were introduced in the Fund on January 13, l997, generated a
- -2.64% return.
For the full twelve-month period, the Russell 2000 Index rose 6.97% and the
Russell 2000 Growth Index produced a total return of -5.48%.
Your Fund's results were disappointing. It is important to remember, though,
that they occurred during a time when small-company stocks in general, and
technology stocks in particular, lagged behind large-company stock indices.
During this period, we continued to reposition the Fund to place a greater
emphasis on the stocks of companies that we believe have the potential to
produce above-average growth over time.
ENVIRONMENT
During the twelve months, concerns about the pace of economic growth,
accelerating inflation and higher interest rates held back the performance of
small-company stocks. From mid-l996 until late-April 1997, small-company stock
prices fluctuated broadly. During market corrections, small-cap stock prices
declined more than those of large-company stocks; and during market rallies,
their returns rose less than their large-cap counterparts. Finally, in the last
six weeks of the period, the small stock market began to rally as investors
appeared to recognize the attractive relative values there.
STRATEGY
Over the twelve-months, we emphasized companies with market capitalizations of
$1 billion and under. We reduced or eliminated those stocks of companies that we
believed had reached optimal price levels, and we invested in a variety of
high-quality companies that we believed were selling at attractive prices and
that have the potential to generate strong earnings over several years. In
selecting stocks for the portfolio, we focused on businesses that appear to have
sustainable above-average growth prospects. We sought companies in all sectors
of the market, and we emphasized firms that had distinguishing attributes, such
as strong management, unique product lines, and low-cost production. We
diversified your Fund's investments among a number of economic sectors,
including technology, finance, business and consumer services, and industrial
manufacturers.
-- CONTINUED--
<PAGE>
PAGE 2
KEYSTONE SMALL COMPANY GROWTH FUND II
OUTLOOK
Over the next several months, we believe small-company stocks should generate
stronger returns than they have in the recent past. We think economic growth and
inflation should be moderate, and therefore interest rates should be relatively
stable. Historically, small-company stocks have tended to perform well in this
type of environment. In addition, small-company stocks are relatively
inexpensive. Even after they rallied in April and May, valuations on small-
company stocks, in comparison to large-cap stocks, were at their most attractive
levels in several years. We believe these favorable conditions will bode well
for small-cap stocks.
As a small-company investor, you should keep in mind that one of the
characteristics of small-company stocks is their volatility. They tend to
fluctuate in value over short periods of time. Historically, large gains in the
small-cap sector have come during short time frames. Therefore, being invested
in small-caps when they rally is crucial to being a successful small-cap
investor. As we continue to restructure the portfolio, we believe that the
companies in which we have invested are poised to achieve rapid growth and
sustainable profitability. In many areas, such as technology and health care,
these companies are at a stage in their development when they are introducing
products and services that have never existed. Generally, earnings growth in
these types of companies is less dependent on the general level of economic
activity and more on the success of their own particular product cycles.
Thank you for your continued support of Keystone Small Company Growth Fund II.
If you have any questions or comments, we encourage you to write to us.
Sincerely,
/s/ Albert H. Elfner, III
Albert H. Elfner, III
CHAIRMAN
KEYSTONE INVESTMENT MANAGEMENT COMPANY
/s/ George S. Bissell
George S. Bissell
CHAIRMAN OF THE BOARD
KEYSTONE FUNDS
<TABLE>
<S> <C>
(Photo of Albert H. (Photo of George S.
Elfner, III appears here) Bissell appears here)
ALBERT H. ELFNER, III GEORGE S. BISSELL
</TABLE>
June 1997
<PAGE>
PAGE 3
A Discussion With Your
Fund Management Team
(Photo of Thomas L. Holman
appears here)
THOMAS L. HOLMAN IS VICE PRESIDENT AND PORTFOLIO MANAGER OF YOUR FUND. MR.
HOLMAN JOINED KEYSTONE IN JANUARY 1997. PRIOR TO JOINING KEYSTONE, HE WAS
AN INVESTMENT OFFICER AND SECURITIES ANALYST AT INVISTA CAPITAL
MANAGEMENT, A SUBSIDIARY OF THE PRINCIPAL FINANCIAL GROUP, WHERE HE WAS
CO-MANAGER OF PRINCOR GROWTH FUND AND PRINCOR EMERGING GROWTH FUND. MR.
HOLMAN IS A MEMBER OF KEYSTONE'S SMALL COMPANY STOCK TEAM, WHICH IS
COMPOSED OF THREE PORTFOLIO MANAGERS AND FIVE EQUITY ANALYSTS. TOGETHER,
THEY SEARCH FOR STOCKS OF SMALL COMPANIES WITH SUSTAINABLE ABOVE-AVERAGE
GROWTH RATES. THIS TEAM IS HEADED BY J. GARY CRAVEN, SENIOR VICE PRESIDENT
AND CHIEF INVESTMENT OFFICER, SMALL COMPANY STOCKS.
Q WHAT WAS THE INVESTMENT ENVIRONMENT FOR SMALL-CAP STOCKS LIKE DURING THE
TWELVE-MONTH PERIOD?
A It was a volatile environment for small-cap stocks. Small caps generated
strong gains in l995, but midway through l996, the environment changed. Concerns
about slower economic growth and rising interest rates made small-cap stocks
less appealing to investors, and they shifted money to large-company stocks.
Small company stocks were hit hardest during a market correction in the summer
of l996 and, again, during the market downturn that occurred in March and April
of l997. Toward the end of April, however, investors appeared to recognize that
small-cap stock prices were at very attractive price levels and began to favor
small-cap stocks. Small-cap stock prices rose and continued on an upward course
through May 1997.
Q WHAT WAS YOUR STRATEGY FOR MANAGING THE PORTFOLIO DURING THE PERIOD?
A We invested in companies with market capitali-
zations of $1 billion and under. Our strategy was to invest in high-quality
companies that we believe have above average long-term growth prospects and that
were relatively inexpensive. The companies we selected for the portfolio tended
to have strong competitive positions in their market sectors and superior
business models which have the potential to generate high returns on capital.
These business models can include: low cost production, technological
leadership, exceptional distribution systems and high-quality management teams.
Q TECHNOLOGY STOCKS WERE AN IMPORTANT AREA OF INVESTMENT. WHAT WAS ATTRACTIVE
ABOUT TECHNOLOGY STOCKS?
A When we refer to technology stocks, we include a broad area that encompasses
telecommunications, software and hardware businesses. One strategy we employed
was to invest in small companies that are benefitting from doing business with
some of the large, dominant companies in the technology sector. Microsoft, Intel
and Cisco Systems are market leaders. Because they are very large companies, we
would not include them in your Fund's portfolio. However, we can take advantage
of their strength by investing in smaller firms that do business with these
larger companies. Two examples are Avid Technology and Rational Software. Avid
Technology produces editing software for the television and movie industries.
It is currently developing this high-end technical equipment for the corporate
and consumer markets. Rational Software produces software that makes it easier
to write computer programs.
<PAGE>
PAGE 4
KEYSTONE SMALL COMPANY GROWTH FUND II
TOP 5 INDUSTRIES
AS OF MAY 31, 1997
<TABLE>
<CAPTION>
PERCENTAGE OF
INDUSTRY NET ASSETS
<S> <C>
Oil 15.8%
Information Services & Technology 12.2%
Finance & Insurance 9.5%
Healthcare Products & Services 9.0%
Telecommunication Services & Equipment 8.9%
</TABLE>
Q DID YOU MAKE ANY CHANGES IN THE FINANCE AREA?
A We made a number of changes in the finance sector. We eliminated stocks that
we believe had reached their target price levels. We also were concerned about
the impact that increases in interest rates could have on some lenders. As a
result, when the Federal Reserve Board raised rates in March, we repositioned
our investments from sub-prime lenders to higher quality lenders. For example,
we sold automobile loan companies and mortgage lending businesses and increased
our emphasis on quality regional banks. Going forward, we are optimistic about
the potential for financial stocks. We believe that the need for financial
services and products will increase for the rest of the decade and that the
finance sector of the market should be one of the strongest growth areas.
Q OIL SERVICES STOCKS WERE AN AREA OF EMPHASIS FOR THE FUND. DID YOU MAKE
CHANGES IN THIS PART OF THE PORTFOLIO?
A While energy stocks accounted for a significant portion of net assets, we
trimmed the Fund's exposure to oil services stocks as they reached their price
objectives. Even though energy and oil services stocks have strong returns for
more than a year, the level of drilling activity is increasing. We have
concentrated Fund holdings in companies we believe are well positioned to
participate in this activity.
Q SMALL INDUSTRIAL COMPANIES WERE AN IMPORTANT PART OF THE PORTFOLIO. WHAT
ATTRACTED YOU TO THESE TYPES OF COMPANIES?
A We invested in a number of companies that, in addition to meeting our criteria
for attractive prices and potential growth, have another advantage. They are
benefitting from a demographic trend. As the percentage of college graduates
rises in the U.S., more people are going into the white collar professions and
fewer into the construction and heavy industry businesses. As a result, there is
growing demand for products that reduce the labor intensity of these industries.
Therefore, companies that provide quality goods and services for the industrial
sector have an opportunity to become market leaders. Two fund holdings exemplify
this trend: AFC Cable, a firm that produces color-coded metal clad electrical
wiring; and Omniquip, a company that produces telescopic material handlers that
are a more versatile alternative to forklifts.
Q WHAT IS YOUR OUTLOOK?
A We believe there are several factors that bode well for the future. Prices of
small-company stocks are very attractive, relative to their large-cap
counterparts. However, it is going to take earnings growth to drive small-cap
prices higher over the long term. The
<PAGE>
PAGE 5
TOP 10 HOLDINGS
AS OF MAY 31, 1997
<TABLE>
<CAPTION>
PERCENTAGE OF
COMPANY INDUSTRY NET ASSETS
<S> <C> <C>
Falcon Drilling Oil 2.8%
Newpark Resources Inc. Oil 2.6%
Total Renal Care Health Care Products 2.5%
Holdings, Inc. & Services
Seacor Smit, Inc. Oil 2.4%
Cox Radio, Inc. Broadcasting 2.3%
BJ Services Company Oil 2.2%
McLeod, Inc. Telecommunication 2.1%
Services & Equipment
Tower Automotive, Inc. Automotive Equipment 2.1%
& Manufacturing
Omniquip International, Machinery-- 2.1%
Inc. Diversified
Queens City Bancorp Finance & Insurance 2.1%
</TABLE>
development of new products and technologies should add the impetus that these
stocks need to perform well over the long term. We are optimistic about economic
growth. We believe that any increase in interest rates will be relatively small
and will set the stage for moderate economic growth, relatively low inflation,
and lower interest rates over the long term. We think this should be a positive
backdrop for small companies.
(Diamond appears here)
THIS COLUMN IS INTENDED TO ANSWER QUESTIONS ABOUT YOUR FUND.
IF YOU HAVE A QUESTION YOU WOULD LIKE ANSWERED, PLEASE WRITE TO:
EVERGREEN KEYSTONE INVESTMENT SERVICES, INC.
ATTN: SHAREHOLDER COMMUNICATIONS
201 SOUTH COLLEGE STREET, SUITE 400,
CHARLOTTE, N.C. 28288-1195.
<PAGE>
PAGE 6
KEYSTONE SMALL COMPANY GROWTH FUND II
Your Fund's Performance
(Chart appears here with the following information)
Growth of an investment in
Small Company Growth Fund II Class A
2/21/96 2/96 5/96 8/96 11/96 2/97 5/97
Dividend Reinvestment (Customer to supply plot points)
Initial Investment
A $10,000 investment in Keystone Small Company Growth Fund II made on
February 21, 1996 with all distributions reinvested was worth $10,250
on May 31, 1997. Past performance is no guarantee of future results.
The performance of each class may vary based on the differences in loads
and fees paid by shareholders investing in the different classes.
(Chart appears here with the following information)
Comparison of change in value of a $10,000 investment in
Keystone Small Company Growth Fund II Class A and the
Russell 2000 Index
2/21/96 2/96 5/96 8/96 11/96 2/97 5/97
Class A Shares (Customer to supply plot points)
Russell 2000
Past performance is no guarantee of future results. The performance of
each class may vary based on differences in loads and fees paid by the
shareholders investing in the each classes. The Russell 2000 index is an
unmanaged market index. The index does not include transaction costs
associated with buying securities nor any management fees.
Class A shares were introduced on February 21, 1996. Performance is reported at
the current maximum front-end sales charge of 4.75%.
Class B and C shares were introduced on February 21, 1996. Shares purchased
after January 1, 1997 are subject to a contingent deferred sales charge (CDSC)
that declines from 5% to 1% over six years after the month purchased.
Performance assumes that shares were redeemed after the end of a one-year
holding period and reflects the deduction of a 5% CDSC.
Class C shares are subject to a 1% contingent deferred sales charge for 12
months after the month purchased. Performance reflects the return you would have
received after holding shares for one year or more and redeeming after the end
of that period.
Class Y shares were introduced on January 13, 1997. Class Y shares are
available without a front-end charge or contingent deferred sales charge.
<TABLE>
<CAPTION>
TWELVE-MONTH PERFORMANCE AS OF MAY 31, 1997
<S> <C> <C> <C> <C>
<CAPTION>
CLASS A CLASS B CLASS C CLASS Y
<S> <C> <C> <C> <C>
Total Return* (8.07%) (8.81%) (8.81%) (2.64%)
Net asset value
5/31/96 $11.15 $11.12 $11.12 $10.59**
5/31/97 $10.25 $10.14 $10.14 $10.31
Dividends None None None None
Capital gain
distributions None None None None
</TABLE>
*BEFORE DEDUCTION OF FRONT-END OR CONTINGENT DEFERRED SALES CHARGES (CDSC).
TOTAL RETURN FIGURE FOR CLASS Y CALCULATED FOR THE PERIOD FROM JANUARY 13, 1997
(DATE OF INITIAL PUBLIC OFFERING) TO MAY 31, 1997.
** CLASS Y SHARES WERE INITIALLY OFFERED TO THE PUBLIC ON
JANUARY 13, 1997.
<TABLE>
<CAPTION>
HISTORICAL RECORD AS OF MAY 31, 1997
<S> <C> <C> <C>
CUMULATIVE TOTAL RETURNS CLASS A CLASS B CLASS C
<S> <C> <C> <C>
1-year w/o sales charge (8.07%) (8.81%) (8.81% )
1-year (12.44%) (13.37%) (9.72% )
Life of Fund 2.50% 1.40% 1.40%
AVERAGE ANNUAL TOTAL RETURN
1-year w/o sales charge (8.07%) (8.81%) (8.81% )
1-year (12.44%) (13.37%) (9.72% )
Life of Fund 1.95% 1.09% 1.09%
</TABLE>
<PAGE>
PAGE 7
SCHEDULE OF INVESTMENTS-- MAY 31, 1997
<TABLE>
<CAPTION>
SHARES VALUE
<C> <S> <C> <C>
COMMON STOCKS-- 95.6%
<C> <S> <C> <C>
AUTOMOTIVE EQUIPMENT & MANUFACTURING-- 2.1%
21,100 Tower Automotive Inc............ $ 836,087
BUILDING, CONSTRUCTION & FURNISHINGS-- 3.2%
40,000 Champion Enterprises, Inc....... 735,000
23,000 * Oakwood Homes Corp.............. 546,250
1,281,250
BUSINESS EQUIPMENT & SERVICES-- 6.2%
25,000 Alternative Resources Corp...... 460,938
47,000 Donnelley Enterprise
Solutions..................... 470,000
8,100 Factset Research Systems Inc.... 157,950
15,000 G&K Services.................... 485,625
10,500 Renaissance Solutions Inc....... 384,562
15,400 Vincam Group Inc................ 473,550
2,432,625
CHEMICAL & AGRICULTURAL PRODUCTS-- 1.8%
22,500 * OM Group, Inc................... 708,750
CONSUMER PRODUCTS & SERVICES-- 1.9%
17,000 * Stanhome Inc.................... 533,375
17,500 USA Detergents Inc.............. 225,313
758,688
ELECTRONICS-- 8.8%
12,900 ADFlex Solutions, Inc........... 211,238
20,800 AFC Cable Systems Inc........... 565,500
21,700 Altron Inc...................... 360,763
13,700 * BMC Industries, Inc............. 450,387
22,000 ESS Technology Inc.............. 339,625
17,700 Flextronics International....... 414,844
25,000 Integrated Process Equipment
Corp.......................... 457,812
12,000 Lattice Semiconductor Corp...... 694,500
3,494,669
<CAPTION>
SHARES VALUE
<C> <S> <C> <C>
<CAPTION>
COMMON STOCKS (CONTINUED)
<C> <S> <C> <C>
FINANCE & INSURANCE-- 9.5%
40,000 * BostonFed Bancorp Inc........... $ 605,000
17,000 * CMAC Investment Corp............ 707,625
27,000 * Everen Capital Corporation...... 668,250
14,400 First Alliance Company.......... 354,600
17,000 Firstplus Financial Group Inc... 431,375
5,000 * Investors Financial Services
Corp.......................... 176,875
19,999 * Queens County Bancorp........... 827,459
3,771,184
HEALTHCARE PRODUCTS & SERVICES-- 9.0%
12,400 Cardiothoracic Systems Inc...... 170,500
4,200 CRA Managed Care Inc............ 192,938
19,400 Gilead Sciences Inc............. 522,587
15,800 Heartport Inc................... 380,187
30,000 Lifecore Biomedical Inc......... 418,125
20,000 Neurogen Corp................... 377,500
20,000 Thermo Cardiosystems, Inc....... 537,500
27,000 Total Renal Care Holdings Inc... 972,000
3,571,337
INDUSTRIAL SPECIALTY PRODUCTS & SERVICES-- -
0.4%
5,300 * Trimas Corp..................... 150,388
INFORMATION SERVICES & TECHNOLOGY-- 12.2%
24,300 Avid Technology Inc............. 571,050
20,000 Black Box Corp.................. 705,000
54,200 Clarify Inc..................... 653,787
14,000 Cognex Corp..................... 364,875
20,000 Geoworks........................ 125,625
20,000 Inso Corp....................... 558,750
24,600 Rational Software Corp.......... 462,787
19,024 Synopsys Inc.................... 708,644
25,800 Vantive Corp.................... 693,375
4,843,893
MACHINERY-- DIVERSIFIED-- 4.1%
41,500 Omniquip International Inc...... 832,594
37,000 Rental Service Corp............. 804,750
1,637,344
METAL PRODUCTS & SERVICES-- 2.1%
22,000 Molten Metal Tech Inc........... 155,375
26,300 Oregon Metallurgical Corp....... 677,225
832,600
</TABLE>
<PAGE>
PAGE 8
KEYSTONE SMALL COMPANY GROWTH FUND II
SCHEDULE OF INVESTMENTS-- MAY 31, 1997
SHARES VALUE
COMMON STOCKS (CONTINUED)
LEISURE & TOURISM-- 2.1%
3,400 Anchor Gaming................... $ 144,925
18,700 Promus Hotel Corp............... 675,538
820,463
OIL-- 15.8%
16,000 BJ Services Company............. 884,000
41,900 Denbury Resources, Inc.......... 644,212
24,400 Falcon Drilling................. 1,119,350
14,100 Flores & Rucks Inc.............. 690,900
11,800 * KCS Energy Inc.................. 491,175
20,000 Newpark Resources, Inc.......... 1,050,000
18,700 Seacor Smit Inc................. 967,725
15,000 Swift Energy Company............ 401,250
6,248,612
RETAILING & WHOLESALE-- 3.1%
15,000 Gadzooks Inc.................... 495,000
20,000 Pacific Sunwear of California... 727,500
1,222,500
TELECOMMUNICATION SERVICES & EQUIPMENT--
8.9%
24,000 Aspect Telecommunications
Corp.......................... 540,000
35,000 Centigram Communications Corp... 400,313
36,000 McLeod USA Inc.................. 846,000
30,000 Natural Microsystems Corp....... 736,875
17,100 Proxim Inc...................... 434,981
25,000 Smartalk Teleservices Inc....... 337,500
10,000 Spectrian Corp.................. 221,250
3,516,919
SHARES VALUE
COMMON STOCKS (CONTINUED)
TRANSPORTATION-- 0.6%
9,300 Coach USA Inc Class A........... $ 244,125
COMMERCIAL SERVICES-- 1.5%
21,000 Budget Group Inc................ 585,375
BROADCASTING-- 2.3%
40,800 Cox Radio Inc................... 912,900
TOTAL COMMON STOCKS
(COST $37,534,851)............................... 37,869,709
PAR
VALUE
REPURCHASE AGREEMENT-- 3.6%
$1,439,000 Keystone Joint Repurchase Agreement
(investment in repurchase agreement,
in joint trading account,
purchased 5/30/97, 5.5734%,
maturing 6/2/97, maturity
value $1,439,668)(a)
(Cost-- $1,439,000)........... 1,439,000
TOTAL INVESTMENTS
(COST $38,973,851) 99.2% 39,308,709
OTHER ASSETS AND LIABILITIES--
NET 0.8% 322,760
NET ASSETS 100.0% $39,631,469
* Income-producing security.
(a) The repurchase agreement is fully collateralized by U.S. Government and/or
agency obligations based on market prices at May 31, 1997.
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 9
FINANCIAL HIGHLIGHTS-- CLASS A SHARES
(FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD)
<TABLE>
<CAPTION>
FEBRUARY 21, 1996
(COMMENCEMENT OF
YEAR ENDED OPERATIONS)
MAY 31, 1997(C) TO MAY 31, 1996
<S> <C> <C>
NET ASSET VALUE BEGINNING OF PERIOD $11.15 $10.00
INCOME FROM INVESTMENT OPERATIONS:
Net investment loss (0.16) (0.02)
Net realized and unrealized gain (loss) on investments (0.74) 1.17
Total from investment operations (0.90) 1.15
NET ASSET VALUE END OF PERIOD $10.25 $11.15
TOTAL RETURN (A) (8.07%) 11.50%
RATIOS/SUPPLEMENTAL DATA
RATIOS TO AVERAGE NET ASSETS:
Total expenses 1.97% 2.10%(b)
Total expenses, excluding indirectly paid expenses 1.92% 1.95%(b)
Total expenses, excluding reimbursement N/A 3.70%(b)
Net investment loss (1.55%) (1.41%)(b)
PORTFOLIO TURNOVER RATE 5% 13%
AVERAGE COMMISSION RATE PAID $0.0554 $0.0607
NET ASSETS END OF PERIOD (THOUSANDS) $10,779 $ 8,201
</TABLE>
(a) Excluding applicable sales charges.
(b) Annualized.
(c) Calculated based on average shares outstanding.
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 10
KEYSTONE SMALL COMPANY GROWTH FUND II
FINANCIAL HIGHLIGHTS-- CLASS B SHARES
(FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD)
<TABLE>
<CAPTION>
FEBRUARY 21, 1996
(COMMENCEMENT OF
YEAR ENDED OPERATIONS)
MAY 31, 1997(C) TO MAY 31, 1996
<S> <C> <C>
NET ASSET VALUE BEGINNING OF PERIOD $11.12 $10.00
INCOME FROM INVESTMENT OPERATIONS:
Net investment loss (0.24) (0.03)
Net realized and unrealized gain (loss) on investments (0.74) 1.15
Total from investment operations (0.98) 1.12
NET ASSET VALUE END OF PERIOD $10.14 $11.12
TOTAL RETURN (A) (8.81%) 11.20%
RATIOS/SUPPLEMENTAL DATA
RATIOS TO AVERAGE NET ASSETS:
Total expenses 2.72% 2.85%(b)
Total expenses, excluding indirectly paid expenses 2.67% 2.70%(b)
Total expenses, excluding reimbursement N/A 4.45%(b)
Net investment loss (2.29%) (2.16%)(b)
PORTFOLIO TURNOVER RATE 5% 13%
AVERAGE COMMISSION RATE PAID $0.0554 $0.0607
NET ASSETS END OF PERIOD (THOUSANDS) $21,187 $12,487
</TABLE>
(a) Excluding applicable sales charges.
(b) Annualized.
(c) Calculated based on average shares outstanding.
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 11
FINANCIAL HIGHLIGHTS-- CLASS C SHARES
(FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD)
<TABLE>
<CAPTION>
FEBRUARY 21, 1996
(COMMENCEMENT OF
YEAR ENDED OPERATIONS)
MAY 31, 1997(C) TO MAY 31, 1996
<S> <C> <C>
NET ASSET VALUE BEGINNING OF PERIOD $11.12 $10.00
INCOME FROM INVESTMENT OPERATIONS:
Net investment loss (0.24) (0.02)
Net realized and unrealized gain (loss) on investments (0.74) 1.14
Total from investment operations (0.98) 1.12
NET ASSET VALUE END OF PERIOD $10.14 $11.12
TOTAL RETURN (A) (8.81%) 11.20%
RATIOS/SUPPLEMENTAL DATA
RATIOS TO AVERAGE NET ASSETS:
Total expenses 2.73% 2.85%(b)
Total expenses, excluding indirectly paid expenses 2.68% 2.70%(b)
Total expenses, excluding reimbursement N/A 4.44%(b)
Net investment loss (2.29%) (2.20%)(b)
PORTFOLIO TURNOVER RATE 5% 13%
AVERAGE COMMISSION RATE PAID $0.0554 $0.0607
NET ASSETS END OF PERIOD (THOUSANDS) $7,661 $8,315
</TABLE>
(a) Excluding applicable sales charges.
(b) Annualized.
(c) Calculated based on average shares outstanding.
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 12
KEYSTONE SMALL COMPANY GROWTH FUND II
FINANCIAL HIGHLIGHTS-- CLASS Y SHARES
(FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD)
<TABLE>
<CAPTION>
JANUARY 13, 1997
(DATE OF INITIAL
PUBLIC OFFERING)
TO MAY 31, 1997(C)
<S> <C>
NET ASSET VALUE BEGINNING OF PERIOD $10.59
INCOME FROM INVESTMENT OPERATIONS:
Net investment loss 0.00
Net realized and unrealized gain (loss) on investments (0.28)
Total from investment operations (0.28)
NET ASSET VALUE END OF PERIOD $10.31
TOTAL RETURN (2.64%)
RATIOS/SUPPLEMENTAL DATA
RATIOS TO AVERAGE NET ASSETS:
Total expenses 2.23%(a)
Total expenses, excluding indirectly paid expenses 2.23%(a)
Net investment loss (1.26%)(a)
PORTFOLIO TURNOVER RATE 5%
AVERAGE COMMISSION RATE PAID $ 0.0554
NET ASSETS END OF PERIOD (THOUSANDS) $5
</TABLE>
(a) Annualized for the period from May 28, 1997 (commencement of investment
operations) to May 31, 1997.
(c) Calculated based on average shares outstanding.
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 13
STATEMENT OF ASSETS AND LIABILITIES
MAY 31, 1997
<TABLE>
<CAPTION>
<S> <C>
ASSETS
Investments at value (identified cost,
$38,973,851) $39,308,709
Cash 823
Receivable for investments sold 713,035
Receivable for Fund shares sold 11,806
Dividends and interest receivable 3,386
Deferred organization expenses 13,164
Prepaid expenses 50,669
Total assets 40,101,592
LIABILITIES
Payable for Fund shares redeemed 210,998
Payable for investments purchased 188,344
Distribution fees payable 9,674
Accrued expenses and other liabilities 61,107
Total liabilities 470,123
NET ASSETS $39,631,469
NET ASSETS REPRESENTED BY
Paid-in capital $40,493,273
Accumulated net realized loss on investments (1,196,662)
Net unrealized appreciation on investments 334,858
Total net assets $39,631,469
NET ASSET VALUE PER SHARE
Class A Shares
Net asset value of $10,778,554/1,051,352
shares outstanding $ 10.25
Offering price per share ($10.25/0.9525)
(based on a sales charge of 4.75%
of the offering price on May 31, 1997) $ 10.76
Class B Shares
Net asset value of $21,186,809/2,089,105
shares outstanding $ 10.14
Class C Shares
Net asset value of $7,661,075/755,277
shares outstanding $ 10.14
Class Y Shares
Net asset value of $5,031/488 shares
outstanding $ 10.31
</TABLE>
STATEMENT OF OPERATIONS
YEAR ENDED MAY 31, 1997
<TABLE>
<CAPTION>
<S> <C> <C>
INVESTMENT INCOME
Dividends $ 70,527
Interest 91,971
Total Income 162,498
EXPENSES
Management fee $ 297,833
Distribution Plan expenses 332,976
Transfer Agent fees 195,716
Registration fees 134,306
Custodian fees 50,734
Miscellaneous expenses 60,138
Total expense 1,071,703
Less: Expenses paid indirectly (21,273)
Net expenses 1,050,430
Net investment loss (887,932)
NET REALIZED AND UNREALIZED GAIN
(LOSS) ON INVESTMENTS
Net realized loss on investments (1,014,769)
Net change in unrealized
appreciation on investments (961,813)
Net realized and unrealized loss
on investments (1,976,582)
Net decrease in net assets
resulting from operations $(2,864,514)
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 14
KEYSTONE SMALL COMPANY GROWTH FUND II
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
FEBRUARY 21, 1996
(COMMENCEMENT
YEAR ENDED OF OPERATIONS)
MAY 31, 1997 TO MAY 31, 1996
<S> <C> <C>
OPERATIONS
Net investment loss $ (887,932 ) $ (59,141)
Net realized loss on investments (1,014,769 ) (181,893)
Net change in unrealized appreciation on investments (961,813 ) 1,296,671
Net increase (decrease) in net assets resulting from operations (2,864,514 ) 1,055,637
CAPITAL SHARE TRANSACTIONS
Proceeds from shares sold:
Class A Shares 10,500,455 8,267,986
Class B Shares 24,464,278 12,267,442
Class C Shares 5,257,765 8,667,945
Class Y Shares 5,011 0
Payment for shares redeemed:
Class A Shares (7,163,980 ) (410,693)
Class B Shares (14,359,496 ) (284,594)
Class C Shares (5,211,808 ) (559,965)
Class Y Shares 0 0
Net increase in net assets resulting from capital share transactions 13,492,225 27,948,121
Total increase in net assets 10,627,711 29,003,758
NET ASSETS
Beginning of period 29,003,758 0
End of period $39,631,469 $29,003,758
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 15
NOTES TO FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
Keystone Small Company Growth Fund II (the "Fund") is a Massachusetts business
trust for which Keystone Investment Management Company ("Keystone") is the
investment adviser and manager. Keystone was formerly a wholly-owned subsidiary
of Keystone Investments, Inc.("KII") and is currently a subsidiary of First
Union Corporation ("First Union").
The Fund is registered under the Investment Company Act of 1940, as amended
(the "1940 Act"), as a diversified, open-end investment company. The Fund offers
several classes of shares. The Fund's investment objective is to seek long-term
growth of capital through investments in emerging growth companies.
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
policies are in conformity with generally accepted accounting principles, which
require management to make estimates and assumptions that affect amounts
reported herein. Although actual results could differ from these estimates, any
such differences are expected to be immaterial to the net assets of the Fund.
A. VALUATION OF SECURITIES
Investments are usually valued at the closing sales price, or in the absence of
sales and for over-the-counter securities, the mean of the bid and asked prices.
Securities for which valuations are not available from an independent pricing
service (including restricted securities) are valued at fair value as determined
in good faith according to procedures established by the Board of Trustees.
Short-term investments with remaining maturities of 60 days or less are
carried at amortized cost, which approximates market value. Short-term
securities with greater than 60 days to maturity are valued at market value.
B. REPURCHASE AGREEMENTS
Pursuant to an exemptive order issued by the Securities and Exchange Commission,
the Fund, along with certain other Evergreen Keystone funds, may transfer
uninvested cash balances into a joint trading account. These balances are
invested in one or more repurchase agreements that are fully collateralized by
U.S. Treasury and/or federal agency obligations.
Securities pledged as collateral for repurchase agreements are held by the
custodian on the Fund's behalf. The Fund monitors the adequacy of the collateral
daily and will require the seller to provide additional collateral in the event
the market value of the securities pledged falls below the carrying value of the
repurchase agreement.
C. SECURITY TRANSACTIONS AND INVESTMENT INCOME
Securities transactions are accounted for no later than one business day after
the trade date. Realized gains and losses are computed on the identified cost
basis. Interest income is recorded on the accrual basis and includes
amortization of discounts and premiums. Dividend income is recorded on the
ex-dividend date.
D. ORGANIZATION EXPENSES
The Fund's organization expenses are amortized to operations over a five-year
period on a straight-line basis. In the event any of the initial shares of the
Fund are redeemed by First Union during the five-year amortization period,
redemption proceeds will be reduced by any unamortized organization expenses in
the same proportion as the number of initial shares being redeemed bears to the
number of initial shares outstanding at the time of redemption.
E. FEDERAL INCOME TAXES
The Fund has qualified and intends to qualify in the future as a regulated
investment company under the Internal Revenue Code of 1986, as amended (the
"Code"). Thus, the Fund is relieved of any federal income tax liability by
distributing all of its net taxable investment income and net taxable capital
gains, if any, to its shareholders. The Fund also intends to avoid excise tax
liability by making the required distributions under the Code. Accordingly, no
provision for federal income taxes is required.
<PAGE>
PAGE 16
KEYSTONE SMALL COMPANY GROWTH FUND II
F. DISTRIBUTIONS
The Fund distributes net investment income and net capital gains, if any, at
least annually. Distributions to shareholders are recorded at the close of
business on the ex-dividend date.
Income and capital gains distributions to shareholders are determined in
accordance with income tax regulations, which may differ from generally accepted
accounting principles. These differences are primarily due to the treatment of
net operating losses.
G. CLASS DESCRIPTIONS & ALLOCATIONS
Class A shares are currently offered at a public offering price, which includes
a maximum sales charge of 4.75% payable at the time of purchase. Class B shares
are sold subject to a contingent deferred sales charge that is payable upon
redemption and decreases depending on how long the shares have been held. Class
B shares purchased on or after January 1, 1997 will convert to Class A shares
after seven years. Class B shares purchased prior to January 1, 1997 retain
their existing conversion features. Class C shares are sold subject to a
contingent deferred sales charge payable on shares redeemed within one year
after the month of purchase. Class Y shares are available without a front-end
sales charge or contingent deferred sales charge only to investment advisory
clients of First Union and its affiliates and certain institutional clients.
Class Y shares were initially offered to the public on January 13, 1997.
Investment operations for Class Y began on May 28, 1997.
Income, expenses (other than class specific expenses) and realized and
unrealized gains and losses are prorated among the classes based on the relative
net assets of each class. Currently, class specific expenses are limited to
expenses incurred under the Distribution Plans for each class.
2. CAPITAL SHARE TRANSACTIONS
The Fund's Declaration of Trust authorizes the issuance of an unlimited number
of shares of beneficial interest with no par value. As of May 31, 1997, shares
of beneficial interest of the Fund were divided into Class A, Class B, Class C
and Class Y. Transactions in shares of the Fund were as follows:
<TABLE>
<CAPTION>
FEBRUARY 21, 1996
(COMMENCEMENT OF
YEAR ENDED OPERATIONS)
MAY 31, 1997 TO MAY 31, 1996
<S> <C> <C>
CLASS A
Shares sold 1,023,296 772,993
Shares redeemed (707,396) (37,541)
Net increase 315,900 735,452
CLASS B
Shares sold 2,388,573 1,149,103
Shares redeemed (1,422,533) (26,038)
Net increase 966,040 1,123,065
CLASS C
Shares sold 518,678 797,320
Shares redeemed (511,324) (49,397)
Net increase 7,354 747,923
</TABLE>
<TABLE>
<CAPTION>
JANUARY 13, 1997
(DATE OF INITIAL
PUBLIC OFFERING)
CLASS Y TO MAY 31, 1997
<S> <C>
Shares sold 488
Shares redeemed 0
Net increase 488
</TABLE>
3. SECURITIES TRANSACTIONS
Cost of purchases and proceeds from sales of investment securities (excluding
short-term securities and U.S. government securities) for the year ended May 31,
1997, were $57,416,702 and $45,416,755, respectively.
On May 31, 1997, the cost of investments for federal income tax purposes was
$39,039,175, gross unrealized appreciation of investments was $4,950,338 and
gross
<PAGE>
PAGE 17
unrealized depreciation of investments was $4,680,804, resulting in net
unrealized appreciation of $269,534 for federal income income tax purposes. At
May 31, 1997, the Fund had capital loss carryovers of $1,010,468, all of which
expire on May 31, 2005.
4. DISTRIBUTION PLANS
The Fund bears some of the costs of selling its shares under Distribution Plans
adopted for its Class A, B and C shares pursuant to Rule 12b-1 under the 1940
Act. Under the Distribution Plans, the Fund pays its principal underwriter
amounts which are calculated daily and paid monthly.
On December 11, 1996, the Fund entered into a principal underwriting agreement
with Evergreen Keystone Distributors, Inc. (Formerly, Evergreen Fund
Distributor, Inc.) ("EKD"), a wholly owned subsidiary of The BISYS Group, Inc.
Prior to December 11, 1996, Evergreen Keystone Investment Services, Inc.
(Formerly Keystone Investment Distributors Company) ("EKIS"), a wholly owned
subsidiary of Keystone, served as the Fund's principal underwriter.
The Class A Distribution Plan provides for expenditures, which are currently
limited to 0.25% annually of the average daily net assets of the Class A shares,
to pay expenses related to the distribution of Class A shares. During the year
ended May 31, 1997, the Fund paid $30,858 under the Class A Distribution Plan.
Pursuant to the Fund's Class B and Class C Distribution Plans, the Fund pays a
distribution fee, which may not exceed 1.00% annually of the average daily net
assets of Class B and Class C shares, respectively. Of that amount, 0.75% is
used to pay distribution expenses and 0.25% is used to pay service fees. During
the year ended May 31, 1997, the Fund paid or accrued $211,893 under the Class B
Distribution Plan and $90,225 under the Class C Distribution Plan.
Each of the Distribution Plans may be terminated at any time by vote of the
Independent Trustees or by vote of a majority of the outstanding voting shares
of the respective class. However, after the termination of any Distribution
Plan, and subject to the discretion of the Independent Trustees, payments to EKD
and/or EKIS may continue as compensation for services which had been earned
while the Distribution Plan was in effect.
EKD intends, but is not obligated, to continue to pay distribution costs that
exceed the current annual payments from the Fund. EKD intends to seek full
payment of such distribution costs from the Fund at such time in the future as,
and to the extent that, payment thereof by the Class B or Class C shares would
be within permitted limits.
Contingent deferred sales charges paid by redeeming shareholders are paid to
EKD or its predecessor.
5. INVESTMENT MANAGEMENT AGREEMENT AND OTHER AFFILIATED TRANSACTIONS
Under the terms of an investment advisory agreement between the Fund and
Keystone, Keystone serves as the investment adviser and manager to the Fund. As
such, Keystone manages the Fund's investments, provides certain administrative
services and supervises the Fund's daily business affairs. In return, Keystone
is paid a management fee, computed daily and paid monthly, which is determined
by applying percentage rates starting at 0.70% and declining as net assets
increase to 0.35% per annum, to the average daily net asset value of the Fund.
During the year ended May 31, 1997, the Fund paid or accrued $148 to Keystone
for certain accounting services. Evergreen Keystone Service Company ("EKSC")
(formerly Keystone Investor Resource Center, Inc.), a wholly-owned subsidiary of
Keystone, serves as the Fund's transfer and dividend disbursing agent.
Effective January 1, 1997, BISYS Fund Services, Inc. ("BISYS"), an affiliate
of EKD, began serving as the Fund's sub-administrator. As sub-administrator,
BISYS provides the officers of the Fund. For these services, BISYS was paid a
fee by Keystone, which was not a Fund expense.
<PAGE>
PAGE 18
KEYSTONE SMALL COMPANY GROWTH FUND II
Officers of the Fund and affiliated Trustees receive no compensation directly
from the Fund. Currently the Independent Trustees of the Fund receive no
compensation for their services.
6. EXPENSE OFFSET ARRANGEMENT
The Fund has entered into an expense offset arrangement with its custodian. For
the year ended May 31, 1997, the Fund incurred total custody fees of $50,734 and
received a credit of $21,273 pursuant to this expense offset arrangement,
resulting in a net custody expense of $29,461. The assets deposited with the
custodian under this expense offset arrangement could have been invested in
income-producing assets.
<PAGE>
PAGE 19
INDEPENDENT AUDITORS' REPORT
THE TRUSTEES AND SHAREHOLDERS
KEYSTONE SMALL COMPANY GROWTH FUND II
We have audited the accompanying statement of assets and liabilities of Keystone
Small Company Growth Fund II, including the schedule of investments, as of May
31, 1997, and the related statement of operations for the year then ended and
the statements of changes in net assets and financial highlights for the year
then ended and the period from February 21, 1996 (commencement of operations) to
May 31, 1996. These financial statements and financial highlights are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and financial highlights based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of May
31, 1997 by correspondence with the custodian and brokers. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of
Keystone Small Company Growth Fund II as of May 31, 1997, the results of its
operations for the year then ended and the changes in its net assets and
financial highlights for the year then ended and the period from February 21,
1996 to May 31, 1996, in conformity with generally accepted accounting
principles.
KPMG Peat Marwick LLP
Boston, Massachusetts
June 27, 1997
<PAGE>
PAGE 20
KEYSTONE SMALL COMPANY GROWTH FUND II
ADDITIONAL INFORMATION
(UNAUDITED)
The Fund held a special meeting of shareholders on Monday, December 9, 1996. On
October 18, 1996, the record date for the meeting, the Fund had 4,767,887 shares
outstanding, of which 3,779,030 shares were represented at the meeting. The
votes at the meeting were as follows:
PROPOSAL 1: TO ELECT THE FOLLOWING PERSONS AS TRUSTEE OF THE FUND:
<TABLE>
<CAPTION>
NUMBER OF SHARES
NOMINEES FOR TRUSTEE AFFIRMATIVE WITHHELD
<S> <C> <C>
Lawrence B. Ashkin 3,715,047 63,983
Frederick Amling 3,715,241 63,789
Charles A Austin, III 3,718,320 60,710
Foster Bam 3,715,047 63,983
George S. Bissell 3,715,241 63,789
Edwin D. Campbell 3,715,241 63,789
Charles F. Chapin 3,715,241 63,789
K. Dun Gifford 3,718,320 60,710
James S. Howell 3,715,047 63,983
Leroy Keith, Jr. 3,718,320 60,710
F. Ray Keyser 3,715,241 63,789
Gerald M. McDonnell 3,718,126 60,904
Thomas L. McVerry 3,718,023 61,007
William Walt Pettit 3,718,126 60,904
David M. Richardson 3,718,320 60,710
Russell A Salton, III M.D. 3,718,126 60,904
Michael S. Scofield 3,718,126 60,904
Richard J. Shima 3,718,320 60,710
Andrew J. Simons 3,718,320 60,710
</TABLE>
PROPOSAL 2: TO APPROVE AN INVESTMENT ADVISORY AND MANAGEMENT AGREEMENT BETWEEN
KEYSTONE INVESTMENT
MANAGEMENT COMPANY AND THE FUND:
<TABLE>
<S> <C>
Affirmative 3,592,843
Against 42,704
Abstain 143,483
</TABLE>
<PAGE>
KEYSTONE AMERICA
FAMILY OF FUNDS
(Diamond appears here)
Balanced Fund II
Capital Preservation and Income Fund
Government Securities Fund
Intermediate Term Bond Fund
Strategic Income Fund
World Bond Fund
Tax Free Income Fund
California Tax Free Fund
Florida Tax Free Fund
Massachusetts Tax Free Fund
Missouri Tax Free Fund
New York Tax Free Fund
Pennsylvania Tax Free Fund
Fund for Total Return
Global Opportunities Fund
Hartwell Emerging Growth Fund, Inc.
Omega Fund
Fund of the Americas
Small Company Growth Fund II
Strategic Development Fund
This report was prepared primarily for the information of the Fund's
shareholders. It is authorized for distribution if preceded or accompanied by
the Fund's current prospectus. The prospectus contains important information
about the Fund including fees and expenses. Read it carefully before you invest
or send money. For a free prospectus on other Evergreen Keystone funds, contact
your financial adviser or call Evergreen Keystone.
Evergreen Keystone
(Tree appears here) FUNDS (SM) (Keystone symbol appears here)
P.O. Box 2121
Boston, Massachusetts 02106-2121
(Recycle symbol appears here)
SCG2 R541256 7/97
KEYSTONE
(Graphic appears here)
SMALL COMPANY
GROWTH FUND II
Evergreen Keystone
(Tree appears here) FUNDS (SM) (Keystone symbol appears here)
ANNUAL REPORT
MAY 31, 1997
<PAGE>
PAGE 1
KEYSTONE SMALL COMPANY GROWTH FUND (S-4)
SEEKS LONG-TERM GROWTH OF CAPITAL BY INVESTING IN EMERGING GROWTH COMPANIES.
Dear Shareholder:
We are pleased to report to you on the activities of Keystone Small Company
Growth Fund (S-4) for the twelve-month period that ended May 31, l997. Following
this letter, we have included an interview with the Fund's manager J. Gary
Craven, in which he discusses his portfolio strategy.
PERFORMANCE
For the twelve-month period, which ended May 31, l997, your Fund produced a
total return of -8.61%, exclusive of any deferred sales charge. The Russell 2000
Index rose 6.97% and the Russell 2000 Growth Index produced a total return of
- -5.48% for the same period.
Your Fund's results were disappointing. It is important to remember, though,
that they occurred during a time when small-company stocks in general, and
technology stocks in particular, lagged behind large-company stock indices.
During this period, particularly the last six months, we continued to reposition
the Fund for greater consistency by emphasizing the stocks of companies that we
believe have the potential to produce sustainable above-average growth over
time.
ENVIRONMENT
During the twelve months, concerns about the pace of economic growth,
accelerating inflation and higher interest rates held back the performance of
small-company stocks. From mid-l996 until late-April 1997, small-company stock
prices fluctuated broadly. During market corrections, small-cap stock prices
declined more than those of large-company stocks; and during market rallies,
their returns rose less than their large-cap counterparts. Finally, in the last
six weeks of the period, the small stock market began to rally as investors
appeared to recognize the attractive relative values there.
STRATEGY
Over the twelve-months, we emphasized companies with market capitalizations of
$1 billion and under. We cut back on the stocks of companies that we believed
had reached optimal price levels, and we invested in a variety of high-quality
companies that we believed were selling at attractive prices and that have the
potential to generate strong earnings over several years. In selecting stocks
for the portfolio, we focused on businesses that appear to have sustainable
above-average growth prospects. We sought companies in all sectors of the
market, and we emphasized firms that had distinguishing attributes, such as
strong management, unique product lines, and low-cost goods and services. We
diversified your Fund's investments among a number of economic sectors,
including technology, health care and finance.
OUTLOOK
Over the next several months, we believe small-company stocks should generate
stronger returns than they have in the recent past. We think economic growth
should be moderate and inflation and interest rates should be relatively low.
Historically, small-company stocks have tended to perform well in this type of
environment. In addition, small company stocks are relatively inexpensive. Even
after the small-cap stock rally of April and May, valuations on small-company
stocks, in comparison to large-cap stocks, were at their most attractive levels
in several years. We believe these favorable conditions should bode well for
small-cap stocks.
As a small-company investor, you should keep in mind that one of the
characteristics of small-company stocks is their volatility. They tend to
fluctuate in value over short periods of time. Historically, large gains in the
small-cap sector
-- CONTINUED--
<PAGE>
PAGE 2
KEYSTONE SMALL COMPANY GROWTH FUND (S-4)
have come during short time frames. Therefore, being invested in small-caps when
they rally is crucial to being a successful small-cap investor. As we continue
to restructure the portfolio, we believe that the companies in which we have
invested are poised to achieve their highest profitability and fastest growth.
In many areas, such as technology and health care, these companies are at a
stage in their development when they are introducing products and services that
have never existed. Generally, earnings growth in these types of companies is
less dependent on the general level of economic activity and more on the success
of their own particular product cycles.
Thank you for your continued support of Keystone Small Company Growth Fund
(S-4). If you have any questions or comments about your investment, we encourage
you to write to us.
Sincerely,
/s/ Albert H. Elfner, III
Albert H. Elfner, III
CHAIRMAN
KEYSTONE INVESTMENT MANAGEMENT COMPANY
/s/ George S. Bissell
George S. Bissell
CHAIRMAN OF THE BOARD
KEYSTONE FUNDS
<TABLE>
<S> <C>
(Photo of Albert H. (Photo of George S.
Elfner, III appears here) Bissell appears here)
ALBERT H. ELFNER, III GEORGE S. BISSELL
</TABLE>
June 1997
<PAGE>
PAGE 3
A Discussion With
Your Fund Manager
(Photo of J. Gary Craven appears here)
J. GARY CRAVEN IS SENIOR VICE PRESIDENT AND CHIEF INVESTMENT OFFICER,
SMALL COMPANY STOCKS AND PORTFOLIO MANAGER OF YOUR FUND. MR. CRAVEN IS A
CHARTERED FINANCIAL ANALYST. PRIOR TO JOINING KEYSTONE IN NOVEMBER L996,
HE WAS A PORTFOLIO MANAGER AT INVISTA CAPITAL MANAGEMENT, INC., A
SUBSIDIARY OF THE PRINCIPAL FINANCIAL GROUP. AT INVISTA, HE MANAGED AN
$860 MILLION SMALL COMPANY GROWTH PENSION ACCOUNT AND CO-MANAGED PRINCOR
EMERGING GROWTH FUND AND PRINCOR GROWTH FUND, ALL OF WHICH HAD ATTRACTIVE
PERFORMANCE RECORDS RELATIVE TO SMALL-CAP BENCHMARKS WHILE UNDER HIS
MANAGEMENT. KEYSTONE'S SMALL COMPANY STOCK TEAM IS COMPOSED OF THREE
PORTFOLIO MANAGERS AND SUPPORTED BY FIVE EQUITY ANALYSTS. TOGETHER, THEY
SEARCH FOR STOCKS OF SMALL COMPANIES WITH SUSTAINABLE ABOVE-
AVERAGE GROWTH RATES.
Q WHAT WAS THE INVESTMENT ENVIRONMENT FOR SMALL-CAP STOCKS LIKE DURING THE
TWELVE-MONTH PERIOD?
A It was a volatile environment for small-cap stocks. Small caps generated very
strong gains in l995, but midway through l996, the environment changed. Concerns
about slower economic growth and rising interest rates made small-cap stocks
less appealing to investors, and they shifted money to large-company stocks.
Small company stocks were hit hardest during a market correction in the summer
of l996 and, again, during the market downturn that occurred in March and April
of l997. Toward the end of April, however, investors appeared to recognize that
small-cap stock prices were at very attractive price levels and began to favor
small-cap stocks. Small-cap stock prices rose and continued on an upward course
through May 1997.
Q WHAT WAS YOUR STRATEGY FOR MANAGING THE PORTFOLIO DURING THE PERIOD?
A We invested in companies with market capitalizations of $1 billion and under.
Our strategy was to reposition the portfolio to reduce volatility. We invested
in high-quality companies that we believe have above average long-term growth
prospects and that were relatively inexpensive. The companies we selected for
the portfolio tended to have strong competitive positions in their market
sectors and superior business models which have the potential to generate high
returns on capital. These business models can include: low cost production,
technological leadership, exceptional distribution systems and high-quality
management teams.
Q TECHNOLOGY STOCKS ACCOUNTED FOR THE LARGEST AREA OF INVESTMENT. WHAT WAS
ATTRACTIVE ABOUT TECHNOLOGY STOCKS?
A When we refer to technology stocks, we include a broad area that encompasses
telecommunications, software and hardware businesses. During the period, we
changed the composition of the technology portion of the portfolio. We sold
stocks that we believed had reached optimal price levels. For example, we
reduced two long-standing software holdings, McAfee Associates and BMC Software.
We found opportunity in a number of other companies that were attractively
priced and met our criteria for growth.
<PAGE>
PAGE 4
KEYSTONE SMALL COMPANY GROWTH FUND (S-4)
TOP 5 INDUSTRIES
AS OF MAY 31, 1997
<TABLE>
<CAPTION>
PERCENTAGE OF
INDUSTRY NET ASSETS
<S> <C>
Information Services & Technology 19.4%
Healthcare Products & Services 11.2%
Finance & Insurance 9.8%
Oil 8.7%
Electronics 7.3%
</TABLE>
Q WHAT WERE SOME OF THE TECHNOLOGY COMPANIES YOU ADDED TO THE PORTFOLIO?
A We believe there are several dominant hardware companies in the technology
sector, including Microsoft, Intel and Cisco Systems. Because these are very
large companies, your Fund does not invest in them. However, we can take
advantage of their strength by investing in smaller firms that do business with
these larger firms. We increased our exposure to companies that we believe
should benefit from providing products and services to large, dominant
technology companies. Two examples are Avid Technology and Rational Software.
Avid Technology produces editing software for the television and movie
industries. It is currently developing this high-end technical equipment for the
corporate and consumer markets. Rational Software produces software that makes
it easier to write computer programs.
Q DID YOU MAKE ANY CHANGES IN THE FINANCE AREA?
A We made a number of changes in the finance sector. We eliminated stocks that
we believe had reached their target price levels. We also were concerned about
the impact that increases in interest rates could have on some lenders. As a
result, when the Federal Reserve Board raised rates in March, we repositioned
our investments from sub-prime lenders to higher quality lenders. We sold
automobile loan companies and mortgage lending businesses and increased our
emphasis on quality, regional banks. Going forward, we are optimistic about the
potential for financial stocks. We believe that the need for financial services
and products will increase for the rest of the decade and that the finance
sector of the market should be one of the strongest growth areas.
Q SIX MONTHS AGO, OIL SERVICES STOCKS WERE AN AREA OF EMPHASIS FOR THE FUND.
WERE THEY AS DOMINANT IN THE PORTFOLIO AT THE END OF THE PERIOD?
A We trimmed the Fund's exposure to oil services stocks as they reached their
price objectives. Even though energy and oil services stocks have produced
strong returns for more than a year, the level of drilling activity is
increasing. We have concentrated Fund holdings in companies we believe are well
positioned to participate in this activity. We cut back on ENSCO International,
which had been the Fund's largest holding. It is still among the portfolio's top
ten holdings, but we reduced its position in the portfolio.
Q HEALTH CARE STOCKS WERE AN IMPORTANT PART OF THE PORTFOLIO. HOW DID THESE
STOCKS PERFORM?
A In the health care area, prices on several companies declined because of
concerns about changes in Medicare regulations. We believe investors overreacted
to the possible changes in Medicare, and we invested in several health care
companies. These included Lincare, American Home Patients, and Rotech. These are
home health care businesses that specialize in respiration technology, that is,
they provide oxygen to patients with Asthma, Emphysema and Chronic Bronchitis.
We also increased the portfolio's exposure to biotechnology companies.
<PAGE>
PAGE 5
TOP 10 HOLDINGS
AS OF MAY 31, 1997
<TABLE>
<CAPTION>
PERCENTAGE OF
COMPANY INDUSTRY NET ASSETS
<S> <C> <C>
BMC Software, Inc. Information Services 3.0%
& Technology
Synopsis, Inc. Information Services 2.2.%
& Technology
Maxim Integrated Electronics 1.7%
Products, Inc.
Seacor Smit, Inc. Oil 1.7%
Astoria Financial Corp Finance & Insurance 1.6%
ENSCO International, Inc. Oil 1.6%
Microchip Technology, Information Services 1.5%
Inc. & Technology
Health Management Healthcare Products & 1.5%
Associates, Inc. Services
USA Waste Services, Inc. Business Equipment 1.5%
TCF Financial Corp Finance & Insurance 1.4%
</TABLE>
Q WHAT IS YOUR OUTLOOK?
A We believe there are several factors that bode well for the future. Prices of
small-company stocks are very attractive, relative to their large-cap
counterparts. However, it is going to take earnings growth to drive small-cap
prices higher over the long term. We believe that the development of new
products and technologies should add the impetus that these stocks need to
perform well over the long term. We are optimistic about economic growth. We
believe that any increase in interest rates will be relatively small and will
set the stage for moderate economic growth, relatively low inflation, and lower
interest rates over the long term. We think this should be a positive backdrop
for small companies.
(Diamond appears here)
THIS COLUMN IS INTENDED TO ANSWER QUESTIONS ABOUT YOUR FUND.
IF YOU HAVE A QUESTION YOU WOULD LIKE ANSWERED, PLEASE WRITE TO:
EVERGREEN KEYSTONE INVESTMENT SERVICES, INC.
ATTN. SHAREHOLDER COMMUNICATIONS
201 SOUTH COLLEGE STREET, SUITE 400,
CHARLOTTE, N.C. 28288-1195
<PAGE>
PAGE 6
KEYSTONE SMALL COMPANY GROWTH FUND (S-4)
Your Fund's Performance
(Charts appear here with the following information)
Growth of an investment in
Keystone Small Company Growth Fund
5/86 5/87 5/88 5/89 5/90 5/91 5/93 5/94 5/95 5/96 5/97
Dividend Reinvestment (Customer to supply plot points)
Initial Investment
A $10,000 investment in Keystone Small Company Growth Fund (S-4) made on
May 31, 1987 with all distributions reinvested was worth $30,805 on May 31,
1997. Past performance is no guarantee of future results.
Comparison of change in value of a $10,000 investment in
Keystone Small Company Growth Fund (S-4), the Russell
2000 Index, the NASDAQ Composite Index and the
Consumer Price Index.
5/31/87 5/88 5/89 5/90 5/91 5/92 5/93 5/94 5/95 5/96 5/97
Fund (Customer to supply plot points)
CPI
Russell 2000
NASDAQ
Past performance is no guarantee of future results. The Russell 2000 index and
NASDAQ Composite Index are unmanaged market indices. These indices do not
include transaction costs associated with buying and selling securities nor any
management fees. The Consumer Price Index, a measure of inflation, is through
May 31, 1997.
The "If you redeemed" returns reflect the deduction of the 3% contingent
deferred sales charge (CDSC) for those investors who sold Fund shares after one
calendar year. Investors who retained their fund investment earned the returns
reported in the second column of the table.
The investment return and principal value will fluctuate so that your shares,
when redeemed, may be worth more or less than the original cost.
You may exchange your shares for another Keystone Classic fund by phone or in
writing. The Fund reserves the right to change or terminate the exchange offer.
TWELVE-MONTH PERFORMANCE AS OF MAY 31, 1997
Total Return* (8.61%)
Net asset value 5/31/96 $10.35
5/31/97 $ 8.44
Dividends None
Capital gain distributions $ 1.02
* BEFORE DEDUCTION OF CONTINGENT DEFERRED SALES CHARGES
(CDSC).
<TABLE>
<CAPTION>
HISTORICAL RECORD AS OF MAY 31, 1997
<S> <C> <C>
IF YOU IF YOU DID NOT
REDEEMED REDEEM
<S> <C> <C>
CUMULATIVE TOTAL RETURN
1-year (11.06%) (8.61%)
5-year 106.68% 106.68%
10-year 208.05% 208.05%
AVERAGE ANNUAL TOTAL RETURN
1-year (11.06%) (8.61%)
5-year 15.63% 15.63%
10-year 11.91% 11.91%
</TABLE>
<PAGE>
PAGE 7
SCHEDULE OF INVESTMENTS-- MAY 31, 1997
<TABLE>
<CAPTION>
SHARES VALUE
<C> <S> <C> <C>
COMMON STOCKS-- 97.2%
<C> <S> <C> <C>
AUTOMOTIVE EQUIPMENT & MANUFACTURING--
1.7%
359,500 Gentex Corp.................. $ 7,190,000
411,160 Tower Automotive Inc......... 16,292,215
23,482,215
BANKS-- 1.7%
93,100 * Community First Bankshares
Inc........................ 3,217,769
233,160 * Hubco Inc.................... 6,076,732
390,080 * North Fork Bancorp, Inc...... 8,191,680
207,800 * Sovereign Bancorp Inc........ 2,740,362
61,646 * Westamerica Bancorp.......... 4,230,457
24,457,000
BUILDING, CONSTRUCTION & FURNISHINGS--
3.4%
631,020 Champion Enterprises, Inc.... 11,594,993
235,419 Furniture Brands
International, Inc......... 3,678,422
824,791 * Oakwood Homes Corp........... 19,588,786
125,000 Service Experts Inc.......... 3,546,875
194,160 Shaw Group Inc............... 3,373,530
299,420 Toll Brothers, Inc........... 5,464,415
47,247,021
BUSINESS EQUIPMENT & SERVICES-- 4.8%
235,660 Alternative Resources
Corp....................... 4,344,981
25,000 American Management Systems
Inc........................ 646,875
339,780 * Comdisco, Inc................ 12,529,388
325,121 * G&K Services................. 10,525,792
196,596 * Norrell Corporation Georgia.. 6,340,221
141,000 Renaissance Solutions,
Inc........................ 5,164,125
584,616 USA Waste Services, Inc...... 21,192,330
217,945 Vincam Group Inc............. 6,701,809
67,445,521
CHEMICAL & AGRICULTURAL PRODUCTS-- 0.7%
291,240 * OM Group, Inc................ 9,174,060
COMMERCIAL SERVICES-- 0.3%
116,967 Budget Group Inc............. 3,260,455
23,800 Hertz Corp................... 815,150
4,075,605
COMMUNICATION SYSTEMS & SERVICES--
0.5%
200,000 Data General Corp............ 4,275,000
200,000 Fore Systems................. 3,312,500
7,587,500
<CAPTION>
SHARES VALUE
<C> <S> <C> <C>
<CAPTION>
COMMON STOCKS (CONTINUED)
<C> <S> <C> <C>
CONSUMER PRODUCTS & SERVICES-- 3.0%
318,517 Action Performance Cos Inc... $ 7,664,315
69,880 Blyth Industries Inc......... 3,109,660
532,484 Devry Inc.................... 14,709,871
370,069 Equity Corporation
International.............. 8,812,268
200,000 * Stanhome Inc................. 6,275,000
172,007 USA Detergents Inc........... 2,214,590
42,785,704
ELECTRONICS-- 7.3%
53,200 ADFlex Solutions, Inc........ 871,150
353,857 Altron Inc................... 5,882,873
626,640 Analog Devices, Inc.......... 16,762,620
3,500 Asyst Technologies Inc....... 1,337,906
300,560 * BMC Industries Inc........... 9,880,910
150,000 Credence Systems Corp........ 4,443,750
291,240 DII Group Inc................ 9,210,465
488,320 ESS Technology Inc........... 7,538,440
50,000 Flextronics International.... 1,171,875
200,000 Integrated Process Equipment
Corp....................... 3,662,500
210,563 * Linear Technology Corp....... 10,541,310
433,889 Maxim Integrated Products
Inc........................ 23,375,770
289,007 Sipex Corp................... 8,597,958
103,277,527
FINANCE & INSURANCE-- 9.8%
389,582 Amerin Corp.................. 9,057,781
561,462 * Astoria Financial Corp....... 23,090,125
248,255 The BISYS Group Inc. (a)..... 9,418,174
291,240 * BostonFed Bancorp Inc........ 4,405,005
28,188 * Capital Re Corp.............. 1,236,749
342,126 * CMAC Investment Corp......... 14,240,995
216,489 * Everen Capital Corp.......... 5,358,103
90,648 First Alliance Company....... 2,232,207
582,480 Firstplus Financial Group
Inc........................ 14,780,430
361,023 * HCC Insurance Holdings Inc... 9,431,726
97,080 * Legg Mason, Inc.............. 4,477,815
266,970 * Long Islands Bancorp Inc..... 9,293,893
281,532 * Queens County Bancorp........ 11,648,386
465,980 * TCF Financial Corp........... 19,804,150
138,475,539
</TABLE>
<PAGE>
PAGE 8
KEYSTONE SMALL COMPANY GROWTH FUND (S-4)
SCHEDULE OF INVESTMENTS-- MAY 31, 1997
SHARES VALUE
COMMON STOCKS (CONTINUED)
FOOD & BEVERAGE PRODUCTS-- 1.1%
351,527 * Applebee's International
Inc........................ $ 8,678,323
382,500 * Flowers Industries Inc....... 6,741,562
15,419,885
HEALTHCARE PRODUCTS & SERVICES-- 11.2%
85,800 Agouron Pharmaceuticals
Inc........................ 6,880,087
180,000 American Home Patient Inc.... 3,465,000
964,198 Amylin Pharmaceuticals Inc... 12,474,312
23,100 CRA Managed Care Inc......... 1,061,156
281,026 Cytotherapeutics............. 1,563,207
188,044 Cytyc Corp................... 4,595,325
292,502 Emeritus Corp................ 4,460,655
662,085 Gilead Sciences Inc.......... 17,834,915
727,226 Health Management Associates,
Inc........................ 21,271,360
213,673 Heartport Inc................ 5,141,507
167,985 Idexx Laboratories, Inc...... 2,383,287
369,584 Lifecore Biomedical Inc...... 5,151,077
150,000 Lincare Holdings, Inc........ 5,840,625
582,480 Magainin Pharmaceutical...... 4,295,790
255,569 Neurogen Corp................ 4,823,865
192,510 Norland Medical Systems
Inc........................ 1,672,431
329,684 Parexel International
Corp....................... 10,776,546
145,620 Pediatrix Med Group.......... 5,788,395
142,320 Perclose Inc................. 3,273,360
512,582 Phymatrix Corp............... 7,336,330
120,000 Polymer Group Inc............ 1,740,000
140,000 Rotech Medical Corp.......... 2,388,750
339,780 Strategic Distribution
Inc........................ 1,337,884
372,680 Thermo Cardiosystems Inc..... 10,015,775
235,711 Total Renal Care Holdings
Inc........................ 8,485,596
63,102 Urologix Inc................. 1,064,846
24,076 Virus Research Institute
Inc........................ 153,485
150,000
Weider Nutrition
International Inc.......... 1,912,500
157,188,066
SHARES VALUE
COMMON STOCKS (CONTINUED)
INDUSTRIAL SPECIALTY PRODUCTS &
SERVICES-- 2.3%
363,274 Brown & Sharpe Manufacturing
Co. Cl. A.................. $ 5,176,655
354,050 GTS Duratek Inc.............. 3,075,809
180,500 * Roper Industries............. 8,867,062
47,500 * Trimas Corp.................. 1,347,813
438,037 United States Filter Corp.... 13,798,165
32,265,504
INFORMATION SERVICES & TECHNOLOGY--
19.4%
130,000 ABR Information Services
Inc........................ 4,168,125
15,000 Acxiom Corp.................. 247,500
280,800 Avid Technology Inc.......... 6,598,800
415,864 BDM International Inc........ 10,656,515
133,097 Bitstream Inc................ 382,654
217,000 Black Box Corp............... 7,649,250
788,095 BMC Software, Inc............ 42,606,386
420,380 Cambridge Technology
Partners................... 12,847,864
80,182 Ciber Inc.................... 3,312,519
483,700 Clarify Inc.................. 5,834,631
485,400 Cognex Corp.................. 12,650,737
207,654 Dataworks Corp............... 3,932,448
485,400 Geoworks..................... 3,048,919
4,000 Inacom Corp.................. 129,250
227,184 INSO Corp.................... 6,346,953
48,540 Manugistics Group Inc........ 3,142,965
5,000 May & Speh Inc............... 55,937
205,290 McAfee Associates Inc........ 13,510,648
232,798 Mechanical Dynamics Inc...... 2,182,481
605,290 Microchip Technology Inc..... 21,601,287
237,054 * National Data Corp........... 10,400,744
291,240 Parametric Technology Corp... 13,087,597
236,681 Project Software &
Development Inc............ 4,556,109
150,000 Pure Atria Corp.............. 2,390,625
174,200 Radisys Corp................. 6,380,075
350,000 Rational Software Corp....... 6,584,375
504,816 Safeguard Scientifics Inc.... 13,630,032
348,323 Security Dynamics............ 12,844,411
832,455 Synopsys Inc................. 31,008,949
100,000 Vantive Corp................. 2,687,500
233,497 Wind River Systems Inc....... 7,880,524
272,356,810
<PAGE>
PAGE 9
SCHEDULE OF INVESTMENTS-- MAY 31, 1997
<TABLE>
<CAPTION>
SHARES VALUE
COMMON STOCKS (CONTINUED)
<C> <S> <C> <C>
LEISURE & TOURISM-- 2.0%
43,000 Anchor Gaming................ $ 1,832,875
49,395 Casino America Inc........... 494
479,589 Colorado Gaming &
Entertainment Company (c).. 2,158,150
291,240 * Louisiana Quinta Inns Inc.... 6,698,520
467,246 Promus Hotel Corp............ 16,879,262
27,569,301
MACHINERY-- DIVERSIFIED-- 0.5%
99,400 Omniquip International Inc... 1,994,213
215,324 Rental Service Corp.......... 4,683,297
6,677,510
METAL PRODUCTS & SERVICES-- 1.2%
452,490 Molten Metal Tech Inc........ 3,195,711
250,000 Oregon Metallurgical Corp.... 6,437,500
235,613 RMI Titanium Company......... 5,478,002
116,496 Special Metals Corp.......... 2,169,738
17,280,951
NATURAL GAS-- 1.2%
398,028 Nuevo Energy Company......... 17,363,972
OFFICE EQUIPMENT & SUPPLIES-- 2.0%
485,400 EMC Corp..................... 19,355,325
293,220 Komag Inc.................... 8,466,727
27,822,052
OIL-- 8.7%
191,240 BJ Services Company.......... 10,566,010
81,742 * Carbo Ceramics Inc........... 1,808,542
457,248 ENSCO International Inc...... 22,805,244
300,050 Falcon Drilling.............. 13,764,794
242,700 Forcenergy, Inc.............. 8,464,162
321,917 Global Industries, Inc....... 7,021,815
160,182 * KCS Energy Inc............... 6,667,576
316,039 Newpark Resources, Inc....... 16,592,047
448,999 Seacor Smit Inc.............. 23,235,698
24,950 Stone Energy Corp............ 698,600
83,586 * Saint Mary Land & Exploration
Company.................... 2,653,856
325,218 Swift Energy Company......... 8,699,581
122,977,925
<CAPTION>
SHARES VALUE
<C> <S> <C> <C>
<CAPTION>
COMMON STOCKS (CONTINUED)
<C> <S> <C> <C>
PUBLISHING, BROADCASTING &
ENTERTAINMENT-- 1.7%
371,040 Cox Radio Inc................ $ 8,302,020
388,320 Jacor Communications, Inc.... 13,421,310
75,800 Young Broadcasting Inc.
Cl. A...................... 2,032,387
23,755,717
RETAILING & WHOLESALE-- 5.4%
390,055 Abercrombie & Fitch Company.. 6,777,205
882,480 Corporate Express Inc........ 12,244,410
181,877 Global Directmail Corp....... 4,319,579
141,240 Kohl's Corp.................. 7,609,305
187,680 Nautica Enterprises, Inc..... 4,422,210
485,400 Saks Holdings Inc............ 12,074,325
493,200 Sports Authority Inc......... 8,877,600
310,656 * Tiffany & Company New........ 14,406,672
236,293 West Marine Inc.............. 6,187,923
76,919,229
TELECOMMUNICATION SERVICES &
EQUIPMENT-- 6.1%
77,800 ACC Corp..................... 1,993,625
427,288 Aspect Telecommunications
Corp....................... 9,613,980
398,978 Billing Information Concepts
Corp....................... 11,470,618
138,300 Boston Communications Group.. 1,339,781
346,768 Brooks Fiber Properties
Inc........................ 8,907,603
435,000 McLeod USA Incorporated...... 10,222,500
326,286 Natural Microsystems Corp.... 8,014,400
300,000 Pairgain Technologies Inc.... 6,281,250
161,444 Proxim Inc................... 4,106,732
121,700 Spectrian.................... 2,692,612
829,053 Tel-Save Holdings Inc........ 12,746,690
582,480 Winstar Communications Inc... 8,227,530
85,617,321
TRANSPORTATION-- 0.3%
146,399 Coach USA Inc................ 3,842,974
TRANSPORTATION-- 0.9%
242,700 * ASA Holdings, Inc............ 6,310,200
77,320 Railtex Inc.................. 1,420,755
153,956 Swift Transportation Inc..... 4,965,082
12,696,037
<CAPTION>
TOTAL COMMON STOCKS
(COST $1,056,771,773)......................... 1,367,760,946
<C> <S> <C> <C>
</TABLE>
<PAGE>
PAGE 10
KEYSTONE SMALL COMPANY GROWTH FUND (S-4)
SCHEDULE OF INVESTMENTS-- MAY 31, 1997
<TABLE>
<CAPTION>
PAR
VALUE VALUE
<C> <S> <C> <C>
<CAPTION>
SHORT-TERM INVESTMENTS-- 1.9%
<C> <S> <C> <C>
GOVERNMENT AGENCIES-- 0.7%
10,000,000 FHLB Discount Notes
5.50%, 6/2/97.................... $ 9,998,472
REPURCHASE AGREEMENTS-- 1.2%
16,205,000 Keystone Joint Repurchase Agreement
(investments in repurchase
agreements, in joint trading
account, purchased 5/30/97,
5.5734%, maturing 6/2/97,
maturity value $16,212,526)(b)...
16,205,000
<CAPTION>
TOTAL SHORT-TERM INVESTMENTS
(COST $26,203,472)............................ 26,203,472
<C> <S> <C> <C>
<CAPTION>
TOTAL INVESTMENTS
(COST-- $1,082,975,245) 99.1% 1,393,964,418
<C> <S> <C> <C>
OTHER ASSETS AND LIABILITIES--
NET 0.9 12,804,201
NET ASSETS 100.0% $1,406,768,619
</TABLE>
* Income producing securities.
FHLB-- Federal Home Loan Bank
(a) At May 31, 1997, the Fund owned 248,255 shares of common stock of The BISYS
Group, Inc. at a cost of $6,474,363. During the year ended May 31, 1997 the
Fund earned no dividend income from this investment. These shares were
purchased prior to Evergreen Keystone Distributors Inc., a wholly owned
subsidiary of The BISYS Group, Inc. becoming the Fund's principal
underwriter and BISYS Fund Services, Inc. becoming the Fund's
sub-administrator.
(b) The repurchase agreement is fully collateralized by U.S. Government and/or
agency obligations based on market prices at May 31, 1997.
(c) Investment in non-controlled affiliate holding over 5% of outstanding
shares. At May 31, 1997, the Fund held 479,589 of Colorado Gaming &
Entertainment Company with a value of $2,158,150 and acquisition cost of
$2,766,251. The Fund has not earned any income from this investment.
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 11
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT EACH YEAR)
<TABLE>
<CAPTION>
YEAR ENDED MAY 31,
1997(A) 1996 1995 1994 1993(A) 1992(A) 1991(A) 1990(A) 1989(A)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE
BEGINNING OF YEAR $10.35 $8.62 $7.64 $7.95 $7.61 $7.17 $6.24 $5.66 $4.48
INCOME FROM INVESTMENT
OPERATIONS
Net investment income
(loss) (0.11) (0.13) (0.07) (0.12) (0.12) (0.08) (0.04) 0.00 0.02
Net realized and
unrealized gain (loss)
on investments (0.78) 2.87 1.68 0.63 1.82 0.98 1.17 0.63 1.20
Total from investment
operations (0.89) 2.74 1.61 0.51 1.70 0.90 1.13 0.63 1.22
LESS DISTRIBUTIONS FROM
Net investment income 0.00 0.00 0.00 0.00 0.00 0.00 0.00 (0.05) (0.01)
Net realized gain on
investments (1.02) (1.01) (0.63) (0.82) (1.36) (0.46) (0.20) 0.00 (0.03)
Total distributions (1.02) (1.01) (0.63) (0.82) (1.36) (0.46) (0.20) (0.05) (0.04)
NET ASSET VALUE END OF
YEAR $8.44 $10.35 $8.62 $7.64 $7.95 $7.61 $7.17 $6.24 $5.66
TOTAL RETURN (B) (8.61%) 33.03% 23.58% 6.84% 28.76% 13.45% 19.42% 11.24% 27.45%
RATIOS/SUPPLEMENTAL DATA
RATIOS TO AVERAGE NET
ASSETS:
Total expenses 1.75% 1.73% 1.78% 1.73% 2.04% 1.47% 1.48% 1.40% 1.27%
Total expenses,
excluding indirectly
paid expenses 1.73% 1.72% N/A N/A N/A N/A N/A N/A N/A
Net investment income
(loss) (1.32%) (1.34%) (1.10%) (1.49%) (1.68%) (1.09%) (0.68%) 0.02% 0.47%
PORTFOLIO TURNOVER RATE 48% 94% 38% 60% 78% 81% 73% 77% 57%
AVERAGE COMMISSION RATE
PAID $0.0551 $0.0563 N/A N/A N/A N/A N/A N/A N/A
NET ASSETS END OF YEAR
(THOUSANDS) $1,406,769 $2,005,803 $1,459,955 $1,005,595 $965,959 $702,442 $623,291 $537,912 $503,908
<CAPTION>
1988
<S> <C>
NET ASSET VALUE
BEGINNING OF YEAR $7.80
INCOME FROM INVESTMENT
OPERATIONS
Net investment income
(loss) 0.00
Net realized and
unrealized gain (loss)
on investments (1.64)
Total from investment
operations (1.64)
LESS DISTRIBUTIONS FROM
Net investment income 0.00
Net realized gain on
investments (1.68)
Total distributions (1.68)
NET ASSET VALUE END OF
YEAR $4.48
TOTAL RETURN (B) (22.39%)
RATIOS/SUPPLEMENTAL DATA
RATIOS TO AVERAGE NET
ASSETS:
Total expenses 1.17%
Total expenses,
excluding indirectly
paid expenses N/A
Net investment income
(loss) 0.03%
PORTFOLIO TURNOVER RATE 80%
AVERAGE COMMISSION RATE
PAID N/A
NET ASSETS END OF YEAR
(THOUSANDS) $442,020
</TABLE>
(a) Calculation based on average shares outstanding.
(b) Excluding applicable sales charges.
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 12
KEYSTONE SMALL COMPANY GROWTH FUND (S-4)
STATEMENT OF ASSETS AND LIABILITIES
MAY 31, 1997
ASSETS
Investments at market value (identified
cost, $1,082,975,245) $1,393,964,418
Cash 4,911
Foreign currency at market value
(identified cost, $1,122,855) 1,110,711
Receivable for investments sold 18,176,302
Receivable for Fund shares sold 6,513,064
Interest and dividends receivable 225,195
Prepaid expenses 102,776
Other assets 103,431
Total assets 1,420,200,808
LIABILITIES
Payable for investments purchased 8,028,277
Payable for Fund shares redeemed 3,920,705
Distribution fees payable 718,600
Accrued expenses and other liabilities 764,607
Total liabilities 13,432,189
NET ASSETS $1,406,768,619
NET ASSETS REPRESENTED BY
Paid-in capital $ 983,582,840
Accumulated net investment loss (7,516)
Accumulated net realized gains on
investments 112,216,266
Net unrealized appreciation on investments
and foreign currency 310,977,029
Total net assets $1,406,768,619
NET ASSET VALUE PER SHARE OF BENEFICIAL
INTEREST OUTSTANDING
Net assets of $1,406,768,619 / 166,737,931
shares outstanding $ 8.44
STATEMENT OF OPERATIONS
YEAR ENDED MAY 31, 1997
INVESTMENT INCOME
Dividends $ 2,562,283
Interest 4,364,898
Total income 6,927,181
EXPENSES
Management fee $ 7,788,033
Distribution plan expenses 16,641,755
Transfer agent fees 3,702,109
Accounting expenses 17,039
Custodian fees 700,665
Professional fees 150,577
Trustees' fees and expenses 54,381
Miscellaneous expenses 244,220
Total expenses 29,298,779
Less: Expenses paid indirectly (231,796)
Net expenses 29,066,983
Net investment loss (22,139,802)
NET REALIZED AND UNREALIZED GAIN
(LOSS) ON INVESTMENTS
Net realized gain on investments
and foreign currency related
transactions 117,982,561
Net change in unrealized
appreciation on investments
and foreign currency (279,047,661)
Net realized and unrealized loss
on investments and foreign
currency (161,065,100)
Net decrease in net assets
resulting from operations $(183,204,902)
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 13
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
YEAR ENDED MAY 31,
1997 1996
<S> <C> <C>
OPERATIONS:
Net investment loss $ (22,139,802) $ (24,478,442)
Net realized gain on investments 117,982,561 389,754,504
Net change in unrealized appreciation on investments and foreign currency (279,047,661) 127,581,090
Net increase (decrease) in net assets resulting from operations (183,204,902) 492,857,152
DISTRIBUTIONS TO SHAREHOLDERS FROM NET REALIZED GAINS ON INVESTMENTS (200,508,632) (173,760,139)
CAPITAL SHARE TRANSACTIONS
Proceeds from shares sold 1,018,919,437 1,354,600,987
Payments for shares redeemed (1,402,606,782) (1,267,570,849)
Net asset value of shares issued in reinvestment of distributions 168,366,921 139,720,568
Net increase (decrease) in net assets resulting from capital share
transactions (215,320,424) 226,750,706
Total increase (decrease) in net assets (599,033,958) 545,847,719
NET ASSETS:
Beginning of year 2,005,802,577 1,459,954,858
End of year [including accumulated net investment loss of $7,516 and $7,483,
respectively] $ 1,406,768,619 $ 2,005,802,577
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 14
KEYSTONE SMALL COMPANY GROWTH FUND (S-4)
NOTES TO FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
Keystone Small Company Growth Fund (S-4) (the "Fund") is a Pennsylvania common
law trust for which Keystone Investment Management Company ("Keystone") is the
investment advisor and manager. Keystone was formerly a wholly owned subsidiary
of Keystone Investments, Inc ("KII") and is currently a subsidiary of First
Union Corporation ("First Union").
The Fund is registered under the Investment Company Act of 1940, as amended
(the "1940 Act"), as a diversified, open-end management investment company. The
Fund's investment objective is to seek long-term growth of capital through
investments in emerging growth companies.
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
policies are in conformity with generally accepted accounting principles, which
require management to make estimates and assumptions that affect amounts
reported herein. Although actual results could differ from these estimates, any
such differences are expected to be immaterial to the net assets of the Fund.
A. VALUATION OF SECURITIES
Investments are usually valued at the closing sales price, or, in the absence of
sales and for over-the-counter securities, the mean of the bid and asked prices.
Securities for which valuations are not available from an independent pricing
service (including restricted securities) are valued at fair value as determined
in good faith according to procedures established by the Board of Trustees.
Short-term investments with remaining maturities of 60 days or less are
carried at amortized cost, which approximates market value. Short-term
securities with greater than 60 days to maturity are valued at market value.
B. REPURCHASE AGREEMENTS
Pursuant to an exemptive order issued by the Securities and Exchange Commission,
the Fund, along with certain other Evergreen Keystone funds, may transfer
uninvested cash balances into a joint trading account. These balances are
invested in one or more repurchase agreements that are fully collateralized by
U.S. Treasury and/or federal agency obligations.
Securities pledged as collateral for repurchase agreements are held by the
custodian on the Fund's behalf. The Fund monitors the adequacy of the collateral
daily and will require the seller to provide additional collateral in the event
the market value of the securities pledged falls below the carrying value of the
repurchase agreement.
C. FOREIGN CURRENCY
The books and records of the Fund are maintained in United States (U.S.)
dollars. Foreign currency amounts are translated into U.S. dollars as follows:
market value of investments, assets and liabilities at the daily rate of
exchange; purchases and sales of investments, income and expenses at the rate of
exchange prevailing on the respective dates of such transactions. Net unrealized
foreign exchange gain (loss) resulting from changes in foreign currency exchange
rates is a component of net unrealized appreciation (depreciation) on
investments and foreign currency transactions. Net realized foreign currency
gains and losses resulting from changes in exchange rates include foreign
currency gains and losses between trade date and settlement date on investment
securities transactions, foreign currency transactions and the difference
between the amounts of interest and dividends recorded on the books of the Fund
and the amount actually received. The portion of foreign currency gains and
losses related to fluctuations in exchange rates between the initial purchase
trade date and subsequent sale trade date is included in realized gain (loss) on
foreign currency transactions.
D. FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS
The Fund may enter into forward foreign currency exchange contracts ("forward
contracts") to settle portfolio purchases and sales of securities denominated in
a foreign currency and to hedge certain foreign currency
<PAGE>
PAGE 15
assets or liabilities. Forward contracts are recorded at the forward rate and
are marked-to-market daily. Realized gains and losses arising from such
transactions are included in net realized gain (loss) on investments and foreign
currency related transactions. The Fund bears the risk of an unfavorable change
in the foreign currency exchange rate underlying the forward contract and is
subject to the credit risk that the other party will not fulfill their
obligations under the contract. Forward contracts involve elements of market
risk in excess of the amount reflected in the statement of assets and
liabilities.
E. SECURITIES TRANSACTIONS AND INVESTMENT INCOME
Securities transactions are accounted for no later than one business day after
the trade date. Realized gains and losses are computed on the identified cost
basis. Interest income is recorded on the accrual basis and includes
amortization of discount and premium. Dividend income is recorded on the
ex-dividend date.
F. FEDERAL INCOME TAXES
The Fund has qualified and intends to qualify in the future as a regulated
investment company under the Internal Revenue Code of 1986, as amended (the
"Code"). Thus, the Fund is relieved of any federal income tax liability by
distributing all of its net taxable investment income and net taxable capital
gains, if any, to its shareholders. The Fund also intends to avoid excise tax
liability by making the required distributions under the Code. Accordingly, no
provision for federal income tax is required.
G. DISTRIBUTIONS
The Fund distributes net investment income and net capital gains, if any, at
least annually. Distributions to shareholders are recorded at the close of
business on the ex-dividend date.
Income and capital gains distributions to shareholders are determined in
accordance with income tax regulations, which may differ from generally accepted
accounting principles. These differences are primarily due to net operating
losses generated by the Fund and the reclassification of certain gains related
to the sale of passive foreign investment company securities.
2. CAPITAL SHARE TRANSACTIONS
The Fund's Declaration of Trust authorizes the issuance of an unlimited number
of shares of beneficial interest with a par value of $1.00. Transactions in
shares of the Fund were as follows:
YEAR ENDED MAY 31,
1997 1996
Shares sold 121,645,715 141,592,081
Shares redeemed (168,659,715) (131,599,635)
Shares issued in
reinvestment of
distributions 19,925,079 14,560,340
Net increase (decrease) (27,088,921) 24,552,786
3. SECURITIES TRANSACTIONS
Cost of purchases and proceeds from sales of investment securities excluding
short-term securities for the year ended May 31, 1997, were $766,944,947 and
$1,214,970,663, respectively.
On May 31, 1997, the cost of investments for federal income tax purposes was
$1,085,389,073, gross unrealized appreciation of investments was $394,159,617
and gross unrealized depreciation of investments was $85,584,272, resulting in
net unrealized appreciation of $308,575,345 for federal income income tax
purposes.
4. DISTRIBUTION PLAN
The Fund bears some of the costs of selling its shares under a Distribution Plan
(the "Plan") adopted pursuant to Rule 12b-1 under the 1940 Act. Under the Plan,
the Fund pays its principal underwriter amounts which are calculated daily and
paid monthly.
On December 11, 1996, the Fund entered into a principal underwriting agreement
with Evergreen Keystone Distributors, Inc. (Formerly, Evergreen Fund
Distributor, Inc.) ("EKD"), a wholly owned subsidiary of The BISYS Group, Inc.
Prior to December 11, 1996, Evergreen Keystone Investment Services, Inc.
(Formerly Keystone Investment Distributors Company) ("EKIS"), a
<PAGE>
PAGE 16
KEYSTONE SMALL COMPANY GROWTH FUND (S-4)
wholly owned subsidiary of Keystone, served as the Fund's principal underwriter.
Under the Plan, the Fund pays a distribution fee amount which may not exceed
1.00% of the Fund's average daily net assets. Of that amount, 0.75% is used to
pay distribution expenses and 0.25% may be used to pay service fees. Contingent
deferred sales charges paid by redeeming shareholders may be paid to EKD.
The Plan may be terminated at any time by vote of the Independent Trustees or
by vote of a majority of the outstanding voting shares of the Fund. However,
after the termination of the Plan, and subject to the discretion of the
Independent Trustees, payments to EKD and/or EKIS may continue as compensation
for services which had been earned while the Plan was in effect.
EKD intends, but is not obligated, to continue to pay distribution costs that
exceed the current annual payments from the Fund. EKD intends to seek full
payment of such distribution costs from the Fund at such time in the future as,
and to the extent that, payment thereof by the Fund would be within permitted
limits.
5. INVESTMENT MANAGEMENT AGREEMENT AND OTHER AFFILIATED TRANSACTIONS
Under the terms of the investment advisory agreement dated December 11, 1996,
Keystone serves as the investment adviser and manager to the Fund. As such,
Keystone manages the Fund's investments, provides certain administrative
services and supervises the Fund's daily business affairs. In return, Keystone
is paid a management fee, computed daily and paid monthly, which is determined
by applying percentage rates starting at 0.70% and declining as net assets
increase to 0.35% per annum, to the average daily net asset value of the Fund.
Prior to December 11, 1996, Keystone Management, Inc. ("KMI"), a wholly owned
subsidiary of Keystone, served as investment manager to the Fund and provided
investment management and administrative services. Under an investment advisory
agreement between KMI and Keystone, Keystone served as investment adviser and
provided investment advisory and management services to the Fund. In return for
its services, Keystone received an annual fee equal to 85% of the management fee
received by KMI.
During the year ended May 31, 1997, the Fund paid or accrued $17,039 to
Keystone for certain administrative and accounting services. Evergreen Keystone
Service Company (formerly Keystone Investor Resource Center, Inc.), a
wholly-owned subsidiary of Keystone, serves as the Fund's transfer and dividend
disbursing agent.
Effective January 1, 1997, BISYS Fund Services, Inc. ("BISYS"), an affiliate
of EKD, began serving as the Fund's sub-administrator. As sub-administrator,
BISYS provides the officers of the Fund. For this service, BISYS was paid a fee
by Keystone, which was not a Fund expense.
Officers of the Fund and affiliated Trustees receive no compensation directly
from the Fund.
6. EXPENSE OFFSET ARRANGEMENT
The Fund has entered into an expense offset arrangement with its custodian. For
the year ended May 31, 1997, the Fund incurred total custody fees of $700,665
and received a credit of $231,796 pursuant to this expense offset arrangement,
resulting in a net custody expense of $468,869. The assets deposited with the
custodian under this expense offset arrangement could have been invested in
income-producing assets.
7. DISTRIBUTIONS TO SHAREHOLDERS
A distribution of $0.70 per share was declared on July 2, 1997 from the taxable
net long-term capital gains realized during the fiscal year ended May 31, 1997.
This distribution was payable on July 8, 1997 to shareholders of record at the
close of business on July 2, 1997. This distribution is not reflected in the
financial statements
<PAGE>
PAGE 17
INDEPENDENT AUDITORS' REPORT
THE TRUSTEES AND SHAREHOLDERS
KEYSTONE SMALL COMPANY GROWTH FUND (S-4)
We have audited the accompanying statement of assets and liabilities of Keystone
Small Company Growth Fund (S-4), including the schedule of investments, as of
May 31, 1997, and the related statement of operations for the year then ended,
the statements of changes in net assets for each of the years in the two-year
period then ended, and the financial highlights for each of the years in the
ten-year period then ended. These financial statements and financial highlights
are the responsibility of the Fund's management. Our responsibility is to
express an opinion on these financial statements and financial highlights based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of May
31, 1997 by correspondence with the custodian and brokers. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of
Keystone Small Company Growth Fund (S-4) as of May 31, 1997, the results of its
operations for the year then ended, the changes in net assets for each of the
years in the two-year period then ended and the financial highlights for each of
the years in the ten-year period then ended in conformity with generally
accepted accounting principles.
KPMG Peat Marwick LLP
Boston, Massachusetts
June 27, 1997
<PAGE>
PAGE 18
KEYSTONE SMALL COMPANY GROWTH FUND (S-4)
ADDITIONAL INFORMATION
(UNAUDITED)
The Fund held a special meeting of shareholders on Monday, December 9, 1996. On
October 18, 1996, the record date for the meeting, the Fund had 212,762,098
shares outstanding, of which 144,843,580 shares were represented at the meeting.
The votes at the meeting were as follows:
PROPOSAL 1: TO ELECT THE FOLLOWING PERSONS AS TRUSTEE OF THE FUND:
NUMBER OF SHARES
NOMINEES FOR TRUSTEE AFFIRMATIVE WITHHELD
Lawrence B. Ashkin 141,046,717 3,796,863
Frederick Amling 141,122,165 3,721,415
Charles A Austin, III 141,183,433 3,660,148
Foster Bam 141,056,902 3,786,678
George S. Bissell 141,083,525 3,760,055
Edwin D. Campbell 141,090,815 3,752,765
Charles F. Chapin 141,112,237 3,731,343
K. Dun Gifford 141,185,185 3,658,395
James S. Howell 141,002,239 3,841,341
Leroy Keith, Jr. 141,180,151 3,663,429
F. Ray Keyser 141,079,535 3,764,045
Gerald M. McDonnell 141,117,661 3,725,919
Thomas L. McVerry 141,139,537 3,704,043
William Walt Pettit 141,105,380 3,738,200
David M. Richardson 141,188,804 3,654,776
Russell A Salton, III M.D. 141,132,530 3,711,050
Michael S. Scofield 141,121,690 3,721,890
Richard J. Shima 141,179,300 3,664,280
Andrew J. Simons 141,170,649 3,672,931
PROPOSAL 2: TO APPROVE AN INVESTMENT ADVISORY AND MANAGEMENT AGREEMENT BETWEEN
KEYSTONE INVESTMENT MANAGEMENT COMPANY AND THE FUND:
Affirmative 137,959,295
Against 2,706,790
Abstain 4,177,495
FEDERAL TAX STATUS-- FISCAL 1997 DISTRIBUTIONS
(UNAUDITED)
During the fiscal year ended May 31, 1997, long-term capital gains distributions
totalling $1.02 per share were paid in shares or cash.
In January 1998, we will send to you complete information on the distributions
paid during the calendar year 1997 to help you in completing your federal income
tax return.
<PAGE>
This Page Left Blank Intentionally.
<PAGE>
KEYSTONE
FAMILY OF FUNDS
(Diamond appears here)
Balanced Fund (K-1)
Diversified Bond Fund (B-2)
Growth and Income Fund (S-1)
High Income Bond Fund (B-4)
International Fund Inc.
Liquid Trust
Mid-Cap Growth Fund (S-3)
Precious Metals Holdings, Inc.
Quality Bond Fund (B-1)
Small Company Growth Fund (S-4)
Strategic Growth Fund (K-2)
Tax Free Fund
This report was prepared primarily for the information of the Fund's
shareholders. It is authorized for distribution if preceded or accompanied by
the Fund's current prospectus. The prospectus contains important information
about the Fund including fees and expenses. Read it carefully before you invest
or send money. For a free prospectus on other Evergreen Keystone funds, contact
your financial adviser or call Evergreen Keystone.
Evergreen Keystone
(Tree appears here) FUNDS (SM) (Keystone symbol appears here)
P.O. Box 2121
Boston, Massachusetts 02106-2121
(Recycle symbol appears here)
S4-R 541255 7/97
KEYSTONE
(Graphic appears here)
SMALL COMPANY
GROWTH FUND (S-4)
Evergreen Keystone
(Tree appears here) FUNDS (SM) (Keystone symbol appears here)
ANNUAL REPORT
MAY 31, 1997
<PAGE>
EVERGREEN EQUITY TRUST
PART C
OTHER INFORMATION
Item 15. Indemnification.
The response to this item is incorporated by reference to "Liability
and Indemnification of Trustees" under the caption "Comparative Information on
Shareholders' Rights" in Part A of this Registration Statement.
Item 16. Exhibits:
Number Description
1 Declaration of Trust (1)
2 By-Laws (1)
3 Not applicable
4 Agreements and Plans of Reorganization (included as
Exhibits A-1 and A-2 to the Prospectus contained in
Part A to this registration statement)
5 Declaration of Trust Articles II, III.(6)(c), IV.(3),
IV.(8), V, VI, VII, VIII and By-Laws Articles II,
III, and VIII
6 Investment Advisory Agreement between Keystone
Investment Management Company and the Registrant (1)
7(A) Distribution Agreement between Evergreen Keystone
Distributor, Inc. and the Registrant (1)
(B) Form of Dealer Agreement for Class A, Class B and Class C shares
used by Evergreen Keystone Distributor, Inc. (1)
8 Deferred Compensation Plan (3)
9 Custody Agreement between State Street Bank and Trust
Company and Registrant (1)
10(A) Rule 12b-1 Distribution Plan (1)
(B) Multiple Class Plan (1)
11 Opinion and consent of counsel as to the legality of
the shares being issued (2)
12 Tax opinion and consent of counsel (3)
13 Not applicable
14 Consent of KPMG Peat Marwick LLP (2)
15 Not applicable
16 Powers of Attorney (2)
17(A) Forms of Proxy Card (2)
(B) Registrant's Rule 24f-2 Declaration (1)
- ----------------------
<PAGE>
(1) Incorporated by reference to Registrant's registration statement (File
Nos. 333-37453/811-08413) (the "Registration Statement") dated October
8, 1997.
(2) Filed herewith.
(3) To be filed by amendment.
Item 17. Undertakings.
(1) The undersigned Registrant agrees that prior to any public
reoffering of the securities registered through the use of a prospectus that is
a part of this Registration Statement by any person or party who is deemed to be
an underwriter within the meaning of Rule 145(c) of the Securities Act of 1933,
the reoffering prospectus will contain the information called for by the
applicable registration form for reofferings by persons who may be deemed
underwriters, in addition to the information called for by the other items of
the applicable form.
(2) The undersigned Registrant agrees that every prospectus that is
filed under paragraph (1) above will be filed as a part of an amendment to the
Registration Statement and will not be used until the amendment is effective,
and that, in determining any liability under the Securities Act of 1933, each
post-effective amendment shall be deemed to be a new Registration Statement for
the securities offered therein, and the offering of the securities at that time
shall be deemed to be the initial bona fide offering of them.
(3) The undersigned Registrant agrees to file, by post-effective
amendment, opinions of counsel or copies of an Internal Revenue Service ruling
supporting the tax consequences of the proposed Reorganizations within a
reasonable time after receipt of such opinions or rulings.
<PAGE>
SIGNATURES
As required by the Securities Act of 1933, this Registration Statement
has been signed on behalf of the Registrant, in the City of New York and State
of New York, on the 9th day of October, 1997.
EVERGREEN EQUITY TRUST
By: /s/ John J. Pileggi
----------------------
Name: John J. Pileggi
Title: President
As required by the Securities Act of 1933, the following persons have
signed this Registration Statement in the capacities on the 9th day of October,
1997.
Signatures Title
- ---------- -----
/s/John J. Pileggi President and
- ------------------ Treasurer
John J. Pileggi
/s/Laurence B. Ashkin* Trustee
- ---------------------
Laurence B. Ashkin
/s/Charles A. Austin III* Trustee
- ------------------------
Charles A. Austin III
/s/K. Dun Gifford* Trustee
- -----------------
K. Dun Gifford
/s/James S. Howell* Trustee
- ------------------
James S. Howell
/s/Leroy Keith, Jr.* Trustee
- -------------------
Leroy Keith, Jr.
/s/Gerald M. McDonnell* Trustee
- ----------------------
Gerald M. McDonnell
<PAGE>
/s/Thomas L. McVerry* Trustee
- --------------------
Thomas L. McVerry
/s/William Walt Pettit* Trustee
- ---------------------
William Walt Pettit
/s/David M. Richardson* Trustee
- ----------------------
David M. Richardson
/s/Russell A. Salton III* Trustee
- -------------------------
Russell A. Salton, III
/s/Michael S. Scofield* Trustee
- ----------------------
Michael S. Scofield
/s/Richard J. Shima* Trustee
- -------------------
Richard J. Shima
* By: /s/Martin J. Wolin
------------------
Martin J. Wolin
Attorney-in-Fact
Martin J. Wolin, by signing his name hereto, does hereby sign this
document on behalf of each of the above-named individuals pursuant to powers of
attorney duly executed by such persons and included as Exhibit 16 to this
Registration Statement.
<PAGE>
INDEX TO EXHIBITS
N-14
EXHIBIT NO.
11 Opinion and Consent of Sullivan & Worcester LLP
14 Consent of KPMG Peat Marwick LLP
16 Powers of Attorney
17(a) Forms of Proxy
- --------------------
SULLIVAN & WORCESTER LLP
1025 CONNECTICUT AVENUE, N.W.
WASHINGTON, D.C. 20036
TELEPHONE: 202-775-8190
FACSIMILE: 202-293-2275
767 THIRD AVENUE ONE POST OFFICE SQUARE
NEW YORK, NEW YORK 10017 BOSTON, MASSACHUSETTS 02109
TELEPHONE: 212-486-8200 TELEPHONE: 617-338-2800
FACSIMILE: 212-758-2151 FACSIMILE: 617-338-2880
October 9, 1997
Evergreen Equity Trust
200 Berkeley Street
Boston, Massachusetts 02116
Ladies and Gentlemen:
We have been requested by the Evergreen Equity Trust, a Delaware
business trust with transferable shares and currently consisting of two series
(the "Trust") established under an Agreement and Declaration of Trust dated
September 17, 1997 as amended (the "Declaration"), for our opinion with respect
to certain matters relating to Evergreen Small Company Growth Fund (the
"Acquiring Fund"), a series of the Trust. We understand that the Trust is about
to file a Registration Statement on Form N-14 for the purpose of registering
shares of the Trust under the Securities Act of 1933, as amended (the "1933
Act"), in connection with the proposed acquisition by the Acquiring Fund of all
of the assets of Keystone Small Company Growth Fund II, a Massachusetts business
trust or a series of a Massachusetts business trust, and Keystone Small Company
Growth Fund (S-4), a Pennsylvania common law trust or a series of a Pennsylvania
common law trust (the "Acquired Funds"), with transferable shares, in exchange
solely for shares of the Acquiring Fund and the assumption by the Acquiring Fund
of certain identified liabilities of the Acquired Funds pursuant to Agreements
and Plans of Reorganization, forms of which are included in the Form N-1A
Registration Statement (the "Plans").
We have, as counsel, participated in various business and other
proceedings relating to the Trust. We have examined copies, either certified or
otherwise proved to be genuine to our satisfaction, of the Trust's Declaration
and By-Laws, and other documents relating to its organization, operation, and
proposed operation, including the proposed Plans and we have made such other
investigations as, in our judgment, are
<PAGE>
Evergreen Equity Trust
October 9, 1997
Page 2
necessary or appropriate to enable us to render the opinion
expressed below.
Based upon the foregoing, and assuming the approval by shareholders of
each Acquired Fund of certain matters scheduled for their consideration at a
meeting presently anticipated to be held on January 6, 1998, it is our opinion
that the shares of the Acquiring Fund currently being registered, when issued in
accordance with the Plans and the Trust's Declaration and By-Laws, will be
legally issued, fully paid and non-assessable by the Trust, subject to
compliance with the 1933 Act, the Investment Company Act of 1940, as amended and
applicable state laws regulating the offer and sale of securities.
We hereby consent to the filing of this opinion with and as a part of
the Registration Statement on Form N-14 and to the reference to our firm under
the caption "Legal Matters" in the Prospectus/Proxy Statement filed as part of
the Registration Statement. In giving such consent, we do not thereby admit that
we come within the category of persons whose consent is required under Section 7
of the 1933 Act or the rules and regulations promulgated thereunder.
Very truly yours,
/s/SULLIVAN & WORCESTER LLP
---------------------------
SULLIVAN & WORCESTER LLP
<PAGE>
CONSENT OF INDEPENDENT AUDITORS
The Trustees and Shareholders
Evergreen Equity Trust
We consent to:
1) the use of our report dated June 27, 1997 for Keystone
Small Company Growth Fund II incorporated by reference
herein;
2) the use of our report dated June 27, 1997 for Keystone Small Company
Growth Fund (S-4) incorporated by reference herein; and
3) the reference to our firm under the caption "FINANCIAL
STATEMENTS AND EXPERTS" in the prospectus/proxy
statement.
/s/KPMG Peat Marwick LLP
------------------------
KPMG Peat Marwick LLP
Boston, Massachusetts
October 9, 1997
<PAGE>
POWER OF ATTORNEY
I, the undersigned, hereby constitute Dorothy E. Bourassa, Terrence J.
Cullen, Rosemary D. Van Antwerp, James P. Wallin, Martin J. Wolin and John J.
Pileggi, each of them singly, my true and lawful attorneys, with full power to
them and each of them to sign for me and in my name in the capacity indicated
below any and all registration statements, including, but not limited to, Forms
N-8A, N-8B-1, S-5, N-14 and N-1A, as amended from time to time, and any and all
amendments thereto to be filed with the Securities and Exchange Commission for
the purpose of registering from time to time all investment companies of which I
am now or hereafter a Director or Trustee and for which Keystone Investment
Management Company, Evergreen Asset Management Corp. or First Union National
Bank of North Carolina serves as Adviser or Manager and registering from time to
time the shares of such companies, and generally to do all such things in my
name and on my behalf to enable such investment companies to comply with the
provisions of the Securities Act of 1933, as amended, the Investment Company Act
of 1940, as amended, and all requirements and regulations of the Securities and
Exchange Commission thereunder, hereby ratifying and confirming my signature as
it may be signed by my said attorneys to any and all registration statements and
amendments thereto.
In Witness Whereof, I have executed this Power of Attorney as of June
18, 1997.
Signature Title
- --------- -----
/s/Laurence B. Ashkin Director/Trustee
- ---------------------
Laurence B. Ashkin
<PAGE>
POWER OF ATTORNEY
I, the undersigned, hereby constitute Dorothy E. Bourassa, Terrence J.
Cullen, Rosemary D. Van Antwerp, James P. Wallin, Martin J. Wolin and John J.
Pileggi, each of them singly, my true and lawful attorneys, with full power to
them and each of them to sign for me and in my name in the capacity indicated
below any and all registration statements, including, but not limited to, Forms
N-8A, N-8B-1, S-5, N-14 and N-1A, as amended from time to time, and any and all
amendments thereto to be filed with the Securities and Exchange Commission for
the purpose of registering from time to time all investment companies of which I
am now or hereafter a Director or Trustee and for which Keystone Investment
Management Company, Evergreen Asset Management Corp. or First Union National
Bank of North Carolina serves as Adviser or Manager and registering from time to
time the shares of such companies, and generally to do all such things in my
name and on my behalf to enable such investment companies to comply with the
provisions of the Securities Act of 1933, as amended, the Investment Company Act
of 1940, as amended, and all requirements and regulations of the Securities and
Exchange Commission thereunder, hereby ratifying and confirming my signature as
it may be signed by my said attorneys to any and all registration statements and
amendments thereto.
In Witness Whereof, I have executed this Power of Attorney as of June
18, 1997.
Signature Title
- --------- -----
/s/Charles A. Austin, III Director/Trustee
- -------------------------
Charles A. Austin, III
<PAGE>
POWER OF ATTORNEY
I, the undersigned, hereby constitute Dorothy E. Bourassa, Terrence J.
Cullen, Rosemary D. Van Antwerp, James P. Wallin, Martin J. Wolin and John J.
Pileggi, each of them singly, my true and lawful attorneys, with full power to
them and each of them to sign for me and in my name in the capacity indicated
below any and all registration statements, including, but not limited to, Forms
N-8A, N-8B-1, S-5, N-14 and N-1A, as amended from time to time, and any and all
amendments thereto to be filed with the Securities and Exchange Commission for
the purpose of registering from time to time all investment companies of which I
am now or hereafter a Director or Trustee and for which Keystone Investment
Management Company, Evergreen Asset Management Corp. or First Union National
Bank of North Carolina serves as Adviser or Manager and registering from time to
time the shares of such companies, and generally to do all such things in my
name and on my behalf to enable such investment companies to comply with the
provisions of the Securities Act of 1933, as amended, the Investment Company Act
of 1940, as amended, and all requirements and regulations of the Securities and
Exchange Commission thereunder, hereby ratifying and confirming my signature as
it may be signed by my said attorneys to any and all registration statements and
amendments thereto.
In Witness Whereof, I have executed this Power of Attorney as of June
18, 1997.
Signature Title
- --------- -----
/s/K. Dun Gifford Director/Trustee
- -----------------
K. Dun Gifford
<PAGE>
POWER OF ATTORNEY
I, the undersigned, hereby constitute Dorothy E. Bourassa, Terrence J.
Cullen, Rosemary D. Van Antwerp, James P. Wallin, Martin J. Wolin and John J.
Pileggi, each of them singly, my true and lawful attorneys, with full power to
them and each of them to sign for me and in my name in the capacity indicated
below any and all registration statements, including, but not limited to, Forms
N-8A, N-8B-1, S-5, N-14 and N-1A, as amended from time to time, and any and all
amendments thereto to be filed with the Securities and Exchange Commission for
the purpose of registering from time to time all investment companies of which I
am now or hereafter a Director or Trustee and for which Keystone Investment
Management Company, Evergreen Asset Management Corp. or First Union National
Bank of North Carolina serves as Adviser or Manager and registering from time to
time the shares of such companies, and generally to do all such things in my
name and on my behalf to enable such investment companies to comply with the
provisions of the Securities Act of 1933, as amended, the Investment Company Act
of 1940, as amended, and all requirements and regulations of the Securities and
Exchange Commission thereunder, hereby ratifying and confirming my signature as
it may be signed by my said attorneys to any and all registration statements and
amendments thereto.
In Witness Whereof, I have executed this Power of Attorney as of June
18, 1997.
Signature Title
- --------- -----
/s/James S. Howell Director/Trustee
- ------------------
James S. Howell
<PAGE>
POWER OF ATTORNEY
I, the undersigned, hereby constitute Dorothy E. Bourassa, Terrence J.
Cullen, Rosemary D. Van Antwerp, James P. Wallin, Martin J. Wolin and John J.
Pileggi, each of them singly, my true and lawful attorneys, with full power to
them and each of them to sign for me and in my name in the capacity indicated
below any and all registration statements, including, but not limited to, Forms
N-8A, N-8B-1, S-5, N-14 and N-1A, as amended from time to time, and any and all
amendments thereto to be filed with the Securities and Exchange Commission for
the purpose of registering from time to time all investment companies of which I
am now or hereafter a Director or Trustee and for which Keystone Investment
Management Company, Evergreen Asset Management Corp. or First Union National
Bank of North Carolina serves as Adviser or Manager and registering from time to
time the shares of such companies, and generally to do all such things in my
name and on my behalf to enable such investment companies to comply with the
provisions of the Securities Act of 1933, as amended, the Investment Company Act
of 1940, as amended, and all requirements and regulations of the Securities and
Exchange Commission thereunder, hereby ratifying and confirming my signature as
it may be signed by my said attorneys to any and all registration statements and
amendments thereto.
In Witness Whereof, I have executed this Power of Attorney as of June
18, 1997.
Signature Title
- --------- -----
/s/Leroy Keith, Jr. Director/Trustee
- -------------------
Leroy Keith, Jr.
<PAGE>
POWER OF ATTORNEY
I, the undersigned, hereby constitute Dorothy E. Bourassa, Terrence J.
Cullen, Rosemary D. Van Antwerp, James P. Wallin, Martin J. Wolin and John J.
Pileggi, each of them singly, my true and lawful attorneys, with full power to
them and each of them to sign for me and in my name in the capacity indicated
below any and all registration statements, including, but not limited to, Forms
N-8A, N-8B-1, S-5, N-14 and N-1A, as amended from time to time, and any and all
amendments thereto to be filed with the Securities and Exchange Commission for
the purpose of registering from time to time all investment companies of which I
am now or hereafter a Director or Trustee and for which Keystone Investment
Management Company, Evergreen Asset Management Corp. or First Union National
Bank of North Carolina serves as Adviser or Manager and registering from time to
time the shares of such companies, and generally to do all such things in my
name and on my behalf to enable such investment companies to comply with the
provisions of the Securities Act of 1933, as amended, the Investment Company Act
of 1940, as amended, and all requirements and regulations of the Securities and
Exchange Commission thereunder, hereby ratifying and confirming my signature as
it may be signed by my said attorneys to any and all registration statements and
amendments thereto.
In Witness Whereof, I have executed this Power of Attorney as of June
18, 1997.
Signature Title
- --------- -----
/s/Gerald M. McDonnell Director/Trustee
- ----------------------
Gerald M. McDonnell
<PAGE>
POWER OF ATTORNEY
I, the undersigned, hereby constitute Dorothy E. Bourassa, Terrence J.
Cullen, Rosemary D. Van Antwerp, James P. Wallin, Martin J. Wolin and John J.
Pileggi, each of them singly, my true and lawful attorneys, with full power to
them and each of them to sign for me and in my name in the capacity indicated
below any and all registration statements, including, but not limited to, Forms
N-8A, N-8B-1, S-5, N-14 and N-1A, as amended from time to time, and any and all
amendments thereto to be filed with the Securities and Exchange Commission for
the purpose of registering from time to time all investment companies of which I
am now or hereafter a Director or Trustee and for which Keystone Investment
Management Company, Evergreen Asset Management Corp. or First Union National
Bank of North Carolina serves as Adviser or Manager and registering from time to
time the shares of such companies, and generally to do all such things in my
name and on my behalf to enable such investment companies to comply with the
provisions of the Securities Act of 1933, as amended, the Investment Company Act
of 1940, as amended, and all requirements and regulations of the Securities and
Exchange Commission thereunder, hereby ratifying and confirming my signature as
it may be signed by my said attorneys to any and all registration statements and
amendments thereto.
In Witness Whereof, I have executed this Power of Attorney as of June
18, 1997.
Signature Title
- --------- -----
/s/Thomas L. McVerry Director/Trustee
- --------------------
Thomas L. McVerry
<PAGE>
POWER OF ATTORNEY
I, the undersigned, hereby constitute Dorothy E. Bourassa, Terrence J.
Cullen, Rosemary D. Van Antwerp, James P. Wallin, Martin J. Wolin and John J.
Pileggi, each of them singly, my true and lawful attorneys, with full power to
them and each of them to sign for me and in my name in the capacity indicated
below any and all registration statements, including, but not limited to, Forms
N-8A, N-8B-1, S-5, N-14 and N-1A, as amended from time to time, and any and all
amendments thereto to be filed with the Securities and Exchange Commission for
the purpose of registering from time to time all investment companies of which I
am now or hereafter a Director or Trustee and for which Keystone Investment
Management Company, Evergreen Asset Management Corp. or First Union National
Bank of North Carolina serves as Adviser or Manager and registering from time to
time the shares of such companies, and generally to do all such things in my
name and on my behalf to enable such investment companies to comply with the
provisions of the Securities Act of 1933, as amended, the Investment Company Act
of 1940, as amended, and all requirements and regulations of the Securities and
Exchange Commission thereunder, hereby ratifying and confirming my signature as
it may be signed by my said attorneys to any and all registration statements and
amendments thereto.
In Witness Whereof, I have executed this Power of Attorney as of June
18, 1997.
Signature Title
- --------- -----
/s/William Walt Pettit Director/Trustee
- ----------------------
William Walt Pettit
<PAGE>
POWER OF ATTORNEY
I, the undersigned, hereby constitute Dorothy E. Bourassa, Terrence J.
Cullen, Rosemary D. Van Antwerp, James P. Wallin, Martin J. Wolin and John J.
Pileggi, each of them singly, my true and lawful attorneys, with full power to
them and each of them to sign for me and in my name in the capacity indicated
below any and all registration statements, including, but not limited to, Forms
N-8A, N-8B-1, S-5, N-14 and N-1A, as amended from time to time, and any and all
amendments thereto to be filed with the Securities and Exchange Commission for
the purpose of registering from time to time all investment companies of which I
am now or hereafter a Director or Trustee and for which Keystone Investment
Management Company, Evergreen Asset Management Corp. or First Union National
Bank of North Carolina serves as Adviser or Manager and registering from time to
time the shares of such companies, and generally to do all such things in my
name and on my behalf to enable such investment companies to comply with the
provisions of the Securities Act of 1933, as amended, the Investment Company Act
of 1940, as amended, and all requirements and regulations of the Securities and
Exchange Commission thereunder, hereby ratifying and confirming my signature as
it may be signed by my said attorneys to any and all registration statements and
amendments thereto.
In Witness Whereof, I have executed this Power of Attorney as of June
18, 1997.
Signature Title
- --------- -----
/s/David M. Richardson Director/Trustee
- ----------------------
David M. Richardson
<PAGE>
POWER OF ATTORNEY
I, the undersigned, hereby constitute Dorothy E. Bourassa, Terrence J.
Cullen, Rosemary D. Van Antwerp, James P. Wallin, Martin J. Wolin and John J.
Pileggi, each of them singly, my true and lawful attorneys, with full power to
them and each of them to sign for me and in my name in the capacity indicated
below any and all registration statements, including, but not limited to, Forms
N-8A, N-8B-1, S-5, N-14 and N-1A, as amended from time to time, and any and all
amendments thereto to be filed with the Securities and Exchange Commission for
the purpose of registering from time to time all investment companies of which I
am now or hereafter a Director or Trustee and for which Keystone Investment
Management Company, Evergreen Asset Management Corp. or First Union National
Bank of North Carolina serves as Adviser or Manager and registering from time to
time the shares of such companies, and generally to do all such things in my
name and on my behalf to enable such investment companies to comply with the
provisions of the Securities Act of 1933, as amended, the Investment Company Act
of 1940, as amended, and all requirements and regulations of the Securities and
Exchange Commission thereunder, hereby ratifying and confirming my signature as
it may be signed by my said attorneys to any and all registration statements and
amendments thereto.
In Witness Whereof, I have executed this Power of Attorney as of June
18, 1997.
Signature Title
- --------- -----
/s/Russell A. Salton, III MD Director/Trustee
- ----------------------------
Russell A. Salton, III MD
<PAGE>
POWER OF ATTORNEY
I, the undersigned, hereby constitute Dorothy E. Bourassa, Terrence J.
Cullen, Rosemary D. Van Antwerp, James P. Wallin, Martin J. Wolin and John J.
Pileggi, each of them singly, my true and lawful attorneys, with full power to
them and each of them to sign for me and in my name in the capacity indicated
below any and all registration statements, including, but not limited to, Forms
N-8A, N-8B-1, S-5, N-14 and N-1A, as amended from time to time, and any and all
amendments thereto to be filed with the Securities and Exchange Commission for
the purpose of registering from time to time all investment companies of which I
am now or hereafter a Director or Trustee and for which Keystone Investment
Management Company, Evergreen Asset Management Corp. or First Union National
Bank of North Carolina serves as Adviser or Manager and registering from time to
time the shares of such companies, and generally to do all such things in my
name and on my behalf to enable such investment companies to comply with the
provisions of the Securities Act of 1933, as amended, the Investment Company Act
of 1940, as amended, and all requirements and regulations of the Securities and
Exchange Commission thereunder, hereby ratifying and confirming my signature as
it may be signed by my said attorneys to any and all registration statements and
amendments thereto.
In Witness Whereof, I have executed this Power of Attorney as of June
18, 1997.
Signature Title
- --------- -----
/s/Michael S. Scofield Director/Trustee
- ----------------------
Michael S. Scofield
<PAGE>
POWER OF ATTORNEY
I, the undersigned, hereby constitute Dorothy E. Bourassa, Terrence J.
Cullen, Rosemary D. Van Antwerp, James P. Wallin, Martin J. Wolin and John J.
Pileggi, each of them singly, my true and lawful attorneys, with full power to
them and each of them to sign for me and in my name in the capacity indicated
below any and all registration statements, including, but not limited to, Forms
N-8A, N-8B-1, S-5, N-14 and N-1A, as amended from time to time, and any and all
amendments thereto to be filed with the Securities and Exchange Commission for
the purpose of registering from time to time all investment companies of which I
am now or hereafter a Director or Trustee and for which Keystone Investment
Management Company, Evergreen Asset Management Corp. or First Union National
Bank of North Carolina serves as Adviser or Manager and registering from time to
time the shares of such companies, and generally to do all such things in my
name and on my behalf to enable such investment companies to comply with the
provisions of the Securities Act of 1933, as amended, the Investment Company Act
of 1940, as amended, and all requirements and regulations of the Securities and
Exchange Commission thereunder, hereby ratifying and confirming my signature as
it may be signed by my said attorneys to any and all registration statements and
amendments thereto.
In Witness Whereof, I have executed this Power of Attorney as of June
18, 1997.
Signature Title
- --------- -----
/s/Richard J. Shima Director/Trustee
- -------------------
Richard J. Shima
KEYSTONE SMALL COMPANY GROWTH FUND II
PROXY FOR THE MEETING OF SHAREHOLDERS
TO BE HELD ON JANUARY 6, 1998
The undersigned, revoking all Proxies heretofore given, hereby appoints
Dorothy E. Bourassa, Terrence J. Cullen, Martin Wolin or Rosemary Van Antwerp or
any of them as Proxies of the undersigned, with full power of substitution, to
vote on behalf of the undersigned all shares of Keystone Small Company Growth
Fund II ("Keystone Small Company Growth II") that the undersigned is entitled to
vote at the special meeting of shareholders of Keystone Small Company Growth II
to be held at 3:00 p.m. on Tuesday, January 6, 1998 at the offices of the
Evergreen Keystone Funds, 26th Floor, 200 Berkeley Street, Boston, Massachusetts
02116 and at any adjournments thereof, as fully as the undersigned would be
entitled to vote if personally present, as follows:
1. To approve an Agreement and Plan of Reorganization whereby Evergreen
Small Company Growth Fund, a series of Evergreen Equity Trust, will (i) acquire
all of the assets of Keystone Small Company Growth II in exchange for shares of
Evergreen Small Company Growth Fund; and (ii) assume certain identified
liabilities of Keystone Small Company Growth II, as substantially described in
the accompanying Prospectus/Proxy Statement.
---- FOR ---- AGAINST ---- ABSTAIN
2. To consider and vote upon such other matters as may properly come
before said meeting or any adjournments thereof.
---- FOR ---- AGAINST ---- ABSTAIN
PROXY SOLICITED ON BEHALF OF THE BOARD OF TRUSTEES
OF KEYSTONE SMALL COMPANY GROWTH II
THE BOARD OF TRUSTEES OF KEYSTONE SMALL COMPANY
GROWTH II RECOMMENDS A VOTE FOR THE
PROPOSALS.
THE SHARES REPRESENTED HEREBY WILL BE VOTED AS INDICATED
-1-
<PAGE>
OR FOR THE PROPOSALS IF NO CHOICE IS INDICATED.
NOTE: PLEASE SIGN EXACTLY AS YOUR
NAME(S) APPEAR ON THIS CARD.
Dated: , 199
----------------- --
Signature(s):
Signature (of joint owner, if any):
NOTE: When signing as attorney, executor, administrator, trustee, guardian, or
as custodian for a minor, please sign your name and give your full title as
such. If signing on behalf of a corporation, please sign the full corporate name
and your name and indicate your title. If you are a partner signing for a
partnership, please sign the partnership name and your name. Joint owners should
each sign this proxy.
Please sign, date and return.
-2-
<PAGE>
KEYSTONE SMALL COMPANY GROWTH FUND (S-4)
PROXY FOR THE MEETING OF SHAREHOLDERS
TO BE HELD ON JANUARY 6, 1998
The undersigned, revoking all Proxies heretofore given, hereby appoints
Dorothy E. Bourassa, Terrence J. Cullen, Martin Wolin or Rosemary Van Antwerp or
any of them as Proxies of the undersigned, with full power of substitution, to
vote on behalf of the undersigned all shares of Keystone Small Company Growth
Fund (S-4) ("Keystone Small Company Growth (S- 4)") that the undersigned is
entitled to vote at the special meeting of shareholders of Keystone Small
Company Growth (S-4) to be held at 3:00 p.m. on Tuesday, January 6, 1998 at the
offices of the Evergreen Keystone Funds, 26th Floor, 200 Berkeley Street,
Boston, Massachusetts 02116 and at any adjournments thereof, as fully as the
undersigned would be entitled to vote if personally present, as follows:
1. To approve an Agreement and Plan of Reorganization whereby Evergreen
Small Company Growth Fund, a series of Evergreen Equity Trust, will (i) acquire
all of the assets of Keystone Small Company Growth (S-4) in exchange for shares
of Evergreen Small Company Growth Fund; and (ii) assume certain identified
liabilities of Keystone Small Company Growth (S-4), as substantially described
in the accompanying Prospectus/Proxy Statement.
---- FOR ---- AGAINST ---- ABSTAIN
2. To consider and vote upon such other matters as may properly come
before said meeting or any adjournments thereof.
---- FOR ---- AGAINST ---- ABSTAIN
PROXY SOLICITED ON BEHALF OF THE BOARD OF TRUSTEES
OF KEYSTONE SMALL COMPANY GROWTH (S-4)
THE BOARD OF TRUSTEES OF KEYSTONE SMALL COMPANY
GROWTH (S-4) RECOMMENDS A VOTE FOR THE
PROPOSALS.
-3-
<PAGE>
THE SHARES REPRESENTED HEREBY WILL BE VOTED AS
INDICATED OR FOR THE PROPOSALS IF NO CHOICE IS
INDICATED.
NOTE: PLEASE SIGN EXACTLY AS YOUR
NAME(S) APPEAR ON THIS CARD.
Dated: , 199
----------------- --
Signature(s):
Signature (of joint owner, if any):
NOTE: When signing as attorney, executor, administrator, trustee, guardian, or
as custodian for a minor, please sign your name and give your full title as
such. If signing on behalf of a corporation, please sign the full corporate name
and your name and indicate your title. If you are a partner signing for a
partnership, please sign the partnership name and your name. Joint owners should
each sign this proxy.
Please sign, date and return.
-4-
<PAGE>
