<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON DECEMBER 23, 1997
SECURITIES ACT FILE NO. 333-
INVESTMENT COMPANY ACT FILE NO. 811-
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- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------
FORM N-2
[X] REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
[_] PRE-EFFECTIVE AMENDMENT NO.
[_] POST-EFFECTIVE AMENDMENT NO.
AND/OR
[X] REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
[_] AMENDMENT NO.
(CHECK APPROPRIATE BOX OR BOXES)
--------------
MUNIHOLDINGS CALIFORNIA FUND, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
--------------
800 SCUDDERS MILL ROAD
PLAINSBORO, NEW JERSEY 08536
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
--------------
(609) 282-2800
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
--------------
ARTHUR ZEIKEL
MUNIHOLDINGS CALIFORNIA FUND, INC.
800 SCUDDERS MILL ROAD, PLAINSBORO, NEW JERSEY 08536
MAILING ADDRESS: P.O. BOX 9011, PRINCETON, NEW JERSEY 08543-9011
(NAME AND ADDRESS OF AGENT FOR SERVICE)
--------------
COPIES TO:
PHILIP M. MANDEL, ESQ. FRANK P. BRUNO, ESQ.
FUND ASSET MANAGEMENT, L.P. LAURIN BLUMENTHAL KLEIMAN, ESQ.
P.O. BOX 9011 BROWN & WOOD LLP
PRINCETON, NEW JERSEY 08543-9011 ONE WORLD TRADE CENTER
NEW YORK, NEW YORK 10048-0557
--------------
APPROXIMATE DATE OF PROPOSED PUBLIC OFFERING: As soon as practicable after the
effective date of this Registration Statement.
--------------
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, as amended (the "Securities Act"), other than securities offered only in
connection with dividend or interest reinvestment plans, check the following
box. [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration number of the earlier effective registration statement for the
same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434
under the Securities Act, please check the following box. [_]
--------------
CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933
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- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PROPOSED
PROPOSED MAXIMUM
AMOUNT MAXIMUM AGGREGATE AMOUNT OF
TITLE OF BEING OFFERING PRICE OFFERING REGISTRATION
SECURITIES BEING REGISTERED REGISTERED(1) PER UNIT(1) PRICE(1) FEE(2)
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Common Stock ($.10 par val-
ue).................... 66,666 shares $15.00 $999,990 $295
</TABLE>
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- -------------------------------------------------------------------------------
(1) Estimated solely for the purpose of calculating the registration fee.
(2) Transmitted to the designated lockbox at Mellon Bank in Pittsburgh, PA.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS
REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH
SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID
SECTION 8(A), MAY DETERMINE.
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- -------------------------------------------------------------------------------
<PAGE>
MUNIHOLDINGS CALIFORNIA FUND, INC.
CROSS REFERENCE SHEET
<TABLE>
<CAPTION>
ITEM NUMBER, FORM N-2 CAPTION IN PROSPECTUS
- --------------------- ---------------------
<S> <C>
PART A--INFORMATION REQUIRED IN A PROSPECTUS
1.Outside Front Cover Page............ Outside Front Cover Page
2.Inside Front and Outside Back Cover Inside Front and Outside Back Cover
Pages............................. Pages; Underwriting
3.Fee Table and Synopsis.............. Prospectus Summary; Fee Table
4.Financial Highlights................ Not Applicable
5.Plan of Distribution................ Prospectus Summary; Net Asset Value;
Underwriting
6.Selling Shareholders................ Not Applicable
7.Use of Proceeds..................... Use of Proceeds; Investment Objective
and Policies
8.General Description of the Prospectus Summary; The Fund;
Registrant........................ Investment Objective and Policies;
Risks and Special Considerations of
Leverage; Investment Restrictions;
Dividends and Distributions; Automatic
Dividend Reinvestment Plan; Mutual Fund
Investment Option
9.Management.......................... Directors and Officers; Investment
Advisory and Management Arrangements;
Custodian; Transfer Agent, Dividend
Disbursing Agent and Registrar
10.Capital Stock, Long-Term Debt, and Description of Capital Stock
Other Securities..................
11.Defaults and Arrears on Senior Not Applicable
Securities........................
12.Legal Proceedings................... Not Applicable
13.Table of Contents of the Statement
of Additional Information......... Not Applicable
PART B--INFORMATION REQUIRED IN A STATEMENT OF ADDITIONAL INFORMATION
14.Cover Page.......................... Not Applicable
15.Table of Contents................... Not Applicable
16.General Information and History..... Not Applicable
17.Investment Objective and Policies... Prospectus Summary; Investment
Objective and Policies; Investment
Restrictions
18.Management.......................... Directors and Officers; Investment
Advisory and Management Arrangements
19.Control Persons and Principal Investment Advisory and Management
Holders of Securities............. Arrangements
20.Investment Advisory and Other Investment Advisory and Management
Services.......................... Arrangements; Custodian; Underwriting;
Transfer Agent, Dividend Disbursing
Agent and Registrar; Legal Opinions;
Experts
21.Brokerage Allocation and Other Portfolio Transactions
Practices.........................
22.Tax Status.......................... Taxes; Automatic Dividend Reinvestment
Plan
23.Financial Statements................ Report of Independent Auditors;
Statement of Assets, Liabilities and
Capital
</TABLE>
PART C--OTHER INFORMATION
Information required to be included in Part C is set forth under the
appropriate Item, so numbered, in Part C to this Registration Statement.
<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A +
+REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE +
+SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY +
+OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT +
+BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR +
+THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE +
+SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE +
+UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF +
+ANY STATE. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION
PRELIMINARY PROSPECTUS DATED DECEMBER 23, 1997
PROSPECTUS
SHARES
MUNIHOLDINGS CALIFORNIA FUND, INC.
COMMON STOCK
------------
MuniHoldings California Fund, Inc. (the "Fund") is a newly organized, non-
diversified, closed-end management investment company that seeks to provide
shareholders with current income exempt from Federal and California income
taxes. The Fund seeks to achieve its investment objective by investing
primarily in a portfolio of long-term, investment grade municipal obligations
the interest on which, in the opinion of bond counsel to the issuer, is exempt
from Federal and California income taxes. The Fund intends to maintain at least
75% of its total assets in municipal obligations that are rated investment
grade or, if unrated, are considered by Fund Asset Management, L.P. (the
"Investment Adviser") to be of comparable quality. THE FUND MAY INVEST UP TO
25% OF ITS TOTAL ASSETS IN MUNICIPAL OBLIGATIONS THAT ARE RATED BELOW
INVESTMENT GRADE OR, IF UNRATED, ARE CONSIDERED BY THE INVESTMENT ADVISER TO BE
OF COMPARABLE QUALITY. Investors are advised to read this Prospectus carefully
and retain it for future reference.
Because the Fund is newly organized, its shares have no history of public
trading. Shares of closed-end investment companies frequently trade at a
discount from their net asset value. This risk may be greater for investors
expecting to sell their shares in a relatively short period after completion of
the public offering. See "Prospectus Summary--Risk Factors and Special
Considerations."
Within approximately three months after completion of the offering of Common
Stock described herein, the Fund intends to offer shares of preferred stock
representing approximately 40% of the Fund's capital immediately after the
issuance of such preferred stock. There can be no assurance, however, that
preferred stock representing such percentage of the Fund's capital will
actually be issued. INVESTORS SHOULD NOTE THE SPECIAL RISKS ASSOCIATED WITH THE
LEVERAGING OF THE COMMON STOCK. SEE "RISKS AND SPECIAL CONSIDERATIONS OF
LEVERAGE" AND "DESCRIPTION OF CAPITAL STOCK."
(Continued on next page)
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE COMMISSION PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION
TO THE CONTRARY IS A CRIMINAL OFFENSE.
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- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PRICE TO SALES LOAD PROCEEDS TO
PUBLIC (1)(2) FUND(3)
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Per Share.............. $15.00 None $15.00
- -------------------------------------------------------------------------------
Total(4)............... None
</TABLE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
(1) The Investment Adviser or an affiliate will pay the Underwriter a
commission in the amount of % of the Price to Public per share in
connection with the sale of shares of Common Stock offered hereby. See
"Underwriting."
(2) The Fund and the Investment Adviser have agreed to indemnify the
Underwriter against certain liabilities under the Securities Act of 1933.
See "Underwriting."
(3) Before deducting organizational and offering expenses payable by the Fund
estimated at $ .
(4) The Fund has granted the Underwriter an option to purchase up to an
additional shares to cover over-allotments. If all such shares
are purchased, the total Price to Public and Proceeds to Fund will be
. See "Underwriting."
------------
The shares are offered by the Underwriter, subject to prior sale, when, as
and if issued by the Fund and accepted by the Underwriter, subject to approval
of certain legal matters by counsel for the Underwriter and certain other
conditions. The Underwriter reserves the right to withdraw, cancel or modify
such offer and to reject orders in whole or in part. It is expected that
delivery of the shares will be made in New York, New York on or about ,
1998.
------------
MERRILL LYNCH & CO.
------------
The date of this Prospectus is , 1998.
<PAGE>
(Continued from preceding page)
The Fund may invest all or a portion of its assets in certain tax-exempt
securities classified as "private activity bonds" that may subject certain
investors in the Fund to an alternative minimum tax. At times, the Fund may
seek to hedge its portfolio through the use of options and futures
transactions. There can be no assurance that the investment objective of the
Fund will be realized. The Fund is designed primarily for long-term investors
and should not be considered a vehicle for trading purposes. The address of
the Fund is 800 Scudders Mill Road, Plainsboro, New Jersey 08536, and its
telephone number is (609) 282-2800.
Prior to this offering, there has been no public market for the Common Stock
of the Fund. Application will be made to list the Fund's shares of Common
Stock on the New York Stock Exchange. However, during an initial period which
is not expected to exceed two weeks from the date of this Prospectus, the
Fund's Common Stock will not be listed on any securities exchange. During such
period, the Underwriter does not intend to make a market in the Fund's Common
Stock. Consequently, it is anticipated that an investment in the Fund will be
illiquid during such period.
The issuance of the preferred stock will result in leveraging of the Common
Stock. Although the terms of the preferred stock offering will be determined
by the Fund's Board of Directors, it is anticipated that the preferred stock
will pay dividends that will be adjusted over either relatively short-term
periods (generally seven to 28 days) or medium-term periods (up to five years)
and that the dividend rate will be based upon prevailing interest rates for
debt obligations of comparable maturity. The proceeds of the preferred stock
offering will be invested in longer-term obligations in accordance with the
Fund's investment objective. Because under normal market conditions,
obligations with longer maturities produce higher yields than short-term and
medium-term obligations, the Investment Adviser believes that the spread
inherent in the difference between the short-term and medium-term rates paid
by the Fund and the longer-term rates received by the Fund will provide
holders of Common Stock with a potentially higher yield.
The Underwriter may engage in transactions that stabilize, maintain, or
otherwise affect the price of the Fund's Common Stock. Such transactions may
include stabilizing, the purchase of the Fund's Common Stock to cover short
positions and the imposition of penalty bids. For a description of these
activities, see "Underwriting."
2
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by reference to the more
detailed information included elsewhere in this Prospectus.
THE FUND MuniHoldings California Fund, Inc. (the "Fund") is a newly
organized, non-diversified, closed-end management investment
company. See "The Fund."
THE The Fund is offering shares of Common Stock at an initial
OFFERING offering price of $15.00 per share. The Common Stock is being
offered by Merrill Lynch, Pierce, Fenner & Smith Incorporated
("Merrill Lynch" or the "Underwriter"). The Underwriter has been
granted an option, exercisable for 45 days from the date of this
Prospectus, to purchase up to additional shares of Common
Stock to cover over-allotments. See "Underwriting."
INVESTMENT The investment objective of the Fund is to provide shareholders
OBJECTIVE with current income exempt from Federal and California income
AND taxes. The Fund seeks to achieve its investment objective by
POLICIES investing primarily in a portfolio of long-term, investment grade
municipal obligations the interest on which, in the opinion of bond
counsel to the issuer, is exempt from Federal and California income
taxes ("California Municipal Bonds"). The Fund intends to maintain
at least 75% of its total assets in municipal obligations that are
rated investment grade or, if unrated, are considered by the
Investment Adviser to be of comparable quality. The Fund may invest
up to 25% of its total assets in municipal obligations that are
rated below investment grade or, if unrated, are considered by the
Investment Adviser to be of comparable quality. Such lower quality
municipal obligations (also commonly referred to as "junk bonds")
are frequently traded only in markets where the number of potential
purchasers and sellers, if any, is very limited. The Fund will seek
to achieve its investment objective by seeking to invest
substantially all (a minimum of 80%) of its assets in California
Municipal Bonds, except at times when, in the judgment of the
Investment Adviser, California Municipal Bonds of sufficient
quality and quantity are unavailable for investment at suitable
prices by the Fund. At all times, except during interim periods
pending investment of the net proceeds of public offerings of the
Fund's securities and during temporary defensive periods, the Fund
will maintain at least 65% of its assets in California Municipal
Bonds and at least 80% of its assets in California Municipal Bonds
and other long-term municipal obligations exempt from Federal
income taxes, but not from California income taxes ("Municipal
Bonds"). The Fund does not ordinarily intend to realize significant
investment income not exempt from Federal and California income
taxes. See "Investment Objective and Policies."
LISTING Prior to this offering, there has been no public market for the
Common Stock of the Fund. Application will be made to list the
Fund's shares of Common Stock on the New York Stock Exchange.
However, during an initial period which is not expected to exceed
two weeks from the date of this Prospectus, the Fund's shares of
Common Stock will not be listed on any securities exchange. During
such period, the Underwriter does not intend to make a market in
the Fund's shares of Common Stock. Consequently, it is anticipated
that an investment in the Fund will be illiquid during such period.
See "Underwriting."
3
<PAGE>
LEVERAGE The Fund anticipates that it will be substantially invested in
longer-term municipal obligations within approximately three months
after completion of the offering of Common Stock described herein.
To leverage the Common Stock, the Fund intends to offer shares of
preferred stock within three months after completion of this
offering representing approximately 40% of the Fund's capital
immediately after the issuance of such preferred stock. There can
be no assurance, however, that preferred stock representing such
percentage of the Fund's capital will actually be issued. The
issuance of the preferred stock will result in the leveraging of
the Common Stock. Although the terms of the preferred stock
offering will be determined by the Fund's Board of Directors, it is
anticipated that the preferred stock will pay dividends that will
be adjusted over either relatively short-term periods (generally
seven to 28 days) or medium-term periods (up to five years) and
that the dividend rate will be based upon prevailing interest rates
for debt obligations of comparable maturity. The proceeds of the
preferred stock offering will be invested in longer-term
obligations in accordance with the Fund's investment objective.
Issuance and ongoing expenses of the preferred stock will be borne
by the Fund and will reduce the net asset value of the Common
Stock. Additionally, under certain circumstances, when the Fund is
required to allocate taxable income to holders of preferred stock,
it is anticipated that the terms of the preferred stock will
require the Fund to make an additional distribution to such holders
in an amount approximately equal to the tax liability resulting
from such allocation and such additional distribution (such amount,
an "Additional Distribution").
The use of leverage by the Fund creates an opportunity for
increased net income, but, at the same time, creates special risks.
Because, under normal market conditions, obligations with longer
maturities produce higher yields than short-term and medium-term
obligations, the Investment Adviser believes that the spread
inherent in the difference between the short-term and medium-term
rates (and any Additional Distribution) paid by the Fund and the
longer-term rates received by the Fund will provide holders of
Common Stock with a potentially higher yield. Investors should
note, however, that leverage creates certain risks for holders of
Common Stock, including higher volatility of both the net asset
value and market value of the Common Stock. Since any decline in
the value of the Fund's investments will be borne entirely by
holders of Common Stock, the effect of leverage in a declining
market would result in a greater decrease in net asset value than
if the Fund were not leveraged, which would likely be reflected in
a decline in the market price for shares of Common Stock.
Additionally, fluctuations in the dividend rates on, and the amount
of taxable income allocable to, the preferred stock will affect the
yield to holders of Common Stock. See "Risks and Special
Considerations of Leverage." Upon issuance of the preferred stock,
holders of the Common Stock will receive all net income of the Fund
remaining after payment of dividends (and any Additional
Distribution) on the preferred stock and will generally be entitled
to a pro rata share of net realized capital gains. Upon any
liquidation of the Fund, the holders of shares of preferred stock
will be entitled to receive liquidating distributions (expected to
equal the original purchase price per share of preferred stock plus
any accumulated and unpaid dividends thereon and any accumulated
and unpaid Additional Distribution) before any distribution is made
to holders of Common Stock. See "Description of Capital Stock--
Preferred Stock."
4
<PAGE>
Holders of preferred stock, voting as a separate class, will be
entitled to elect two of the Fund's Directors, and holders of
common and preferred stock, voting together as a single class, will
be entitled to elect the remaining Directors. If, at any time,
dividends on the Fund's preferred stock were to be in arrears in an
amount equal to two full years of dividend payments, the holders of
all outstanding shares of preferred stock, voting as a separate
class, would be entitled to elect a majority of the Fund's
Directors. The holders of preferred stock will also vote separately
on certain other matters as required under the Fund's Articles of
Incorporation, the Investment Company Act of 1940, as amended (the
"1940 Act") and Maryland law, but otherwise will have equal voting
rights with holders of Common Stock (one vote per share) and will
vote together with holders of Common Stock as a single class. See
"Description of Capital Stock--Preferred Stock--Voting Rights."
There can be no assurance that the Fund will be able to realize a
higher net return on its investment portfolio than the then current
dividend rate (and any Additional Distribution) on the preferred
stock. Changes in certain factors could cause the relationship
between the short-term and medium-term dividend rates (and any
Additional Distribution) paid by the Fund on the preferred stock
and the long-term rates received by the Fund on its investment
portfolio to change so that such short-term and medium-term rates
(and any Additional Distribution) may substantially increase
relative to rates on the long-term obligations in which the Fund
may be invested. Under such conditions, the benefit of leverage to
holders of Common Stock will be reduced, and the Fund's leveraged
capital structure could result in a lower rate of return to holders
of Common Stock than if the Fund were not leveraged. The Fund will
have the authority to redeem the preferred stock for any reason and
may redeem all or part of the preferred stock if it anticipates
that the Fund's leveraged capital structure will result in a lower
rate of return to holders of the Common Stock than that obtainable
if the Common Stock were unleveraged for any significant amount of
time.
Prior to the time it offers the preferred stock, the Fund intends
to apply for ratings on such stock from one or more nationally
recognized statistical ratings organizations ("NRSROs"). The Fund
believes that obtaining a rating for the preferred stock will
enhance the marketability of the preferred stock and thereby reduce
the dividend rate on the preferred stock from that which the Fund
would be required to pay if the preferred stock were not rated.
INVESTMENT Fund Asset Management, L.P. is the Fund's investment adviser and is
ADVISER responsible for the management of the Fund's investment portfolio
and for providing administrative services to the Fund. For its
services, the Fund pays the Investment Adviser a monthly fee at the
annual rate of 0.55 of 1% of the Fund's average weekly net assets,
including any proceeds from the issuance of preferred stock. The
Investment Adviser is an affiliate of Merrill Lynch Asset
Management, L.P. ("MLAM"), which is owned and controlled by Merrill
Lynch & Co., Inc. ("ML & Co."). The Investment Adviser or MLAM acts
as the investment adviser for over 140 registered management
investment companies. The Investment Adviser also offers portfolio
management and portfolio analysis services to individuals and
institutions. As of , 1997, the Investment Adviser and MLAM had
a total of approximately $
5
<PAGE>
billion in investment company and other portfolio assets under
management (approximately $ billion of which was invested in
municipal securities), including accounts of certain affiliates of
the Investment Adviser. See "Investment Advisory and Management
Arrangements."
DIVIDENDS
AND
DISTRIBUTIONS
The Fund intends to pay dividends monthly and to distribute
substantially all of its net investment income to holders of Common
Stock. From and after issuance of the preferred stock, monthly
distributions to holders of Common Stock will consist of
substantially all net investment income remaining after the payment
of dividends (and any Additional Distribution) on the preferred
stock. It is expected that the Fund will commence paying dividends
to holders of Common Stock within approximately 90 days from the
date of this Prospectus. Net capital gains, if any, will be
distributed at least annually to holders of Common Stock and, after
issuance of the preferred stock, on a pro rata basis to holders of
Common Stock and preferred stock. When capital gains or other
taxable income is allocated to holders of preferred stock under
certain circumstances, it is anticipated that the terms of the
preferred stock will require the Fund to make an Additional
Distribution. The Fund is not permitted to declare any cash
dividend or other distribution on its Common Stock unless asset
coverage (as defined in the 1940 Act) with respect to the Fund's
preferred stock is at least 200%. If the Fund issues preferred
stock representing 40% of its capital after the time of issuance,
its asset coverage with respect to the preferred stock will be
approximately 250%. If the Fund's ability to make distributions on
its Common Stock is limited, this could under certain circumstances
impair the ability of the Fund to maintain its qualification for
taxation as a regulated investment company, which would have
adverse tax consequences for holders of Common Stock. See "Taxes."
AUTOMATIC All dividend and capital gains distributions will be automatically
DIVIDEND reinvested in additional shares of Common Stock of the Fund unless
REINVESTMENTa shareholder elects to receive cash. Shareholders whose shares are
PLAN held in the name of a broker or nominee should contact such broker
or nominee to confirm that they may participate in the Fund's
dividend reinvestment plan. See "Automatic Dividend Reinvestment
Plan."
MUTUAL Purchasers of shares of Common Stock of the Fund through Merrill
FUND Lynch in this offering will have an investment option consisting of
INVESTMENT the right to reinvest the net proceeds from a sale of such shares
OPTION (the "Original Shares") in Class D initial sales charge shares of
certain Merrill Lynch-sponsored open-end mutual funds ("Eligible
Class D Shares") at their net asset value, without the imposition
of the initial sales charge, if the conditions set forth below are
satisfied. First, the sale of the Original Shares must be made
through Merrill Lynch, and the net proceeds therefrom must be
immediately reinvested in Eligible Class D Shares. Second, the
Original Shares must have been either acquired in this offering or
be shares representing reinvested dividends from shares of Common
Stock acquired in this offering. Third, the Original Shares must
have been continuously maintained in a Merrill Lynch securities
account. Fourth, there must be a minimum purchase of $250 to be
eligible for the investment option. Class D shares of the mutual
funds are subject to an account maintenance fee at an annual rate
of up to 0.25% of the average daily net asset value of such mutual
fund. See "Mutual Fund Investment Option."
6
<PAGE>
RISK FACTORS AND SPECIAL CONSIDERATIONS
The Fund is a newly organized, non-diversified, closed-end management
investment company and has no operating history. Shares of closed-end
investment companies frequently trade at a discount from their net asset value.
This risk may be greater for investors expecting to sell their shares in a
relatively short period after completion of the public offering. Accordingly,
the Common Stock of the Fund is designed primarily for long-term investors and
should not be considered a vehicle for trading purposes. The net asset value of
the Fund's shares of Common Stock will fluctuate with interest rate changes as
well as with price changes of the Fund's portfolio securities, and these
fluctuations are likely to be greater in the case of a fund having a leveraged
capital structure, as contemplated for the Fund. See "Risks and Special
Considerations of Leverage."
The Fund intends to invest a substantial portion of its assets in California
Municipal Bonds and, therefore, it is more susceptible to factors adversely
affecting issuers of California Municipal Bonds than is a municipal bond fund
that is not concentrated in issuers of California Municipal Bonds to this
degree. See "Investment Objective and Policies--Special Considerations Relating
to California Municipal Bonds" and Appendix I, "Economic Conditions in
California."
The Fund has registered as a "non-diversified" investment company so that it
will be able to invest more than 5% of its assets in the obligations of any
single issuer, subject to the diversification requirements of Subchapter M of
the Internal Revenue Code of 1986, as amended (the "Code"), applicable to the
Fund. Since the Fund may invest a relatively high percentage of its assets in
the obligations of a limited number of issuers, the Fund may be more
susceptible than a more widely-diversified fund to any single economic,
political or regulatory occurrence.
The Fund intends to invest at least 75% of its total assets in municipal
obligations that are rated in the investment grade rating categories by
Standard & Poor's Ratings Services ("S&P"), Moody's Investors Service, Inc.
("Moody's") or Fitch IBCA, Inc. ("Fitch") or, if not rated, are considered to
be of comparable quality by the Investment Adviser. Obligations rated in the
lowest investment grade category may have certain speculative characteristics.
Additionally, the Fund may invest up to 25% of its total assets in municipal
obligations that are rated below investment grade or, if not rated, are
considered by the Investment Adviser to be of comparable quality. These
securities are regarded as predominantly speculative and investments therein
entail certain risks. See "Investment Objective and Policies." The Fund may
invest in certain tax-exempt securities classified as "private activity bonds"
that may subject certain investors in the Fund to the alternative minimum tax.
See "Taxes--General."
The Fund will be subject to certain restrictions on investments imposed by
guidelines of one or more NRSROs that may issue ratings for the preferred
stock. These guidelines may impose asset coverage or portfolio composition
requirements that are more stringent than those imposed by the 1940 Act. It is
not anticipated that these covenants or guidelines will impede the Investment
Adviser from managing the Fund's portfolio in accordance with the Fund's
investment objective and policies.
In order to seek to hedge various portfolio positions or to enhance its
return, the Fund may invest in certain instruments that may be characterized as
derivatives. These investments include various types of options
7
<PAGE>
transactions and futures and options thereon. Such investments also may consist
of non-municipal tax-exempt securities and securities the potential investment
return on which is based on the change in particular measurements of value or
interest rates ("indexed securities"), including securities the potential
investment return on which is inversely related to a change in particular
measurements of value or interest rates ("inverse securities"). Certain of such
investments may be made solely for hedging purposes, not for speculation, and
may in some cases require limitations as to the type of permissible
counterparty to the transaction. Investments in indexed securities, including
inverse securities, subject the Fund to the risks associated with changes in
the particular indices, which may include reduced or eliminated interest
payments and losses of invested principal. Derivative instruments may have
certain characteristics that have a similar effect on the return to Common
Stock investors as the leverage transactions discussed under "Risks and Special
Considerations of Leverage;" however, certain derivative investments will not
be taken into account for purposes of calculating the percentage of leverage of
the Fund's portfolio. For a further discussion of the risks associated with
derivative investments, see "Investment Objective and Policies," "Investment
Objective and Policies--Other Investment Policies--Indexed and Inverse Floating
Obligations," "--Call Rights" and "Investment Objective and Policies--Options
and Futures Transactions."
Subject to its investment restrictions, the Fund is authorized to engage in
options and futures transactions on exchanges and in the over-the-counter
markets ("OTC options") for hedging purposes with certain specified entities
meeting the criteria of the Fund. These transactions involve certain risk
considerations. These risks include the risk of imperfect correlation in
movements in the price of futures contracts and movements in the price of the
security that is the subject of the hedge and the inability to close futures
transactions under certain conditions. Because of the anticipated leveraged
nature of the Common Stock, hedging transactions will result in a larger impact
on the net asset value of the Common Stock than would be the case if the Common
Stock were not leveraged. Certain OTC options and assets used to cover OTC
options written by the Fund may be considered to be illiquid. The illiquidity
of such options or assets may prevent a successful sale of such options or
assets, result in a delay of sale, or reduce the amount of proceeds that might
be otherwise realized. See "Investment Objective and Policies--Options and
Futures Transactions." The Fund intends to apply for ratings of the preferred
stock from one or more NRSROs. In order to obtain these ratings, the Fund may
be required to limit its use of hedging techniques in accordance with the
specified guidelines of such NRSRO.
The Fund's Articles of Incorporation include provisions that could have the
effect of limiting the ability of other entities or persons to acquire control
of the Fund or to change the composition of its Board of Directors and could
have the effect of depriving shareholders of an opportunity to sell their
shares at a premium over prevailing market prices by discouraging a third party
from seeking to obtain control of the Fund. See "Description of Capital Stock--
Certain Provisions of the Articles of Incorporation."
8
<PAGE>
FEE TABLE
<TABLE>
<S> <C>
SHAREHOLDER TRANSACTION EXPENSES:
Maximum Sales Load (as a percentage of offering price)................ None
Dividend Reinvestment Plan Fees....................................... None
ANNUAL EXPENSES (as a percentage of net assets attributable to shares of
Common Stock):
Management Fees(a)(b)................................................. 0.55%
Interest Payments on Borrowed Funds................................... None
Other Expenses(b)..................................................... %
----
Total Annual Expenses(b)............................................ %
====
</TABLE>
<TABLE>
<CAPTION>
1 3 5 10
YEAR YEARS YEARS YEARS
EXAMPLE ---- ----- ----- -----
<S> <C> <C> <C> <C>
An investor would pay the following expenses on a
$1,000 investment, assuming (1) total annual expenses
of % (assuming no leverage) and % (assuming
leverage) and (2) a 5% annual return throughout the
periods:
Assuming No Leverage.................................. $ $ $ $
Assuming Leverage..................................... $ $ $ $
</TABLE>
- --------
(a) See "Investment Advisory and Management Arrangements"--page 26.
(b) In the event that the Fund utilizes leverage by issuing preferred stock in
an amount of approximately 40% of the Fund's capital, it is estimated
that, as a percentage of net assets attributable to Common Stock, the
Management Fees would be %, Other Expenses would be % and Total
Annual Expenses would be %. See "Risks and Special Considerations of
Leverage."
The foregoing Fee Table is intended to assist investors in understanding the
costs and expenses that a shareholder in the Fund will bear directly or
indirectly. The expenses set forth under "Other Expenses" are based on
estimated amounts through the end of the Fund's first fiscal year on an
annualized basis. The Example set forth above assumes reinvestment of all
dividends and distributions and utilizes a 5% annual rate of return as
mandated by the Securities and Exchange Commission regulations. THE EXAMPLE
SHOULD NOT BE CONSIDERED A REPRESENTATION OF FUTURE EXPENSES OR ANNUAL RATE OF
RETURN, AND ACTUAL EXPENSES OR ANNUAL RATE OF RETURN MAY BE MORE OR LESS THAN
THOSE ASSUMED FOR PURPOSES OF THE EXAMPLE.
9
<PAGE>
THE FUND
MuniHoldings California Fund, Inc. (the "Fund") is a newly organized, non-
diversified, closed-end management investment company. The Fund was
incorporated under the laws of the State of Maryland on December 4, 1997, and
has registered under the 1940 Act. The Fund's principal office is located at
800 Scudders Mill Road, Plainsboro, New Jersey 08536, and its telephone number
is (609) 282-2800.
The Fund has been organized as a closed-end investment company. Closed-end
investment companies differ from open-end investment companies (commonly
referred to as "mutual funds") in that closed-end investment companies do not
generally make a continuous offering of their shares or redeem their
securities at the option of the shareholder, whereas open-end companies issue
securities redeemable at net asset value at any time at the option of the
shareholder and typically engage in a continuous offering of their shares.
Accordingly, open-end investment companies are subject to continuous asset in-
flows and out-flows that can complicate portfolio management. Shares of
closed-end investment companies, however, frequently trade at a discount from
their net asset value. This risk may be greater for investors expecting to
sell their shares in a relatively short period after completion of the public
offering.
USE OF PROCEEDS
The net proceeds of this offering will be $ (or approximately
$ assuming the Underwriter exercises the over-allotment option in
full) after payment of organizational and offering expenses.
The net proceeds of the offering will be invested in accordance with the
Fund's investment objective and policies within approximately three months
after completion of the offering of Common Stock, depending on market
conditions and the availability of appropriate securities. Pending such
investment, it is anticipated that the proceeds will be invested in short-
term, tax-exempt securities. See "Investment Objective and Policies."
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to provide shareholders with current
income exempt from Federal and California income taxes. The Fund seeks to
achieve its investment objective by investing primarily in a portfolio of
long-term, investment grade municipal obligations issued by or on behalf of
the State of California, its political subdivisions, agencies and
instrumentalities and by other qualifying issuers that pay interest which, in
the opinion of bond counsel to the issuer, is exempt from Federal and
California income taxes. The Fund will seek to achieve its investment
objective by seeking to invest substantially all (a minimum of 80%) of its
assets in California Municipal Bonds, except at times when, in the judgment of
the Investment Adviser, California Municipal Bonds of sufficient quality and
quantity are unavailable for investment by the Fund. At all times, except
during temporary defensive periods, the Fund will maintain at least 75% of its
total assets in California Municipal Bonds and Municipal Bonds that are rated
investment grade by S&P, Moody's or Fitch, or, if unrated, are considered to
be of comparable quality by the Investment Adviser. Additionally, the Fund may
invest up to 25% of its total assets in California Municipal Bonds and
Municipal Bonds that are rated below investment grade by S&P, Moody's or
Fitch, or, if unrated, are considered to be of comparable quality by the
Investment Adviser. Such lower quality California Municipal Bonds and
Municipal Bonds are frequently traded only in markets where the number of
potential purchasers and sellers, if any, is very limited. In addition, the
Fund also will maintain at least 65% of its assets in California Municipal
Bonds and at least 80% of its assets in California
10
<PAGE>
Municipal Bonds and Municipal Bonds that are exempt from Federal Income taxes,
but not California income taxes. The investment objective of the Fund is a
fundamental policy that may not be changed without a vote of a majority of the
Fund's outstanding voting securities, as defined below under "Investment
Restrictions." There can be no assurance that the investment objective of the
Fund will be realized. At times the Fund may seek to hedge its portfolio
through the use of futures transactions and options to reduce volatility in
the net asset value of its shares of Common Stock.
The Fund ordinarily does not intend to realize significant investment income
not exempt from Federal and California income taxes. To the extent that
suitable California Municipal Bonds are not available for investment by the
Fund, as determined by the Investment Adviser, the Fund may purchase long-term
obligations issued by or on behalf of states, territories and possessions of
the United States and their political subdivisions, agencies and
instrumentalities paying interest which, in the opinion of bond counsel to the
issuer, is exempt from Federal but not California income taxes. At all times,
except during interim periods pending investment of the net proceeds of public
offerings of the Fund's securities and during temporary defensive periods, the
Fund will have at least 80% of its assets invested in California Municipal
Bonds and Municipal Bonds. The Fund may invest all or a portion of its assets
in certain tax-exempt securities classified as "private activity bonds" (in
general, bonds that benefit non-governmental entities) that may subject
certain investors in the Fund to an alternative minimum tax.
The Fund also may invest in securities not issued by or on behalf of a state
or territory or by an agency or instrumentality thereof, if the Fund
nevertheless believes such securities pay interest or distributions that are
exempt from Federal income taxation ("Non-Municipal Tax-Exempt Securities").
Non-Municipal Tax-Exempt Securities may also include securities issued by
other investment companies that invest in California Municipal Bonds and
Municipal Bonds, to the extent such investments are permitted by the 1940 Act.
Other Non-Municipal Tax-Exempt Securities could include trust certificates or
other instruments evidencing interests in one or more long-term California
Municipal Bonds or Municipal Bonds. Certain Non-Municipal Tax-Exempt
Securities may be characterized as derivative instruments. Non-Municipal Tax-
Exempt Securities will be considered "California Municipal Bonds" or
"Municipal Bonds" for purposes of the Fund's investment objective and
policies.
Investment in shares of Common Stock of the Fund offers several potential
benefits. The Fund offers investors the opportunity to receive income exempt
from Federal and California income taxes by investing in a professionally
managed portfolio comprised primarily of investment grade California Municipal
Bonds. Investment in the Fund also relieves the investor of the burdensome
administrative details involved in managing a portfolio of California
Municipal Bonds. Additionally, the Investment Adviser will seek to enhance the
yield on the Common Stock by leveraging the Fund's capital structure through
the issuance of preferred stock. The benefits are at least partially offset by
the expenses involved in operating an investment company. Such expenses
primarily consist of the advisory fee and operational costs. Additionally, the
use of leverage involves certain expenses and special risk considerations. See
"Risks and Special Considerations of Leverage."
The investment grade California Municipal Bonds and Municipal Bonds in which
the Fund will primarily invest are those California Municipal Bonds and
Municipal Bonds rated at the date of purchase in the four highest rating
categories of S&P, Moody's or Fitch or, if unrated, are considered to be of
comparable quality by the Investment Adviser. In the case of long-term debt,
the investment grade rating categories are AAA through BBB for S&P, Aaa
through Baa for Moody's and AAA through BBB for Fitch. In the case of short-
term notes, the investment grade rating categories are SP-1+ through SP-3 for
S&P, MIG-1 through MIG-4 for Moody's and F-1+ through F-3 for Fitch. In the
case of tax-exempt commercial paper, the investment grade rating categories
are A-1+ through A-3 for S&P, Prime-1 through Prime-3 for Moody's and F-1+
through F-3 for
11
<PAGE>
Fitch. Obligations ranked in the fourth highest rating category (BBB, SP-3 and
A-3 for S&P; Baa, MIG-4 and Prime-3 for Moody's; and BBB and F-3 for Fitch),
while considered "investment grade," may have certain speculative
characteristics. There may be sub-categories or gradations indicating relative
standing within the rating categories set forth above. See Appendix II to this
Prospectus for a description of S&P's, Moody's and Fitch's ratings of
Municipal Bonds. In assessing the quality of California Municipal Bonds and
Municipal Bonds with respect to the foregoing requirements, the Investment
Adviser will take into account the nature of any letters of credit or similar
credit enhancements to which particular California Municipal Bonds and
Municipal Bonds are entitled and the creditworthiness of the financial
institution that provided such insurance.
As noted above, the Fund may invest up to 25% of its assets in California
Municipal Bonds and Municipal Bonds that are rated below investment grade, or,
if unrated, are considered to be of comparable quality by the Investment
Adviser. These high yield bonds are commonly referred to as "junk bonds" and
are regarded as predominantly speculative as to the issuer's ability to make
payments of principal and interest. Consequently, although such bonds can be
expected to provide higher yields and be less subject to interest rate
fluctuations, they may be subject to greater market price fluctuations and
risk of loss of principal than lower yielding, higher rated fixed-income
securities. Such securities are particularly vulnerable to adverse changes in
the issuer's industry and in general economic conditions. Issuers of high
yield bonds may be highly leveraged and may not have available to them more
traditional methods of financing. The risk of loss due to default by the
issuer is significantly greater for the holders of these bonds because such
securities may be unsecured and may be subordinated to other creditors of the
issuer. In addition, while the high yield bonds in which the Fund may invest
normally will not include securities that at the time of investment are in
default or the issuers of which are in bankruptcy, there can be no assurance
that such events will not occur after the Fund purchases a particular
security, in which case the Fund may experience losses and incur costs.
High yield bonds frequently have call or redemption features that permit an
issuer to repurchase such bonds from the Fund, which may decrease the net
investment income to the Fund and dividends to shareholders in the event that
the Fund is required to replace a called security with a lower yielding
security. The Funds may have difficulty disposing of certain high yield bonds
because there may be a thin trading market for such securities. Reduced
secondary market liquidity may have an adverse impact on market price and the
Fund's ability to dispose of particular issues when necessary to meet the
Fund's liquidity needs or in response to a specific economic event such as a
deterioration in the creditworthiness of the issuer. In addition, market
quotations are generally available on many high yield bond issues only from a
limited number of dealers and may not necessarily represent firm bids of such
dealers or prices for actual sales.
Certain California Municipal Bonds and Municipal Bonds may be entitled to
the benefits of letters of credit or similar credit enhancements issued by
financial institutions. In such instances, the Board of Directors and the
Investment Adviser will take into account in assessing the quality of such
bonds not only the creditworthiness of the issuer of such bonds but also the
creditworthiness of the financial institution providing the credit
enhancement.
The Fund's investments may also include variable rate demand obligations
("VRDOs") and VRDOs in the form of participation interests ("Participating
VRDOs") in variable rate tax-exempt obligations held by a financial
institution, typically a commercial bank. The VRDOs in which the Fund will
invest are tax-exempt obligations, in the opinion of counsel to the issuer,
that contain a floating or variable interest rate adjustment formula and an
unconditional right of demand on the part of the holder thereof to receive
payment of the unpaid principal balance plus accrued interest on a short
notice period not to exceed seven days. Participating VRDOs provide the Fund
with a specified undivided interest (up to 100%) in the underlying obligation
and the right to
12
<PAGE>
demand payment of the unpaid principal balance plus accrued interest on the
Participating VRDOs from the financial institution on a specified number of
days' notice, not to exceed seven days. There is, however, the possibility
that because of default or insolvency, the demand feature of VRDOs or
Participating VRDOs may not be honored. The Fund has been advised by its
counsel that the Fund should be entitled to treat the income received on
Participating VRDOs as interest from tax-exempt obligations.
The average maturity of the Fund's portfolio securities will vary based upon
the Investment Adviser's assessment of economic and market conditions. The net
asset value of the shares of common stock of a closed-end investment company,
such as the Fund, which invests primarily in fixed-income securities, changes
as the general levels of interest rates fluctuate. When interest rates
decline, the value of a fixed-income portfolio can be expected to rise.
Conversely, when interest rates rise, the value of a fixed-income portfolio
can be expected to decline. Prices of longer-term securities generally
fluctuate more in response to interest rate changes than do short-term or
medium-term securities. These changes in net asset value are likely to be
greater in the case of a fund having a leveraged capital structure, as
proposed for the Fund. See "Risks and Special Considerations of Leverage."
The Fund intends to invest primarily in long-term California Municipal Bonds
and Municipal Bonds with a maturity of more than ten years. Also, the Fund may
invest in intermediate-term California Municipal Bonds and Municipal Bonds
with a maturity of between three years and ten years. The Fund may invest in
short-term, tax-exempt securities, short-term U.S. Government securities,
repurchase agreements or cash. Such short-term securities or cash will not
exceed 20% of its total assets except during interim periods pending
investment of the net proceeds of public offerings of the Fund's securities or
in anticipation of the repurchase or redemption of the Fund's securities and
temporary periods when, in the opinion of the Investment Adviser, prevailing
market or economic conditions warrant. The Fund does not ordinarily intend to
realize significant interest income not exempt from Federal and California
income taxes.
The Fund is classified as non-diversified within the meaning of the 1940
Act, which means that the Fund is not limited by such Act in the proportion of
its assets that it may invest in securities of a single issuer. However, the
Fund's investments will be limited so as to qualify the Fund for special tax
treatment afforded regulated investment companies under the Code. See "Taxes."
To qualify, among other requirements, the Fund will limit its investments so
that, at the close of each quarter of the taxable year, (i) not more than 25%
of the market value of the Fund's total assets will be invested in the
securities (other than U.S. Government securities) of a single issuer, and
(ii) with respect to 50% of the market value of its total assets, not more
than 5% of the market value of its total assets will be invested in the
securities (other than U.S. Government securities) of a single issuer. A fund
that elects to be classified as "diversified" under the 1940 Act must satisfy
the foregoing 5% requirement with respect to 75% of its total assets. To the
extent that the Fund assumes large positions in the securities of a small
number of issuers, the Fund's yield may fluctuate to a greater extent than
that of a diversified company as a result of changes in the financial
condition or in the market's assessment of the issuers.
DESCRIPTION OF CALIFORNIA MUNICIPAL BONDS AND MUNICIPAL BONDS
California Municipal Bonds and Municipal Bonds include debt obligations
issued to obtain funds for various public purposes, including construction of
a wide range of public facilities, refunding of outstanding obligations and
obtaining funds for general operating expenses and loans to other public
institutions and facilities. In addition, certain types of industrial
development bonds are issued by or on behalf of public authorities to finance
various privately operated facilities, including certain local facilities for
water supply, gas, electricity, sewage or
13
<PAGE>
solid waste disposal. For purposes of this Prospectus, such obligations are
Municipal Bonds if the interest paid thereon is exempt from Federal income tax
and as California Municipal Bonds if the interest thereon is exempt from
Federal income tax and exempt from California income tax, even though such
bonds may be industrial development bonds ("IDBs") or "private activity bonds"
as discussed below. Also, for purposes of this Prospectus, Non-Municipal Tax-
Exempt securities as discussed above will be considered California Municipal
Bonds or Municipal Bonds.
The two principal classifications of California Municipal Bonds and
Municipal Bonds are "general obligation" bonds and "revenue" bonds, which
latter category includes IDBs and, for bonds issued after August 15, 1986,
private activity bonds. General obligation bonds (other than those of the
State of California which has limited taxing powers) are secured by the
issuer's pledge of faith, credit and taxing power for the repayment of
principal and the payment of interest. Revenue or special obligation bonds are
payable only from the revenues derived from a particular facility or class of
facilities or, in some cases, from the proceeds of a special excise tax or
other specific revenue source such as from the user of the facility being
financed. IDBs are in most cases revenue bonds and do not generally constitute
the pledge of the credit or taxing power of the issuer of such bonds. The
repayment of principal and the payment of interest on such industrial
development bonds depends solely on the ability of the user of the facility
financed by the bonds to meet its financial obligations and the pledge, if
any, of real and personal property so financed as security for such payment.
California Municipal Bonds and Municipal Bonds may also include "moral
obligation" bonds, which are normally issued by special purpose public
authorities. If an issuer of moral obligation bonds is unable to meet its
obligations, the repayment of such bonds becomes a moral commitment but not a
legal obligation of the state or municipality in question.
The Fund may purchase California Municipal Bonds and Municipal Bonds
classified as "private activity bonds" (in general, bonds that benefit non-
governmental entities). Interest received on certain tax-exempt securities
that are classified as "private activity bonds" may subject certain investors
in the Fund to an alternative minimum tax. There is no limitation on the
percentage of the Fund's assets that may be invested in California Municipal
Bonds and Municipal Bonds that may subject certain investors to an alternative
minimum tax. See "Taxes--General." Also included within the general category
of California Municipal Bonds and Municipal Bonds are participation
certificates issued by government authorities or entities to finance the
acquisition or construction of equipment, land and/or facilities. The
certificates represent participations in a lease, an installment purchase
contract or a conditional sales contract (hereinafter collectively referred to
as "lease obligations") relating to such equipment, land or facilities.
Although lease obligations do not constitute general obligations of the issuer
for which the issuer's unlimited taxing power is pledged, a lease obligation
frequently is backed by the issuer's covenant to budget for, appropriate and
make the payments due under the lease obligation. However, certain lease
obligations contain "non-appropriation" clauses, which provide that the issuer
has no obligation to make lease or installment purchase payments in future
years unless money is appropriated for such purpose on a yearly basis.
Although "non-appropriation" lease obligations are secured by the lease
property, disposition of the property in the event of foreclosure might prove
difficult. These securities represent a relatively new type of financing that
has not yet developed the depth of marketability associated with more
conventional securities.
Federal tax legislation has limited the types and volume of bonds the
interest on which qualifies for a Federal income tax exemption. As a result,
this legislation and legislation that may be enacted in the future may affect
the availability of California Municipal Bonds and Municipal Bonds for
investment by the Fund.
14
<PAGE>
SPECIAL CONSIDERATIONS RELATING TO CALIFORNIA MUNICIPAL BONDS
The Fund ordinarily will invest at least 80% of its total assets in
California Municipal Bonds, and therefore it is more susceptible to factors
adversely affecting issuers of California Municipal Bonds than is a municipal
bond mutual fund that is not concentrated in issuers of California Municipal
Bonds to this degree. Beginning in the 1990-91 fiscal year, the State of
California faced the worst economic, fiscal and budget conditions since the
1930's. On July 5, 1994, all three of the rating agencies rating the State of
California's long-term debt lowered their ratings of the State of California's
general obligation bonds. Moody's lowered its rating from "Aa" to A1", S&P
lowered its rating from "A+" to "A" and Fitch lowered its rating from "AA" to
"A". Although a steady upturn has been under way since 1994, pre-recession job
levels are not expected to be reached until later in the decade. As of the
date of this Prospectus, S&P and Fitch have upgraded their ratings to A+ and
AA-, respectively. No assurance can be given that ratings will not be lowered
in the future. FAM does not believe that the current economic conditions in
California will have a significant adverse effect on the ability of the Fund
to invest in high quality California Municipal Bonds. For a discussion of
economic and other conditions in the State of California, see Appendix I,
"Economic and Other Conditions in California."
OTHER INVESTMENT POLICIES
The Fund has adopted certain other policies as set forth below:
Borrowings. The Fund is authorized to borrow money in amounts of up to 5% of
the value of its total assets at the time of such borrowings; provided,
however, that the Fund is authorized to borrow moneys in amounts of up to 33
1/3% of the value of its total assets at the time of such borrowings to
finance the repurchase of its own Common Stock pursuant to tender offers or
otherwise to redeem or repurchase shares of preferred stock or for temporary,
extraordinary or emergency purposes. Borrowings by the Fund (commonly known,
as with the issuance of preferred stock, as "leveraging") create an
opportunity for greater total return since the Fund will not be required to
sell portfolio securities to repurchase or redeem shares but, at the same
time, increase exposure to capital risk. In addition, borrowed funds are
subject to interest costs that may offset or exceed the return earned on the
borrowed funds.
When-Issued Securities and Delayed Delivery Transactions. The Fund may
purchase or sell California Municipal Bonds and Municipal Bonds on a delayed
delivery basis or on a when-issued basis at fixed purchase or sale terms.
These transactions arise when securities are purchased or sold by the Fund
with payment and delivery taking place in the future. The purchase will be
recorded on the date the Fund enters into the commitment, and the value of the
obligation will thereafter be reflected in the calculation of the Fund's net
asset value. The value of the obligation on the delivery day may be more or
less than its purchase price. A separate account of the Fund will be
established with its custodian consisting of cash, cash equivalents or liquid
securities having a market value at all times at least equal to the amount of
the commitment.
Indexed and Inverse Floating Obligations. The Fund may invest in California
Municipal Bonds and Municipal Bonds the return on which is based on a
particular index of value or interest rates. For example, the Fund may invest
in California Municipal Bonds and Municipal Bonds that pay interest based on
an index of Municipal Bond interest rates. The principal amount payable upon
maturity of certain California Municipal Bonds and Municipal Bonds also may be
based on the value of an index. To the extent the Fund invests in these types
of Municipal Bonds, the Fund's return on such California Municipal Bonds and
Municipal Bonds will be subject to risk with respect to the value of the
particular index. Also, the Fund may invest in so-called "inverse
15
<PAGE>
floating obligations" or "residual interest bonds" on which the interest rates
typically vary inversely with a short-term floating rate (which may be reset
periodically by a dutch auction, a remarketing agent, or by reference to a
short-term tax-exempt interest rate index). The Fund may purchase in the
secondary market synthetically-created inverse floating rate bonds evidenced
by custodial or trust receipts. Generally, interest rates on inverse floating
rate bonds will decrease when short-term rates increase, and will increase
when short-term rates decrease. Such securities have the effect of providing a
degree of investment leverage, since they may increase or decrease in value in
response to changes, as an illustration, in market interest rates at a rate
that is a multiple (typically two) of the rate at which fixed-rate, long-term,
tax-exempt securities increase or decrease in response to such changes. As a
result, the market values of such securities generally will be more volatile
than the market values of fixed-rate tax-exempt securities. To seek to limit
the volatility of these securities, the Fund may purchase inverse floating
obligations with shorter-term maturities or limitations on the extent to which
the interest rate may vary. The Investment Adviser believes that indexed and
inverse floating obligations represent a flexible portfolio management
instrument for the Fund that allows the Investment Adviser to vary the degree
of investment leverage relatively efficiently under different market
conditions.
Call Rights. The Fund may purchase a California Municipal Bond or Municipal
Bond issuer's right to call all or a portion of such California Municipal Bond
or Municipal Bond for mandatory tender for purchase (a "Call Right"). A holder
of a Call Right may exercise such right to require a mandatory tender for the
purchase of related California Municipal Bonds or Municipal Bonds, subject to
certain conditions. A Call Right that is not exercised prior to the maturity
of the related California Municipal Bond or Municipal Bond will expire without
value. The economic effect of holding both the Call Right and the related
California Municipal Bond or Municipal Bond is identical to holding a
California Municipal Bond or Municipal Bond as a non-callable security.
Repurchase Agreements. The Fund may invest in securities pursuant to
repurchase agreements. Repurchase agreements may be entered into only with a
member bank of the Federal Reserve System or a primary dealer in U.S.
Government securities or an affiliate thereof. Under such agreements, the
seller agrees, upon entering into the contract, to repurchase the security at
a mutually agreed-upon time and price, thereby determining the yield during
the term of the agreement. The Fund may not invest in repurchase agreements
maturing in more than seven days if such investments, together with all other
illiquid investments, would exceed 15% of the Fund's net assets. In the event
of default by the seller under a repurchase agreement, the Fund may suffer
time delays and incur costs or possible losses in connection with the
disposition of the underlying securities.
In general, for Federal income tax purposes, repurchase agreements are
treated as collateralized loans secured by the securities "sold." Therefore,
amounts earned under such agreements will not be considered tax-exempt
interest.
OPTIONS AND FUTURES TRANSACTIONS
The Fund may hedge all or a portion of its portfolio investments against
fluctuations in interest rates through the use of options and certain
financial futures contracts ("financial futures contracts") and options
thereon. While the Fund's use of hedging strategies is intended to reduce the
volatility of the net asset value of the Common Stock, the net asset value of
the Common Stock will fluctuate. There can be no assurance that the Fund's
hedging transactions will be effective. In addition, because of the
anticipated leveraged nature of the Common Stock, hedging transactions will
result in a larger impact on the net asset value of the Common Stock
16
<PAGE>
than would be the case if the Common Stock were not leveraged. Furthermore,
the Fund will only engage in hedging activities from time to time and may not
necessarily be engaging in hedging activities when movements in interest rates
occur.
Certain Federal income tax requirements may limit the Fund's ability to
engage in hedging transactions. Gains from transactions in options and futures
contracts distributed to shareholders will be taxable as ordinary income or,
in certain circumstances, as long-term capital gains to shareholders. See
"Taxes--Tax Treatment of Options and Futures Transactions." In addition, in
order to obtain ratings of the preferred stock from one or more NRSROs, the
Fund may be required to limit its use of hedging techniques in accordance with
the specified guidelines of such organizations.
The following is a description of the options and futures transactions in
which the Fund may engage, limitations on the use of such transactions and
risks associated therewith. The investment policies with respect to the
hedging transactions of the Fund are not fundamental policies and may be
modified by the Board of Directors of the Fund without the approval of the
Fund's shareholders.
Writing Covered Call Options. The Fund may write (i.e., sell) covered call
options with respect to California Municipal Bonds and Municipal Bonds it
owns, thereby giving the holder of the option the right to buy the underlying
security covered by the option from the Fund at the stated exercise price
until the option expires. The Fund writes only covered call options, which
means that so long as the Fund is obligated as the writer of a call option, it
will own the underlying securities subject to the option. The Fund may not
write covered call options on underlying securities in an amount exceeding 15%
of the market value of its total assets.
The Fund will receive a premium from writing a call option, which increases
the Fund's return on the underlying security in the event the option expires
unexercised or is closed out at a profit. By writing a call, the Fund limits
its opportunity to profit from an increase in the market value of the
underlying security above the exercise price of the option for as long as the
Fund's obligation as a writer continues. Covered call options serve as a
partial hedge against a decline in the price of the underlying security. The
Fund may engage in closing transactions in order to terminate outstanding
options that it has written.
Purchase of Options. The Fund may purchase put options in connection with
its hedging activities. By buying a put the Fund has a right to sell the
underlying security at the exercise price, thus limiting the Fund's risk of
loss through a decline in the market value of the security until the put
expires. The amount of any appreciation in the value of the underlying
security will be partially offset by the amount of the premium paid for the
put option and any related transaction costs. Prior to its expiration, a put
option may be sold in a closing sale transaction; profit or loss from the sale
will depend on whether the amount received is more or less than the premium
paid for the put option plus the related transaction costs. A closing sale
transaction cancels out the Fund's position as the purchaser of an option by
means of an offsetting sale of an identical option prior to the expiration of
the option it has purchased. In certain circumstances, the Fund may purchase
call options on securities held in its portfolio on which it has written call
options or on securities that it intends to purchase. The Fund will not
purchase options on securities if, as a result of such purchase, the aggregate
cost of all outstanding options on securities held by the Fund would exceed 5%
of the market value of the Fund's total assets.
Financial Futures Contracts and Options. The Fund is authorized to purchase
and sell certain financial futures contracts and options thereon solely for
the purpose of hedging its investments in California Municipal Bonds and
Municipal Bonds against declines in value and to hedge against increases in
the cost of securities it
17
<PAGE>
intends to purchase. A financial futures contract obligates the seller of a
contract to deliver and the purchaser of a contract to take delivery of the
type of financial instrument covered by the contract or, in the case of index-
based futures contracts, to make and accept a cash settlement, at a specific
future time for a specified price. A sale of financial futures contracts may
provide a hedge against a decline in the value of portfolio securities because
such depreciation may be offset, in whole or in part, by an increase in the
value of the position in the financial futures contracts. A purchase of
financial futures contracts may provide a hedge against an increase in the
cost of securities intended to be purchased because such appreciation may be
offset, in whole or in part, by an increase in the value of the position in
the futures contracts.
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, an
amount of cash or securities acceptable to the broker equal to approximately
5% of the contract amount must be deposited with the broker. This amount is
known as initial margin. Subsequent payments to and from the broker, called
variation margin, are made on a daily basis as the price of the financial
futures contract fluctuates making the long and short positions in the
financial futures contract more or less valuable.
The Fund may purchase and sell financial futures contracts based on The Bond
Buyer Municipal Bond Index, a price-weighted measure of the market value of 40
large tax-exempt issues, and purchase and sell put and call options on such
financial futures contracts for the purpose of hedging California Municipal
Bonds and Municipal Bonds that the Fund holds or anticipates purchasing
against adverse changes in interest rates. The Fund also may purchase and sell
financial futures contracts on U.S. Government securities and purchase and
sell put and call options on such financial futures contracts for such hedging
purposes. With respect to U.S. Government securities, currently there are
financial futures contracts based on long-term U.S. Treasury bonds, U.S.
Treasury notes, GNMA Certificates and three-month U.S. Treasury bills.
Subject to policies adopted by the Board of Directors, the Fund also may
engage in transactions in other financial futures contracts, such as financial
futures contracts on other municipal bond indices that may become available,
if the Investment Adviser should determine that there is normally sufficient
correlation between the prices of such financial futures contracts and the
California Municipal Bonds and Municipal Bonds in which the Fund invests to
make such hedging appropriate.
Over-The-Counter Options. The Fund may engage in options and futures
transactions on exchanges and in the over-the-counter markets ("OTC options").
In general, exchange-traded contracts are third-party contracts (i.e.,
performance of the parties' obligations is guaranteed by an exchange or
clearing corporation) with standardized strike prices and expiration dates.
OTC options transactions are two-party contracts with prices and terms
negotiated by the buyer and seller. See "Restrictions on OTC Options" below
for information as to restrictions on the use of OTC options.
Restrictions on OTC Options. The Fund will engage in transactions in OTC
options only with banks or dealers that have capital of at least $50 million
or whose obligations are guaranteed by an entity having capital of at least
$50 million. Certain OTC options and assets used to cover OTC options written
by the Fund may be considered to be illiquid. The illiquidity of such options
or assets may prevent a successful sale of such options or assets, result in a
delay of sale, or reduce the amount of proceeds that might otherwise be
realized.
Risk Factors in Options and Futures Transactions. Utilization of futures
transactions involves the risk of imperfect correlation in movements in the
price of financial futures contracts and movements in the price of the
18
<PAGE>
security that is the subject of the hedge. If the price of the financial
futures contract moves more or less than the price of the security that is the
subject of the hedge, the Fund will experience a gain or loss that will not be
completely offset by movements in the price of such security. There is a risk
of imperfect correlation where the securities underlying financial futures
contracts have different maturities, ratings, geographic compositions or other
characteristics than the security being hedged. In addition, the correlation
may be affected by additions to or deletions from the index that serves as a
basis for a financial futures contract. Finally, in the case of financial
futures contracts on U.S. Government securities and options on such financial
futures contracts, the anticipated correlation of price movements between the
U.S. Government securities underlying the futures or options and California
Municipal Bonds and Municipal Bonds may be adversely affected by economic,
political, legislative or other developments that have a disparate impact on
the respective markets for such securities.
Under regulations of the Commodity Futures Trading Commission ("CFTC"), the
futures trading activities described herein will not result in the Fund being
deemed a "commodity pool," as defined under such regulations, provided that
the Fund adheres to certain restrictions. In particular, the Fund may purchase
and sell financial futures contracts and options thereon (i) for bona fide
hedging purposes, without regard to the percentage of the Fund's assets
committed to margin and option premiums, and (ii) for non-hedging purposes if,
immediately thereafter, the sum of the amount of initial margin deposits on
the Fund's existing futures positions and option premiums entered into for
non-hedging purposes do not exceed 5% of the market value of the liquidation
value of the Fund's portfolio, after taking into account unrealized profits
and unrealized losses on any such transactions. Margin deposits may consist of
cash or securities acceptable to the broker and the relevant contract market.
When the Fund purchases a financial futures contract, or writes a put option
or purchases a call option thereon, it will maintain an amount of cash, cash
equivalents (e.g., commercial paper and daily tender adjustable notes) or
liquid securities in a segregated account with the Fund's custodian so that
the amount so segregated plus the amount of initial and variation margin held
in the account of its broker equals the market value of the financial futures
contract, thereby ensuring that the use of such financial futures contract is
unleveraged.
Although certain risks are involved in options and futures transactions, the
Investment Adviser believes that, because the Fund will engage in options and
futures transactions only for hedging purposes, the options and futures
portfolio strategies of the Fund will not subject the Fund to certain risks
frequently associated with speculation in options and futures transactions.
The volume of trading in the exchange markets with respect to California
Municipal Bond or Municipal Bond options may be limited, and it is impossible
to predict the amount of trading interest that may exist in such options. In
addition, there can be no assurance that viable exchange markets will continue
to be available.
The Fund intends to enter into options and futures transactions, on an
exchange or in the over-the-counter market, only if there appears to be a
liquid secondary market for such options or futures. There can be no
assurance, however, that a liquid secondary market will exist at any specific
time. Thus, it may not be possible to close an options or futures transaction.
The inability to close options and futures positions also could have an
adverse impact on the Fund's ability to effectively hedge its portfolio. There
is also the risk of loss by the Fund of margin deposits or collateral in the
event of bankruptcy of a broker with which the Fund has an open position in an
option or financial futures contract.
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<PAGE>
The liquidity of a secondary market in a financial futures contract may be
adversely affected by "daily price fluctuation limits" established by
commodity exchanges that limit the amount of fluctuation in a financial
futures contract price during a single trading day. Once the daily limit has
been reached in the contract, no trades may be entered into at a price beyond
the limit, thus preventing the liquidation of open futures positions. Prices
have in the past moved beyond the daily limit on a number of consecutive
trading days.
If it is not possible to close a financial futures position entered into by
the Fund, the Fund would continue to be required to make daily cash payments
of variation margin in the event of adverse price movements. In such a
situation, if the Fund has insufficient cash, it may have to sell portfolio
securities to meet daily variation margin requirements at a time when it may
be disadvantageous to do so.
The successful use of these transactions also depends on the ability of the
Investment Adviser to forecast correctly the direction and extent of interest
rate movements within a given time frame. To the extent these rates remain
stable during the period in which a financial futures contract is held by the
Fund or move in a direction opposite to that anticipated, the Fund may realize
a loss on the hedging transaction that is not fully or partially offset by an
increase in the value of portfolio securities. As a result, the Fund's total
return for such period may be less than if it had not engaged in the hedging
transaction. Furthermore, the Fund will only engage in hedging transactions
from time to time and may not necessarily be engaged in hedging transactions
when movements in interest rates occur.
RISKS AND SPECIAL CONSIDERATIONS OF LEVERAGE
EFFECTS OF LEVERAGE
Within approximately three months after the completion of the offering of
shares of Common Stock, the Fund intends to offer shares of preferred stock
representing approximately 40% of the Fund's capital immediately after the
issuance of such preferred stock. There can be no assurance, however, that
preferred stock representing such percentage of the Fund's capital will
actually be issued. The issuance of the preferred stock will result in the
leveraging of the Common Stock. Although the terms of the preferred stock
offering will be determined by the Fund's Board of Directors, it is
anticipated that the preferred stock will pay dividends that will be adjusted
over either relatively short-term periods (generally seven to 28 days) or
medium-term periods (up to five years) and that the dividend rate will be
based upon prevailing interest rates for debt obligations of comparable
maturity. The proceeds of the preferred stock offering will be invested in
longer-term obligations in accordance with the Fund's investment objective.
Issuance and ongoing expenses of the preferred stock will be borne by the Fund
and will reduce the net asset value of the Common Stock. Additionally, under
certain circumstances, when the Fund is required to allocate taxable income to
holders of preferred stock, it is anticipated that the terms of the preferred
stock will require the Fund to make an additional distribution to such holders
in an amount approximately equal to the tax liability resulting from such
allocation and such additional distribution (such amount, an "Additional
Distribution"). Because under normal market conditions, obligations with
longer maturities produce higher yields than short-term and medium-term
obligations, the Investment Adviser believes that the spread inherent in the
difference between the short-term and medium-term rates (and any Additional
Distribution) paid by the Fund as dividends on the preferred stock and the
longer-term rates received by the Fund will provide holders of Common Stock
with a potentially higher yield.
Utilization of leverage, however, involves certain risks to the holders of
Common Stock. For example, issuance of the preferred stock may result in
higher volatility of the net asset value of the Common Stock and
20
<PAGE>
potentially more volatility in the market value of the Common Stock. In
addition, fluctuations in the short-term and medium-term dividend rates on,
and the amount of taxable income allocable to, the preferred stock will affect
the yield to holders of Common Stock. So long as the Fund, taking into account
the costs associated with the preferred stock and the Fund's operating
expenses, is able to realize a higher net return on its investment portfolio
than the then current dividend rate (and any Additional Distribution) of the
preferred stock, the effect of leverage will be to cause holders of Common
Stock to realize a higher current rate of return than if the Fund were not
leveraged. Similarly, since a pro rata portion of the Fund's net realized
capital gains on its investment assets are generally payable to holders of
Common Stock if net capital gains are realized by the Fund, the effect of
leverage will be to increase the amount of such gains distributed to holders
of Common Stock. However, short-term, medium-term and long-term interest rates
change from time to time as does their relationship to each other (i.e., the
slope of the yield curve) depending upon such factors as supply and demand
forces, monetary and tax policies and investor expectations. Changes in any or
all of such factors could cause the relationship between short-term, medium-
term and long-term rates to change (i.e., to flatten or to invert the slope of
the yield curve) so that short-term and medium-term rates may substantially
increase relative to the long-term obligations in which the Fund may be
invested. To the extent that the current dividend rate (and any Additional
Distribution) on the preferred stock approaches the net return on the Fund's
investment portfolio, the benefit of leverage to holders of Common Stock will
be reduced, and if the current dividend rate (and any Additional Distribution)
on the preferred stock were to exceed the net return on the Fund's portfolio,
the Fund's leveraged capital structure would result in a lower rate of return
to holders of Common Stock than if the Fund were not leveraged. Similarly,
since both the cost associated with the issuance of preferred stock and any
decline in the value of the Fund's investments (including investments
purchased with the proceeds from any preferred stock offering) will be borne
entirely by holders of Common Stock, the effect of leverage in a declining
market would result in a greater decrease in net asset value to holders of
Common Stock than if the Fund were not leveraged.
In an extreme case, a decline in net asset value could affect the Fund's
ability to pay dividends on the Common Stock. Failure to make such dividend
payments could adversely affect the Fund's qualification as a regulated
investment company under the Code. See "Taxes." The Fund intends, however, to
take all measures necessary to continue to make Common Stock dividend
payments. If the Fund's current investment income were not sufficient to meet
dividend requirements on either the Common Stock or the preferred stock, it
could be necessary for the Fund to liquidate certain of its investments. In
addition, the Fund will have the authority to redeem the preferred stock for
any reason and may redeem all or part of the preferred stock if (i) it
anticipates that the Fund's leveraged capital structure will result in a lower
rate of return for any significant amount of time to holders of the Common
Stock than that obtainable if the Common Stock were unleveraged, (ii) the
asset coverage for the preferred stock declines below 200% either as a result
of a decline in the value of the Fund's portfolio investments or as a result
of the repurchase of Common Stock in tender offers, or (iii) in order to
maintain the asset coverage guidelines established by the NRSROs that have
rated the preferred stock. Redemption of the preferred stock or insufficient
investment income to make dividend payments, may reduce the net asset value of
the Common Stock and require the Fund to liquidate a portion of its
investments at a time when it may be disadvantageous, in the absence of such
extraordinary circumstances, to do so.
Assuming the utilization of leverage by the issuance of preferred stock that
pays dividends at a rate that generally will be adjusted every 28 days in an
amount representing approximately 40% of the Fund's capital at an annual
dividend rate of % payable on such preferred stock based on market rates as
of the date of this Prospectus, the annual return that the Fund's portfolio
must experience (net of expenses) in order to cover such dividend payments
would be %.
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<PAGE>
The following table is designed to illustrate the effect on the return to a
holder of the Fund's Common Stock of the leverage obtained by the issuance of
preferred stock representing approximately 40% of the Fund's capital, assuming
hypothetical annual returns on the Fund's portfolio of minus 10% to plus 10%.
As the table shows, leverage generally increases the return to stockholders
when portfolio return is positive and decreases the return when the portfolio
return is negative. The figures appearing in the table are hypothetical and
actual returns may be greater or less than those appearing in the table.
<TABLE>
<S> <C> <C> <C> <C> <C>
Assumed Portfolio Return
(net of expenses)................................. (10)% (5)% 0 % 5% 10%
Corresponding Common Stock Return.................. ( )% ( )% ( )% % %
</TABLE>
Leveraging of the Common Stock cannot be fully achieved until preferred
stock is issued and the proceeds of the offering of preferred stock have been
invested in long-term California Municipal Bonds and Municipal Bonds.
PORTFOLIO MANAGEMENT AND OTHER CONSIDERATIONS
In the event of an increase in short-term or medium-term rates or other
change in market conditions to the point where the Fund's leverage could
adversely affect holders of Common Stock as noted above, or in anticipation of
such changes, the Fund may attempt to shorten the average maturity of its
investment portfolio, which would tend to offset the negative impact of
leverage on holders of Common Stock. The Fund also may attempt to reduce the
degree to which it is leveraged by redeeming preferred stock pursuant to the
provisions of the Fund's Articles Supplementary establishing the rights and
preferences of the preferred stock or otherwise purchasing shares of preferred
stock. Purchases and redemptions of preferred stock, whether on the open
market or in negotiated transactions, are subject to limitations under the
1940 Act. If market conditions subsequently change, the Fund may sell
previously unissued shares of preferred stock or shares of preferred stock
that the Fund previously issued but later repurchased or redeemed. In
determining whether or not it is in the best interest of the Fund and its
stockholders to redeem outstanding preferred stock, the Board of Directors
will take into account a variety of factors including market conditions, the
ratio of preferred stock to Common Stock and the expenses associated with such
redemption.
The Fund intends to apply for ratings of the preferred stock from one or
more NRSROs. In order to obtain these ratings, the Fund may be required to
maintain portfolio holdings meeting specified guidelines of such
organizations. These guidelines may impose asset coverage requirements that
are more stringent than those imposed by the 1940 Act. It is not anticipated
that these guidelines will impede the Investment Adviser from managing the
Fund's portfolio in accordance with the Fund's investment objective and
policies. Ratings on preferred stock issued by the Fund should not be confused
with ratings on obligations held by the Fund.
Under the 1940 Act, the Fund is not permitted to issue shares of preferred
stock unless immediately after such issuance the net asset value of the Fund's
portfolio is at least 200% of the liquidation value of the outstanding
preferred stock (expected to equal the original purchase price of the
outstanding shares of preferred stock plus any accumulated and unpaid
dividends thereon and any accumulated and unpaid Additional Distribution). In
addition, the Fund is not permitted to declare any cash dividend or other
distribution on its Common Stock unless, at the time of such declaration, the
net asset value of the Fund's portfolio (determined after deducting the amount
of such dividend or distribution) is at least 200% of the liquidation value of
the outstanding preferred stock. Under the Fund's proposed capital structure,
assuming the sale of shares of preferred
22
<PAGE>
stock representing approximately 40% of the Fund's capital, the net asset
value of the Fund's portfolio is expected to be approximately 250% of the
liquidation value of the Fund's preferred stock. To the extent possible, the
Fund intends to purchase or redeem shares of preferred stock from time to time
to maintain coverage of preferred stock of at least 200%.
INVESTMENT RESTRICTIONS
The following are fundamental investment restrictions of the Fund and, prior
to issuance of the preferred stock, may not be changed without the approval of
the holders of a majority of the Fund's outstanding shares of Common Stock
(which for this purpose and under the 1940 Act means the lesser of (i) 67% of
the shares of Common Stock represented at a meeting at which more than 50% of
the outstanding shares of Common Stock are represented or (ii) more than 50%
of the outstanding shares). Subsequent to the issuance of the preferred stock,
the following investment restrictions may not be changed without the approval
of a majority of the outstanding shares of Common Stock and of the outstanding
shares of preferred stock, voting together as a class, and the approval of a
majority of the outstanding shares of preferred stock, voting separately as a
class. The Fund may not:
1. Make investments for the purpose of exercising control or management.
2. Purchase or sell real estate, commodities or commodity contracts;
provided that the Fund may invest in securities secured by real estate or
interests therein or issued by entities that invest in real estate or
interest therein, and the Fund may purchase and sell financial futures
contracts and options thereon.
3. Issue senior securities or borrow money except as permitted by Section
18 of the 1940 Act.
4. Underwrite securities of other issuers except insofar as the Fund may
be deemed an underwriter under the Securities Act of 1933, as amended, in
selling portfolio securities.
5. Make loans to other persons, except that the Fund may purchase
California Municipal Bonds, Municipal Bonds and other debt securities and
enter into repurchase agreements in accordance with its investment
objective, policies and limitations.
6. Invest more than 25% of its total assets (taken at market value at the
time of each investment) in securities of issuers in a single industry;
provided that, for purposes of this restriction, states, municipalities and
their political subdivisions are not considered to be part of any industry.
Additional investment restrictions adopted by the Fund, which may be changed
by the Board of Directors without shareholder approval, provide that the Fund
may not:
a. Purchase securities of other investment companies, except to the
extent that such purchases are permitted by applicable law. Applicable law
currently prohibits the Fund from purchasing the securities of other
investment companies except if immediately thereafter not more than (i) 3%
of the total outstanding voting stock of such company is owned by the Fund,
(ii) 5% of the Fund's total assets, taken at market value, would be
invested in any one such company, (iii) 10% of the Fund's total assets,
taken at market value, would be invested in such securities, and (iv) the
Fund, together with other investment companies having the same investment
adviser and companies controlled by such companies, owns not more than 10%
of the total outstanding stock of any one closed-end investment company.
b. Mortgage, pledge, hypothecate or in any manner transfer, as security
for indebtedness, any securities owned or held by the Fund except as may be
necessary in connection with borrowings mentioned
23
<PAGE>
in investment restriction (3) above or except as may be necessary in
connection with transactions in financial futures contracts and options
thereon.
c. Purchase any securities on margin, except that the Fund may obtain
such short-term credit as may be necessary for the clearance of purchases
and sales of portfolio securities (the deposit or payment by the Fund of
initial or variation margin in connection with financial futures contracts
and options thereon is not considered the purchase of a security on
margin).
d. Make short sales of securities or maintain a short position or invest
in put, call, straddle or spread options, except that the Fund may write,
purchase and sell options and futures on California Municipal Bonds,
Municipal Bonds, U.S. Government obligations and related indices or
otherwise in connection with bona fide hedging activities and may purchase
and sell Call Rights to require mandatory tender for the purchase of
related California Municipal Bonds and Municipal Bonds.
If a percentage restriction on investment policies or the investment or use
of assets set forth above is adhered to at the time a transaction is effected,
later changes in percentages resulting from changing values will not be
considered a violation.
The Investment Adviser of the Fund and Merrill Lynch are owned and
controlled by ML & Co. Because of the affiliation of Merrill Lynch with the
Investment Adviser, the Fund is prohibited from engaging in certain
transactions involving Merrill Lynch except pursuant to an exemptive order or
otherwise in compliance with the provisions of the 1940 Act and the rules and
regulations thereunder. Included among such restricted transactions will be
purchases from or sales to Merrill Lynch of securities in transactions in
which it acts as principal. An exemptive order has been obtained that permits
the Fund to effect principal transactions with Merrill Lynch in high quality,
short-term, tax-exempt securities subject to conditions set forth in such
order. The Fund may consider in the future requesting an order permitting
other principal transactions with Merrill Lynch, but there can be no assurance
that such application will be made and, if made, that such order would be
granted.
DIRECTORS AND OFFICERS
Information about the Directors, executive officers and the portfolio
managers of the Fund, including their ages and their principal occupations
during the last five years is set forth below. Unless otherwise noted, the
address of each Director, executive officer and the portfolio manager is 800
Scudders Mill Road, Plainsboro, New Jersey 08536.
Arthur Zeikel (65)--President and Director (1)(2)--Chairman of the
Investment Adviser (which term, as used herein, includes its corporate
predecessors) since 1997; President of the Investment Adviser from 1977 to
1997; Chairman of MLAM (which term, as used herein, includes its corporate
predecessors) since 1997; President of MLAM from 1977 to 1997; President and
Director of Princeton Services, Inc. ("Princeton Services") from 1993 to 1997;
Executive Vice President of ML & Co. since 1990.
James H. Bodurtha (53)--Director(2) -- 36 Popponesset Road, Cotuit,
Massachusetts 02635. Director and Executive Vice President, The China Business
Group, Inc. since 1996; Chairman and Chief Executive Officer, China Enterprise
Management Corporation from 1993 to 1996; Chairman, Berkshire Corporation
since 1980; Partner, Squire, Sanders & Dempsey from 1980 to 1993.
24
<PAGE>
Herbert I. London (58)--Director(2) -- 113-115 University Place, New York,
New York 10003. John M. Olin Professor of Humanities, New York University
since 1993 and Professor thereof since 1980; President, Hudson Institute since
1997 and Trustee since 1980; Dean, Gallatin Division of New York University
from 1976 to 1993; Distinguished Fellow, Herman Kahn Chair, Hudson Institute
from 1984 to 1985; Director, Damon Corporation from 1991 to 1995; Overseer,
Center for Naval Analyses from 1983 to 1993; Limited Partner, Hypertech LP in
1996.
Robert R. Martin (70)--Director(2) -- 513 Grand Hill, St. Paul, Minnesota
55102. Chairman and Chief Executive Officer, Kinnard Investments, Inc. from
1990 to 1993; Executive Vice President, Dain Bosworth from 1974 to 1989;
Director, Carnegie Capital Management from 1977 to 1985 and Chairman thereof
in 1979; Director, Securities Industry Association from 1981 to 1982 and
Public Securities Association from 1979 to 1980; Chairman of the Board, WTC
Industries, Inc. in 1994; Trustee, Northland College since 1992.
Joseph L. May (68)--Director(2) -- 424 Church Street, Suite 2000, Nashville,
Tennessee 37219. Attorney in private practice since 1984; President, May and
Athens Hosiery Mills Division, Wayne-Gossard Corporation from 1954 to 1983;
Vice President, Wayne-Gossard Corporation from 1972 to 1983; Chairman, The May
Corporation (personal holding company) from 1972 to 1983; Director, Signal
Apparel Co. from 1972 to 1989.
Andre F. Perold (45)--Director(2) -- Morgan Hall, Soldiers Field, Boston,
Massachusetts 02163. Professor, Harvard Business School since 1989 and
Associate Professor from 1983 to 1989; Trustee, The Common Fund since 1989;
Director, Quantec Limited since 1991 and TIBCO from 1994 to 1996.
Terry K. Glenn (57)--Executive Vice President (1)(2)--Executive Vice
President of the Investment Adviser and MLAM since 1983; Executive Vice
President and Director of Princeton Services since 1993; President of MLFD
since 1986 and Director thereof since 1991; President of Princeton
Administrators, L.P. since 1988.
Vincent R. Giordano (53)--Senior Vice President (1)(2)--Senior Vice
President of the Investment Adviser and MLAM since 1984; Senior Vice President
of Princeton Services since 1993.
Donald C. Burke (37)--Vice President (1)(2)--First Vice President of MLAM
since 1997; Vice President of MLAM from 1990 to 1997; Director of Taxation of
MLAM since 1990.
Kenneth A. Jacob (46)--Vice President (1)(2)--First Vice President of MLAM
since 1997; Vice President of MLAM from 1984 to 1997.
Walter O'Connor (35)--Vice President and Portfolio Manager (1)(2)--Director
of MLAM since 1997; Vice President of MLAM since 1993; Assistant Vice
President of MLAM from 1991 to 1993.
Gerald M. Richard (48)--Treasurer (1)(2)--Senior Vice President and
Treasurer of the Investment Adviser and MLAM since 1984; Senior Vice President
and Treasurer of Princeton Services since 1993; Vice President of MLFD since
1981; Treasurer since 1984.
Philip M. Mandel (50)--Secretary (1)(2)--First Vice President of MLAM since
1997; Assistant General Counsel of Merrill Lynch from 1989 to 1997.
- --------
(1) Interested person, as defined in the 1940 Act, of the Fund.
(2) Such Director or officer is a director, trustee or officer of one or more
additional investment companies for which the Investment Adviser or its
affiliate, MLAM, acts as investment adviser or manager.
25
<PAGE>
In the event that the Fund issues preferred stock, in connection with the
election of the Fund's Directors, holders of shares of preferred stock, voting
as a separate class, will be entitled to elect two of the Fund's Directors,
and the remaining Directors will be elected by all holders of capital stock,
voting as a single class. See "Description of Capital Stock."
COMPENSATION OF DIRECTORS
The Fund pays each Director not affiliated with the Investment Adviser (each
a "non-affiliated Director") a fee of $2,500 per year plus $250 per meeting
attended, together with such Director's actual out-of-pocket expenses relating
to attendance at meetings. The Fund also compensates members of its Audit
Committee, which consists of all the non-affiliated Directors, an annual fee
of $500 per year plus $125 per Committee meeting attended. The Fund reimburses
each non-affiliated Director for his out-of-pocket expenses relating to
attendance at Board and Committee Meetings.
The following table sets forth compensation to be paid by the Fund to the
non-affiliated Directors projected through the end of the Fund's first full
fiscal year and for the calendar year ended December 31, 1997 the aggregate
compensation paid by all investment companies advised by the Investment
Adviser and its affiliate, MLAM ("FAM/MLAM Advised Funds"), to the non-
affiliated Directors.
<TABLE>
<CAPTION>
TOTAL COMPENSATION
PENSION OR FROM FUND AND
AGGREGATE RETIREMENT BENEFITS FAM/MLAM ADVISED
COMPENSATION ACCRUED AS PART OF FUNDS PAID TO
NAME OF DIRECTOR FROM FUND FUND EXPENSE DIRECTORS
- ---------------- ------------ ------------------- ------------------
<S> <C> <C> <C>
James H. Bodurtha (1)....... $ None $
Herbert I. London (1)....... $ None $
Robert R. Martin (1)........ $ None $
Joseph L. May (1)........... $ None $
Andre F. Perold (1)......... $ None $
</TABLE>
- --------
(1) In addition to the Fund, the Directors serve on the boards of other
FAM/MLAM Advised Funds as follows: Mr. Bodurtha (22 registered investment
companies consisting of 46 portfolios); Mr. London (22 registered
investment companies consisting of 46 portfolios); Mr. Martin (22
registered investment companies consisting of 46 portfolios); Mr. May (22
registered investment companies consisting of 46 portfolios); and Mr.
Perold (22 registered investment companies consisting of 46 portfolios).
INVESTMENT ADVISORY AND MANAGEMENT ARRANGEMENTS
The Investment Adviser is an affiliate of MLAM and is owned and controlled
by ML & Co., a financial services holding company. The Investment Adviser will
provide the Fund with investment advisory and management services. The
Investment Adviser or MLAM acts as the investment adviser for over 140 other
registered investment companies. The Investment Adviser also offers portfolio
management and portfolio analysis services to individuals and institutions. As
of , 1997, the Investment Adviser and MLAM had a total of approximately
$ billion in investment company and other portfolio assets under management
(approximately $ billion of which were invested in municipal securities),
including accounts of certain affiliates of the Investment Adviser. The
principal business address of the Investment Adviser is 800 Scudders Mill
Road, Plainsboro, New Jersey 08536.
The Investment Advisory Agreement with the Investment Adviser (the
"Investment Advisory Agreement") provides that, subject to the supervision of
the Board of Directors of the Fund, the Investment Adviser is
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<PAGE>
responsible for the actual management of the Fund's portfolio. The
responsibility for making decisions to buy, sell or hold a particular security
rests with the Investment Adviser, subject to review by the Board of
Directors. The Fund's portfolio manager will consider analyses from various
sources (including brokerage firms with which the Fund does business), make
the necessary investment decisions, and place orders for transactions
accordingly. The Investment Adviser will also be responsible for the
performance of certain administrative and management services for the Fund.
Walter O'Connor is the portfolio manager for the Fund and is primarily
responsible for the Fund's day-to-day management.
For the services provided by the Investment Adviser under the Investment
Advisory Agreement, the Fund will pay a monthly fee at an annual rate of 0.55
of 1% of the Fund's average weekly net assets (i.e., the average weekly value
of the total assets of the Fund, including proceeds from the issuance of
shares of preferred stock, minus the sum of accrued liabilities of the Fund
and accumulated dividends on the shares of preferred stock). For purposes of
this calculation, average weekly net assets are determined at the end of each
month on the basis of the average net assets of the Fund for each week during
the month. The assets for each weekly period are determined by averaging the
net assets at the last business day of a week with the net assets at the last
business day of the prior week.
The Investment Advisory Agreement obligates the Investment Adviser to
provide investment advisory services and to pay all compensation of and
furnish office space for officers and employees of the Fund connected with
investment and economic research, trading and investment management of the
Fund, as well as the compensation of all Directors of the Fund who are
affiliated persons of the Investment Adviser or any of its affiliates. The
Fund pays all other expenses incurred in the operation of the Fund, including,
among other things, expenses for legal and auditing services, taxes, costs of
printing proxies, listing fees, stock certificates and shareholder reports,
charges of the custodian and the transfer and dividend disbursing agent and
registrar, fees and expenses with respect to the issuance of preferred stock,
Securities and Exchange Commission fees, fees and expenses of unaffiliated
Directors, accounting and pricing costs, insurance, interest, brokerage costs,
litigation and other extraordinary or non-recurring expenses, mailing and
other expenses properly payable by the Fund. Accounting services are provided
to the Fund by the Investment Adviser, and the Fund reimburses the Investment
Adviser for its costs in connection with such services.
Unless earlier terminated as described below, the Investment Advisory
Agreement will remain in effect for a period of two years from the date of
execution and will remain in effect from year to year thereafter if approved
annually (a) by the Board of Directors of the Fund or by a majority of the
outstanding shares of the Fund and (b) by a majority of the Directors who are
not parties to such contract or interested persons (as defined in the 1940
Act) of any such party. Such contract is not assignable and may be terminated
without penalty on 60 days' written notice at the option of either party
thereto or by the vote of the shareholders of the Fund.
Securities held by the Fund may also be held by, or be appropriate
investments for, other funds or investment advisory clients for which the
Investment Adviser or its affiliates act as an adviser. Because of different
objectives or other factors, a particular security may be bought for one or
more clients when one or more clients are selling the same security. If
purchases or sales of securities by the Investment Adviser for the Fund or
other funds for which it acts as investment adviser or for other advisory
clients arise for consideration at or about the same time, transactions in
such securities will be made, insofar as feasible, for the respective funds
and clients in a manner deemed equitable to all. To the extent that
transactions on behalf of more than one client
27
<PAGE>
of the Investment Adviser or its affiliates during the same period may
increase the demand for securities being purchased or the supply of securities
being sold, there may be an adverse effect on price.
CODE OF ETHICS
The Board of Directors of the Fund has adopted a Code of Ethics pursuant to
Rule 17j-1 under the 1940 Act that incorporates the Code of Ethics of the
Investment Adviser (together, the "Codes"). The Codes significantly restrict
the personal investing activities of all employees of the Investment Adviser
and, as described below, impose additional, more onerous, restrictions on Fund
investment personnel.
The Codes require that all employees of the Investment Adviser preclear any
personal securities investment (with limited exceptions, such as U.S.
Government securities). The preclearance requirement and associated procedures
are designed to identify any substantive prohibition or limitation applicable
to the proposed investment. The substantive restrictions applicable to all
employees of the Investment Adviser include a ban on acquiring any securities
in a "hot" initial public offering and a prohibition from profiting on short-
term trading securities. In addition, no employee may purchase or sell any
security that at the time is being purchased or sold (as the case may be), or
to the knowledge of the employee is being considered for purchase or sale, by
any fund advised by the Investment Adviser. Furthermore, the Codes provide for
trading "blackout periods" that prohibit trading by investment personnel of
the Fund within periods of trading by the Fund in the same (or equivalent)
security (15 or 30 days depending upon the transaction).
PORTFOLIO TRANSACTIONS
Subject to policies established by the Board of Directors of the Fund, the
Investment Adviser is primarily responsible for the execution of the Fund's
portfolio transactions. In executing such transactions, the Investment Adviser
seeks to obtain the best results for the Fund, taking into account such
factors as price (including the applicable brokerage commission or dealer
spread), size of order, difficulty of execution and operational facilities of
the firm involved and the firm's risk in positioning a block of securities.
While the Investment Adviser generally seeks reasonably competitive commission
rates, the Fund does not necessarily pay the lowest commission or spread
available.
The Fund has no obligation to deal with any broker or dealer in the
execution of transactions in portfolio securities. Subject to obtaining the
best price and execution, securities firms that provided supplemental
investment research to the Investment Adviser, including Merrill Lynch, may
receive orders for transactions by the Fund. Information so received will be
in addition to and not in lieu of the services required to be performed by the
Investment Adviser under the Investment Advisory Agreement, and the expenses
of the Investment Adviser will not necessarily be reduced as a result of the
receipt of such supplemental information.
The securities in which the Fund primarily will invest are traded in the
over-the-counter markets, and the Fund intends to deal directly with the
dealers who make markets in the securities involved, except in those
circumstances where better prices and execution are available elsewhere. Under
the 1940 Act, except as permitted by exemptive order, persons affiliated with
the Fund are prohibited from dealing with the Fund as principal in the
purchase and sale of securities. Since transactions in the over-the-counter
market usually involve transactions with dealers acting as principal for their
own account, the Fund will not deal with affiliated persons, including Merrill
Lynch and its affiliates, in connection with such transactions except that,
pursuant to an
28
<PAGE>
exemptive order obtained by the Investment Adviser, the Fund may engage in
principal transactions with Merrill Lynch in high quality, short-term, tax-
exempt securities. See "Investment Restrictions." An affiliated person of the
Fund may serve as its broker in over-the-counter transactions conducted on an
agency basis.
The Fund may also purchase tax-exempt debt instruments in individually
negotiated transactions with the issuers. Because an active trading market may
not exist for such securities, the prices that the Fund may pay for these
securities or receive on their resale may be lower than that for similar
securities with a more liquid market.
PORTFOLIO TURNOVER
Generally, the Fund does not purchase securities for short-term trading
profits. However, the Fund may dispose of securities without regard to the
time they have been held when such action, for defensive or other reasons
appears advisable to the Investment Adviser. While it is not possible to
predict turnover rates with any certainty, at present it is anticipated that
the Fund's annual portfolio turnover rate, under normal circumstances after
the Fund's portfolio is invested in accordance with its investment objective,
will be less than 100%. The portfolio turnover rate is calculated by dividing
the lesser of purchases or sales of portfolio securities for the particular
fiscal year by the monthly average of the value of the portfolio securities
owned by the Fund during the particular fiscal year. For purposes of
determining this rate, all securities whose maturities at the time of
acquisition are one year or less are excluded.
DIVIDENDS AND DISTRIBUTIONS
The Fund intends to distribute all its net investment income. Dividends from
such net investment income will be declared and paid monthly to holders of
Common Stock. It is expected that the Fund will commence paying dividends to
holders of Common Stock within approximately 90 days of the date of this
Prospectus. From and after issuance of the preferred stock, monthly
distributions to holders of Common Stock normally will consist of
substantially all net investment income remaining after the payment of
dividends (and any Additional Distribution) on the preferred stock. All net
realized capital gains, if any, will be distributed pro rata at least annually
to holders of Common Stock and any preferred stock. While any shares of
preferred stock are outstanding, the Fund may not declare any cash dividend or
other distribution on its Common Stock, unless at the time of such
declaration, (i) all accumulated preferred stock dividends, including any
Additional Distribution, have been paid, and (ii) the net asset value of the
Fund's portfolio (determined after deducting the amount of such dividend or
other distribution) is at least 200% of the liquidation value of the
outstanding preferred stock (expected to equal the original purchase price of
the outstanding shares of preferred stock plus any accumulated and unpaid
dividends thereon and any accumulated but unpaid Additional Distribution). If
the Fund's ability to make distributions on its Common Stock is limited, such
limitation could under certain circumstances impair the ability of the Fund to
maintain its qualification for taxation as a regulated investment company,
which would have adverse tax consequences for holders of Common Stock. See
"Taxes."
See "Automatic Dividend Reinvestment Plan" for information concerning the
manner in which dividends and distributions to holders of Common Stock may be
automatically reinvested in shares of Common Stock of the Fund. Dividends and
distributions may be taxable to shareholders under certain circumstances as
discussed below, whether they are reinvested in shares of the Fund or received
in cash.
29
<PAGE>
TAXES
GENERAL
The Fund intends to elect and to qualify for the special tax treatment
afforded regulated investment companies ("RICs") under the Code. As long as it
so qualifies, in any taxable year in which it distributes at least 90% of its
taxable net income and 90% of its tax-exempt net income (see below), the Fund
(but not its shareholders) will not be subject to Federal income tax to the
extent that it distributes its net investment income and net realized capital
gains. The Fund intends to distribute substantially all of such income.
The Code requires a RIC to pay a nondeductible 4% excise tax to the extent
the RIC does not distribute, during each calendar year, 98% of its ordinary
income, determined on a calendar year basis, and 98% of its capital gains,
determined, in general, on an October 31 year-end, plus certain undistributed
amounts from previous years. The required distributions, however, are based
only on the taxable income of a RIC. The excise tax, therefore, generally will
not apply to the tax-exempt income of a RIC, such as the Fund, that pays
exempt-interest dividends.
The Fund intends to qualify to pay "exempt-interest dividends" as defined in
Section 852(b)(5) of the Code. Under such section if, at the close of each
quarter of its taxable year, at least 50% of the value of its total assets
consists of obligations exempt from Federal income tax ("tax-exempt
obligations") under Section 103(a) of the Code (relating generally to
obligations of a state or local governmental unit), the Fund shall be
qualified to pay exempt-interest dividends to its shareholders. Exempt-
interest dividends are dividends or any part thereof paid by the Fund that are
attributable to interest on tax-exempt obligations and designated by the Fund
as exempt-interest dividends in a written notice mailed to the Fund's
shareholders within 60 days after the close of its taxable year. To the extent
that the dividends distributed to the Fund's shareholders are derived from
interest income exempt from tax under Code Section 103(a) and are properly
designated as exempt-interest dividends, they will be excludable from a
shareholder's gross income for Federal income tax purposes. Exempt-interest
dividends are included, however, in determining the portion, if any, of a
person's Social Security and railroad retirement benefits subject to Federal
income taxes. Each shareholder is advised to consult a tax adviser with
respect to whether exempt-interest dividends retain the exclusion under Code
Section 103(a) if such shareholder would be treated as a "substantial user" or
"related person" under Code Section 147(a) with respect to property financed
with the proceeds of an issue of "industrial development bonds" or "private
activity bonds," if any, held by the Fund.
The portion of exempt-interest dividends paid from interest received by the
Fund from California Municipal Bonds also will be exempt from California
income tax. However, exempt-interest dividends paid to a corporate shareholder
subject to California state franchise tax will not be exempt from California
taxation. Shareholders subject to income taxation by states other than
California will realize a lower after-tax rate of return than California
shareholders since the dividends distributed by the Fund generally will not be
exempt, to any significant degree, from income taxation by such other states.
The Fund will inform shareholders annually as to the portion of the Fund's
distributions which constitutes exempt-interest dividends and the portion
which is exempt from California income taxes. Interest on indebtedness
incurred or continued to purchase or carry Fund shares is not deductible for
Federal or California income tax purposes to the extent attributable to
exempt-interest dividends.
To the extent that the Fund's distributions are derived from interest on its
taxable investments or from an excess of net short-term capital gains over net
long-term capital losses ("ordinary income dividends"), such distributions
will be considered taxable ordinary income for Federal and California income
tax purposes.
30
<PAGE>
Distributions, if any, from an excess of net long-term capital gains over net
short-term capital losses derived from the sale of securities or from certain
transactions in futures or options ("capital gain dividends") are taxable as
long-term capital gains for Federal income tax purposes, regardless of the
length of time the shareholder has owned Fund shares and, for California
income tax purposes, are treated as capital gains which are taxed at ordinary
income tax rates. Recent legislation creates additional categories of capital
gains taxable at different rates. Generally not later than 60 days after the
close of its taxable year, the Fund will provide its shareholders with a
written notice designating the amounts of any exempt-interest dividends,
ordinary income dividends or capital gain dividends, as well as the amount of
capital gain dividends in the different categories of capital gain referred to
above. Distributions by the Fund, whether from exempt-income, ordinary income
or capital gains, will not be eligible for the dividends received deduction
allowed to corporations under the Code.
All or a portion of the Fund's gain from the sale or redemption of tax-
exempt obligations purchased at a market discount will be treated as ordinary
income rather than capital gain. This rule may increase the amount of ordinary
income dividends received by shareholders. Distributions in excess of the
Fund's earnings and profits will first reduce the adjusted tax basis of a
holder's shares and, after such adjusted tax basis is reduced to zero, will
constitute capital gains to such holder (assuming the shares are held as a
capital asset). Any loss upon the sale or exchange of Fund shares held for six
months or less will be disallowed to the extent of any exempt-interest
dividends received by the shareholder. In addition, any such loss that is not
disallowed under the rule stated above will be treated as long-term capital
loss to the extent of any capital gain dividends received by the shareholder.
If the Fund pays a dividend in January that was declared in the previous
October, November or December to shareholders of record on a specified date in
one of such months, then such dividend will be treated for tax purposes as
being paid by the Fund and received by its shareholders on December 31 of the
year in which such dividend was declared.
The Internal Revenue Service ("Service") has taken the position in a revenue
ruling that if a RIC has two classes of shares, it may designate distributions
made to each class in any year as consisting of no more than such class's
proportionate share of particular types of income, including exempt-interest
income and net long-term capital gains (including the additional categories of
capital gains discussed above). A class's proportionate share of a particular
type of income is determined according to the percentage of total dividends
paid by the RIC during such year that was paid to such class. Consequently,
when both Common Stock and preferred stock are outstanding, the Fund intends
to designate distributions made to the classes as consisting of particular
types of income in accordance with each class's proportionate share of such
income. Thus, the Fund will designate dividends paid as exempt-interest
dividends in a manner that allocates such dividends between the holders of
Common Stock and preferred stock in proportion to the total dividends paid to
each class during the taxable year, or otherwise as required by applicable
law. Capital gain dividends (including the additional categories of capital
gains discussed above) will similarly be allocated between the two classes in
proportion to the total dividends paid to each class during the taxable year,
or otherwise as required by applicable law. When capital gain or other taxable
income is allocated to holders of preferred stock pursuant to the allocation
rules described above, the terms of the preferred stock may require the Fund
to make an additional distribution to or otherwise compensate such holders for
the tax liability resulting from such allocation.
The Code subjects interest received on certain otherwise tax-exempt
securities to an alternative minimum tax. The alternative minimum tax will
apply to interest received on certain "private activity bonds" issued after
August 7, 1986. Private activity bonds are bonds that, although tax-exempt,
are used for purposes other than those generally performed by governmental
units and that benefit non-governmental entities (e.g., bonds used for
31
<PAGE>
industrial development or housing purposes). Income received on such bonds is
classified as an item of "tax preference" that could subject certain investors
in such bonds, including shareholders of the Fund, to an increased alternative
minimum tax. The Fund intends to purchase such "private activity bonds" and
will report to shareholders within 60 days after its taxable year-end the
portion of its dividends declared during the year that constitutes an item of
tax preference for alternative minimum tax purposes. The Code further provides
that corporations are subject to an alternative minimum tax based, in part, on
certain differences between taxable income as adjusted for other tax
preferences and the corporation's "adjusted current earnings," which more
closely reflect a corporation's economic income. Because an exempt-interest
dividend paid by the Fund will be included in adjusted current earnings, a
corporate shareholder may be required to pay an alternative minimum tax on
exempt-interest dividends paid by the Fund.
The Fund may invest in high yield securities, as previously described.
Furthermore, the Fund may invest in instruments the return on which includes
nontraditional features such as indexed principal or interest payments
("nontraditional instruments"). These instruments may be subject to special
tax rules under which the Fund may be required to accrue and distribute income
before amounts due under the obligations are paid. In addition, it is possible
that all or a portion of the interest payments on such high yield securities
and/or nontraditional instruments could be recharacterized as taxable ordinary
income.
If at any time when shares of preferred stock are outstanding the Fund does
not meet the asset coverage requirements of the 1940 Act, the Fund will be
required to suspend distributions to holders of Common Stock until the asset
coverage is restored. See "Dividends and Distributions." This may prevent the
Fund from distributing at least 90% of its net investment income and may,
therefore, jeopardize the Fund's qualification for taxation as a RIC. Upon any
failure to meet the asset coverage requirements of the 1940 Act, the Fund, in
its sole discretion, may redeem shares of preferred stock in order to maintain
or restore the requisite asset coverage and avoid the adverse consequences to
the Fund and its shareholders of failing to qualify as a RIC. There can be no
assurance, however, that any such action would achieve such objectives.
As noted above, the Fund must distribute annually at least 90% of its net
taxable and tax-exempt interest income. A distribution will only be counted
for this purpose if it qualifies for the dividends paid deduction under the
Code. Some types of preferred stock that the Fund currently contemplates
issuing may raise an issue as to whether distributions on such preferred stock
are "preferential" under the Code and, therefore, not eligible for the
dividends paid deduction. The Fund intends to issue preferred stock that
counsel advises will not result in the payment of a preferential dividend and
may seek a private letter ruling from the Service to that effect. If the Fund
ultimately relies solely on a legal opinion when it issues such preferred
stock, there is no assurance that the Service would agree that dividends on
the preferred stock are not preferential. If the Service successfully
disallowed the dividends paid deduction for dividends on the preferred stock,
the Fund could be disqualified as a RIC. In this case, dividends on the Common
Stock would not be exempt from Federal income taxes. Additionally, the Fund
would be subject to the alternative minimum tax.
The value of shares acquired pursuant to the Fund's dividend reinvestment
plan will generally be excluded from gross income to the extent that the cash
amount reinvested would be excluded from gross income. If, when the Fund's
shares are trading at a premium over net asset value, the Fund issues shares
pursuant to the dividend reinvestment plan that have a greater fair market
value than the amount of cash reinvested, it is possible that all or a portion
of such discount (which may not exceed 5% of the fair market value of the
Fund's shares) could be
32
<PAGE>
viewed as a taxable distribution. If the discount is viewed as a taxable
distribution, it is also possible that the taxable character of this discount
would be allocable to all of the shareholders, including shareholders who do
not participate in the dividend reinvestment plan. Thus, shareholders who do
not participate in the dividend reinvestment plan might be required to report
as ordinary income a portion of their distributions equal to their allocable
share of the discount.
Ordinary income dividends paid to shareholders who are nonresident aliens or
foreign entities will be subject to a 30% United States withholding tax under
existing provisions of the Code applicable to foreign individuals and entities
unless a reduced rate of withholding or a withholding exemption is provided
under applicable treaty law. Nonresident shareholders are urged to consult
their own tax advisers concerning the applicability of the United States
withholding tax.
Under certain Code provisions, some taxpayers may be subject to 31%
withholding tax on certain ordinary income dividends and on capital gain
dividends and redemption payments ("backup withholding"). Generally,
shareholders subject to backup withholding will be those for whom no certified
taxpayer identification number is on file with the Fund or who, to the Fund's
knowledge, have furnished an incorrect number. When establishing an account,
an investor must certify under penalty of perjury that such number is correct
and that such investor is not otherwise subject to backup withholding.
The Code provides that every shareholder required to file a tax return must
include for information purposes on such return the amount of exempt-interest
dividends received from all sources (including the Fund) during the taxable
year.
TAX TREATMENT OF OPTIONS AND FUTURES TRANSACTIONS
The Fund may purchase or sell municipal bond index financial futures
contracts and interest rate financial futures contracts on U.S. Government
securities. The Fund may also purchase and write call and put options on such
financial futures contracts. In general, unless an election is available to
the Fund or an exception applies, such options and financial futures contracts
that are "Section 1256 contracts" will be "marked to market" for Federal
income tax purposes at the end of each taxable year, i.e., each such option or
financial futures contract will be treated as sold for its fair market value
on the last day of the taxable year, and any gain or loss attributable to
Section 1256 contracts will be 60% long-term and 40% short-term capital gain
or loss. Application of these rules to Section 1256 contracts held by the Fund
may alter the timing and character of distributions to shareholders. The mark-
to-market rules outlined above, however, will not apply to certain
transactions entered into by the Fund solely to reduce the risk of changes in
price or interest rates with respect to its investments.
Code Section 1092, which applies to certain "straddles," may affect the
taxation of the Fund's sales of securities and transactions in financial
futures contracts and related options. Under Section 1092, the Fund may be
required to postpone recognition for tax purposes of losses incurred in
certain sales of securities and certain closing transactions in financial
futures contracts or the related options.
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code and Treasury Regulations and California income and
corporate franchise tax laws presently in effect. For the complete provisions,
reference should be made to the pertinent Code sections, the Treasury
Regulations promulgated thereunder and California income and corporate
franchise tax laws. The Code and the Treasury Regulations, as
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<PAGE>
well as the California tax laws, are subject to change by legislative,
judicial or administrative action either prospectively or retroactively.
Shareholders are urged to consult their tax advisers regarding specific
questions as to Federal, state, local or foreign taxes.
AUTOMATIC DIVIDEND REINVESTMENT PLAN
Pursuant to the Fund's Automatic Dividend Reinvestment Plan (the "Plan"),
unless a holder of Common Stock otherwise elects, all dividend and capital
gains distributions will be automatically reinvested by The Bank of New York,
as agent for shareholders in administering the Plan (the "Plan Agent"), in
additional shares of Common Stock of the Fund. Holders of Common Stock who
elect not to participate in the Plan will receive all distributions in cash
paid by check mailed directly to the shareholder of record (or, if the shares
are held in street or other nominee name, then to such nominee) by, The Bank
of New York, as dividend paying agent. Such participants may elect not to
participate in the Plan and to receive all distributions of dividends and
capital gains in cash by sending written instructions to The Bank of New York,
as dividend paying agent, at the address set forth below. Participation in the
Plan is completely voluntary and may be terminated or resumed at any time
without penalty by written notice if received by the Plan Agent not less than
ten days prior to any dividend record date; otherwise, such termination or
resumption will be effective with respect to any subsequently declared
dividend or distribution.
Whenever the Fund declares an income dividend or a capital gains
distribution (collectively, referred to as "dividends") payable either in
shares or in cash, non-participants in the Plan will receive cash, and
participants in the Plan will receive the equivalent in shares of Common
Stock. The shares will be acquired by the Plan Agent for the participant's
account, depending upon the circumstances described below, either (i) through
receipt of additional unissued but authorized shares of Common Stock from the
Fund ("newly issued shares") or (ii) by purchase of outstanding shares of
Common Stock on the open market ("open-market purchases") on the New York
Stock Exchange or elsewhere. If on the payment date for the dividend, the net
asset value per share of the Common Stock is equal to or less than the market
price per share of the Common Stock plus estimated brokerage commissions (such
condition being referred to herein as "market premium"), the Plan Agent will
invest the dividend amount in newly issued shares on behalf of the
participant. The number of newly issued shares of Common Stock to be credited
to the participant's account will be determined by dividing the dollar amount
of the dividend by the net asset value per share on the date the shares are
issued, provided that the maximum discount from the then current market price
per share on the date of issuance may not exceed 5%. If on the dividend
payment date the net asset value per share is greater than the market value
(such condition being referred to herein as "market discount"), the Plan Agent
will invest the dividend amount in shares acquired on behalf of the
participant in open-market purchases. Prior to the time the shares of Common
Stock commence trading on the New York Stock Exchange, participants in the
Plan will receive any dividends in newly issued shares.
In the event of a market discount on the dividend payment date, the Plan
Agent will have until the last business day before the next date on which the
shares trade on an "ex-dividend" basis or in no event more than 30 days after
the dividend payment date (the "last purchase date") to invest the dividend
amount in shares acquired in open-market purchases. It is contemplated that
the Fund will pay monthly income dividends. Therefore, the period during which
open-market purchases can be made will exist only from the payment date
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<PAGE>
on the dividend through the date before the next "ex-dividend" date, which
typically will be approximately ten days. If, before the Plan Agent has
completed its open-market purchases, the market price of a share of Common
Stock exceeds the net asset value per share, the average per share purchase
prices paid by the Plan Agent may exceed the net asset value of the Fund's
shares, resulting in the acquisition of fewer shares than if the dividend had
been paid in newly issued shares on the dividend payment date. Because of the
foregoing difficulty with respect to open-market purchases, the Plan provides
that if the Plan Agent is unable to invest the full dividend amount in open-
market purchases during the purchase period or if the market discount shifts
to a market premium during the purchase period, the Plan Agent will cease
making open-market purchases and will invest the uninvested portion of the
dividend amount in newly issued shares at the close of business on the last
purchase date.
The Plan Agent maintains all shareholders' accounts in the Plan and
furnishes written confirmation of all transactions in the account, including
information needed by shareholders for tax records. Shares in the account of
each Plan participant will be held by the Plan Agent in non-certificated form
in the name of the participant and each shareholder's proxy will include those
shares purchased or received pursuant to the Plan. The Plan Agent will forward
all proxy solicitation materials to participants and vote proxies for shares
held pursuant to the Plan in accordance with the instructions of the
participants.
In the case of shareholders such as banks, brokers or nominees that hold
shares for others who are the beneficial owners, the Plan Agent will
administer the Plan on the basis of the number of shares certified from time
to time by the record shareholders as representing the total amount registered
in the record shareholder's name and held for the account of beneficial owners
who are to participate in the Plan.
There will be no brokerage charges with respect to shares issued directly by
the Fund as a result of dividends or capital gains distributions payable
either in shares or in cash. However, each participant will pay a pro rata
share of brokerage commissions incurred with respect to the Plan Agent's open-
market purchases in connection with the reinvestment of dividends.
The automatic reinvestment of dividends and distributions will not relieve
participants of any Federal, state or local income tax that may be payable (or
required to be withheld) on such dividends. See "Taxes."
Shareholders participating in the Plan may receive benefits not available to
shareholders not participating in the Plan. If the market price plus
commissions of the Fund's shares is above the net asset value, participants in
the Plan will receive shares of the Fund at less than they could otherwise
purchase them and will have shares with a cash value greater than the value of
any cash distribution they would have received on their shares. If the market
price plus commissions is below the net asset value, participants will receive
distributions in shares with a net asset value greater than the value of any
cash distribution they would have received on their shares. However, there may
be insufficient shares available in the market to make distributions in shares
at prices below the net asset value. Also, since the Fund does not redeem its
shares, the price on resale may be more or less than the net asset value. See
"Taxes" for a discussion of tax consequences of the Plan.
Experience under the Plan may indicate that changes are desirable.
Accordingly, the Fund reserves the right to amend or terminate the Plan. There
is no direct service charge to participants in the Plan; however, the Fund
reserves the right to amend the Plan to include a service charge payable by
the participants.
All correspondence concerning the Plan should be directed to the Plan Agent
at 101 Barclay Street, New York, New York 10286.
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<PAGE>
MUTUAL FUND INVESTMENT OPTION
Purchasers of shares of Common Stock of the Fund through Merrill Lynch in
this offering will have an investment option consisting of the right to
reinvest the net proceeds from a sale of such shares (the "Original Shares")
in Class D initial sales charge shares of certain Merrill Lynch-sponsored
open-end mutual funds ("Eligible Class D Shares") at their net asset value,
without the imposition of the initial sales charge, if the conditions set
forth below are satisfied. First, the sale of the Original Shares must be made
through Merrill Lynch, and the net proceeds therefrom must be immediately
reinvested in Eligible Class D Shares. Second, the Original Shares must have
been either acquired in this offering or be shares representing reinvested
dividends from shares of Common Stock acquired in this offering. Third, the
Original Shares must have been continuously maintained in a Merrill Lynch
securities account. Fourth, there must be a minimum purchase of $250 to be
eligible for the investment option. Class D shares of the mutual funds are
subject to an account maintenance fee at an annual rate of up to 0.25% of the
average daily net asset value of such mutual fund. The Eligible Class D Shares
may be redeemed at any time at the next determined net asset value, subject in
certain cases to a redemption fee. Prior to the time the shares of Common
Stock commence trading on the New York Stock Exchange, the distributor for the
mutual funds will advise Merrill Lynch Financial Consultants as to those
mutual funds that offer the investment option described above.
NET ASSET VALUE
Net asset value per share of Common Stock is determined as of 15 minutes
after the close of business on the New York Stock Exchange (generally, 4:00
p.m., New York time) on the last business day in each week. For purposes of
determining the net asset value of a share of Common Stock, the value of the
securities held by the Fund plus any cash or other assets (including interest
accrued but not yet received) minus all liabilities (including accrued
expenses) and the aggregate liquidation value of the outstanding shares of
preferred stock is divided by the total number of shares of Common Stock
outstanding at such time. Expenses, including the fees payable to the
Investment Adviser, are accrued daily.
The California Municipal Bonds and Municipal Bonds in which the Fund invests
are traded primarily in the over-the-counter markets. In determining net asset
value, the Fund utilizes the valuations of portfolio securities furnished by a
pricing service approved by the Board of Directors. The pricing service
typically values portfolio securities at the bid price or the yield equivalent
when quotations are readily available. California Municipal Bonds and
Municipal Bonds for which quotations are not readily available are valued at
fair market value on a consistent basis as determined by the pricing service
using a matrix system to determine valuations. The procedures of the pricing
service and its valuations are reviewed by the officers of the Fund under the
general supervision of the Board of Directors. The Board of Directors has
determined in good faith that the use of a pricing service is a fair method of
determining the valuation of portfolio securities. Positions in futures
contracts are valued at closing prices for such contracts established by the
exchange on which they are traded, or if market quotations are not readily
available, are valued at fair value on a consistent basis using methods
determined in good faith by the Board of Directors.
The Fund determines and makes available for publication the net asset value
of its Common Stock weekly. Currently, the net asset values of shares of
publicly traded closed-end investment companies investing in debt securities
are published in Barron's, the Monday edition of The Wall Street Journal, and
the Monday and Saturday editions of The New York Times.
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<PAGE>
DESCRIPTION OF CAPITAL STOCK
The Fund is authorized to issue 200,000,000 shares of capital stock, par
value $.10 per share, all of which shares are initially classified as Common
Stock. The Board of Directors is authorized, however, to classify or
reclassify any unissued shares of capital stock by setting or changing the
preferences, conversion or other rights, voting powers, restrictions,
limitations as to dividends, qualifications, or terms or conditions of
redemption. Within approximately three months after completion of the offering
of the Common Stock described herein, the Fund intends to reclassify an amount
of unissued Common Stock as preferred stock and at that time to offer shares
of preferred stock representing approximately 40% of the Fund's capital
immediately after the issuance of such preferred stock. There is no assurance
that such preferred stock will be issued.
COMMON STOCK
Shares of Common Stock, when issued and outstanding, will be fully paid and
non-assessable. Shareholders are entitled to share pro rata in the net assets
of the Fund available for distribution to shareholders upon liquidation of the
Fund. Shareholders are entitled to one vote for each share held.
So long as any shares of the Fund's preferred stock are outstanding, holders
of Common Stock will not be entitled to receive any net income of or other
distributions from the Fund unless all accumulated dividends on preferred
stock have been paid and unless asset coverage (as defined in the 1940 Act)
with respect to preferred stock would be at least 200% after giving effect to
such distributions. See "Preferred Stock" below.
The Fund will send unaudited reports at least semi-annually and audited
annual financial statements to all of its shareholders.
The Investment Adviser provided the initial capital for the Fund by
purchasing 6,667 shares of Common Stock of the Fund for $100,005. As of the
date of this Prospectus, the Investment Adviser owned 100% of the outstanding
shares of Common Stock of the Fund. The Investment Adviser may be deemed to
control the Fund until such time as it owns less than 25% of the outstanding
shares of the Fund.
PREFERRED STOCK
It is anticipated that the Fund's shares of preferred stock will be issued
in one or more series, with rights as determined by the Board of Directors, by
action of the Board of Directors without the approval of the holders of Common
Stock. Under the 1940 Act, the Fund is permitted to have outstanding more than
one series of preferred stock so long as no single series has a priority over
another series as to the distribution of assets of the Fund or the payment of
dividends. Holders of Common Stock have no preemptive right to purchase any
shares of preferred stock that might be issued. It is anticipated that the net
asset value per share of the preferred stock will equal its original purchase
price per share plus accumulated dividends per share.
The Fund's Board of Directors has declared its intention to authorize an
offering of shares of preferred stock (representing approximately 40% of the
Fund's capital immediately after the issuance of such preferred stock) within
approximately three months after completion of the offering of Common Stock,
subject to market conditions and to the Board's continuing to believe that
leveraging the Fund's capital structure through the issuance of preferred
stock is likely to achieve the benefits to the holders of Common Stock
described in the Prospectus. Although the terms of the preferred stock,
including its dividend rate, voting rights, liquidation
37
<PAGE>
preference and redemption provisions will be determined by the Board of
Directors (subject to applicable law and the Fund's Articles of
Incorporation), the initial series of preferred stock will be structured to
carry either a relatively short-term dividend rate, in which case periodic
redetermination of the dividend rate will be made at relatively short
intervals (generally seven or 28 days), or a medium-term dividend rate, in
which case periodic redetermination of the dividend rate will be made at
intervals of up to five years. In either case, such redetermination of the
dividend rate will be made through an auction or remarketing procedure.
Additionally, under certain circumstances, when the Fund is required to
allocate taxable income to holders of the preferred stock, it is anticipated
that the terms of the preferred stock will require the Fund to make an
Additional Distribution (as defined in "Special Leverage Considerations and
Risks--Effects of Leverage") to such holders. The Board also has indicated
that it is likely that the liquidation preference, voting rights and
redemption provisions of the preferred stock will be as stated below. The
Fund's Articles of Incorporation, as amended, together with any Articles
Supplementary, is referred to below as the "Charter."
Liquidation Preference. In the event of any voluntary or involuntary
liquidation, dissolution or winding up of the Fund, the holders of shares of
preferred stock will be entitled to receive a preferential liquidating
distribution (expected to equal the original purchase price per share plus an
amount equal to accumulated and unpaid dividends whether or not earned or
declared and any accumulated and unpaid Additional Distribution) before any
distribution of assets is made to holders of Common Stock. After payment of
the full amount of the liquidating distribution to which they are entitled,
the preferred stockholders will not be entitled to any further participation
in any distribution of assets by the Fund. A consolidation or merger of the
Fund with or into any other corporation or corporations or a sale of all or
substantially all of the assets of the Fund will not be deemed to be a
liquidation, dissolution or winding up of the Fund.
Voting Rights. Except as otherwise indicated in this Prospectus and except
as otherwise required by applicable law, holders of shares of preferred stock
will have equal voting rights with holders of shares of Common Stock (one vote
per share) and will vote together with holders of Common Stock as a single
class.
In connection with the election of the Fund's directors, holders of shares
of preferred stock, voting as a separate class, will be entitled to elect two
of the Fund's directors, and the remaining directors will be elected by all
holders of capital stock, voting as a single class. So long as any preferred
stock is outstanding, the Fund will have not less than five directors. If at
any time dividends on shares of the Fund's preferred stock shall be unpaid in
an amount equal to two full years' dividends thereon, the holders of all
outstanding shares of preferred stock, voting as a separate class, will be
entitled to elect a majority of the Fund's directors until all dividends in
default have been paid or declared and set apart for payment.
The affirmative vote of the holders of a majority of the outstanding shares
of the preferred stock, voting as a separate class, will be required to (i)
authorize, create or issue any class or series of stock ranking prior to any
series of preferred stock with respect to payment of dividends or the
distribution of assets on liquidation or (ii) amend, alter or repeal the
provisions of the Charter, whether by merger, consolidation or otherwise, so
as to adversely affect any of the contract rights expressly set forth in the
Charter of holders of preferred stock.
Redemption Provisions. It is anticipated that shares of preferred stock will
generally be redeemable at the option of the Fund at a price equal to their
liquidation preference plus accumulated but unpaid dividends to the date of
redemption plus, under certain circumstances, a redemption premium. Shares of
preferred stock will also be subject to mandatory redemption at a price equal
to their liquidation preference plus accumulated but unpaid dividends to the
date of redemption upon the occurrence of certain specified events, such as
the failure of the
38
<PAGE>
Fund to maintain asset coverage requirements for the preferred stock specified
by the rating agencies that issue ratings on the preferred stock.
CERTAIN PROVISIONS OF THE ARTICLES OF INCORPORATION
The Fund's Articles of Incorporation include provisions that could have the
effect of limiting the ability of other entities or persons to acquire control
of the Fund or to change the composition of its Board of Directors and could
have the effect of depriving shareholders of an opportunity to sell their
shares at a premium over prevailing market prices by discouraging a third
party from seeking to obtain control of the Fund. A director may be removed
from office with or without cause, but only by vote of the holders of at least
66 2/3% of the votes entitled to be voted on the matter. A director elected by
all the holders of capital stock may be removed only by action of such
holders, and a director elected by the holders of preferred stock may be
removed only by action of such holders.
In addition, the Articles of Incorporation require the favorable vote of the
holders of at least 66 2/3% of the Fund's shares of capital stock then
entitled to be voted, voting as a single class, to approve, adopt or authorize
the following:
(i) a merger or consolidation or statutory share exchange of the Fund
with other corporations,
(ii) a sale of all or substantially all of the Fund's assets (other than
in the regular course of the Fund's investment activities), or
(iii) a liquidation or dissolution of the Fund, unless such action has
been approved, adopted or authorized by the affirmative vote of two-thirds
of the total number of Directors fixed in accordance with the by-laws, in
which case the affirmative vote of a majority of the Fund's shares of
capital stock is required. Following the proposed issuance of the preferred
stock, it is anticipated that the approval, adoption or authorization of
the foregoing would also require the favorable vote of a majority of the
Fund's shares of preferred stock then entitled to be voted, voting as a
separate class.
In addition, conversion of the Fund to an open-end investment company would
require an amendment to the Fund's Articles of Incorporation. The amendment
would have to be declared advisable by the Board of Directors prior to its
submission to shareholders. Such an amendment would require the favorable vote
of the holders of at least 66 2/3% of the Fund's outstanding shares of capital
stock (including any preferred stock) entitled to be voted on the matter,
voting as a single class (or a majority of such shares if the amendment was
previously approved, adopted or authorized by two-thirds of the total number
of Directors fixed in accordance with the by-laws), and, assuming preferred
stock is issued, the affirmative vote of a majority of outstanding shares of
preferred stock of the Fund, voting as a separate class. Such a vote also
would satisfy a separate requirement in the 1940 Act that the change be
approved by the shareholders. Shareholders of an open-end investment company
may require the company to redeem their shares of common stock at any time
(except in certain circumstances as authorized by or under the 1940 Act) at
their net asset value, less such redemption charge, if any, as might be in
effect at the time of a redemption. All redemptions will be made in cash. If
the Fund is converted to an open-end investment company, it could be required
to liquidate portfolio securities to meet requests for redemption, and the
Common Stock would no longer be listed on a stock exchange.
Conversion to an open-end investment company would also require redemption
of all outstanding shares of preferred stock and would require changes in
certain of the Fund's investment policies and restrictions, such as those
relating to the issuance of senior securities, the borrowing of money and the
purchase of illiquid securities.
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<PAGE>
The Board of Directors has determined that the 66 2/3% voting requirements
described above, which are greater than the minimum requirements under
Maryland law or the 1940 Act, are in the best interests of shareholders
generally. Reference should be made to the Charter on file with the Securities
and Exchange Commission for the full text of these provisions.
CUSTODIAN
The Fund's securities and cash are held under a custodial agreement with The
Bank of New York, 90 Washington Street, New York, New York 10286.
UNDERWRITING
Merrill Lynch, Pierce, Fenner & Smith Incorporated (the "Underwriter") has
agreed, subject to the terms and conditions of a Purchase Agreement with the
Fund and the Investment Adviser, to purchase shares of Common Stock
from the Fund. The Underwriter is committed to purchase all of such shares if
any are purchased.
The Underwriter has advised the Fund that it proposes initially to offer the
shares of Common Stock to the public at the public offering price set forth on
the cover page of this Prospectus. There is no sales charge or underwriting
discount charged to investors on purchases of shares of Common Stock in the
offering. The Investment Adviser or an affiliate has agreed to pay the
Underwriter from its own assets a commission in connection with the sale of
shares of Common Stock in the offering in the amount of $. per share. Such
payment is equal to % of the initial public offering price per share. The
Underwriter also has advised the Fund that from this amount the Underwriter
may pay a concession to certain dealers not in excess of $. per share on
sales by such dealers. After the initial public offering, the public offering
price and other selling terms may be changed. Investors must pay for shares of
Common Stock purchased in the offering on or before , 1998.
The Fund has granted the Underwriter an option, exercisable for 45 days
after the date hereof, to purchase up to additional shares of Common
Stock to cover over-allotments, if any, at the initial offering price.
The Underwriter may engage in certain transactions that stabilize the price
of the shares of Common Stock. Such transactions consist of bids or purchases
for the purpose of pegging, fixing or maintaining the price of the shares of
Common Stock.
If the Underwriter creates a short position in the shares of Common Stock in
connection with the offering, i.e., if it sells more shares of Common Stock
than are set forth on the cover page of this Prospectus, the Underwriter may
reduce that short position by purchasing shares of Common Stock in the open
market. The Underwriter also may elect to reduce any short position by
exercising all or part of the over-allotment option described above.
The Underwriter also may impose a penalty bid on certain selling group
members. This means that if the Underwriter purchases shares of Common Stock
in the open market to reduce the Underwriter's short position or to stabilize
the price of the shares of Common Stock, it may reclaim the amount of the
selling concession from the selling group members who sold those shares of
Common Stock as part of the offering.
In general, purchases of a security for the purpose of stabilization or to
reduce a short position could cause the price of the security to be higher
than it might be in the absence of such purchases. The imposition of a
40
<PAGE>
penalty bid might also have an effect on the price of a security to the extent
that it were to discourage resales of the security.
Neither the Fund nor the Underwriter makes any representation or prediction
as to the direction or magnitude of any effect that the transactions described
above may have on the price of the shares of Common Stock. In addition,
neither the Fund nor the Underwriter makes any representation that the
Underwriter will engage in such transactions or that such transactions, once
commenced, will not be discontinued without notice.
Prior to this offering, there has been no public market for the shares of
the Common Stock. Application will be made to list the Fund's shares of Common
Stock on the New York Stock Exchange. However, during an initial period which
is not expected to exceed two weeks from the date of this Prospectus, the
Fund's Common Stock will not be listed on any securities exchange.
Additionally, during such period, the Underwriter does not intend to make a
market in the Fund's Common Stock, although a limited market may develop.
Consequently, it is anticipated that an investment in the Fund will be
illiquid during such period. In order to meet the requirements for listing,
the Underwriter has undertaken to sell lots of 100 or more shares to a minimum
of 2,000 beneficial owners.
The Fund anticipates that the Underwriter may from time to time act as a
broker in connection with the execution of its portfolio transactions. The
Fund has obtained an exemptive order permitting it to engage in certain
principal transactions with the Underwriter involving high quality, short-
term, tax-exempt securities subject to certain conditions. See "Investment
Restrictions" and "Portfolio Transactions."
The Underwriter is an affiliate of the Investment Adviser of the Fund.
The Fund and the Investment Adviser have agreed to indemnify the Underwriter
against certain liabilities, including liabilities under the Securities Act of
1933.
TRANSFER AGENT, DIVIDEND DISBURSING AGENT AND REGISTRAR
The transfer agent, dividend disbursing agent and registrar for the shares
of Common Stock of the Fund will be The Bank of New York, 101 Barclay Street,
New York, New York 10286.
LEGAL OPINIONS
Certain legal matters in connection with the Common Stock offered hereby
will be passed upon for the Fund and the Underwriter by Brown & Wood LLP, New
York, New York.
EXPERTS
The statement of assets, liabilities and capital of the Fund included in
this Prospectus has been so included in reliance on the report of ,
independent auditors, and on their authority as experts in auditing and
accounting. The selection of independent auditors is subject to ratification
by shareholders of the Fund.
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<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholder, MuniHoldings California Fund, Inc.:
We have audited the accompanying statement of assets, liabilities and
capital of MuniHoldings California Fund, Inc. as of , 1998. This
financial statement is the responsibility of the Fund's management. Our
responsibility is to express an opinion on this financial statement based on
our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statement is free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statement. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, such statement of assets, liabilities and capital presents
fairly, in all material respects, the financial position of MuniHoldings
California Fund, Inc. as of , 1998 in conformity with generally accepted
accounting principles.
42
<PAGE>
MUNIHOLDINGS CALIFORNIA FUND, INC.
STATEMENT OF ASSETS, LIABILITIES AND CAPITAL
, 1998
<TABLE>
<S> <C>
ASSETS
Cash................................................................ $100,005
Deferred organization expenses (Note 1).............................
--------
Total assets......................................................
--------
LIABILITIES
Accrued expenses (Note 1)...........................................
--------
NET ASSETS............................................................ $100,005
========
CAPITAL
Common Stock, par value $.10 per share; 200,000,000 shares
authorized; 6,667 shares issued and outstanding (Note 1)........... $ 667
Paid-in Capital in excess of par.................................... 99,338
--------
Total Capital-Equivalent to $15.00 net asset value per share of
common stock (Note 1).............................................. $100,005
========
</TABLE>
NOTES TO STATEMENT OF ASSETS, LIABILITIES AND CAPITAL
NOTE 1. ORGANIZATION
The Fund was incorporated under the laws of the State of Maryland on
December 4, 1997 as a closed-end, non-diversified management investment
company and has had no operations other than the sale to Fund Asset
Management, L.P. (the "Investment Adviser") of an aggregate of 6,667 shares
for $100,005 on , 1998. The General Partner of the Investment Adviser is
an indirectly wholly-owned subsidiary of Merrill Lynch & Co., Inc.
Deferred organization costs will be amortized on a straight-line basis over
a five-year period beginning with the commencement of operations of the Fund.
NOTE 2. MANAGEMENT ARRANGEMENTS
The Fund has engaged the Investment Adviser to provide investment advisory
and management services to the Fund. The Investment Adviser will receive a
monthly fee for advisory services, at an annual rate equal to 0.55 of 1% of
the average weekly net assets of the Fund.
NOTE 3. FEDERAL INCOME TAXES
The Fund intends to qualify as a "regulated investment company" and as such
(and by complying with the applicable provisions of the Internal Revenue Code
of 1986, as amended) will not be subject to Federal income tax on taxable
income (including realized capital gains) that is distributed to shareholders.
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<PAGE>
APPENDIX I
ECONOMIC AND OTHER CONDITIONS IN CALIFORNIA
The following information is a brief summary of factors affecting the
economy of the State of California ("California" or "State") and does not
purport to be a complete description of such factors. Other factors will
affect State issuers. The summary is based primarily upon one or more publicly
available offering statements relating to debt offerings of State issuers;
however, it has not been updated nor will it be updated during the year. The
Fund has not independently verified the information.
GENERAL ECONOMIC CONDITIONS
The economy of the State of California is the largest among the 50 states
and one of the largest in the world and has major components in agriculture,
manufacturing, high technology, trade, entertainment, tourism, construction
and services. Total State gross domestic product is expected to exceed $1
trillion in 1997. On a stand-alone basis, California's economy is larger than
all but six nations in the world.
California's July 1, 1996 population of over 32 million represented over 12%
of the total United States population. As of July 1, 1990 the population of
29,944,000 represented an increase of over 6 million persons, or 26%, during
the decade of the 1980's.
California's population is concentrated in metropolitan areas. As of the
April 1, 1990 Census, 96% of the citizens resided in the 23 Metropolitan
Statistical Areas in the State. As of July 1, 1995, the 5-county Los Angeles
area accounted for 49%, with 15.7 million residents. The 10-county San
Francisco Bay Area represented 21% with a population of 6.7 million.
From 1990-1993, the State suffered through a severe recession, the worst
since the 1930's, heavily influenced by large cutbacks in defense/aerospace
industries and military base closures and by a major drop in real estate
construction. California's economy has been recovering and growing steadily
since the start of 1994; currently the State's economic growth is outpacing
the rest of the nation. More than 300,000 nonfarm jobs were added in the State
in 1996, while personal income grew by more than $55 billion. Another 380,000
jobs are expected to be created in 1997. The unemployment rate, while still
higher than the national average, fell to the low 6% range in mid-1997,
compared to over 10% at the worst of the recession.
California's economic expansion is being fueled by growth in high-technology
industries, including computer software, electronics manufacturing and motion
picture/television production; growth is also strong in business services,
export trade, and manufacturing, with even the aerospace sector now showing
increased employment. The State's economy is now more diversified than it was
during the 1980's. Nonresidential real estate construction has grown rapidly
in response to the growth in the economy. Residential construction has been
growing slowly since the depths of the recession, but remains much lower (as
measured by annual new unit permits) than the late 1980's.
THE STATE
Fiscal Years Prior to 1995-96. The State's budget problems in recent years
were caused by a combination of external economic conditions and a structural
imbalance in that the largest general fund programs--K-14 education, health,
welfare and corrections--were increasing faster than the revenue base, driven
by the State's
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<PAGE>
rapid population growth. These pressures are expected to continue as
population trends maintain strong demand for health and welfare services, as
the school age population continues to grow, and as the State's corrections
program responds to a "Three Strikes" law enacted in 1994, which requires
mandatory life prison terms for a certain third-time felony offenders.
As a result of these factors and others, and especially because a severe
recession between 1990-94 reduced revenues and increased expenditures for
social welfare programs, from the late 1980's until 1992-93, the State had a
period of budget imbalance. During this period, expenditures exceeded revenues
in four out of six years, and the State accumulated and sustained a budget
deficit in its budget reserve, the Special Fund for Economic Uncertainties
("SFEU") approaching $2.8 billion at its peak at June 30, 1993. Starting in
the 1990-91 Fiscal Year and for each fiscal year thereafter, each budget
required multibillion dollar actions to bring projected revenues and
expenditures into balance. The State Legislature and Governor agreed on the
following principal steps to produce Budget Acts in the years 1991-92 to 1994-
95, although not all these actions were taken in each year.
. significant cuts in health and welfare program expenditures;
. transfers of program responsibilities and funding from the State to local
governments (referred to as "realignment"), coupled with some reduction
in mandates on local government;
. transfer of about $3.6 billion in local property tax revenues from
cities, counties, redevelopment agencies and some other districts to
local school districts, thereby reducing State funding for schools under
Proposition 98 (discussed below);
. reduction in growth of support for higher education programs, coupled
with increases in student fees, through the 1994-95 Fiscal Year;
. maintenance of the minimum Proposition 98 funding guarantee for K-14
schools, and the disbursement of additional funds to keep a constant
level of about $4,200 per K-12 pupils through the 1993-94 Fiscal Year;
. revenue increases (particularly in the 1991-92 Fiscal Year budget), most
of which were for a short duration;
. increased reliance on aid from the federal government to offset the costs
of incarcerating, educating and providing health and welfare services to
illegal immigrants, although during this time frame, most of the
additional aid requested by the Administration was not received; and
. various one-time adjustments and accounting changes.
Despite these budget actions, as noted, the effects of the recession led to
large, unanticipated deficits in the budget reserve, the SFEU, as compared to
project positive balances. By the 1993-94 Fiscal Year, the accumulated deficit
was so large that it was impractical to budget to retire it in one year, so a
two-year program was implemented, using the issuance of revenue anticipation
warrants to carry a portion of the deficit over the end of the fiscal year.
When the economy failed to recover sufficiently in 1993-94, a second two-year
plan was implemented in 1994-95, again using cross-fiscal year revenue
anticipation warrants to partly finance the deficit into the 1995-96 fiscal
year.
Another consequence of the accumulated budget deficits, together with other
factors such as disbursement of funds to local school districts "borrowed"
from future fiscal years and hence not shown in the annual budget, was to
significantly reduce the State's cash resources available to pay its ongoing
obligations. When the
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Legislature and the Governor failed to adopt a budget for the 1992-93 Fiscal
Year by July 1, 1992, which would have allowed the State to carry out its
normal annual cash flow borrowing to replenish its cash reserves, the State
Controller issued registered warrants to pay a variety of obligations
representing prior years' or continuing appropriations, and mandates from
court order. Available funds were used to make constitutionally-mandated
payments, such as debt service on bonds and warrants. Between July 1 and
September 4, 1992, when the budget was adopted, the State Controller issued a
total of approximately $3.8 billion of registered warrants.
During the past several fiscal years, the State was forced to rely
increasingly on external debt markets to meet its cash needs, as a succession
of notes and revenue anticipation warrants were issued in the period from June
1992 to July 1994, often needed to pay previously maturing notes or warrants.
These borrowings were used also in part to spread out the repayment of the
accumulated budget deficit over the end of a fiscal year, as noted earlier.
The last and largest of these borrowings was $4.0 billion of revenue
anticipation warrants which were issued in July 1994 and matured on April 25,
1996.
1995-96 Fiscal Year. The 1995-96 Budget Act was signed by the Governor on
August 3, 1995, 34 days after the start of the fiscal year. The Budget Act
projected general fund revenues and transfers of $44.1 billion, a 3.5%
increase from the prior year. Expenditures were budgeted at $43.4 billion, a 4
percent increase. The Budget Act also projected Special Fund revenues of $12.7
billion and appropriated Special Fund expenditures of $13.0 billion.
Final data for the 1995-96 Fiscal Year showed revenues and transfers of
$46.1 billion, some $2 billion over the original fiscal year estimate, which
was attributed to the strong economic recovery. Expenditures also increased,
to an estimated $45.4 billion, as a result of the requirement to expend
revenues for schools under Proposition 98, and, among other things, failure of
the federal government to enact welfare reform during the fiscal year and to
budget new aid for illegal immigrant costs, both of which had been counted on
to allow reductions in State costs. SFEU had a small negative balance of about
$87 million at June 30, 1996, all but eliminating the accumulated budget
deficit from the early 1990's. Available internal borrowable resources
(available cash, after payment of all obligations due) on June 30, 1996 was
about $3.8 billion, representing a significant improvement in the State's cash
position, and ending the need for deficit borrowing over the end of the fiscal
year. The State's improved cash position allowed it to repay the $4.0 billion
Revenue Anticipation Warrant issue on April 25, 1996, and to issue only $2.0
billion of revenue anticipation notes during the fiscal year, which matured on
June 28, 1996.
The 1995-96 Budget Act included substantial additional funding under
Proposition 98 for schools and community colleges (about $1.0 billion general
fund and $1.2 billion total above 1994-95 levels). Because of higher than
projected revenues in 1994-95, an additional $561 million ($92 per K-12 pupil
(also called per ADA, or average daily attendance)) was appropriated to the
1994-95 Proposition 98 entitlement. A large part of this was a block grant of
about $50 per pupil for any one-time purpose. For the first time in several
years, a full 2.7 percent cost of living allowance was funded. The budget was
based on the settlement of the CTA v. Gould litigation. Cuts in health and
welfare costs totaled about $220 million, almost $700 million less than had
been anticipated, because of the failure by the federal government to approve
certain of these actions in a timely manner. The federal government also
failed to appropriate all but $31 million of an anticipated $500 million in
new federal aid for incarceration and health care costs of illegal immigrants.
Funding from the general fund for the University of California was increased
by $106 million and for the California State University system by $97 million,
with no increase in student fees.
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1996-97 Fiscal Year. The 1996-97 Budget Act was signed by the Governor on
July 15, 1996, along with various implementing bills. The Governor vetoed
about $82 million of appropriations (both general fund and Special Fund). With
the signing of the Budget Act, the State implemented its regular cash flow
borrowing program with the issuance of $3.0 billion of Revenue Anticipation
Notes to mature on June 30, 1997. The Budget Act appropriated a modest budget
reserve in the SFEU of $305 million, as of June 30, 1997. The Department of
Finance projected that, on June 30, 1997, the State's available internal
borrowing (cash) resources will be $2.9 billion, after payment of all
obligations due by that date, so that no cross-fiscal year borrowing will be
needed.
Revenues. The Legislature rejected the Governor's proposed 15% cut in
personal income taxes (to be phased in over three years), but did not approve
a 5% cut in bank and corporation taxes, to be effective for income years
starting on January 1, 1997. As a result, revenues for the Fiscal Year were
estimated to total $47.643 billion, a 3.3% increase over the final estimated
1995-96 revenues. Special Fund revenues were estimated to be $13.3 billion.
Expenditures. The Budget Act contained general fund appropriations totaling
$47.251 billion, a 4.0% increase over the final estimated 1995-96
expenditures. Special Fund expenditures were budgeted at $12.6 billion.
The following are principal features of the 1996-97 Budget Act:
Proposition 98 funding for schools and community college districts
increased by almost $1.6 billion (general fund) and $1.65 billion total
above revised 1995-96 levels. Almost half of this money was budgeted to
fund class-size reductions in kindergarten and grades 1-3. Also, for the
second year in a row, the full cost of living allowance (3.2%) was funded.
The Proposition 98 increases have brought K-12 expenditures to almost
$4,800 per ADA, an almost 15% increase over the level prevailing during the
recession years. Community colleges will receive an increase in funding of
$157 million for 1996-97 out of this $1.6 billion total.
Because of the higher than projected revenues in 1995-96, an additional
$1.1 billion ($190 per K-12 ADA and $145 million for community colleges)
was appropriated and retroactively applied towards the 1995-96 Proposition
98 guarantee, bringing K-12 expenditures in that year to over $4,600 per
ADA. These new funds were appropriated for a variety of purposes, including
block grants, allocations for each school site, facilities for class size
reduction, and a reading initiative. Similar retroactive increases totaling
$230 million, based on final figures on revenues and State population
growth, were made to the 1991-92 and the 1994-95 Proposition 98 guarantees,
most of which were allocated to each school site.
The Budget Act assumed savings of approximately $660 million in health
and welfare costs which required changes in federal law, including federal
welfare reform. The Budget Act further assumed federal law changes in
August 1996 which would allow welfare cash grant levels to be reduced by
October 1, 1996. These cuts totaled approximately $163 million of the
anticipated $660 million savings.
A 4.9% increase in funding for the University of California ($130 million
general fund) and the California State University system ($101 million
general fund), with no increases in student fees, maintaining the second
year of the Governor's four-year "Compact" with the State's higher
education units.
The Budget Act assumed the federal government will provide approximately
$700 million in new aid for incarceration and health care costs of illegal
immigrants. These funds reduce appropriations in these categories that
would otherwise have to be paid from the general fund. (For purposes of
cash flow
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projections, the State Department of Finance expects $540 million of this
amount to be received during the 1996-97 fiscal year.)
General fund support for the State Department of Corrections was
increased by about 7% over the prior year, reflecting estimates of
increased prison population.
With respect to aid to local governments, the principal new programs
included in the Budget Act are $100 million in grants to cities and
counties for law enforcement purposes, and budgeted $50 million for
competitive grants to local governments for programs to combat juvenile
crime.
Subsequent Events. On January 9, 1997, the Governor released his proposed
budget for the 1997-98 Fiscal Year (the "Proposed Budget"). The Proposed
Budget estimated general fund revenues and transfers in 1997-98 of $50.7
billion, a 4.6% increase from revised 1996-97 figures. The Governor proposes
expenditures of $50.3 billion, a 3.9% increase from 1996-97. The Proposed
Budget projected a balance in the SFEU of $553 million on June 30, 1998.
At the time of the May Revision, released on May 14, 1997, the Department of
Finance increased its revenue estimate for the upcoming fiscal year by $1.3
billion, in response to the continued strong growth in the State's economy.
Budget negotiations continued into the summer, with major issues to be
resolved including final agreement on State welfare reform, increase in State
employee salaries and consideration of a tax cut proposed by the Governor.
In May 1997, action was taken by the California Supreme Court in an ongoing
lawsuit, PERS v. Wilson, which made final a judgment against the State
requiring an immediate payment from the General Fund to the Public Employees
Retirement Fund ("PERF") to make up certain deferrals in annual retirement
fund contributions which had been legislated in earlier years for budget
savings, and which the courts found to be unconstitutional. On July 30, 1997,
following a direction from the Governor, the Controller transferred $1.235
billion from the General Fund to the PERF in satisfaction of the judgment,
representing the principal amount of the improperly deferred payments from
1995-96 and 1996-97.
1997-98 Fiscal Year. Once the pension payment eliminated essentially all the
"increased" revenue in the budget, final agreement was reached within a few
weeks on the welfare package and the remainder of the budget. The Legislature
passed the Budget Bill on August 11, 1997, along with numerous related bills
to implement its provisions. Agreement was not finally reached, however, on
one aspect of the budget plan, concerning the Governor's proposal for a
comprehensive educational testing program.
On August 18, 1997, the Governor signed the Budget Act, but vetoed about
$314 million of specific spending items, primarily in health and welfare and
education areas from both the General Fund and Special Funds. The Governor
announced that he was prepared to restore about $200 million of education
spending upon satisfactory completion of legislation on the education testing
program.
The Budget Act anticipates General Fund revenues and transfers of $52.5
billion (a 6.8 percent increase over the final 1996-97 amount), and
expenditures of $52.8 billion (an 8.0 percent increase from the 1996-97
levels). On a budgetary basis, the budget reserve (SFEU) is projected to
decrease from $408 million at June 30, 1997 to $112 million at June 30, 1998.
(The expenditure figure assumes restoration of $200 million of vetoed
funding.) The Budget Act also includes Special Fund expenditures of $14.4
billion (as against estimated Special Fund
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revenues of $14.0 billion), and $2.1 billion of expenditures from various Bond
Funds. The State has implemented its normal annual cash flow borrowing
program, issuing $3 billion of notes which mature on June 30, 1998.
The following are major features of the 1997-98 Budget Act:
1. For the second year in a row, the Budget contains a large increase in
funding for K-14 education under Proposition 98, reflecting strong revenues
which have exceeded initial budgeted amounts. Part of the nearly $1.75
billion in increased spending is allocated to prior fiscal years. Funds are
provided to fully pay for the cost-of-living increase component of
Proposition 98, and to extend class size reduction and reading initiatives.
2. The Budget Act reflects the $1.235 billion pension case judgment
payment, and brings funding of the State's pension contribution back to the
quarterly basis which existed prior to the deferral actions which were
invalidated by the courts. There is no provision for any additional
payments relating to this court case.
3. Continuing the third year of a four-year "compact" which the
Administration has made with higher education units, funding from the
General Fund for the University of California and California State
University has increased by about 6 percent ($121 million and $107 million,
respectively), and there was no increase in student fees.
4. Because of the effect of the pension payment, most other State
programs were continued at 1996-97 levels.
5. Health and welfare costs are contained, continuing generally the grant
levels from prior years, as part of the initial implementation of the new
CalWORKs program.
6. Unlike prior years, this Budget Act does not depend on federal budget
actions. About $300 million in federal funds, already included in the
federal FY 1997 and 1998 budgets, are included in the Budget Act, to offset
incarceration costs for illegal aliens.
7. The Budget Act contains no tax increases, and no tax reductions. The
Renters Tax Credit was suspended for another year, saving approximately
$500 million.
Federal Welfare Reform. Congress passed and the President signed (on August
22, 1996) the Personal Responsibility and Work Opportunity Act of 1996 (the
"Law") making a fundamental reform of the current welfare system. Among many
provisions, the Law includes: (i) conversion of Aid to Families with Dependent
Children from an entitlement program to a block grant titled Temporary
Assistance for Needy Families ("TANF"), with lifetime time limits on TANF
recipients, work requirements and other changes; (ii) provisions denying
certain federal welfare and public benefits to legal noncitizens, allowing
states to elect to deny additional benefits (including TANF) to legal
noncitizens, and generally denying almost all benefits to illegal immigrants;
and (iii) changes in the Food Stamp program, including reducing maximum
benefits and imposing work requirements.
As part of the 1997-98 Budget Act legislative package, the State Legislature
and Governor agreed on a comprehensive reform of the State's public assistance
programs to implement the new federal Law. The new basic State welfare program
is called California Work Opportunity and Responsibility to Kids Act
("CalWORKs"), which replaces the former Aid to Families with Dependent
Children (AFDC) and Greater Avenues to Independence (GAIN) programs effective
January 1, 1998. Consistent with the federal Law, CalWORKs contains new time
limits on receipt of welfare aid, both lifetime as well as for any current
time on aid. The centerpiece of CalWORKs is the linkage of eligibility to work
participation requirements.
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Administration of the new Welfare-to-Work programs will be largely at the
county level, and counties are given financial incentives for success in this
program.
Although the longer-term impact of the new federal Law and CalWORKs cannot
be determined until there has been some experience, the State does not
presently anticipate that these new programs will have any adverse financial
impact on the General Fund. Overall TANF grants from the federal government
are expected to equal or exceed the amounts the State would have received
under the old AFDC program.
LOCAL GOVERNMENTS
The primary units of local government in California are the counties,
ranging in population from 1,300 (Alpine) to over 9,000,000 (Los Angeles).
Counties are responsible for the provision of many basic services, including
indigent healthcare, welfare, courts, jails and public safety in
unincorporated areas. There are also about 480 incorporated cities and
thousands of other special districts formed for education, utility and other
services. The fiscal condition of local governments has been constrained since
the enactment of "Proposition 13" in 1978, which reduced and limited the
future growth of property taxes and limited the ability of local governments
to impose "special taxes" (those devoted to a specific purpose) without two-
thirds voter approval.
Counties, in particular, have had fewer options to raise revenues than many
other local government entities, and have been required to maintain many
services. The entire statewide welfare system has been changed in response to
the change in federal welfare law enacted in 1996 (see "Welfare Reform"
above). Under the CalWORKs program, counties are given flexibility to develop
their own plans, consistent with State law, to implement Welfare-to-Work and
to administer many of its elements. Counties are also given financial
incentives if, at the individual county level or statewide, the CalWORKs
program produces savings associated with specified Welfare-to-Work outcomes;
counties may also suffer penalties for failing to meet federal standards.
Under CalWORKs, counties will still be required to provide "general
assistance" aid to certain persons who cannot obtain welfare from other
programs. It is yet not known how the CalWORKs system will affect county
finances in the long run.
In the aftermath of Proposition 13, the State provided aid from the General
Fund to make up some of the loss of property tax moneys, including taking over
the principal responsibility for funding local K-12 schools and community
colleges. Under the pressure of the recent recession, the Legislature has
eliminated the remnants of this post-Proposition 13 aid to entities other than
K-14 education districts, although it has also provided additional funding
sources (such as sales taxes) and reduced mandates for local services. Many
counties continue to be under severe fiscal stress. While such stress has in
recent years most often been experienced by smaller, rural counties, larger
urban counties, such as Los Angeles, have also been affected. Orange County
implemented significant reductions in services and personnel, and continues to
face fiscal constraints in the aftermath of its bankruptcy, which had been
caused at least in part by large investment losses in its pooled investment
funds.
On November 5, 1996, voters approved Proposition 218, entitled the "Right to
Vote on Taxes Act," which incorporates new Articles XIIIC and XIIID into the
California Constitution. These new provisions enact limitations on the ability
of local government agencies to impose or raise various taxes, fees, charges
and assessments without voter approval. Certain "general taxes" imposed after
January 1, 1995 must be approved by voters in order to remain in effect. In
addition, Article XIIIC clarifies the right of local voters to reduce taxes,
fees, assessments or charges through local initiatives.
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Proposition 218 does not affect the State or its ability to levy or collect
taxes. There are a number of ambiguities concerning the Proposition and its
impact on local governments and their bonded debt which will require
interpretation by the courts or the State Legislature. The State Legislative
Analyst estimated that enactment of Proposition 218 would reduce local
government revenues statewide by over $100 million a year, and that over time,
annual revenues to local government would be reduced by several hundred
million dollars.
In May 1996, a taxpayer filed an action (the "Rider Case") against the City
of San Diego ("San Diego") and the San Diego Convention Center Expansion
Authority (the "Authority") challenging the validity of a lease revenue
financing involving a lease having features similar to the leases commonly
used in California lease-based financings such as certificates of
participation. In the Rider Case, the plaintiffs maintain that voter approval
is required for the San Diego lease (a) since the lease constituted
indebtedness prohibited by Article XVI, Section 18 of the California
Constitution without a two-thirds vote of the electorate, and (b) since San
Diego was prohibited under its charter from issuing bonds without a two-thirds
vote of the electorate, and the power of the Authority, a joint powers'
authority, one of the members of which is San Diego, to issue bonds is no
greater than the power of San Diego. In response to San Diego's motion for
summary judgment, the trial court rejected the plaintiffs' arguments and ruled
that the lease was constitutionally valid and that the Authority's related
lease revenue bonds did not require voter approval. The plaintiffs appealed
the matter to the Court of Appeals for the Fourth District, which likewise
affirmed the validity of the lease and of the lease revenue bond financing
arrangements. The plaintiffs then filed a petition for review with the
California State Supreme Court, and, on April 2, 1997, the California Supreme
Court granted the plaintiff's petition for review. No decision from the State
Supreme Court is expected until sometime during the 1998 calendar year.
CONSTITUTIONAL AND STATUTORY LIMITATIONS; RECENT INITIATIVES; PENDING
LEGISLATION
Constitutional and Statutory Limitations. Article XIIIA of the California
Constitution (which resulted from the voter-approved Proposition 13 in 1978)
limits the taxing powers of California public agencies. Article XIIIA provides
that the maximum ad valorem tax on real property cannot exceed 1% of the "full
cash value" of the property and effectively prohibits the levying of any other
ad valorem tax on real property for general purposes. However, on May 3, 1986,
Proposition 46, an amendment to Article XIIIA, was approved by the voters of
the State of California, creating a new exemption under Article XIIIA
permitting an increase in ad valorem taxes on real property in excess of 1%
for bonded indebtedness approved by two-thirds of the voters voting on the
proposed indebtedness. "Full cash value" is defined as "the County Assessor's
valuation of real property as shown on the 1975-76 tax bill under "full cash
value" or, thereafter, the appraised value of real property when purchased,
newly constructed, or a change in ownership has occurred after the 1975
assessment." The "full cash value" is subject to annual adjustment to reflect
increases (not to exceed 2%) or decreases in the consumer price index or
comparable local data, or to reflect reductions in property value caused by
damage, destruction or other factors.
Article XIIIB of the California Constitution limits the amount of
appropriations of the State and of the local governments to the amount of
appropriation of the entity for the prior year, adjusted for changes in the
cost of living, population and the services that local government has
financial responsibility for providing. To the extent that the revenues of the
State and/or local government exceed in appropriations, the excess revenues
must be rebated to the public either directly or through a tax decrease.
Expenditures for voter-approved debt services are not included in the
appropriations limit.
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At the November 9, 1988 general election, California voters approved an
initiative known as Proposition 98. This initiative amends Article XIIIB to
require that (i) the California Legislature establish a prudent state reserve
fund in an amount it shall deem reasonable and necessary and (ii) revenues in
excess of amounts permitted to be spent and which would otherwise be returned
pursuant to Article XIIIB by revision of tax rates or fee schedules be
transferred and allocated (up to a maximum of 40%) to the State School Fund
and be expended solely for purposes of instructional improvement and
accountability. Proposition 98 also amends Article XVI to require that the
State of California provide a minimum level of funding for public schools and
community colleges. Commencing with 1988-89 Fiscal Year, money to be applied
by the State for the support of school districts and community college
districts shall not be less than the greater of: (i) the amount which, as a
percentage of the State general fund revenues which may be appropriated
pursuant to Article XIIIB, equals the percentage of such State general fund
revenues appropriated for school districts and community college districts,
respectively, in Fiscal Year 1986-87 or (ii) the amount required to ensure
that the total allocations to school districts and community college districts
from the State general fund proceeds of taxes appropriated pursuant to Article
XIIIB and allocated local proceeds of taxes shall not be less than the total
amount from these sources in the prior year, adjusted for increases in
enrollment and adjusted for changes in the cost of living pursuant to the
provisions of Article XIIIB. The initiative permits the enactment of
legislation, by a two-thirds vote, to suspend the minimum funding requirements
for one year. As a result of Proposition 98, funds that the State might
otherwise make available to its political subdivisions may be allocated
instead to satisfy such minimum funding level.
During the recent recession, general fund revenues for several years were
less than originally projected, so that the original Proposition 98
appropriations turned out to be higher than the minimum percentage provided in
the law. The Legislature responded to these developments by designating the
"extra" Proposition 98 payments in one year as a "loan" from future years'
Proposition 98 entitlements and also intended that the "extra" payments would
not be included in the Proposition 98 "base" for calculating future years'
entitlement. By implementing these actions, per-pupil funding from Proposition
98 sources stayed almost constant at approximately $4,220 from Fiscal Year
1991-92 to Fiscal Year 1993-94.
In 1992, a lawsuit was filed, called California Teachers' Association v.
Gould, which challenged the validity of these off-budget loans. The settlement
of this case, finalized in July 1996, provides, among other things, that both
the State and K-14 schools share in the repayment of prior years' emergency
loans to schools. Of the total $1.76 billion in loans, the State will repay
$935 million by forgiveness of the amount owed, while schools will repay $825
million. The State share of the repayment will be reflected as an
appropriation above the current Proposition 98 base calculation. The schools'
share of the repayment will count as appropriations that count toward
satisfying the Proposition 98 guarantee, or from "below" the current base.
Repayments are spread over the eight-year period of 1994-95 through 2001-02 to
mitigate any adverse fiscal impact.
Substantially increased general find revenues, above the initial budget
projections, in the 1994-95, 1995-96 and 1996-97 fiscal years have resulted or
will result in retroactive increases in Proposition 98 appropriations from
subsequent fiscal years' budgets.
On November 8, 1994, the voters approved Proposition 187, an initiative
statute ("Proposition 187"). Proposition 187 specifically prohibits funding by
the State of social services, health care services and public school education
for the benefit of any person not verified as either a United States citizen
or a person legally admitted to the United States. Among the provisions in
Proposition 187 pertaining to public school education, the measure requires,
commencing January 1, 1995, that every school district in the State verify the
legal status
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of every child enrolling in the district for the first time. By January 1,
1996, each school district must also verify the legal status of children
already enrolled in the district and of all parents or guardians of all
students. If the district "reasonably suspects" that a student, parent or
guardian is not legally in the United States, that district must report the
student to the United States Immigration and Naturalization Service and
certain other parties. The measure also prohibits a school district from
providing education to a student it does not verify as either a United States
citizen or a person legally admitted to the United States. The State
Legislative Analyst estimates the verification costs could be in the tens of
millions of dollars on a statewide level (including verification costs
incurred by other local governments), with first-year costs potentially in
excess of $100 million.
The reporting requirements may violate the Family Educational Rights and
Privacy Act ("FERPA"), which generally prohibits schools that receive Federal
funds from disclosing information in student records without parental consent.
Compliance with FERPA is a condition of receiving Federal education funds,
which total $2.3 billion annually to California school districts. The
Secretary of the United States Department of Education has indicated that the
reporting requirements in Proposition 187 could jeopardize the ability of
school districts to receive these funds.
Opponents of Proposition 187 have filed at least eight lawsuits challenging
the constitutionality and validity of the measure. On November 2, 1995, a
United States District Court judge struck down the central provisions of
Proposition 187 by ruling that parts of Proposition 187 conflict with Federal
power over immigration. The ruling concluded that states may not enact their
own schemes to "regulate immigration or devise immigration regulations which
run parallel or purport to supplement Federal immigration law." As a
consequence of the ruling, students may not be denied public education and may
not be asked about their immigration status when enrolling in public schools.
Further, the ruling struck down the requirements of Proposition 187 that
teachers and district employees report information on the immigrant status of
students, parents and guardians. An appeal has been filed.
Article XIIIA, Article XIIIB and a number of other propositions were adopted
pursuant to California's constitutional initiative process. From time to time,
other initiative measures could be adopted by California voters. The adoption
of any such initiatives may cause California issuers to receive reduced
revenues, or to increase expenditures, or both.
Pending Litigation. The State is a party to numerous legal proceedings, many
of which normally occur in governmental operations. Some of the more
significant lawsuits pending against the State are described herein.
The State is involved in a lawsuit, Thomas Hayes v. Commission on State
Mandates, related to state-mandated costs. The action involves an appeal by
the Director of Finance from a 1984 decision by the State Board of Control
(now succeeded by the Commission on State Mandates ("Commission")). The Board
of Control decided in favor of local school districts' claims for
reimbursement for special education programs for handicapped students. The
case was then brought to the trial court by the State and later remanded to
the Commission for redetermination. The Commission has since expanded the
claim to include supplemental claims filed by seven other educational
institutions; the issuance of a final consolidated decision is anticipated
sometime in early 1997. To date, the Legislature has not appropriated funds.
The liability of the State, if all potentially eligible school districts
pursue timely claims, has been estimated by the Department of Finance at more
than $1 billion.
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The State is involved in a lawsuit related to contamination at the
Stringfellow toxic waste site. In United States, People of the State of
California v. J.B. Stringfellow, Jr., et al., the State is seeking recovery
for post costs of cleanup of the site, a declaration that the defendants are
jointly and severally liable for future costs, and an injunction ordering
completion of the cleanup. However, the defendants have filed a counterclaim
against the State for alleged negligent acts. Because the State is the present
owner of the site, the State may be found liable. Present estimates of the
cleanup range from $200 million to $800 million.
The State is a defendant in a coordinated action involving 3,000 plaintiffs
seeking recovery for damages caused by the Yuba River flood of February 1986.
The appellate court affirmed the trial court finding of liability in inverse
condemnation and awarded damages of $500,000 to 12 sample plaintiffs.
Potential liability to the remaining 300 plaintiffs, from claims filed, ranges
from $800 million to $1.5 billion. An appeal has been filed.
In Professional Engineers in California Government v. Wilson, the
petitioners are challenging several appropriations in the 1993, 1994, and 1995
Budget Acts. The appropriations mandate the transfer of approximately $262
million from the State Highway Account and $113 million from the Motor Vehicle
Account to the general fund and appropriate approximately $6 million from the
State Highway Account to fund a highway-grade crossing program administered by
the Public Utilities Commission. Petitioners contend that the transfers
violate several constitutional provisions and request that the moneys be
returned to the State Highway Account and Motor Vehicle Account.
The State is a defendant in Just Say No To Tobacco Dough Campaign v. State
of California, where the petitioners challenge the appropriation of
approximately $166 million of Proposition 99 funds in the Cigarette and
Tobacco Products Surtax Fund for years ended June 30, 1990, through June 30,
1995 for programs which were allegedly not health education or tobacco-related
disease research. If the State loses, the general fund and funds from other
sources would be used to reimburse the Cigarette and Tobacco Products Surtax
Fund for approximately $166 million.
The State is a defendant in the case of Kurt Hathaway, et al. v. Wilson, et
al., where the plaintiffs are challenging the legality of various budget
action transfers and appropriations from particular special funds for years
ended June 30, 1995 and June 30, 1996. The plaintiffs allege that the
transfers and appropriations are contrary to the substantive law establishing
the funds and providing for interest accruals to the funds, violate the single
subject requirement of the State Constitution, and is an invalid "special
law." Plaintiffs seek to have monies totaling approximately $335 million
returned to the special funds.
The State is a defendant in two related cases, Beno vs. Sullivan ("Beno")
and Welch v. Anderson ("Welch"), concerning reductions in Aid to Families with
Dependent Children ("AFDC") grant payments. In the Beno case, plaintiffs seek
to invalidate AFDC grant reductions and in the Welch case, plaintiffs contend
that AFDC grant reductions are not authorized by state law. The Beno case
concerns the total grant reductions while the Welch case concerns the period
of time the State did not have a waiver for those reductions. The State's
potential liability for retroactive AFDC grant reductions is estimated at $831
million if the plaintiffs are awarded the full amount in both cases.
In the case of Board of Administration, California Public Employees'
Retirement System, et al. v. Pete Wilson, Governor, et al., plaintiffs
challenged the constitutionality of legislation which deferred payment of the
State's employer contribution to the Public Employees' Retirement System
("PERS") beginning in Fiscal Year
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1992-93. On January 11, 1995, the Sacramento County Superior Court entered a
judgment finding that the legislation unconstitutionally impaired the vested
contract rights of PERS members. The judgment provides for
issuance of a writ of mandate directing State defendants to disregard the
provisions of the legislation, to implement the statute governing employer
contributions that existed before the changes in the legislation were found to
be unconstitutional and to transfer to PERS the contributions that were unpaid
to date. On February 19, 1997, the State Court of Appeals affirmed the
decision of the Superior Court, and the Supreme Court subsequently refused to
hear the case, making the Court of Appeals' ruling final. On July 30, 1997 the
Controller transferred $1,235 billion from the General Fund to PERS in
repayment of the principal amount determined to have been improperly deferred.
Subsequent State payments to PERS will be made on a quarterly basis. No
prejudgment interest has been paid in accordance with the trial court ruling
that there was insufficient evidence that money for that purpose had been
appropriated and was available. No post-judgment interest was ordered.
STATE GENERAL OBLIGATION BOND RATINGS
As of the date of this Statement of Additional Information, the State's
general obligation bonds are rated A1 by Moody's Investors Services, Inc., A+
by Standard & Poor's Ratings Services, and AA- by Fitch Investors Service,
Inc.
As a result of these factors and others, and especially because a severe
recession between 1990-94 reduced revenues and increased expenditures for
social welfare programs, from the late 1980s until 1992-93, the State had a
period of budget imbalance. During this period, expenditures exceeded revenues
in four out of six years, and the State accumulated and sustained a budget
deficit in its budget reserve, the Special Fund for Economic Uncertainties
("SFEU") approaching $2.8 billion at its peak at June 30, 1993. Starting in
the 1990-91 Fiscal Year and for each fiscal year thereafter, each budget
required multibillion dollar actions to bring projected revenues and
expenditures into balance. The State Legislature and Governor agreed on the
following principal steps to produce Budget Acts in the years 1991-92 to 1994-
95, although not all these actions were taken in each year.
. significant cuts in health and welfare program expenditures;
. transfers of program responsibilities and funding from the State to local
governments (referred to as "realignment"), coupled with some reduction
in mandates on local government;
. transfer of about $3.6 billion in local property tax revenues from
cities, counties, redevelopment agencies and some other districts to
local school districts, thereby reducing State funding for schools under
Proposition 98 (discussed below);
. reduction in growth of support for higher education programs, coupled
with increases in student fees, through the 1994-95 Fiscal Year;
. maintenance of the minimum Proposition 98 funding guarantee for K-14
schools, and the disbursement of additional funds to keep a constant
level of about $4,200 per K-12 pupils through the 1993-94 Fiscal Year;
. revenue increases (particularly in the 1991-92 Fiscal Year budget), most
of which were for a short duration;
. increased reliance on aid from the federal government to offset the costs
of incarcerating, educating and providing health and welfare services to
illegal immigrants, although during this time frame, most of the
additional aid requested by the Administration was not received; and
. various one-time adjustments and accounting changes.
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Despite these budget actions, as noted, the effects of the recession led to
large, unanticipated deficits in the budget reserve, the SFEU, as compared to
projected positive balances. By the 1993-94 Fiscal Year, the accumulated
deficit was so large that it was impractical to budget to retire it in one
year, so a two-year program was implemented, using the issuance of revenue
anticipation warrants to carry a portion of the deficit over the end of the
fiscal year. When the economy failed to recover sufficiently in 1993-94, a
second two-year plan was implemented in 1994-95, again using cross-fiscal year
revenue anticipation warrants to partly finance the deficit into the 1995-96
fiscal year.
Another consequence of the accumulated budget deficits, together with other
factors such as disbursement of funds to local school districts "borrowed"
from future fiscal years and hence not shown in the annual budget, was to
significantly reduce the State's cash resources available to pay its ongoing
obligations. When the Legislature and the Governor failed to adopt a budget
for the 1992-93 Fiscal Year by July 1, 1992, which would have allowed the
State to carry out its normal annual cash flow borrowing to replenish its cash
reserves, the State Controller issued registered warrants to pay a variety of
obligations representing prior years' or continuing appropriations, and
mandates from court order. Available funds were used to make constitutionally-
mandated payments, such as debt service on bonds and warrants. Between July 1
and September 4, 1992, when the budget was adopted, the State Controller
issued a total of approximately $3.8 billion of registered warrants.
During the past several fiscal years, the State was forced to rely
increasingly on external debt markets to meet its cash needs, as a succession
of notes and revenue anticipation warrants were issued in the period from June
1992 to July 1994, often needed to pay previously maturing notes or warrants.
These borrowings were used also in part to spread out the repayment of the
accumulated budget deficit over the end of a fiscal year, as noted earlier.
The last and largest of these borrowings was $4.0 billion of revenue
anticipation warrants which were issued in July, 1994 and matured on April 25,
1996.
1995-96 Fiscal Year. The 1995-96 Budget Act was signed by the Governor on
August 3, 1995, 34 days after the start of the fiscal year. The Budget Act
projected general fund revenues and transfers of $44.1 billion, a 3.5%
increase from the prior year. Expenditures were budgeted at $43.4 billion, a 4
percent increase. The Budget Act also projected Special Fund revenues of $12.7
billion and appropriated Special Fund expenditures of $13.0 billion.
Final data for the 1995-96 Fiscal Year showed revenues and transfers of
$46.1 billion, some $2 billion over the original fiscal year estimate, which
was attributed to the strong economic recovery. Expenditures also increased,
to an estimated $45.4 billion, as a result of the requirement to expend
revenues for schools under Proposition 98, and, among other things, failure of
the federal government to enact welfare reform during the fiscal year and to
budget new aid for illegal immigrant costs, both of which had been counted on
to allow reductions in State costs. SFEU had a small negative balance of about
$87 million at June 30, 1996, all but eliminating the accumulated budget
deficit from the early 1990's. Available internal borrowable resources
(available cash, after payment of all obligations due) on June 30, 1996 was
about $3.8 billion, representing a significant improvement in the State's cash
position, and ending the need for deficit borrowing over the end of the fiscal
year. The State's improved cash position allowed it to repay the $4.0 billion
Revenue Anticipation Warrant issue on April 25, 1996, and to issue only $2.0
billion of revenue anticipation notes during the fiscal year, which matured on
June 28, 1996.
The 1995-96 Budget Act included substantial additional funding under
Proposition 98 for schools and community colleges (about $1.0 billion general
fund and $1.2 billion total above 1994-95 levels). Because of
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higher than projected revenues in 1994-95, an additional $561 million ($92 per
K-12 pupil (also called per ADA, or average daily attendance)) was
appropriated to the 1994-95 Proposition 98 entitlement. A large part of this
was a block grant of about $50 per pupil for any one-time purpose. For the
first time in several years, a full 2.7 percent cost of living allowance was
funded. The budget was based on the settlement of the CTA v. Gould litigation.
Cuts in health and welfare costs totaled about $220 million, almost $700
million less than had been anticipated, because of the failure by the federal
government to approve certain of these actions in a timely manner. The federal
government also failed to appropriate all but $31 million of an anticipated
$500 million in new federal aid for incarceration and health care costs of
illegal immigrants. Funding from the general fund for the University of
California was increased by $106 million and for the California State
University system by $97 million, with no increases in student fees.
1996-97 Fiscal Year. The 1996-97 Budget Act was signed by the Governor on
July 15, 1996, along with various implementing bills. The Governor vetoed
about $82 million of appropriations (both general fund and Special Fund). With
the signing of the Budget Act, the State implemented its regular cash flow
borrowing program with the issuance of $3.0 billion of Revenue Anticipation
Notes to mature on June 30, 1997. The Budget Act appropriated a modest budget
reserve in the SFEU of $305 million, as of June 30, 1997. The Department of
Finance projected that, on June 30, 1997, the State's available internal
borrowing (cash) resources will be $2.9 billion, after payment of all
obligations due by that date, so that no cross-fiscal year borrowing will be
needed.
Revenues--The Legislature rejected the Governor's proposed 15% cut in
personal income taxes (to be phased in over three years), but did approve a 5%
cut in bank and corporation taxes, to be effective for income years starting
on January 1, 1997. As a result, revenues for the Fiscal Year were estimated
to total $47.643 billion, a 3.3% increase over the final estimated 1995-96
revenues. Special Fund revenues were estimated to be $13.3 billion.
Expenditures--The Budget Act contained general fund appropriations totaling
$47.251 billion, a 4.0% increase over the final estimated 1995-96
expenditures. Special Fund expenditures were budgeted at $12.6 billion.
The following are principal features of the 1996-97 Budget Act:
Proposition 98 funding for schools and community college districts
increased by almost $1.6 billion (general fund) and $1.65 billion total
above revised 1995-96 levels. Almost half of this money was budgeted to
fund class-size reductions in kindergarten and grades 1-3. Also, for the
second year in a row, the full cost of living allowance (3.2%) was funded.
The Proposition 98 increases have brought K-12 expenditures to almost
$4,800 per ADA, an almost 15% increase over the level prevailing during the
recession years. Community colleges will receive an increase in funding of
$157 million for 1996-97 out of this $1.6 billion total.
Because of the higher than projected revenues in 1995-96, an additional
$1.1 billion ($190 per K-12 ADA and $145 million for community colleges)
was appropriated and retroactively applied towards the 1995-96 Proposition
98 guarantee, bringing K-12 expenditures in that year to over $4,600 per
ADA. These new funds were appropriated for a variety of purposes, including
block grants, allocations for each school
site, facilities for class size reduction, and a reading initiative.
Similar retroactive increases totaling $230 million, based on final figures
on revenues and State population growth, were made to the 1991-92 and the
1994-95 Proposition 98 guarantees, most of which were allocated to each
school site.
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The Budget Act assumed savings of approximately $660 million in health
and welfare costs which required changes in federal law, including federal
welfare reform. The Budget Act further assumed federal law changes in
August 1996 which would allow welfare cash grant levels to be reduced by
October 1, 1996. These cuts totaled approximately $163 million of the
anticipated $660 million savings.
A 4.9% increase in funding for the University of California ($130 million
general fund) and the California State University system ($101 million
general fund), with no increases in student fees, maintaining the second
year of the Governor's four-year "Compact" with the State's higher
education units.
The Budget Act assumed the federal government will provide approximately
$700 million in new aid for incarceration and health care costs of illegal
immigrants. These funds reduce appropriations in these categories that
would otherwise have to be paid from the general fund. (For purposes of
cash flow projections, the State Department of Finance expects $540 million
of this amount to be received during the 1996-97 fiscal year.)
General fund support for the State Department of Corrections was
increased by about 7% over the prior year, reflecting estimates of
increased prison population.
With respect to aid to local governments, the principal new programs
included in the Budget Act are $100 million in grants to cities and
counties for law enforcement purposes, and budgeted $50 million for
competitive grants to local governments for programs to combat juvenile
crime.
As part of the 1997-98 Budget Act legislative package, the State Legislature
and Governor agreed on a comprehensive reform of the State's public assistance
programs to implement the new federal law. The new basic State welfare program
is called California Work Opportunity and Responsibility to Kids Act
("CalWORKs"), which replaces the former Aid to Families with Dependent
Children (AFDC) and Greater Avenues to Independence (GAIN) programs effective
January 1, 1998. Consistent with the federal law, CalWORKs contains new time
limits on receipt of welfare aid, both lifetime as well as for any current
time on aid. The centerpiece of CalWORKs is the linkage of eligibility to work
participation requirements. Administration of the new Welfare-to-Work programs
will be largely at the county level, and counties are given financial
incentives for success in this program.
Although the long-term impact of the new federal law and CalWORKs cannot be
determined until there has been some experience, the State does not presently
anticipate that these new programs will have any adverse financial impact on
the General Fund. Overall TANF grants from the federal government are expected
to equal or exceed the amounts the State would have received under the old
AFDC program.
1997-98 Fiscal Year. On January 9, 1997, the Governor released his proposed
budget for the 1997-98 Fiscal Year (the "Proposed Budget"). The Proposed
Budget estimated general fund revenues and transfers in 1997-98 of $50.7
billion, a 4.6% increase from revised 1996-97 figures. The Governor proposes
expenditures of $50.3 billion, a 3.9% increase from 1996-97. The Proposed
Budget projected a balance in the SFEU of $553 million on June 30, 1998.
At the time of the May Revision, released on May 14, 1997, the Department of
Finance increased its revenue estimate for the upcoming fiscal year by $1.3
billion, in response to the continued strong growth in the
State's economy. Budget negotiations continued into the summer, with major
issues to be resolved including final agreement on State welfare reform,
increase in State employee salaries and consideration of a tax cut proposed by
the Governor.
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In May, 1997, action was taken by the California Supreme Court in an ongoing
lawsuit, PERS v. Wilson, which made final a judgment against the State
requiring an immediate payment from the General Fund to the Public Employees
Retirement Fund ("PERF") to make up certain deferrals in annual retirement
fund contributions which had been legislated in earlier years for budget
savings, and which the courts found to be unconsitutional. On July 30, 1997,
following a direction from the Governor, the Controller transferred $1.235
billion from the General Fund to the PERF in satisfaction of the judgment,
representing the principal amount of the improperly deferred payments from
1995-96 and 1996-97.
Fiscal Year 1997-98 Budget Act. Once the pension payment eliminated
essentially all the "increased" revenue in the budget, final agreement was
reached within a few weeks on the welfare package and the remainder of the
budget. The Legislature passed the Budget Bill on August 11, 1997, along with
numerous related bills to implement its provisions. Agreement was not finally
reached, however, on one aspect of the budget plan, concerning the Governor's
proposal for a comprehensive educational testing program.
On August 18, 1997, the Governor signed the Budget Act, but vetoed about
$314 million of specific spending items, primarily in health and welfare and
education areas from both the General Fund and Special Funds. The Governor
announced that he was prepared to restore about $200 million of education
spending upon satisfactory completion of legislation on the education testing
program.
The Budget Act anticipates General Fund revenues and transfers of $52.5
billion (a 6.8 percent increase over the final 1996-97 amount), and
expenditures of $52.8 billion (an 8.0 percent increase from the 1996-97
levels). On a budgetary basis, the budget reserve (SFEU) is projected to
decrease from $408 million at June 30, 1997 to $112 million at June 30, 1998.
(The expenditure figure assumes restoration of $200 million in vetoed
funding.) The Budget Act also includes Special Fund expenditures of $14.4
billion (as against estimated Special Fund revenues of $14.0 billion), and
$2.1 billion of expenditures from various Bond Funds. The State has
implemented its normal annual cash flow borrowing program, issuing $3 billion
of notes which mature on June 30, 1998.
The following are major features of the 1997-98 Budget Act:
1. For the second year in a row, the Budget contains a large increase in
funding for K-14 education under Proposition 98, reflecting strong revenues
which have exceeded initial budget amounts. Part of the nearly $1.75
billion in increased spending is allocated to prior fiscal years. Funds are
provided to fully pay for the cost-of-living-increase component of
Proposition 98, and to extend class size reduction and reading initiatives.
2. The Budget Act reflects the $1.235 billion pension case judgment
payment, and brings funding of the State's pension contribution back to the
quarterly basis which existed prior to the deferral actions which were
invalidated by the courts. There is no provision for any additional
payments relating to this court case.
3. Continuing the third year of a four-year "compact" which the
Administration has made with higher education units, funding from the
General Fund for the University of California and California State
University has increased by about 6 percent ($121 million and $107 million,
respectively), and there was no increase in student fees.
4. Because of the effect of the pension payment, most other State
programs were continued at 1996-97 levels.
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5. Health and welfare costs are contained, continuing generally the grant
levels from prior years, as part of the initial implementation of the new
CalWORKs program.
6. Unlike prior years, this Budget Act does not depend on federal budget
actions. About $300 million in federal funds, already included in the
federal FY 1997 and 1998 budgets, are included in the Budget Act, to offset
incarceration costs for illegal aliens.
7. The Budget Act contains no tax increases, and no tax reductions. The
Renters Tax Credit was suspended for another year, saving approximately
$500 million.
Federal Welfare Reform--Following enactment of the 1996-97 Budget Act,
Congress passed and the President signed (on August 22, 1996) the Personal
Responsibility and Work Opportunity Act of 1996 (the "Law") making a
fundamental reform of the current welfare system. Among many provisions, the
Law includes: (i) conversion of Aid to Families with Dependent Children from
an entitlement program to a block grant titled Temporary Assistance for Needy
Families (TANF), with lifetime time limits on TANF recipients, work
requirements and other changes; (ii) provisions denying certain federal
welfare and public benefits to legal noncitizens, allowing states to elect to
deny additional benefits (including TANF) to legal noncitizens, and generally
denying almost all benefits to illegal immigrants; and (iii) changes in the
Food Stamp program, including reducing maximum benefits and imposing work
requirements.
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APPENDIX II
RATINGS OF MUNICIPAL BONDS
DESCRIPTION OF MOODY'S INVESTORS SERVICE, INC. ("MOODY'S") MUNICIPAL BOND
RATINGS
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.
Aa Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are
generally known as high grade bonds. They are rated lower than the
best bonds because margins of protection may not be as large as in Aaa
securities or fluctuation of protective elements may be of greater
amplitude or there may be other elements present which make the long-
term risks appear somewhat larger than in Aaa securities.
A Bonds which are rated A possess many favorable investment attributes
and are to be considered as upper medium grade obligations. Factors
giving security to principal and interest are considered adequate, but
elements may be present which suggest a susceptibility to impairment
sometime in the future.
Baa Bonds which are rated Baa are considered as medium grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest
payment and principal security appear adequate for the present but
certain protective elements may be lacking or may be
characteristically unreliable over any great length of time. Such
bonds lack outstanding investment characteristics and in fact have
speculative characteristics as well.
Ba Bonds which are rated Ba are judged to have speculative elements;
their future cannot be considered as well assured. Often the
protection of interest and principal payments may be very moderate and
thereby not well safeguarded during both good and bad times over the
future. Uncertainty of position characterizes bonds in this class.
B Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or
of maintenance of other terms of the contract over any long period of
time may be small.
Caa Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to
principal or interest.
Ca Bonds which are rated Ca represent obligations which are speculative
in a high degree. Such issues are often in default or have other
marked shortcomings.
C Bonds which are rated C are the lowest rated class of bonds, and
issues so rated can be regarded as having extremely poor prospects of
ever attaining any real investment standing.
Note: Those bonds in the Aa, A, Baa, Ba and B categories which Moody's
believes possess the strongest credit attributes within those categories are
designated by the symbols Aa1, A1, Baa1, Ba1 and B1.
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Short-term Notes: The four ratings of Moody's for short-term notes are MIG
1/VMIG1, MIG 2/VMIG2, MIG 3/VMIG3 and MIG 4/VMIG4; MIG 1/VMIG1 denotes "best
quality . . . strong protection by established cash flows"; MIG 2/VMIG2
denotes "high quality" with ample margins of protection; MIG 3/VMIG3 notes are
of "favorable quality . . . but . . . lacking the undeniable strength of the
preceding grades"; MIG 4/VMIG4 notes are of "adequate quality . . .
[p]rotection commonly regarded as required of an investment security is
present . . . there is specific risk."
DESCRIPTION OF MOODY'S COMMERCIAL PAPER RATINGS
Moody's Commercial Paper ratings are opinions of the ability of issuers to
repay punctually promissory obligations not having an original maturity in
excess of nine months. Moody's employs the following three designations, all
judged to be investment grade, to indicate the relative repayment ability of
rated issuers:
Issuers rated Prime-1 (or related supporting institutions) have a superior
ability for repayment of short-term promissory obligations. Prime-1 repayment
ability will often be evidenced by the following characteristics: leading
market positions in well established industries; high rates of return on funds
employed; conservative capitalization structure with moderate reliance on debt
and ample asset protection; broad margins in earning coverage of fixed
financial charges and high internal cash generation; and well established
access to a range of financial markets and assured sources of alternate
liquidity.
Issuers rated Prime-2 (or related supporting institutions) have a strong
ability for repayment of short-term promissory obligations. This will normally
be evidenced by many of the characteristics cited above but to a lesser
degree. Earnings trends and coverage ratios, while sound, may be more subject
to variation. Capitalization characteristics, while still appropriate, may be
more affected by external conditions. Ample alternate liquidity is maintained.
Issuers rated Prime-3 (or supporting institutions) have an acceptable
ability for repayment of short-term promissory obligations. The effect of
industry characteristics and market composition may be more pronounced.
Variability in earnings and profitability may result in changes in the level
of debt protection measurements and may require relatively high financial
leverage. Adequate alternate liquidity is maintained.
Issuers rated Not Prime do not fall within any of the Prime rating
categories.
DESCRIPTION OF STANDARD & POOR'S RATINGS SERVICES ("STANDARD & POOR'S")
MUNICIPAL DEBT RATINGS
A Standard & Poor's issue credit rating is a current opinion of the
creditworthiness of an obligor with respect to a specific financial
obligation, a specific class of financial obligations, or a specific financial
program. It takes into consideration the creditworthiness of guarantors,
insurers or other forms of credit enhancement on the obligation.
The issue credit rating is not a recommendation to purchase, sell or hold a
financial obligation, inasmuch as it does not comment as to market price or
suitability for a particular investor.
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The ratings are based on current information furnished by the obligors or
obtained by Standard & Poor's from other sources it considers reliable.
Standard & Poor's does not perform an audit in connection with any rating and
may, on occasion, rely on unaudited financial information. The ratings may be
changed, suspended or withdrawn as a result of changes in, or unavailability
of, such information, or based on other circumstances.
The ratings are based, in varying degrees, on the following considerations:
I.
Likelihood of payment-capacity and willingness of the obligor to meet
its financial commitment on an obligation in accordance with the terms
of obligation;
II.
Nature of and provisions of the obligation; and
III.
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.
AAA Debt rated "AAA" has the highest rating assigned by Standard &
Poor's. The obligor's capacity to meet its financial commitment
on the obligation is extremely strong.
AA Debt rated "AA" differs from the highest rated obligations only
in small degree. The obligor's capacity to meet its financial
commitment on the obligation is very strong.
A Debt rated "A" is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than
debt in higher-rated categories. However, the obligor's capacity
to meet its financial commitment on the obligation is still
strong.
BBB Debt rated "BBB" exhibits adequate protection parameters.
However, adverse economic conditions or changing circumstances
are more likely to lead to a weakened capacity of the obligor to
meet its financial commitment to the obligation.
BB Debt rated "BB," "B," "CCC," "CC" and "C" is regarded as having
B significant speculative characteristics. "BB" indicates the
CCC least degree of speculation and "C" the highest degree of
CC speculation. While such bonds will likely have some quality and
C protective characteristics, these may be outweighed by large
uncertainties or major exposures to adverse conditions.
D Debt rated "D" is in payment default. The "D" rating category is
used when payments on an obligation are not made on the date due
even if the applicable grace period has not expired, unless
Standard & Poor's believes that such payments will be made
during such grace period. The "D" rating also will be used upon
the filing of a bankruptcy petition or the taking of a similar
action if payments on an obligation are jeopardized.
Plus (+) or Minus (-): The ratings from "AA" to "CCC" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
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DESCRIPTION OF STANDARD & POOR'S COMMERCIAL PAPER RATINGS
A Standard & Poor's Commercial Paper Rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of no more
than 365 days. Ratings are graded into several categories, ranging from "A-1"
for the highest-quality obligations to "D" for the lowest. These categories
are as follows:
A-1
This highest category indicates that the degree of safety regarding
timely payment is strong. Those issues determined to possess extremely
strong safety characteristics are denoted with a plus sign (+)
designation.
A-2
Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as
for issues designated "A-1".
A-3
Issues carrying this designation have an adequate capacity for timely
payment. They are, however, more vulnerable to the adverse effects of
changes in circumstances than obligations carrying the higher
designations.
B
Issues rated "B" are regarded as having only speculative capacity for
timely payment.
C
This rating is assigned to short-term debt obligations with a doubtful
capacity for payment.
D
Debt rated "D" is in payment default. The "D" rating category is used
when interest payments or principal payments are not made on the date
due, even if the applicable grace period has not expired, unless
Standard & Poor's believes that such payments will be made during such
grace period.
A Commercial Paper rating is not a recommendation to purchase or sell a
security. The ratings are based on current information furnished to Standard &
Poor's by the issuer or obtained by Standard & Poor's from other sources it
considers reliable. The ratings may be changed, suspended, or withdrawn as a
result of changes in, or unavailability of, such information.
DESCRIPTION OF STANDARD & POOR'S SHORT-TERM ISSUED CREDIT RATING
A Standard & Poor's note rating reflects the liquidity factors and market
access risks unique to notes. Notes due in three years or less will likely
receive a note rating. Notes maturing beyond three years will most likely
receive a long-term debt rating. The following criteria will be used in making
that assessment.
--Amortization schedule--the larger the final maturity relative to other
maturities, the more likely it will be treated as a note.
--Source of payment--the more dependent the issue is on the market for its
refinancing, the more likely it will be treated as a note.
Note rating symbols are as follows:
SP-1
Strong capacity to pay principal and interest. An issue determined to
possess a very strong capacity to pay debt service is given a plus "+"
designation.
SP-2
Satisfactory capacity to pay principal and interest, with some
vulnerability to adverse financial and economic changes over the term
of the notes.
SP-3
Speculative capacity to pay principal and interest.
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DESCRIPTION OF FITCH IBCA, INC. ("FITCH") INVESTMENT GRADE BOND RATINGS
Fitch investment grade bond ratings provide a guide to investors in
determining the credit risk associated with a particular security. The ratings
represent Fitch's assessment of the issuer's ability to meet the obligations
of a specific debt issue or class of debt in a timely manner.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and of any
guarantor, as well as the economic and political environment that might affect
the issuer's future financial strength and credit quality.
Fitch ratings do not reflect any credit enhancement that may be provided by
insurance policies or financial guaranties unless otherwise indicated.
Bonds carrying the same rating are of similar but not necessarily identical
credit quality since the rating categories do not fully reflect small
differences in the degrees of credit risk.
Fitch ratings are not recommendations to buy, sell, or hold any security.
Ratings do not comment on the adequacy of market price, the suitability of any
security for a particular investor, or the tax-exempt nature or taxability of
payments made in respect of any security.
Fitch ratings are based on information obtained from issuers, other
obligors, underwriters, their experts, and other sources Fitch believes to be
reliable. Fitch does not audit or verify the truth or accuracy of such
information. Ratings may be changed, suspended, or withdrawn as a result of
changes in, or the unavailability of, information or for other reasons.
AAA
Bonds considered to be investment grade and of the highest credit
quality. The obligor has an exceptionally strong ability to pay
interest and repay principal, which is unlikely to be affected by
reasonably foreseeable events.
AA
Bonds considered to be investment grade and of very high credit
quality. The obligor's ability to pay interest and repay principal is
very strong, although not quite as strong as bonds rated "AAA". Because
bonds rated in the "AAA" and "AA" categories are not significantly
vulnerable to foreseeable future developments, short-term debt of these
insurers is generally rated "F-1+".
A
Bonds considered to be investment grade and of high credit quality. The
obligor's ability to pay interest and repay principal is considered to
be strong, but may be more vulnerable to adverse changes in economic
conditions and circumstances than bonds with higher ratings.
BBB
Bonds considered to be investment grade and of satisfactory credit
quality. The obligor's ability to pay interest and repay principal is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have adverse impact on these
bonds and, therefore, impair timely payment. The likelihood that the
ratings of these bonds will fall below investment grade is higher than
for bonds with higher ratings.
Plus (+) or Minus (-): Plus and minus signs are used with a rating symbol to
indicate the relative position of a credit within the rating category. Plus
and minus signs, however, are not used in the "AAA" category.
NR Indicates that Fitch does not rate the specific issue.
65
<PAGE>
CONDITIONAL A conditional rating is premised on the successful completion of
a project or the occurrence of a specific event.
SUSPENDED A rating is suspended when Fitch deems the amount of information
available from the issuer to be inadequate for rating purposes.
WITHDRAWN A rating will be withdrawn when an issue matures or is called or
refinanced and, at Fitch's discretion, when an issuer fails to
furnish proper and timely information.
FITCHALERT Ratings are placed on FitchAlert to notify investors of an
occurrence that is likely to result in a rating change and the
likely direction of such change. These are designated as
"Positive," indicating a potential upgrade, "Negative," for
potential downgrade, or "Evolving," where ratings may be raised
or lowered. FitchAlert is relatively short-term, and should be
resolved within 12 months.
RATINGS OUTLOOK
An outlook is used to describe the most likely direction of any
rating change over the intermediate term. It is described as a
"Positive" or "Negative." The absence of a designation indicates
a stable outlook.
DESCRIPTION OF FITCH SPECULATIVE GRADE BOND RATINGS
Fitch speculative grade bond ratings provide a guide to investors in
determining the credit risk associated with a particular security. The ratings
("BB" to "C") represent Fitch's assessment of the likelihood of timely payment
of principal and interest in accordance with the terms of obligation for bond
issues not in default. For defaulted bonds, the rating ("DDD" to "D") is an
assessment of the ultimate recovery value through reorganization or
liquidation.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and any guarantor,
as well as the economic and political environment that might affect the
issuer's future financial strength.
Bonds that have the same rating are of similar but not necessarily identical
credit quality since rating categories cannot fully reflect the differences in
degrees of credit risk.
BB Bonds are considered speculative. The obligor's ability to pay
interest and repay principal may be affected over time by
adverse economic changes. However, business and financial
alternatives can be identified which could assist the obligor in
satisfying its debt service requirements.
B Bonds are considered highly speculative. While bonds in this
class are currently meeting debt service requirements, the
probability of continued timely payment of principal and
interest reflects the obligor's limited margin of safety and the
need for reasonable business and economic activity throughout
the life of the issue.
CCC
Bonds have certain identifiable characteristics which, if not
remedied, may lead to default. The ability to meet obligations
requires an advantageous business and economic environment.
CC
Bonds are minimally protected. Default in payment of interest
and/or principal seems probable over time.
66
<PAGE>
C Bonds are in imminent default in payment of interest or
principal.
DDD Bonds are in default on interest and/or principal payments. Such
DD bonds are extremely speculative and should be valued on the
D basis of their ultimate recovery value in liquidation or
reorganization of the obligor. "DDD" represents the highest
potential for recovery on these bonds, and "D" represents the
lowest potential for recovery.
Plus (+) or Minus (-): Plus and minus signs are used with a rating symbol to
indicate the relative position of a credit within the rating category. Plus
and minus signs, however, are not used in the "DDD," "DD," or "D" categories.
DESCRIPTION OF FITCH INVESTMENT GRADE SHORT-TERM RATINGS
Fitch's short-term ratings apply to debt obligations that are payable on
demand or have original maturities of generally up to three years, including
commercial paper, certificates of deposit, medium-term notes, and municipal
and investment notes.
The short-term rating places greater emphasis than a long-term rating on the
existence of liquidity necessary to meet the issuer's obligations in a timely
manner.
Fitch short-term ratings are as follows:
F-1+ Exceptionally Strong Credit Quality. Issues assigned this rating
are regarded as having the strongest degree of assurance for
timely payment.
F-1 Very Strong Credit Quality. Issues assigned this rating reflect
an assurance of timely payment only slightly less in degree than
issues rated "F-1+."
F-2 Good Credit Quality. Issues assigned this rating have a
satisfactory degree of assurance for timely payment, but the
margin of safety is not as great as for issues assigned "F-1+"
and "F-1" ratings.
F-3 Fair Credit Quality. Issues assigned this rating have
characteristics suggesting that the degree of assurance for
timely payment is adequate, however, near-term adverse changes
could cause these securities to be rated below investment grade.
F-S Weak Credit Quality. Issues assigned this rating have
characteristics suggesting a minimal degree of assurance for
timely payment and are vulnerable to near-term adverse changes
in financial and economic conditions.
D Default. Issues assigned this rating are in actual or imminent
payment default.
LOC The symbol "LOC" indicates that the rating is based on a letter
of credit issued by a commercial bank.
67
<PAGE>
APPENDIX III
<TABLE>
<CAPTION>
A TAX-FREE YIELD OF
-----------------------------------
TAXABLE INCOME* [1998]
- ------------------------------------ 1998 FEDERAL CALIFORNIA
SINGLE RETURN JOINT RETURN TAX BRACKET TAX BRACKET 5.00% 5.50% 6.00% 6.50% 7.00% 7.50%
- ----------------- ----------------- ------------ ----------- ----- ----- ----- ----- ----- -----
IS EQUAL TO A TAXABLE YIELD OF
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
$ 26,046-$ 32,916 $ 52,091-$ 65,832 28.00% 8.0% 7.55 8.30 9.06 9.81 10.57 11.32
$ 32,917-$ 61,400 $ 65,833-$102,300 28.00% 9.3% 7.66 8.42 9.19 9.95 10.72 11.48
$ 61,401-$128,100 $102,301-$155,950 31.00% 9.3% 7.99 8.79 9.59 10.39 11.19 11.98
$128,101-$278,450 $155,951-$278,450 36.00% 9.3% 8.61 9.47 10.34 11.20 12.06 12.92
Over $278,450 Over $278,450 39.60% 9.3% 9.13 10.04 10.95 11.87 12.78 13.69
</TABLE>
TAXABLE EQUIVALENT YIELDS FOR 1998
- --------
* An investor's marginal tax rate may exceed the rates shown in the above
table due to the reduction, or possible elimination, of the personal
exemption deduction for high-income taxpayers and an overall limit on
itemized deductions. For investors who pay alternative minimum tax, tax-free
yields may be equivalent to lower taxable yields than those shown above.
Shareholders subject to income taxation by states other than California will
realize a lower after-tax return than California shareholders. This table is
a combination of the Federal and California taxable income brackets, which
are adjusted annually for inflation. The California taxable income brackets
have not yet been adjusted for 1998. The California taxable yields set forth
in the above table presume that taxpayers in each Federal tax bracket are in
the highest California tax bracket corresponding to that Federal bracket.
The tax rates shown above do not apply to corporate taxpayers subject to the
California corporate franchise tax. The tax characteristics of the Fund are
described more fully elsewhere in this Prospectus. Consult your tax adviser
for further details. This chart is for illustrative purposes only and cannot
be taken as an indication of anticipated Fund performance.
68
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRE-
SENTATIONS NOT CONTAINED IN THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFOR-
MATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED.
THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFERING OF ANY SECURITIES OTHER THAN
THE REGISTERED SECURITIES TO WHICH IT RELATES OR AN OFFER TO ANY PERSON IN ANY
STATE OR JURISDICTION OF THE UNITED STATES OR ANY COUNTRY WHERE SUCH OFFER
WOULD BE UNLAWFUL.
---------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary......................................................... 3
Risk Factors and Special Considerations.................................... 7
Fee Table.................................................................. 9
The Fund................................................................... 10
Use of Proceeds............................................................ 10
Investment Objective and Policies.......................................... 10
Risks and Special Considerations of Leverage............................... 20
Investment Restrictions.................................................... 23
Directors and Officers..................................................... 24
Investment Advisory and Management Arrangements............................ 26
Portfolio Transactions..................................................... 28
Dividends and Distributions................................................ 29
Taxes...................................................................... 30
Automatic Dividend Reinvestment Plan....................................... 34
Mutual Fund Investment Option.............................................. 36
Net Asset Value............................................................ 36
Description of Capital Stock............................................... 37
Custodian.................................................................. 40
Underwriting............................................................... 40
Transfer Agent, Dividend Disbursing Agent and Registrar.................... 41
Legal Opinions............................................................. 41
Experts.................................................................... 41
Independent Auditors' Report............................................... 42
Statement of Assets, Liabilities and Capital............................... 43
Appendix I................................................................. 44
Appendix II................................................................ 61
Appendix III............................................................... 68
</TABLE>
---------------
UNTIL , 1998 (90 DAYS AFTER THE COMMENCEMENT OF THE OFFERING), ALL
DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPAT-
ING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS DELIV-
ERY REQUIREMENT IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PRO-
SPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS
OR SUBSCRIPTIONS.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SHARES
MUNIHOLDINGS CALIFORNIA FUND, INC.
COMMON STOCK
---------------
PROSPECTUS
---------------
MERRILL LYNCH & CO.
, 1998
CODE 19001- 98
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART C
OTHER INFORMATION
ITEM 24. FINANCIAL STATEMENTS AND EXHIBITS.
(1) Financial Statements
Report of Independent Auditors
Statement of Assets, Liabilities and Capital as of , 1998
(2) Exhibits:
(a)(1)--Articles of Incorporation
(a)(2)--Articles of Amendment
(b)--By-Laws
(c)--Not applicable
(d)(1)--Portions of the Articles of Incorporation and By-Laws of the
Registrant defining the rights of holders of shares of the
Registrant(a)
(d)(2)--Form of specimen certificate for shares of Common Stock of the
Registrant
(e)--Form of Dividend Reinvestment Plan
(f)--Not applicable
(g)--Form of Investment Advisory Agreement between the Fund and the
Investment Adviser
(h)(1)--Form of Purchase Agreement
(h)(2)--Merrill Lynch Standard Dealer Agreement
(i)--Not applicable
(j)--Custodian Contract between the Fund and *
(k)--Registrar, Transfer Agency and Service Agreement between the Fund
and *
(l)--Opinion and Consent of Brown & Wood LLP, counsel to the Fund and
the Underwriter*
(m)--Not applicable
(n)--Consent of , independent auditors for the Fund*
(o)--Not applicable
(p)--Certificate of Fund Asset Management, L.P.*
(q)--Not applicable
(r)--Not applicable
- --------
(a) Reference is made to Article V, Article VI (sections 2, 3, 4, 5 and 6),
Article VII, Article VIII, Article X, Article XI, Article XII and Article
XIII of the Registrant's Articles of Incorporation, filed as Exhibit
(a)(1) to this Registration Statement; and to Article II, Article III
(sections 1, 2, 3, 5 and 17), Article VI, Article VII, Article XII,
Article XIII and Article XIV of the Registrant's By-Laws, filed as Exhibit
(b) to this Registration Statement.
* To be filed by amendment.
ITEM 25. MARKETING ARRANGEMENTS.
See Exhibit (h).
C-1
<PAGE>
ITEM 26. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table sets forth the estimated expenses to be incurred in
connection with the offering described in this Registration Statement:
<TABLE>
<S> <C>
Registration fees..................................................... $ *
Stock Exchange listing fee............................................ *
Printing (other than stock certificates).............................. *
Engraving and printing stock certificates............................. *
Legal fees and expenses............................................... *
Accounting fees and expenses.......................................... *
NASD fees............................................................. *
Miscellaneous......................................................... *
-----
Total............................................................... $ *
=====
</TABLE>
- --------
* To be provided by amendment.
ITEM 27. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT.
The information in the Prospectus under the caption "Investment Advisory and
Management Arrangements" and in Note 1 to the Statement of Assets, Liabilities
and Capital is incorporated herein by reference.
ITEM 28. NUMBER OF HOLDERS OF SECURITIES.
There will be one record holder of the Common Stock, par value $0.10 per
share, as of the effective date of this Registration Statement.
ITEM 29. INDEMNIFICATION.
Section 2-418 of the General Corporation Law of the State of Maryland,
Article VI of the Registrant's Articles of Incorporation, filed as Exhibit
(a)(1) to this Registration Statement, Article VI of the Registrant's By-Laws,
filed as Exhibit (b) to this Registration Statement, and the Investment
Advisory Agreement, a form of which is filed as Exhibit (g)(1) to this
Registration Statement, provide for indemnification.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933, as amended (the "1933 Act") may be provided to directors, officers
and controlling persons of the Fund, pursuant to the foregoing provisions or
otherwise, the Fund has been advised that in the opinion of the Securities and
Exchange Commission, such indemnification is against public policy as
expressed in the Act and is, therefore, unenforceable. In the event that a
claim for indemnification against such liabilities (other than the payment by
the Fund of expenses incurred or paid by a director, officer or controlling
person of the Fund in connection with any successful defense of any action,
suit or proceeding) is asserted by such director, officer or controlling
person in connection with the securities being registered, the Fund will,
unless in the opinion of its counsel the matter has been settled by
controlling precedent, submit to a court of appropriate jurisdiction the
question whether such indemnification by it is against public policy as
expressed in the Act and will be governed by the final adjudication of such
issue.
Reference is made to Section Six of the Purchase Agreement, a form of which
is filed as Exhibit (h)(1) hereto, for provisions relating to the
indemnification of the underwriter.
C-2
<PAGE>
ITEM 30. BUSINESS AND OTHER CONNECTIONS OF THE INVESTMENT ADVISER.
Fund Asset Management, L.P. (the "Investment Adviser"), an affiliate of MLAM
acts as investment adviser for the following open-end registered investment
companies: CBA Money Fund, CMA Government Securities Fund, CMA Money Fund, CMA
Multi-State Municipal Series Trust, CMA Tax-Exempt Fund, CMA Treasury Fund,
The Corporate Fund Accumulation Program, Inc., Financial Institutions Series
Trust, Merrill Lynch Basic Value Fund, Inc., Merrill Lynch California
Municipal Series Trust, Merrill Lynch Corporate Bond Fund, Inc., Merrill Lynch
Emerging Tigers Fund, Inc., Merrill Lynch Federal Securities Trust, Merrill
Lynch Funds for Institutions Series, Merrill Lynch Multi-State Limited
Maturity Municipal Series Trust, Merrill Lynch Multi-State Municipal Series
Trust, Merrill Lynch Municipal Bond Fund, Inc., Merrill Lynch Phoenix Fund,
Inc., Merrill Lynch Special Value Fund, Inc., Merrill Lynch World Income Fund,
Inc., and The Municipal Fund Accumulation Program, Inc., and for the following
closed-end registered investment companies: Apex Municipal Fund, Inc.,
Corporate High Yield Fund, Inc., Corporate High Yield Fund II, Inc., Debt
Strategies Fund, Inc., Income Opportunities Fund 1999, Inc., Income
Opportunities Fund 2000, Inc., Merrill Lynch Municipal Strategy Fund, Inc.,
MuniAssets Fund, Inc., MuniEnhanced Fund, Inc., MuniHoldings Fund, Inc.,
MuniHoldings California Insured Fund, Inc., MuniHoldings Florida Insured Fund,
MuniHoldings Florida Insured Fund II, MuniHoldings New York Fund, Inc.,
MuniHoldings New York Insured Fund, Inc., MuniInsured Fund, Inc., MuniVest
Florida Fund, MuniVest Fund, Inc., MuniVest Fund II, Inc., MuniVest Michigan
Insured Fund, Inc., MuniVest New Jersey Fund, Inc., MuniVest Pennsylvania
Insured Fund, MuniYield Arizona Fund, Inc., MuniYield California Fund, Inc.,
MuniYield California Insured Fund, Inc., MuniYield California Insured Fund II,
Inc., MuniYield Florida Fund, MuniYield Florida Insured Fund, MuniYield Fund,
Inc., MuniYield Insured Fund, Inc., MuniYield Michigan Fund, Inc., MuniYield
Michigan Insured Fund, Inc., MuniYield New Jersey Fund, Inc., MuniYield New
Jersey Insured Fund, Inc., MuniYield New York Insured Fund, Inc., MuniYield
New York Insured Fund II, Inc., MuniYield Pennsylvania Fund, MuniYield Quality
Fund, Inc., MuniYield Quality Fund II, Inc., Senior High Income Portfolio,
Inc., Taurus MuniCalifornia Holdings, Inc., Taurus MuniNewYork Holdings, Inc.
and Worldwide DollarVest Fund, Inc.
Merrill Lynch Asset Management, L.P. ("MLAM"), an affiliate of the
Investment Adviser, acts as the investment adviser for the following open-end
registered investment companies: Merrill Lynch Adjustable Rate Securities
Fund, Inc., Merrill Lynch Americas Income Fund, Inc., Merrill Lynch Asset
Builder Program, Inc., Merrill Lynch Asset Growth Fund, Inc., Merrill Lynch
Asset Income Fund, Inc., Merrill Lynch Capital Fund, Inc., Merrill Lynch
Developing Capital Markets Fund, Inc., Merrill Lynch Convertible Fund, Inc.,
Merrill Lynch Dragon Fund, Inc., Merrill Lynch EuroFund, Merrill Lynch
Fundamental Growth Fund, Inc., Merrill Lynch Fund For Tomorrow, Inc., Merrill
Lynch Global Bond Fund for Investment and Retirement, Merrill Lynch Global
Allocation Fund, Inc., Merrill Lynch Global Convertible Fund, Inc., Merrill
Lynch Global Growth Fund, Inc., Merrill Lynch Global Holdings, Merrill Lynch
Global Resources Trust, Merrill Lynch Global SmallCap Fund, Inc., Merrill
Lynch Global Utility Fund, Inc., Merrill Lynch Global Value Fund, Inc.,
Merrill Lynch Government Bond Fund, Inc., Merrill Lynch Growth Fund, Merrill
Lynch Healthcare Fund, Inc., Merrill Lynch International Equity Fund, Merrill
Lynch Latin America Fund, Inc., Merrill Lynch Middle East/Africa Fund, Inc.,
Merrill Lynch Municipal Series Trust, Merrill Lynch Pacific Fund, Inc.,
Merrill Lynch Ready Assets Trust, Merrill Lynch Retirement Series Trust,
Merrill Lynch Series Fund, Inc., Merrill Lynch Short-Term Global Income Fund,
Inc., Merrill Lynch Strategic Dividend Fund, Merrill Lynch Technology Fund,
Inc., Merrill Lynch U.S. Treasury Money Fund, Merrill Lynch U.S.A. Government
Reserves, Merrill Lynch Utility Income Fund, Inc., Merrill Lynch Variable
Series Funds, Inc. and Hotchkis and Wiley Funds (advised by Hotchkis and
Wiley, a division of MLAM); and for the following closed-end registered
investment companies: Merrill Lynch High Income Municipal Bond Fund, Inc. and
Merrill Lynch Senior Floating Rate Fund, Inc.
The address of each of these investment companies is P.O. Box 9011,
Princeton, New Jersey 08543-9011, except that the address of Merrill Lynch
Funds for Institutions Series and Merrill Lynch Intermediate Government Bond
Fund is One Financial Center, 23rd Floor, Boston, Massachusetts 02111-2646.
The address of the Investment Adviser, MLAM, Merrill Lynch Funds Distributor,
Inc. ("MLFD"), Princeton Services, Inc. ("Princeton Services") and Princeton
Administrators, L.P. also is P.O. Box 9011, Princeton, New Jersey 08543-9011.
The address of Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill
Lynch") and Merrill Lynch
C-3
<PAGE>
& Co., Inc. ("ML & Co.") is North Tower, World Financial Center, 250 Vesey
Street, New York, New York 10281-1213.
Set forth below is a list of each executive officer and partner of the
Investment Adviser indicating each business, profession, vocation or
employment of a substantial nature in which each such person or entity has
been engaged for the past two years for his or her or its own account or in
the capacity of director, officer, employee, partner or trustee. In addition,
Mr. Zeikel is President, Mr. Richard is Treasurer and Mr. Glenn is Executive
Vice President of all or substantially all of the investment companies
described in the preceding paragraphs and also hold the same positions with
all or substantially all of the investment companies advised by MLAM as they
do with those advised by the Investment Adviser. Messrs. Giordano, Harvey,
Kirstein and Monagle are directors or officers of one or more of such
companies.
<TABLE>
<CAPTION>
POSITIONS WITH OTHER SUBSTANTIAL BUSINESS, PROFESSION,
NAME INVESTMENT ADVISER VOCATION OR EMPLOYMENT
---- ------------------ ---------------------------------------
<C> <C> <S>
ML & Co. ....... Limited Partner Financial Services Holding Company; Limited
Partner of FAM
Princeton General Partner General Partner of MLAM
Services.......
Arthur Zeikel... Chairman (since Chairman (since December 10, 1997) and President
December 10, 1997); (prior to December 10, 1997) of MLAM; President
President (prior to and Director (prior to December 10, 1997) of
December 10, 1997) Princeton Services; Director (prior to December
10, 1997) of MLFDS; Executive Vice President of ML
& Co.
Jeffrey M. Peek. President (since President (since December 10, 1997) of MLAM;
December 10, 1997) President and Director (since December 10, 1997)
of Princeton Services; Director (since December
10, 1997) of MLFDS; Executive Vice President of ML
& Co.
Terry K. Glenn.. Executive Vice President Executive Vice President of MLAM; Executive Vice
President and Director of Princeton Services;
President and Director of MLFD; Director of MLFDS;
President of Princeton Administrators, L.P.
Vincent R. Senior Vice President Senior Vice President of MLAM; Senior Vice
Giordano....... President of Princeton Services
Elizabeth Senior Vice President Senior Vice President of MLAM; Senior Vice
Griffin........ President of Princeton Services
Norman R. Senior Vice President Senior Vice President of MLAM; Senior Vice
Harvey......... President of Princeton Services
Michael J. Senior Vice President Senior Vice President of MLAM; Senior Vice
Hennewinkel.... President of the MLAM International Group
Philip L. Senior Vice President, Senior Vice President, General Counsel and
Kirstein....... General Counsel and Secretary of MLAM; Senior Vice President, General
Secretary Counsel Director and Secretary of Princeton
Services
Ronald M. Kloss. Senior Vice President Senior Vice President and Controller of MLAM;
and Controller Senior Vice President and Controller of Princeton
Services
Stephen M. M. Senior Vice President Executive Vice President of Princeton
Miller......... Administrators, L.P.; Senior Vice President of
Princeton Services
Joseph T. Senior Vice President Senior Vice President of MLAM; Senior Vice
Monagle........ President of Princeton Services
Michael L. Senior Vice President Senior Vice President of MLAM; Senior Vice
Quinn.......... President of Princeton Services; Managing Director
and First Vice President of Merrill Lynch, Pierce,
Fenner & Smith Incorporated from 1989 to 1995
Richard L. Senior Vice President Senior Vice President of MLAM; Senior Vice
Reller......... President of Princeton Services; Director of MLFD
Gerald M. Senior Vice President Senior Vice President and Treasurer of MLAM;
Richard........ and Treasurer Senior Vice President and Treasurer of Princeton
Services; Vice President and Treasurer of MLFD
Ronald L. Senior Vice President Senior Vice President of MLAM; Senior Vice
Welburn........ President of Princeton Services
</TABLE>
ITEM 31. LOCATION OF ACCOUNT AND RECORDS.
All accounts, books and other documents required to be maintained by Section
31(a) of the Investment Company Act of 1940, as amended, and the rules
promulgated thereunder are maintained at the offices of the registrant (800
Scudders Mill Road, Plainsboro, New Jersey 08536), its investment adviser (800
Scudders Mill Road, Plainsboro, New Jersey 08536), and its custodian and
transfer agent.
ITEM 32. MANAGEMENT SERVICES.
Not applicable.
C-4
<PAGE>
ITEM 33. UNDERTAKINGS.
(a) Registrant undertakes to suspend the offering of the shares of Common
Stock covered hereby until it amends its Prospectus contained herein if (1)
subsequent to the effective date of this Registration Statement, its net asset
value per share of Common Stock declines more than 10% from its net asset
value per share of Common Stock as of the effective date of this Registration
Statement, or (2) its net asset value per share of Common Stock increases to
an amount greater than its net proceeds as stated in the Prospectus contained
herein.
(b) Registrant undertakes that:
(1) For purposes of determining any liability under the 1933 Act, the
information omitted from the form of prospectus filed as part of this
Registration Statement in reliance upon Rule 430A and contained in the form
of prospectus filed by the registrant pursuant to Rule 497(h) under the
1933 Act shall be deemed to be part of this Registration Statement as of
the time it was declared effective.
(2) For the purpose of determining any liability under the 1933 Act, each
post-effective amendment that contains a form of prospectus shall be deemed
to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed
to be the initial bona fide offering thereof.
C-5
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant has duly caused this Amendment
to the Registration Statement to be signed on its behalf by the undersigned,
thereunto duly authorized, in the Township of Plainsboro, and State of New
Jersey, on the 19th day of December, 1997.
MuniHoldings California Fund, Inc.
(Registrant)
/s/ Arthur Zeikel
By_________________________________
(ARTHUR ZEIKEL, PRESIDENT)
Each person whose signature appears below hereby authorizes Arthur Zeikel,
Terry K. Glenn or Gerald M. Richard, or any of them, as attorney-in-fact, to
sign on his or her behalf, individually and in each capacity stated below, any
amendment to this Registration Statement (including post-effective amendments)
and to file the same, with all exhibits thereto, with the Securities and
Exchange Commission.
Pursuant to the requirements of the Securities Act of 1933, this Amendment
to the Registration Statement has been signed below by the following persons
in the capacities and on the date indicated.
SIGNATURES TITLE DATE
/s/ Arthur Zeikel President (Principal December 19,
- ------------------------------------- Executive Officer) 1997
(ARTHUR ZEIKEL) and Director
/s/ Gerald M. Richard Treasurer (Principal December 19,
- ------------------------------------- Financial and 1997
(GERALD M. RICHARD) Accounting Officer)
/s/ James H. Bodurtha Director December 19,
- ------------------------------------- 1997
(JAMES H. BODURTHA)
/s/ Herbert I. London Director December 19,
- ------------------------------------- 1997
(HERBERT I. LONDON)
/s/ Robert R. Martin Director December 19,
- ------------------------------------- 1997
(ROBERT R. MARTIN)
/s/ Joseph L. May Director December 19,
- ------------------------------------- 1997
(JOSEPH L. MAY)
/s/ Andre F. Perold Director December 19,
- ------------------------------------- 1997
(ANDRE F. PEROLD)
C-6
<PAGE>
EXHIBIT INDEX
EXHIBIT NUMBER PAGE NO.
-------------- --------
(a)(1)--Articles of Incorporation
(a)(2)--Articles of Amendment
(b) --By-Laws
(d)(2)--Form of specimen certificate for shares of Common Stock of the
Registrant
(e) --Form of Dividend Reinvestment Plan
(g) --Form of Investment Advisory Agreement between the Fund and the
Investment Adviser
(h)(1)--Form of Purchase Agreement
(h)(2)--Merrill Lynch Standard Dealer Agreement
<PAGE>
EXHIBIT (a)(1)
ARTICLES OF INCORPORATION
OF
MUNIHOLDINGS CALIFORNIA INSURED FUND II, INC.
THE UNDERSIGNED, ROBERT J. BORZONE, JR., whose post-office address is c/o
Brown & Wood LLP, One World Trade Center, 56th Floor, New York, New York 10048,
being at least eighteen (18) years of age, does hereby act as incorporator,
under and by virtue of the General Laws of the State of Maryland authorizing the
formation of corporations and with the intention of forming a corporation.
ARTICLE I.
NAME
----
The name of the corporation is MUNIHOLDINGS CALIFORNIA INSURED FUND II,
INC. (the "Corporation").
ARTICLE II.
PURPOSES AND POWERS
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The purpose or purposes for which the Corporation is formed is to act as a
closed-end, management investment company under the federal Investment Company
Act of 1940, as amended, and in effect from time to time (the "Investment
Company Act"), and to exercise and enjoy all of the powers, rights and
privileges granted to, or conferred upon, corporations by the General Laws of
the State of Maryland now or hereafter in force.
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ARTICLE III.
PRINCIPAL OFFICE AND RESIDENT AGENT
-----------------------------------
The post-office address of the principal office of the Corporation in
the State of Maryland is c/o The Corporation Trust Incorporated, 32 South
Street, Baltimore, Maryland 21202. The name of the resident agent of the
Corporation in this State is The Corporation Trust Incorporated, a corporation
of this State, and the post-office address of the resident agent is The
Corporation Trust Incorporated, 32 South Street, Baltimore, Maryland 21202.
ARTICLE IV.
CAPITAL STOCK
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(1) The total number of shares of capital stock which the Corporation
shall have authority to issue is 200,000,000 shares, all initially classified as
one class called Common Stock, of the par value of Ten Cents ($0.10) per share,
and of the aggregate par value of Twenty Million Dollars ($20,000,000).
(2) The Board of Directors may classify and reclassify any unissued
shares of capital stock into one or more additional or other classes or series
as may be established from time to time by setting or changing in any one or
more respects the designations, preferences, conversion or other rights, voting
powers, restrictions, limitations as to dividends, qualifications or terms or
conditions of redemption of such shares of stock and pursuant to such
classification or reclassification to increase
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or decrease the number of authorized shares of any existing class or series
provided, however, that the total amount of shares of all classes or series
shall not exceed the total number of shares of capital stock authorized in the
Charter.
(3) Unless otherwise expressly provided in the Charter of the
Corporation, including any Articles Supplementary creating any class or series
of capital stock, the holders of each class or series of capital stock shall be
entitled to dividends and distributions in such amounts and at such times as may
be determined by the Board of Directors, and the dividends and distributions
paid with respect to the various classes or series of capital stock may vary
among such classes and series.
(4) Unless otherwise expressly provided in the Charter of the
Corporation, including any Articles Supplementary creating any class or series
of capital stock, on each matter submitted to a vote of stockholders, each
holder of a share of capital stock of the Corporation shall be entitled to one
vote for each share standing in such holder's name on the books of the
Corporation, irrespective of the class or series thereof, and all shares of all
classes and series shall vote together as a single class; provided, however,
that as to any matter with respect to which a separate vote of any class or
series is required by the Investment Company Act, or any rules, regulations or
orders issued thereunder, or by the Maryland General Corporation Law, such
requirement as to a separate vote by that class or series
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shall apply in lieu of a general vote of all classes and series as described
above.
(5) Notwithstanding any provision of the Maryland General Corporation
Law requiring a greater proportion than a majority of the votes of all classes
or series of capital stock of the Corporation (or of any class or series
entitled to vote thereon as a separate class or series) to take or authorize any
action, the Corporation is hereby authorized (subject to the requirements of the
Investment Company Act, and any rules, regulations and orders issued thereunder)
to take such action upon the concurrence of a majority of the votes entitled to
be cast by holders of capital stock of the Corporation (or a majority of the
votes entitled to be cast by holders of a class or series as a separate class or
series) unless a greater proportion is specified in the Charter.
(6) Unless otherwise expressly provided in the Charter of the
Corporation, including any Articles Supplementary creating any class or series
of capital stock, in the event of any liquidation, dissolution or winding up of
the Corporation, whether voluntary or involuntary, the holders of each class or
series of capital stock of the Corporation shall be entitled, after payment or
provision for payment of the debts and other liabilities of the Corporation, to
share ratably in the remaining net assets of the Corporation.
(7) Any fractional shares shall carry proportionately all of the
rights of a whole share, excepting any right to receive a
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certificate evidencing such fractional share, but including, without limitation,
the right to vote and the right to receive dividends.
(8) The presence in person or by proxy of the holders of shares
entitled to cast one-third of the votes entitled to be cast shall constitute a
quorum at any meeting of stockholders, except with respect to any matter which
requires approval by a separate vote of one or more classes or series of stock,
in which case the presence in person or by proxy of the holders of shares
entitled to cast one-third of the votes entitled to be cast by each class or
series entitled to vote as a separate class shall constitute a quorum.
(9) All persons who shall acquire stock in the Corporation shall
acquire the same subject to the provisions of the Charter and the By-Laws of the
Corporation. As used in the Charter of the Corporation, the terms "Charter" and
"Articles of Incorporation" shall mean and include the Articles of Incorporation
of the Corporation as amended, supplemented and restated from time to time by
Articles of Amendment, Articles Supplementary, Articles of Restatement or
otherwise.
ARTICLE V.
PROVISIONS FOR DEFINING, LIMITING AND
REGULATING CERTAIN POWERS OF THE CORPORATION
AND OF THE DIRECTORS AND STOCKHOLDERS
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(1) The initial number of directors of the Corporation shall be three
(3), which number may be increased or decreased
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pursuant to the By-Laws of the Corporation but shall never be less than the
minimum number permitted by the General Laws of the State of Maryland. The
names of the directors who shall act until the first annual meeting or until
their successors are duly elected and qualify are:
Philip M. Mandel
Alice A. Pellegrino
Patrick D. Sweeney
(2) The Board of Directors of the Corporation is hereby empowered to
authorize the issuance from time to time of shares of capital stock of any class
or series, whether now or hereafter authorized, for such consideration as the
Board of Directors may deem advisable, without any action by the stockholders,
subject to such limitations as may be set forth in these Articles of
Incorporation or in the By-Laws of the Corporation or in the General Laws of the
State of Maryland.
(3) No holder of stock of the Corporation shall, as such holder, have
any right to purchase or subscribe for any shares of the capital stock of the
Corporation or any other security of the Corporation which it may issue or sell
(whether out of the number of shares authorized by these Articles of
Incorporation, or out of any shares of the capital stock of the Corporation
acquired by it after the issue thereof, or otherwise) other than such right, if
any, as the Board of Directors, in its discretion, may determine.
(4) Each director and each officer of the Corporation shall be
indemnified and advanced expenses by the Corporation to the
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full extent permitted by the General Laws of the State of Maryland now or
hereafter in force, including the advance of expenses under the procedures and
to the full extent permitted by law subject to the requirements of the
Investment Company Act. The foregoing rights of indemnification shall not be
exclusive of any other rights to which those seeking indemnification may be
entitled. No amendment of these Articles of Incorporation or repeal of any
provision hereof shall limit or eliminate the benefits provided to directors and
officers under this provision in connection with any act or omission that
occurred prior to such amendment or repeal.
(5) To the fullest extent permitted by the General Laws of the State
of Maryland or decisional law, as amended or interpreted, subject to the
requirements of the Investment Company Act, no director or officer of the
Corporation shall be personally liable to the Corporation or its security
holders for money damages. No amendment of these Articles of Incorporation or
repeal of any provision hereof shall limit or eliminate the benefits provided to
directors and officers under this provision in connection with any act or
omission that occurred prior to such amendment or repeal.
(6) The Board of Directors of the Corporation is vested with the sole
power, to the exclusion of the stockholders, to make, alter or repeal from time
to time any of the By-Laws of the Corporation except any particular By-Law which
is specified as
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not subject to alteration or repeal by the Board of Directors, subject to the
requirements of the Investment Company Act.
(7) A director elected by the holders of capital stock may be removed
(with or without cause), but only by action taken by the holders of at least
sixty-six and two-thirds percent (66 2/3%) of the shares of capital stock then
entitled to vote in an election to fill that directorship.
(8) The enumeration and definition of the particular powers of the
Board of Directors included in the Charter shall in no way be limited or
restricted by reference to or inference from the terms of any other clause of
this or any other Article of the Charter of the Corporation, or construed as or
deemed by inference or otherwise in any manner to exclude or limit any powers
conferred upon the Board of Directors under the General Laws of the State of
Maryland now or hereinafter in force.
ARTICLE VI.
DENIAL OF PREEMPTIVE RIGHTS
---------------------------
No stockholder of the Corporation shall by reason of his holding
shares of capital stock have any preemptive or preferential right to purchase or
subscribe to any shares of capital stock of the Corporation, now or hereafter to
be authorized, or any notes, debentures, bonds or other securities convertible
into shares of capital stock, now or hereafter to be authorized, whether or not
the issuance of any such shares, or notes, debentures, bonds or other securities
would adversely
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affect the dividend or voting rights of such stockholder; except that the Board
of Directors, in its discretion, may issue shares of any class of the
Corporation, or any notes, debentures, bonds, other securities convertible into
shares of any class, either in whole or in part, to the existing stockholders or
holders of any class, series or type of stock or other securities at the time
outstanding to the exclusion of any or all of the holders of any or all of the
classes, series or types of stock or other securities at the time outstanding.
ARTICLE VII.
DETERMINATION BINDING
---------------------
Any determination made in good faith and consistent with applicable
law, so far as accounting matters are involved, in accordance with accepted
accounting practice by or pursuant to the direction of the Board of Directors,
as to the amount of assets, obligations or liabilities of the Corporation, as to
the amount of net income of the Corporation from dividends and interest for any
period or amounts at any time legally available for the payment of dividends, as
to the amount of any reserves or charges set up and the propriety thereof, as to
the time of or purpose for creating reserves or as to the use, alteration or
cancellation of any reserves or charges (whether or not any obligation or
liability for which such reserves or as to the use, alteration or cancellation
of any reserves or charges shall have been created, shall have been paid or
discharged or shall be then
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or thereafter required to be paid or discharged), as to the price of any
security owned by the Corporation or as to any other matters relating to the
issuance, sale, redemption or other acquisition or disposition of securities or
shares of capital stock of the Corporation, and any reasonable determination
made in good faith by the Board of Directors as to whether any transaction
constitutes a purchase of securities on "margin," a sale of securities "short,"
or an underwriting or the sale of, or a participation in any underwriting or
selling group in connection with the public distribution of, any securities,
shall be final and conclusive, and shall be binding upon the Corporation and all
holders of its capital stock, past, present and future, and shares of the
capital stock of the Corporation are issued and sold on the condition and
understanding, evidenced by the purchase of shares of capital stock or
acceptance of share certificates, that any and all such determinations shall be
binding as aforesaid. No provision in this Charter shall be effective to (a)
require a waiver of compliance with any provision of the Securities Act of 1933,
as amended, or the Investment Company Act, or of any valid rule, regulation or
order of the Securities and Exchange Commission thereunder or (b) protect or
purport to protect any director or officer of the Corporation against any
liability to the Corporation or its security holders 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.
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ARTICLE VIII.
PRIVATE PROPERTY OF STOCKHOLDERS
--------------------------------
The private property of stockholders shall not be subject to the
payment of corporate debts to any extent whatsoever.
ARTICLE IX.
CONVERSION TO OPEN-END COMPANY
------------------------------
Notwithstanding any other provisions of these Articles of
Incorporation or the By-Laws of the Corporation, a favorable vote of the holders
of at least sixty-six and two-thirds percent (66 2/3%) of the outstanding shares
of capital stock of the Corporation entitled to be voted on the matter shall be
required to approve, adopt or authorize an amendment to these Articles of
Incorporation of the Corporation that makes the Common Stock a "redeemable
security" (as that term is defined in section 2(a) (32) the Investment Company
Act) unless such action has previously been approved, adopted or authorized by
the affirmative vote of at least two-thirds of the total number of directors
fixed in accordance with the By-Laws of the Corporation, in which case the
affirmative vote of the holders of a majority of the outstanding shares of
capital stock of the Corporation entitled to vote thereon shall be required.
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ARTICLE X.
MERGER, SALE OF ASSETS, LIQUIDATION
-----------------------------------
Notwithstanding any other provisions of these Articles of
Incorporation or the By-Laws of the Corporation, a favorable vote of the holders
of at least sixty-six and two-thirds percent (66 2/3%) of the outstanding shares
of capital stock of the Corporation entitled to be voted on the matter shall be
required to approve, adopt or authorize (i) a merger or consolidation or
statutory share exchange of the Corporation with any other corporation, (ii) a
sale of all or substantially all of the assets of the Corporation (other than in
the regular course of its investment activities), or (iii) a liquidation or
dissolution of the Corporation, unless such action has previously been approved,
adopted or authorized by the affirmative vote of at least two-thirds of the
total number of directors fixed in accordance with the By-Laws of the
Corporation, in which case the affirmative vote of the holders of a majority of
the outstanding shares of capital stock of the Corporation entitled to vote
thereon shall be required.
ARTICLE XI.
PERPETUAL EXISTENCE
-------------------
The duration of the Corporation shall be
perpetual.
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ARTICLE XII.
AMENDMENT
---------
The Corporation reserves the right to amend, alter, change or repeal
any provision contained in its Charter, in any manner now or hereafter
prescribed by statute, including any amendment which alters the contract rights,
as expressly set forth in the Charter, of any outstanding stock and
substantially adversely affects the stockholders' rights, and all rights
conferred upon stockholders herein are granted subject to this reservation.
Notwithstanding any other provisions of these Articles of Incorporation or the
By-Laws of the Corporation (and notwithstanding the fact that a lesser
percentage may be specified by law, these Articles of Incorporation or the By-
Laws of the Corporation), the amendment or repeal of Section (5) of Article IV,
Section (1), Section (4), Section (5), Section (6) and Section (7) of Article V,
Article VIII, Article IX, Article X, Article XI or this Article XII, of these
Articles of Incorporation shall require the affirmative vote of the holders of
at least sixty-six and two-thirds percent (66 2/3%) of the outstanding shares of
capital stock of the Corporation entitled to be voted on the matter.
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IN WITNESS WHEREOF, the undersigned incorporator of MUNIHOLDINGS
CALIFORNIA INSURED FUND II, INC. hereby executes the foregoing Articles of
Incorporation and acknowledges the same to be his act.
Dated this 4th day
of December, 1997
/s/ Robert J. Borzone, Jr.
____________________________
Robert J. Borzone, Jr.
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EXHIBIT (a)(2)
MUNIHOLDINGS CALIFORNIA INSURED FUND II, INC.
ARTICLES OF AMENDMENT TO THE
ARTICLES OF INCORPORATION
MUNIHOLDINGS CALIFORNIA INSURED FUND II, INC., a Maryland corporation (the
"Corporation"), to change its name from MuniHoldings California Insured Fund II,
Inc. to MuniHoldings California Fund, Inc., does hereby certify to the State
Department of Assessments and Taxation of Maryland that:
FIRST: The charter of the Corporation is hereby amended by deleting
Article I thereof in its entirety and inserting the following in lieu thereof:
"ARTICLE I
NAME
----
The name of the corporation is MUNIHOLDINGS CALIFORNIA FUND, INC. (the
"Corporation")."
SECOND: Pursuant to Section 2-607 of the Maryland General Corporation
Law, these Articles of Amendment amend the provisions of the Articles of
Incorporation of the Corporation.
THIRD: These Articles of Amendment have been approved by a majority of
the entire Board of Directors of the Corporation,
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there being no stock outstanding or subscribed for at the time of approval.
FOURTH: The authorized capital stock of the Corporation has not been
increased by these Articles of Amendment.
FIFTH: Except as amended hereby, the Corporation's charter shall remain
in full force and effect.
The undersigned President acknowledges these Articles of Amendment to be
the corporate act of the Corporation and as to all matters or facts required to
be verified under oath, the undersigned President acknowledges that to the best
of his knowledge, information and belief, the matters and facts set forth in
these Articles of Amendment with respect to the authorization and approval of
the amendment of the Corporation's charter are true in all material respects,
and that this statement is made under the penalties of perjury.
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IN WITNESS WHEREOF, MUNIHOLDINGS CALIFORNIA INSURED FUND II, INC. has
caused these Articles of Amendment to be signed in its name and on its behalf by
its President and witnessed by its Secretary as of the 22nd day of December,
1997.
MUNIHOLDINGS CALIFORNIA INSURED
FUND II, INC.
(a Maryland corporation)
WITNESS:
/s/ Philip M. Mandel By: /s/ Arthur Zeikel
---------------------- --------------------------
Philip M. Mandel Arthur Zeikel
Secretary President
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EXHIBIT (b)
BY-LAWS
OF
MUNIHOLDINGS CALIFORNIA FUND, INC.
ARTICLE I.
Offices
-------
Section 1. Principal Office. The principal office of the Corporation
----------------
shall be in the City of Baltimore and State of Maryland.
Section 2. Principal Executive Office. The principal executive office of
--------------------------
the Corporation shall be at 800 Scudders Mill Road, Plainsboro, New Jersey
08536.
Section 3. Other Offices. The Corporation may have such other offices in
-------------
such places as the Board of Directors from time to time may determine.
ARTICLE II.
Meetings of Stockholders
------------------------
Section 1. Annual Meeting. Except as otherwise required by the rules of
--------------
any stock exchange on which the Corporation's shares of stock may be listed, the
Corporation shall not be required to hold an annual meeting of its stockholders
in any year in which the election of directors is not required to be acted upon
under the Investment Company Act of 1940, as amended (the "Investment Company
Act"). In the event that the Corporation shall be required to hold an annual
meeting of stockholders to elect
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directors under the Investment Company Act, such meeting shall be held no later
than 120 days after the occurrence of the event requiring the meeting. Any
stockholders' meeting held in accordance with this Section shall for all
purposes constitute the annual meeting of stockholders for the year in which the
meeting is held.
In the event an annual meeting is required by the rules of a stock exchange
on which the Corporation's shares of stock are listed, the annual meeting of the
stockholders of the Corporation for the election of directors and for the
transaction of such other business as may properly be brought before the meeting
shall be held on such day and month of each year as shall be designated annually
by the Board of Directors.
Section 2. Special Meetings. Special meetings of the stockholders, unless
----------------
otherwise provided by law, may be called for any purpose or purposes by a
majority of the Board of Directors, the President, or on the written request of
the holders of at least 10% of the outstanding shares of capital stock of the
Corporation entitled to vote at such meeting if they comply with Section 2-
502(b) or (c) of the Maryland General Corporation Law.
Section 3. Place of Meetings. The annual meeting and any special meeting
-----------------
of the stockholders shall be held at such place within the United States as the
Board of Directors from time to time may determine.
Section 4. Notice of Meetings; Waiver of Notice. Notice of the place,
------------------------------------
date and time of the holding of each annual and
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special meeting of the stockholders and the purpose or purposes of each special
meeting shall be given personally or by mail, not less than ten nor more than 90
days before the date of such meeting, to each stockholder entitled to vote at
such meeting and to each other stockholder entitled to notice of the meeting.
Notice by mail shall be deemed to be duly given when deposited in the United
States mail addressed to the stockholder at his or her address as it appears on
the records of the Corporation, with postage thereon prepaid.
Notice of any meeting of stockholders shall be deemed waived by any
stockholder who shall attend such meeting in person or by proxy, or who, either
before or after the meeting, shall submit a signed waiver of notice which is
filed with the records of the meeting. When a meeting is adjourned to another
time and place, unless the Board of Directors, after the adjournment, shall fix
a new record date for an adjourned meeting, or unless the adjournment is for
more than 120 days after the original record date, notice of such adjourned
meeting need not be given if the time and place to which the meeting shall be
adjourned were announced at the meeting at which the adjournment is taken.
Section 5. Quorum. The presence in person or by proxy of the holders of
------
shares of stock entitled to cast one-third of the votes entitled to be cast
shall constitute a quorum at any meeting of stockholders, except with respect to
any matter which requires approval by a separate vote of one or more classes or
series of stock, in which case the presence in person or by proxy
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of the holders of shares entitled to cast one-third of the votes entitled to be
cast by each class or series entitled to vote as a separate class or series
shall constitute a quorum. In the absence of a quorum no business may be
transacted, except that the holders of a majority of the shares of stock present
in person or by proxy and entitled to vote may adjourn the meeting from time to
time, without notice other than announcement thereat except as otherwise
required by these By-Laws, until the holders of the requisite amount of shares
of stock shall be so present. At any such adjourned meeting at which a quorum
may be present any business may be transacted which might have been transacted
at the meeting as originally called. The absence from any meeting, in person or
by proxy, of holders of the number of shares of stock of the Corporation in
excess of a majority thereof which may be required by the laws of the State of
Maryland, the Investment Company Act, or other applicable statute, the Charter,
or these By-Laws, for action upon any given matter shall not prevent action at
such meeting upon any other matter or matters which properly may come before the
meeting, if there shall be present thereat, in person or by proxy, holders of
the number of shares of stock of the Corporation required for action in respect
of such other matter or matters.
Section 6. Organization. At each meeting of the stockholders, the
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Chairman of the Board (if one has been designated by the Board), or in his or
her absence or inability to act, the President, or in the absence or inability
to act of
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the Chairman of the Board and the President, a Vice President, shall act as
chairman of the meeting. The Secretary, or in his or her absence or inability
to act, any person appointed by the chairman of the meeting, shall act as
secretary of the meeting and keep the minutes thereof.
Section 7. Order of Business. The order of business at all meetings of
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the stockholders shall be as determined by the chairman of the meeting.
Section 8. Voting. Except as otherwise provided by statute or the
------
Charter, each holder of record of shares of stock of the Corporation having
voting power shall be entitled at each meeting of the stockholders to one vote
for every share of such stock standing in his or her name on the record of
stockholders of the Corporation as of the record date determined pursuant to
Section 9 of this Article or, if such record date shall not have been so fixed,
then at the later of (i) the close of business on the day on which notice of the
meeting is mailed or (ii) the thirtieth day before the meeting.
Each stockholder entitled to vote at any meeting of stockholders may
authorize another person or persons to act for him or her by a proxy signed by
such stockholder or his or her attorney-in-fact. No proxy shall be valid after
the expiration of eleven months from the date thereof, unless otherwise provided
in the proxy. Every proxy shall be revocable at the pleasure of the stockholder
executing it, except in those cases where such proxy states that it is
irrevocable and where an irrevocable
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proxy is permitted by law. Except as otherwise provided by statute, the Charter
or these By-Laws, any corporate action to be taken by vote of the stockholders
(other than the election of directors, which shall be by a plurality of votes
cast) shall be authorized by a majority of the total votes cast at a meeting of
stockholders by the holders of shares present in person or represented by proxy
and entitled to vote on such action.
If a vote shall be taken on any question other than the election of
directors, which shall be by written ballot, then unless required by statute or
these By-Laws, or determined by the chairman of the meeting to be advisable, any
such vote need not be by ballot. On a vote by ballot, each ballot shall be
signed by the stockholder voting, or by his or her proxy, if there be such
proxy, and shall state the number of shares voted.
Section 9. Fixing of Record Date. The Board of Directors may set a record
---------------------
date for the purpose of determining stockholders entitled to vote at any meeting
of the stockholders. The record date, which may not be prior to the close of
business on the day the record date is fixed, shall be not more than 90 nor less
than ten days before the date of the meeting of the stockholders. All persons
who were holders of record of shares at such time, and not others, shall be
entitled to vote at such meeting and any adjournment thereof.
Section 10. Inspectors. The Board, in advance of any meeting of
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stockholders, may appoint one or more inspectors to act at such meeting or any
adjournment thereof. If the
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inspectors shall not be so appointed or if any of them shall fail to appear or
act, the chairman of the meeting may, and on the request of any stockholder
entitled to vote thereat shall, appoint inspectors. Each inspector, before
entering upon the discharge of his or her duties, shall take and sign an oath to
execute faithfully the duties of inspector at such meeting with strict
impartiality and according to the best of his or her ability. The inspectors
shall determine the number of shares outstanding and the voting powers of each,
the number of shares represented at the meeting, the existence of a quorum, and
the validity and effect of proxies, and shall receive votes, ballots or
consents, hear and determine all challenges and questions arising in connection
with the right to vote, count and tabulate all votes, ballots or consents,
determine the result, and do such acts as are proper to conduct the election or
vote with fairness to all stockholders. On request of the chairman of the
meeting or any stockholder entitled to vote thereat, the inspectors shall make a
report in writing of any challenge, request or matter determined by them and
shall execute a certificate of any fact found by them. No director or candidate
for the office of director shall act as inspector of an election of directors.
Inspectors need not be stockholders.
Section 11. Consent of Stockholders in Lieu of Meeting.
------------------------------------------
Except as otherwise provided by statute or the Charter, any action required to
be taken at any annual or special meeting of stockholders, or any action which
may be taken at any annual or
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special meeting of such stockholders, may be taken without a meeting, without
prior notice and without a vote, if the following are filed with the records of
stockholders' meetings: (i) a unanimous written consent which sets forth the
action and is signed by each stockholder entitled to vote on the matter and (ii)
a written waiver of any right to dissent signed by each stockholder entitled to
notice of the meeting but not entitled to vote thereat.
ARTICLE III.
Board of Directors
------------------
Section 1. General Powers. Except as otherwise provided in the Charter,
--------------
the business and affairs of the Corporation shall be managed under the direction
of the Board of Directors. All powers of the Corporation may be exercised by or
under authority of the Board of Directors except as conferred on or reserved to
the stockholders by law or by the Charter or these By-Laws.
Section 2. Number of Directors. The number of directors shall be fixed
-------------------
from time to time by resolution of the Board of Directors adopted by a majority
of the entire Board of Directors then in office; provided, however, that in no
event shall the number of directors be less than the minimum permitted by the
General Law of the State of Maryland nor more than 15. Any vacancy created by
an increase in the number of directors may be filled in accordance with Section
6 of this Article III. No reduction in the number of directors shall have the
effect of
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removing any director from office prior to the expiration of his or her term
unless such director specifically is removed pursuant to Section 5 of this
Article III at the time of such decrease. Directors need not be stockholders.
As long as any preferred stock of the Corporation is outstanding, the number of
directors shall be not less than five.
Section 3. Election and Term of Directors. Directors shall be elected
------------------------------
annually at a meeting of stockholders held for that purpose; provided, however,
that if no meeting of the stockholders of the Corporation is required to be held
in a particular year pursuant to Section 1 of Article II of these By-Laws,
directors shall be elected at the next meeting held. The term of office of each
director shall be from the time of his election and qualification until the
election of directors next succeeding his election and until his successor shall
have been elected and shall have qualified, or until his death, or until he
shall have resigned or until December 31 of the year in which he shall have
reached seventy-two years of age, or until he shall have been removed as
hereinafter provided in these By-Laws, or as otherwise provided by statute or by
the Charter.
Section 4. Resignation. A director of the Corporation may resign at any
-----------
time by giving written notice of his or her resignation to the Board or the
Chairman of the Board or the President or the Secretary. Any such resignation
shall take effect at the time specified therein or, if the time when it shall
become effective shall not be specified therein,
9
<PAGE>
immediately upon its receipt; and, unless otherwise specified therein, the
acceptance of such resignation shall not be necessary to make it effective.
Section 5. Removal of Directors. Any director of the Corporation may be
--------------------
removed (with or without cause) by the stockholders by a vote of sixty-six and
two-thirds percent
(66 2/3%) of the outstanding shares of capital stock then entitled to vote in
the election of such director.
Section 6. Vacancies. Subject to the provisions of the Investment Company
---------
Act, any vacancies in the Board of Directors, whether arising from death,
resignation, removal, an increase in the number of directors or any other cause,
shall be filled by a vote of a majority of the Board of Directors then in
office, regardless of whether they constitute a quorum.
Section 7. Place of Meetings. Meetings of the Board may be held at such
-----------------
place as the Board from time to time may determine or as shall be specified in
the notice of such meeting.
Section 8. Regular Meeting. Regular meetings of the Board may be held
---------------
without notice at such time and place as may be determined by the Board of
Directors.
Section 9. Special Meetings. Special meetings of the Board may be called
----------------
by two or more directors of the Corporation or by the Chairman of the Board or
the President.
Section 10. Telephone Meetings. Members of the Board of Directors or of
------------------
any committee thereof may participate in a meeting by means of a conference
telephone or similar
10
<PAGE>
communications equipment if all persons participating in the meeting can hear
each other at the same time. Subject to the provisions of the Investment
Company Act, participation in a meeting by these means constitutes presence in
person at the meeting.
Section 11. Notice of Special Meetings. Notice of each special meeting of
--------------------------
the Board shall be given by the Secretary as hereinafter provided, in which
notice shall be stated the time and place of the meeting. Notice of each such
meeting shall be delivered to each director, either personally or by telephone
or any standard form of telecommunication, at least 24 hours before the time at
which such meeting is to be held, or by first-class mail, postage prepaid,
addressed to him or her at his or her residence or usual place of business, at
least three days before the day on which such meeting is to be held.
Section 12. Waiver of Notice of Meetings. Notice of any special meeting
----------------------------
need not be given to any director who, either before or after the meeting, shall
sign a written waiver of notice which is filed with the records of the meeting
or who shall attend such meeting. Except as otherwise specifically required by
these By-Laws, a notice or waiver of notice of any meeting need not state the
purposes of such meeting.
Section 13. Quorum and Voting. One-third, but not less than two (unless
-----------------
there is only one director) of the members of the entire Board shall be present
in person at any meeting of the Board in order to constitute a quorum for the
transaction of
11
<PAGE>
business at such meeting, and except as otherwise expressly required by statute,
the Charter, these By-Laws, the Investment Company Act, or other applicable
statute, the act of a majority of the directors present at any meeting at which
a quorum is present shall be the act of the Board. In the absence of a quorum
at any meeting of the Board, a majority of the directors present thereat may
adjourn such meeting to another time and place until a quorum shall be present
thereat. Notice of the time and place of any such adjourned meeting shall be
given to the directors who were not present at the time of the adjournment and,
unless such time and place were announced at the meeting at which the
adjournment was taken, to the other directors. At any adjourned meeting at
which a quorum is present, any business may be transacted which might have been
transacted at the meeting as originally called.
Section 14. Organization. The Board, by resolution adopted by a majority
------------
of the entire Board, may designate a Chairman of the Board, who shall preside at
each meeting of the Board. In the absence or inability of the Chairman of the
Board to preside at a meeting, the President or, in his or her absence or
inability to act, another director chosen by a majority of the directors
present, shall act as chairman of the meeting and preside thereat. The
Secretary (or, in his or her absence or inability to act, any person appointed
by the Chairman) shall act as secretary of the meeting and keep the minutes
thereof.
12
<PAGE>
Section 15. Written Consent of Directors in Lieu of a Meeting. Subject to
----------------------------------------- -------
the provisions of the Investment Company Act, any action required or permitted
to be taken at any meeting of the Board of Directors or of any committee thereof
may be taken without a meeting if all members of the Board or the committee, as
the case may be, consent thereto in writing, and the writings or writing are
filed with the minutes of the proceedings of the Board or the committee.
Section 16. Compensation. Directors may receive compensation for services
------------
to the Corporation in their capacities as directors or otherwise in such manner
and in such amounts as may be fixed from time to time by the Board.
Section 17. Investment Policies. It shall be the duty of the Board of
-------------------
Directors to direct that the purchase, sale, retention and disposal of portfolio
securities and the other investment practices of the Corporation at all times
are consistent with the investment policies and restrictions with respect to
securities investments and otherwise of the Corporation, as recited in the
Prospectus of the Corporation included in the registration statement of the
Corporation relating to the initial public offering of its capital stock, as
filed with the Securities and Exchange Commission (or as such investment
policies and restrictions may be modified by the Board of Directors, or, if
required, by a majority vote of the stockholders of the Corporation in
accordance with the Investment Company Act) and as required by the Investment
Company Act. The
13
<PAGE>
Board, however, may delegate the duty of management of the assets and the
administration of its day to day operations to an individual or corporate
management company and/or investment adviser pursuant to a written contract or
contracts which have obtained the requisite approvals, including the requisite
approvals of renewals thereof, of the Board of Directors and/or the stockholders
of the Corporation in accordance with the provisions of the Investment Company
Act.
ARTICLE IV.
Committees
----------
Section 1. Executive Committee. The Board, by resolution adopted by a
-------------------
majority of the entire board, may designate an Executive Committee consisting of
two or more of the directors of the Corporation, which committee shall have and
may exercise all of the powers and authority of the Board with respect to all
matters other than:
(i) the submission to stockholders of any action requiring authorization
of stockholders pursuant to statute or the Charter;
(ii) the filling of vacancies on the Board of Directors;
(iii) the fixing of compensation of the directors for serving on the Board
or on any committee of the Board, including the Executive Committee;
(iv) the approval or termination of any contract with an investment adviser
or principal underwriter, as such terms
14
<PAGE>
are defined in the Investment Company Act, or the taking of any other
action required to be taken by the Board of Directors by the Investment
Company Act;
(v) the amendment or repeal of these By-Laws or the adoption of new By-
Laws;
(vi) the amendment or repeal of any resolution of the Board which by its
terms may be amended or repealed only by the Board;
(vii) the declaration of dividends and, except to the extent permitted by
law, the issuance of capital stock of the Corporation; and
(viii) the approval of any merger or share exchange which does not require
stockholder approval.
The Executive Committee shall keep written minutes of its proceedings and
shall report such minutes to the Board. All such proceedings shall be subject
to revision or alteration by the Board; provided, however, that third parties
shall not be prejudiced by such revision or alteration.
Section 2. Other Committees of the Board. The Board of Directors from
-----------------------------
time to time, by resolution adopted by a majority of the whole Board, may
designate one or more other committees of the Board, each such committee to
consist of two or more directors and to have such powers and duties as the Board
of Directors, by resolution, may prescribe.
Section 3. General. One-third, but not less than two, of the members of
-------
any committee shall be present in person at any
15
<PAGE>
meeting of such committee in order to constitute a quorum for the transaction of
business at such meeting, and the act of a majority present shall be the act of
such committee. The Board may designate a chairman of any committee and such
chairman or any two members of any committee may fix the time and place of its
meetings unless the Board shall otherwise provide. In the absence or
disqualification of any member of any committee, the member or members thereof
present at any meeting and not disqualified from voting, whether or not he or
she or they constitute a quorum, may unanimously appoint another member of the
Board of Directors to act at the meeting in the place of any such absent or
disqualified member. The Board shall have the power at any time to change the
membership of any committee, to fill all vacancies, to designate alternate
members to replace any absent or disqualified member, or to dissolve any such
committee. Nothing herein shall be deemed to prevent the Board from appointing
one or more committees consisting in whole or in part of persons who are not
directors of the Corporation; provided, however, that no such committee shall
have or may exercise any authority or power of the Board in the management of
the business or affairs of the Corporation except as may be prescribed by the
Board.
16
<PAGE>
ARTICLE V.
Officers, Agents and Employees
------------------------------
Section 1. Number of Qualifications. The officers of the Corporation
------------------------
shall be a President, who shall be a director of the Corporation, a Secretary
and a Treasurer, each of whom shall be elected by the Board of Directors. The
Board of Directors may elect or appoint one or more Vice Presidents and also may
appoint such other officers, agents and employees as it may deem necessary or
proper. Any two or more offices may be held by the same person, except the
offices of President and Vice President, but no officer shall execute,
acknowledge or verify any instrument in more than one capacity. Such officers
shall be elected by the Board of Directors each year at its first meeting held
after the annual meeting of stockholders, each to hold office until the next
meeting of the stockholders and until his or her successor shall have been duly
elected and shall have qualified, or until his or her death, or until he or she
shall have resigned, or have been removed, as hereinafter provided in these By-
Laws. The Board from time to time may elect such officers (including one or
more Assistant Vice Presidents, one or more Assistant Treasurers and one or more
Assistant Secretaries) and such agents, as may be necessary or desirable for the
business of the Corporation. The President also shall have the power to appoint
such assistant officers (including one or more Assistant Vice Presidents, one or
more Assistant Treasurers and one or more Assistant Secretaries) as may be
necessary or
17
<PAGE>
appropriate to facilitate the management of the Corporation's affairs. Such
officers and agents shall have such duties and shall hold their offices for such
terms as may be prescribed by the Board or by the appointing authority.
Section 2. Resignations. Any officer of the Corporation may resign at any
------------
time by giving written notice of resignation to the Board, the Chairman of the
Board, the President or the Secretary. Any such resignation shall take effect
at the time specified therein or, if the time when it shall become effective
shall not be specified therein, immediately upon its receipt; and, unless
otherwise specified therein, the acceptance of such resignation shall be
necessary to make it effective.
Section 3. Removal of Officer, Agent or Employee. Any officer, agent or
-------------------------------------
employee of the Corporation may be removed by the Board of Directors with or
without cause at any time, and the Board may delegate such power of removal as
to agents and employees not elected or appointed by the Board of Directors.
Such removal shall be without prejudice to such person's contract rights, if
any, but the appointment of any person as an officer, agent or employee of the
Corporation shall not of itself create contract rights.
Section 4. Vacancies. A vacancy in any office, whether arising from
---------
death, resignation, removal or any other cause, may be filled for the unexpired
portion of the term of the office which shall be vacant, in the manner
prescribed in these By-Laws for the regular election or appointment to such
office.
18
<PAGE>
Section 5. Compensation. The compensation of the officers of the
------------
Corporation shall be fixed by the Board of Directors, but this power may be
delegated to any officer in respect of other officers under his or her control.
Section 6. Bonds or Other Security. If required by the Board, any
-----------------------
officer, agent or employee of the Corporation shall give a bond or other
security for the faithful performance of his or her duties, in such amount and
with such surety or sureties as the Board may require.
Section 7. President. The President shall be the chief executive officer
---------
of the Corporation. In the absence of the Chairman of the Board (or if there be
none), the President shall preside at all meetings of the stockholders and of
the Board of Directors. He or she shall have, subject to the control of the
Board of Directors, general charge of the business and affairs of the
Corporation. He or she may employ and discharge employees and agents of the
Corporation, except such as shall be appointed by the Board, and he or she may
delegate these powers.
Section 8. Vice President. Each Vice President shall have such powers and
--------------
perform such duties as the Board of Directors or the President from time to time
may prescribe.
Section 9. Treasurer. The Treasurer shall:
---------
(i) have charge and custody of, and be responsible for, all of the funds
and securities of the Corporation, except those which the Corporation has
placed in the custody of a bank or trust company or member of a national
securities exchange
19
<PAGE>
(as that term is defined in the Securities Exchange Act of 1934, as
amended) pursuant to a written agreement designating such bank or trust
company or member of a national securities exchange as custodian of the
property of the Corporation;
(ii) keep full and accurate accounts of receipts and disbursements in
books belonging to the Corporation;
(iii) cause all moneys and other valuables to be deposited to the credit
of the Corporation;
(iv) receive, and give receipts for, moneys due and payable to the
Corporation from any source whatsoever;
(v) disburse the funds of the Corporation and supervise the investment of
its funds as ordered or authorized by the Board, taking proper vouchers
therefor; and
(vi) in general, perform all of the duties incident to the office of
Treasurer and such other duties as from time to time may be assigned to him
or her by the Board or the President.
Section 10. Secretary. The Secretary shall:
---------
(i) keep or cause to be kept in one or more books provided for the
purpose, the minutes of all meetings of the Board, the committees of the
Board and the stockholders;
(ii) see that all notices are duly given in accordance with the provisions
of these By-Laws and as required by law;
20
<PAGE>
(iii) be custodian of the records and the seal of the Corporation and
affix and attest the seal to all stock certificates of the Corporation
(unless the seal of the Corporation on such certificates shall be a
facsimile, as hereinafter provided) and affix and attest the seal to all
other documents to be executed on behalf of the Corporation under its seal;
(iv) see that the books, reports, statements, certificates and other
documents and records required by law to be kept and filed are properly
kept and filed; and
(v) in general, perform all of the duties incident to the office of
Secretary and such other duties as from time to time may be assigned to him
or her by the Board or the President.
Section 11. Delegation of Duties. In case of the absence of any officer
--------------------
of the Corporation, or for any other reason that the Board may deem sufficient,
the Board may confer for the time being the powers or duties, or any of them, of
such officer upon any other officer or upon any director.
ARTICLE VI.
Indemnification
---------------
Section 1. General Indemnification. Each officer and director of the
-----------------------
Corporation shall be indemnified by the Corporation to the full extent permitted
under the General Laws of the State of Maryland, except that such indemnity
shall not
21
<PAGE>
protect any such person against any liability to the Corporation or any
stockholder thereof to which such person otherwise would be subject by reason of
willful misfeasance, bad faith, gross negligence or reckless disregard of the
duties involved in the conduct of his or her office. Absent a court
determination that an officer or director seeking indemnification was not liable
on the merits or guilty of willful misfeasance, bad faith, gross negligence or
reckless disregard of the duties involved in the conduct of his or her office,
the decision by the Corporation to indemnify such person must be based upon the
reasonable determination of independent legal counsel or the vote of a majority
of a quorum of the directors who are neither "interested persons," as defined in
Section 2(a)(19) of the Investment Company Act, nor parties to the proceeding
("non-party independent directors"), after review of the facts, that such
officer or director is not guilty of willful misfeasance, bad faith, gross
negligence or reckless disregard of the duties involved in the conduct of his or
her office.
Each officer and director of the Corporation claiming indemnification
within the scope of this Article VI shall be entitled to advances from the
Corporation for payment of the reasonable expenses incurred by him or her in
connection with proceedings to which he or she is a party in the manner and to
the full extent permitted under the General Laws of the State of Maryland;
provided, however, that the person seeking indemnification shall provide to the
Corporation a written
22
<PAGE>
affirmation of his or her good faith belief that the standard of conduct
necessary for indemnification by the Corporation has been met and a written
undertaking to repay any such advance, if it ultimately should be determined
that the standard of conduct has not been met, and provided further that at
least one of the following additional conditions is met:
(i) the person seeking indemnification shall provide a security in form and
amount acceptable to the Corporation for his or her undertaking;
(ii) the Corporation is insured against losses arising by reason of the
advance; or
(iii) a majority of a quorum of non-party independent directors, or
independent legal counsel in a written opinion shall determine, based on a
review of facts readily available to the Corporation at the time the
advance is proposed to be made, that there is reason to believe that the
person seeking indemnification will ultimately be found to be entitled to
indemnification.
The Corporation may purchase insurance on behalf of an officer or director
protecting such person to the full extent permitted under the General Laws of
the State of Maryland, from liability arising from his or her activities as an
officer or director of the Corporation. The Corporation, however, may not
purchase insurance on behalf of any officer or director of the Corporation that
protects or purports to protect such person from liability to the Corporation or
to its stockholders to which such
23
<PAGE>
officer or director otherwise would be subject by reason of willful misfeasance,
bad faith, gross negligence, or reckless disregard of the duties involved in the
conduct of his or her office.
The Corporation may indemnify, make advances or purchase insurance to the
extent provided in this Article VI on behalf of an employee or agent who is not
an officer or director of the Corporation.
Section 2. Other Rights. The indemnification provided by this Article VI
------------
shall not be deemed exclusive of any other right, in respect of indemnification
or otherwise, to which those seeking such indemnification may be entitled under
any insurance or other agreement, vote of stockholders or disinterested
directors or otherwise, both as to action by a director or officer of the
Corporation in his or her official capacity and as to action by such person in
another capacity while holding such office or position, and shall continue as to
a person who has ceased to be a director or officer and shall inure to the
benefit of the heirs, executors and administrators of such person.
ARTICLE VII.
Capital Stock
-------------
Section 1. Stock Certificates. Each holder of stock of the Corporation
------------------
shall be entitled upon request to have a certificate or certificates, in such
form as shall be approved by the Board, representing the number of shares of
stock of the Corporation
24
<PAGE>
owned by him or her, provided, however, that certificates for fractional shares
will not be delivered in any case. The certificates representing shares of
stock shall be signed by or in the name of the Corporation by the President or a
Vice President and by the Secretary or an Assistant Secretary or the Treasurer
or an Assistant Treasurer and sealed with the seal of the Corporation. Any or
all of the signatures or the seal on the certificate may be a facsimile. In
case any officer, transfer agent or registrar who has signed or whose facsimile
signature has been placed upon a certificate shall have ceased to be such
officer, transfer agent or registrar before such certificate shall be issued, it
may be issued by the Corporation with the same effect as if such officer,
transfer agent or registrar were still in office at the date of issue.
Section 2. Books of Account and Record of Stockholders. There shall be
-------------------------------------------
kept at the principal executive office of the Corporation correct and complete
books and records of account of all the business and transactions of the
Corporation.
Section 3. Transfers of Shares. Transfers of shares of stock of the
-------------------
Corporation shall be made on the stock records of the Corporation only by the
registered holder thereof, or by his or her attorney thereunto authorized by
power of attorney duly executed and filed with the Secretary or with a transfer
agent or transfer clerk, and on surrender of the certificate or certificates, if
issued, for such shares properly endorsed or accompanied by a duly executed
stock transfer power and the
25
<PAGE>
payment of all taxes thereon. Except as otherwise provided by law, the
Corporation shall be entitled to recognize the exclusive right of a person in
whose name any share or shares stand on the record of stockholders as the owner
of such share or shares for all purposes, including, without limitation, the
rights to receive dividends or other distributions, and to vote as such owner,
and the Corporation shall not be bound to recognize any equitable or legal claim
to or interest in any such share or shares on the part of any other person.
Section 4. Regulations. The Board may make such additional rules and
-----------
regulations, not inconsistent with these By-Laws, as it may deem expedient
concerning the issue, transfer and registration of certificates for shares of
stock of the Corporation. It may appoint, or authorize any officer or officers
to appoint, one or more transfer agents or one or more transfer clerks and one
or more registrars and may require all certificates for shares of stock to bear
the signature or signatures of any of them.
Section 5. Lost, Destroyed or Mutilated Certificates. The holder of any
-----------------------------------------
certificates representing shares of stock of the Corporation immediately shall
notify the Corporation of any loss, destruction or mutilation of such
certificate, and the Corporation may issue a new certificate of stock in the
place of any certificate theretofore issued by it which the owner thereof shall
allege to have been lost or destroyed or which shall have been mutilated, and
the Board, in its discretion, may require
26
<PAGE>
such owner or his or her legal representatives to give to the Corporation a bond
in such sum, limited or unlimited, and in such form and with such surety or
sureties, as the Board in its absolute discretion shall determine, to indemnify
the Corporation against any claim that may be made against it on account of the
alleged loss or destruction of any such certificate, or issuance of a new
certificate. Anything herein to the contrary notwithstanding, the Board, in its
absolute discretion, may refuse to issue any such new certificate, except
pursuant to legal proceedings under the laws of the State of Maryland.
Section 6. Fixing of a Record Date for Dividends and Distributions. The
----------------------------------------- -------------
Board may fix, in advance, a date not more than 90 days preceding the date fixed
for the payment of any dividend or the making of any distribution or the
allotment of rights to subscribe for securities of the Corporation, or for the
delivery of evidences of rights or evidences of interests arising out of any
change, conversion or exchange of common stock or other securities, as the
record date for the determination of the stockholders entitled to receive any
such dividend, distribution, allotment, rights or interests, and in such case
only the stockholders of record at the time so fixed shall be entitled to
receive such dividend, distribution, allotment, rights or interests.
Section 7. Information to Stockholders and Others. Any stockholder of the
--------------------------------------
Corporation or his or her agent may inspect and copy during usual business hours
the Corporation's By-Laws,
27
<PAGE>
minutes of the proceedings of its stockholders, annual statements of its
affairs, and voting trust agreements on file at its principal office.
ARTICLE VIII.
Seal
----
The seal of the Corporation shall be circular in form and shall bear, in
addition to any other emblem or device approved by the Board of Directors, the
name of the Corporation, the year of its incorporation and the words "Corporate
Seal" and "Maryland". Said seal may be used by causing it or a facsimile
thereof to be impressed or affixed or in any other manner reproduced.
ARTICLE IX.
Fiscal Year
-----------
Unless otherwise determined by the Board, the fiscal year of the
Corporation shall end on the 30th day of April.
ARTICLE X.
Depositories and Custodians
---------------------------
Section 1. Depositories. The funds of the Corporation shall be deposited
------------
with such banks or other depositories as the Board of Directors of the
Corporation from time to time may determine.
Section 2. Custodians. All securities and other investments shall be
----------
deposited in the safekeeping of such banks
28
<PAGE>
or other companies as the Board of Directors of the Corporation from time to
time may determine. Every arrangement entered into with any bank or other
company for the safekeeping of the securities and investments of the Corporation
shall contain provisions complying with the Investment Company Act, and the
general rules and regulations thereunder.
ARTICLE XI.
Execution of Instruments
------------------------
Section 1. Checks, Notes, Drafts, etc. Checks, notes, drafts,
--------------------------
acceptances, bills of exchange and other orders or obligations for the payment
of money shall be signed by such officer or officers or person or persons as the
Board of Directors by resolution from time to time shall designate.
Section 2. Sale or Transfer of Securities. Stock certificates, bonds or
------------------------------
other securities at any time owned by the Corporation may be held on behalf of
the Corporation or sold, transferred or otherwise disposed of subject to any
limits imposed by these By-Laws and pursuant to authorization by the Board and,
when so authorized to be held on behalf of the Corporation or sold, transferred
or otherwise disposed of, may be transferred from the name of the Corporation by
the signature of the President or a Vice President or the Treasurer or pursuant
to any procedure approved by the Board of Directors, subject to applicable law.
29
<PAGE>
ARTICLE XII.
Independent Public Accountants
------------------------------
The firm of independent public accountants which shall sign or certify
the financial statements of the Corporation which are filed with the Securities
and Exchange Commission shall be selected annually by the Board of Directors and
ratified by the stockholders in accordance with the provisions of the Investment
Company Act.
ARTICLE XIII.
Annual Statement
----------------
The books of account of the Corporation shall be examined by an
independent firm of public accountants at the close of each annual period of the
Corporation and at such other times as may be directed by the Board. A report
to the stockholders based upon each such examination shall be mailed to each
stockholder of record of the Corporation on such date with respect to each
report as may be determined by the Board, at his or her address as the same
appears on the books of the Corporation. Such annual statement also shall be
available at the annual meeting of stockholders and shall be placed on file at
the Corporation's principal office in the State of Maryland, and if no annual
meeting is held pursuant to Article II, Section 1, such annual statement of
affairs shall be placed on file as the Corporation's principal office within 120
days after the end of the Corporation's fiscal year. Each such report shall
show the
30
<PAGE>
assets and liabilities of the Corporation as of the close of the period covered
by the report and the securities in which the funds of the Corporation then were
invested. Such report also shall show the Corporation's income and expenses for
the period from the end of the Corporation's preceding fiscal year to the close
of the period covered by the report and any other information required by the
Investment Company Act, and shall set forth such other matters as the Board or
such firm of independent public accountants shall determine.
ARTICLE XIV.
Amendments
----------
These By-Laws or any of them may be amended, altered or repealed by
the affirmative vote of a majority of the Board of Directors. The stockholders
shall have no power to make, amend, alter or repeal By-Laws.
31
<PAGE>
EXHIBIT (d)(2)
COMMON STOCK COMMON STOCK
PAR VALUE $.10 PAR VALUE $.10
CUSIP
See Reverse For Certain
Definitions
INCORPORATED UNDER THE LAWS OF THE STATE OF MARYLAND
MUNIHOLDINGS CALIFORNIA FUND, INC.
This certifies that
is the registered holder of
FULLY PAID AND NON-ASSESSABLE SHARES OF COMMON STOCK OF MuniHoldings
California Fund, Inc. transferable on the books of the Corporation by the holder
in person or by duly authorized attorney upon surrender of this Certificate
properly endorsed. This Certificate and the shares represented hereby are issued
and shall be subject to all of the provisions of the Articles of Incorporation
and of the By-Laws of the Corporation, and of all the amendments from time to
time made thereto. This Certificate is not valid unless countersigned and
registered by the Transfer Agent and Registrar.
Witness the facsimile seal of the Corporation and the facsimile
signatures of its duly authorized officers.
Dated:
President Secretary
Countersigned and Registered:
THE BANK OF NEW YORK
Transfer Agent and Registrar
Authorized Signature
<PAGE>
MUNIHOLDINGS CALIFORNIA FUND, INC.
The Corporation has the authority to issue stock of more than one class. A
full statement of the designations and any preferences, conversion and other
rights, voting powers, restrictions, limitations as to dividends, qualifications
and terms and conditions of redemption of the shares of each class of stock
which the Corporation is authorized to issue and the differences in the relative
rights and preferences between the shares of each class to the extent that they
have been set, and the authority of the Board of Directors to set the relative
rights and preferences of subsequent classes and series, will be furnished by
the Corporation to any stockholder, without charge, upon request to the
Secretary of the Corporation.
The following abbreviations, when used in the inscription on the face of
this certificate, shall be construed as though they were written out in full
according to applicable laws or regulations:
TEN COM--as tenants in common UNIF GIFT MIN ACT--
_______Custodian_______
(Cust) (Minor)
TEN ENT--as tenants by the entireties under Uniform Gifts to
Minors Act _________
(State)
JT TEN --as joint tenants with right
of survivorship and not as
tenants in common
Additional abbreviations may also be used though not in the above list.
For value received,................. hereby sell, assign and transfer unto
PLEASE INSERT SOCIAL SECURITY OR OTHER
IDENTIFYING NUMBER OF ASSIGNEE
[ ]
________________________________
_________________________________________________________________________
Please print or typewrite name and address including zip code of assignee
_________________________________________________________________________
_________________________________________________________________________
__________________________________________________________________Shares
represented by the within Certificate, and do hereby irrevocably
constitute and appoint___________________________________________________
_________________________________________________________________________
<PAGE>
Attorney to transfer the said shares on the books of the within-named
Corporation with full power of substitution in the premises.
Dated:__________________
Signature:___________________________________
NOTICE: The signature to this assignment must correspond with the
name as written upon the face of the certificate, in every
particular, without alteration or enlargement, or any change
whatever.
Signature Guaranteed:____________________________________
- --------------------------------------------------------------------------------
Signatures must be guaranteed by an "eligible guarantor institution" as such
term is defined in Rule 17Ad-15 under the Securities Exchange Act of 1934.
- --------------------------------------------------------------------------------
<PAGE>
EXHIBIT (e)
MUNIHOLDINGS CALIFORNIA FUND, INC.
TERMS AND CONDITIONS OF
AUTOMATIC DIVIDEND REINVESTMENT PLAN
1. Appointment of Agent. You, __________, will act as Agent for me, and
--------------------
will open an account for me under the Dividend Reinvestment Plan (the "Plan") in
the same name as my present shares of common stock, par value $.10 per share
("Common Stock"), of MUNIHOLDINGS CALIFORNIA FUND, INC. (the "Fund") are
registered, and will automatically put into effect for me the dividend
reinvestment option of the Plan as of the first record date for a dividend or
capital gains distribution (collectively referred to herein as a "dividend"),
payable at the election of shareholders in cash or shares of Common Stock.
2. Dividends Payable in Common Stock. My participation in the Plan
---------------------------------
constitutes an election by me to receive dividends in shares of Common Stock
whenever the Fund declares a dividend. In such event, the dividend amount shall
automatically be made payable to me entirely in shares of Common Stock which
shall be acquired by the Agent for my account, depending upon the circumstances
described in paragraph 3, either (i) through receipt of additional shares of
unissued but authorized shares of Common Stock from the Fund ("newly-issued
shares") as described in paragraph 6 or (ii) by purchase of outstanding shares
of Common Stock on the open market ("open-market purchases") as described in
paragraph 7.
3. Determination of Whether Newly-Issued Shares or Open-Market Purchases.
---------------------------------------------------------------------
If on the payment date for the dividend (the "valuation date"), the net asset
value per share of the Common Stock, as defined in paragraph 8, is equal to or
less than the market price per share of the Common Stock, as defined in
paragraph 8, plus estimated brokerage commissions (such condition being referred
to herein as "market premium"), the Agent shall invest the dividend amount in
newly-issued shares on my behalf as described in paragraph 6. If on the
valuation date, the net asset value per share is greater than the market value
(such condition being referred to herein as "market discount"), the Agent shall
invest the dividend amount in shares acquired on my behalf in open-market
purchases as described in paragraph 7.
4. Purchase Period for Open-Market Purchases. In the event of a market
-----------------------------------------
discount on the valuation date, the Agent shall have until the last business day
before the next ex-dividend date with respect to the shares of Common Stock or
in no event more than 30 days after the valuation date (the "last purchase
date") to invest the dividend amount in shares acquired in open-market purchases
except where temporary curtailment or suspension of purchases is necessary to
comply with applicable provisions of federal securities laws.
<PAGE>
5. Failure to Complete Open-Market Purchases During Purchase Period. If
------------------------------------------------- ---------------
the Agent is unable to invest the full dividend amount in open-market
purchases during the purchase period because the market discount has shifted
to a market premium or otherwise, the Agent will invest the uninvested
portion of the dividend amount in newly-issued shares at the close of business
on the last purchase date as described in paragraph 4; except that the Agent may
not acquire newly-issued shares after the valuation date under the foregoing
circumstances unless it has received a legal opinion that registration of such
shares is not required under the Securities Act of 1933, as amended, or unless
the shares to be issued are registered under such Act.
6. Acquisition of Newly-Issued Shares. In the event that all or part of
----------------------------------
the dividend amount is to be invested in newly-issued shares, you shall
automatically receive such newly-issued shares of Common Stock, including
fractions, for my account, and the number of additional newly-issued shares of
Common Stock to be credited to my account shall be determined by dividing the
dollar amount of the dividend on my shares to be invested in newly-issued shares
by the net asset value per share of Common Stock on the date the shares are
issued (the valuation date in the case of an initial market premium or the last
purchase date in case the Agent is unable to complete open-market purchases
during the purchase period); provided, that the maximum discount from the then
current market price per share on the date of issuance shall not exceed 5%.
7. Manner of Making Open-Market Purchases. In the event that the
--------------------------------------
dividend amount is to be invested in shares of Common Stock acquired in open-
market purchases, you shall apply the amount of such dividend on my shares
(less my pro rata share of brokerage commissions incurred with respect to your
open-market purchases) to the purchase on the open-market of shares of the
Common Stock for my account. Open-market purchases may be made on any
securities exchange where the Common Stock is traded, in the over-the-counter
market or in negotiated transactions and may be on such terms as to price,
delivery and otherwise as you shall determine. My funds held by you uninvested
will not bear interest, and it is understood that, in any event, you shall have
no liability in connection with any inability to purchase shares within 30 days
after the initial date of such purchase as herein provided, or with the timing
of any purchases affected. You shall have no responsibility as to the value of
the Common Stock acquired for my account. For the purposes of cash investments
you may commingle my funds with those of other shareholders of the Fund for whom
you similarly act as Agent, and the average price (including brokerage
commissions) of all shares purchased by you as Agent in the open market shall be
the price per share allocable to me in connection with open-market purchases.
2
<PAGE>
8. Meaning of Market Price and Net Asset Value. For all purposes of the
-------------------------------------------
Plan: (a) the market price of the Common Stock on a particular date shall be the
last sales price on the New York Stock Exchange (the "Exchange") on that date,
or, if there is no sale on the Exchange on that date, then the mean between the
closing bid and asked quotations for such stock on the Exchange on such date and
(b) net asset value per share of the Common Stock on a particular date shall be
as determined by or on behalf of the Fund.
9. Registration of Shares Acquired Pursuant to the Plan. You may hold my
----------------------------------------------------
shares of Common Stock acquired pursuant to the Plan, together with the shares
of other shareholders of the Fund acquired pursuant to the Plan, in
noncertificated form in your name or that of your nominee. You will forward to
me any proxy solicitation material and will vote any shares so held for me only
in accordance with the proxy returned by me to the Fund. Upon my written
request, you will deliver to me, without charge, a certificate or certificates
for the full shares held by you for my account.
10. Confirmations. You will confirm to me each acquisition made for my
-------------
account as soon as practicable but not later than 60 days after the date
thereof.
11. Fractional Interests. Although I may from time to time have an
--------------------
undivided fractional interest (computed to three decimal places) in a share of
the Fund, no certificates for a fractional share will be issued. However,
dividends and distributions on fractional shares will be credited to my account.
In the event of termination of my account under the Plan, you will adjust for
any such undivided fractional interest in cash at the market value of the Fund's
shares at the time of termination less the pro rata expense of any sale required
to make such an adjustment.
12. Stock Dividends or Share Purchase Rights. Any stock dividends or
----------------------------------------
split shares distributed by the Fund on shares held by you for me will be
credited to my account. In the event that the Fund makes available to its
shareholders rights to purchase additional shares or other securities, the
shares held for me under the Plan will be added to other shares held by me in
calculating the number of rights to be issued to me.
13. Service Fee. Your service fee for handling capital gains
-----------
distributions or income dividends will be paid by the Fund. I will be charged
for my pro rata share of brokerage commissions on all open market purchases.
14. Termination of Account. I may terminate my account under the Plan by
----------------------
notifying you in writing. Such termination will be effective immediately if my
notice is received by you not less than ten days prior to any dividend or
distribution record
3
<PAGE>
date; otherwise such termination will be effective on the first trading day
after the payment date for such dividend or distribution with respect to any
subsequent dividend or distribution. The Plan may be terminated by you or the
Fund upon notice in writing mailed to me at least 90 days prior to any record
date for the payment of any dividend or distribution by the Fund. Upon any
termination you will cause a certificate or certificates for the full shares
held for me under the Plan and cash adjustment for any fraction to be delivered
to me without charge. If I elect by notice to you in writing in advance of such
termination to have you sell part or all of my shares and remit the proceeds to
me, you are authorized to deduct brokerage commissions for this transaction from
the proceeds.
15. Amendment of Plan. These terms and conditions may be amended or
-----------------
supplemented by you or the Fund at any time or times but, except when necessary
or appropriate to comply with applicable law or the rules or policies of the
Securities and Exchange Commission or any other regulatory authority, only by
mailing to me appropriate written notice at least 90 days prior to the effective
date thereof. The amendment or supplement shall be deemed to be accepted by me
unless, prior to the effective date, thereof, you receive written notice of the
termination of my account under the Plan. Any such amendment may include an
appointment by you in your place and stead of a successor Agent under these
terms and conditions, with full power and authority to perform all or any of the
acts to be performed by the Agent under these terms and conditions. Upon any
such appointment of an Agent for the purpose of receiving dividends and
distributions, the Fund will be authorized to pay to such successor Agent, for
my account, all dividends and distributions payable on Common Stock of the Fund
held in my name or under the Plan for retention or application by such successor
Agent as provided in these terms and conditions.
16. Extent of Responsibility of Agent. You shall at all times act in good
---------------------------------
faith and agree to use your best efforts within reasonable limits to insure the
accuracy of all services performed under this Agreement and to comply with
applicable law, but assume no responsibility and shall not be liable for loss or
damage due to errors unless such error is caused by your negligence, bad faith,
or willful misconduct or that of your employees.
17. Governing Law. These terms and conditions shall be governed by the
-------------
laws of the State of New York without regard to its conflicts of laws
provisions.
4
<PAGE>
EXHIBIT (g)
INVESTMENT ADVISORY AGREEMENT
AGREEMENT, made as of the th day of , 1998, by and between
MUNIHOLDINGS CALIFORNIA FUND, INC., a Maryland corporation (the "Fund"), and
FUND ASSET MANAGEMENT, L.P., a Delaware limited partnership (the "Investment
Adviser").
W I T N E S S E T H:
----------------------------
WHEREAS, the Fund is engaged in business as a closed-end, non-diversified,
management investment company registered under the Investment Company Act of
1940, as amended (the "Investment Company Act"); and
WHEREAS, the Investment Adviser is engaged principally in rendering
management and investment advisory services and is registered as an investment
adviser under the Investment Advisers Act of 1940, as amended; and
WHEREAS, the Fund desires to retain the Investment Adviser to provide
management and investment advisory services to the Fund in the manner and on the
terms hereinafter set forth; and
WHEREAS, the Investment Adviser is willing to provide management and
investment advisory services to the Fund on the terms and conditions hereinafter
set forth;
NOW, THEREFORE, in consideration of the premises and the covenants
hereinafter contained, the Fund and the Investment Adviser hereby agree as
follows:
<PAGE>
ARTICLE I
---------
Duties of the Investment Adviser
--------------------------------
The Fund hereby employs the Investment Adviser to act as investment adviser
of the Fund and to furnish, or arrange for its affiliates to furnish, the
investment advisory services described below, subject to the policies of, review
by and overall control of the Board of Directors of the Fund, for the period and
on the terms and conditions set forth in this Agreement. The Investment Adviser
hereby accepts such employment and agrees during such period, at its own
expense, to render, or arrange for the rendering of, such services and to assume
the obligations herein set forth for the compensation provided for herein. The
Investment Adviser and its affiliates for all purposes herein shall be deemed to
be independent contractors and, unless otherwise expressly provided or
authorized, shall have no authority to act for or represent the Fund in any way
or otherwise be deemed agents of the Fund.
(a) Administrative Services. The Investment Adviser shall perform, or
-----------------------
arrange for its affiliates to perform, the management and administrative
services necessary for the operation of the Fund, including administering
shareholder accounts and handling shareholder relations pursuant to an
Administration Agreement of even date herewith.
(b) Investment Advisory Services. The Investment Adviser shall provide,
----------------------------
or arrange for its affiliates to provide, the Fund with such investment
research, advice and supervision as the
2
<PAGE>
latter from time to time may consider necessary for the proper supervision of
the assets of the Fund, shall furnish continuously an investment program for the
Fund and shall determine from time to time which securities shall be purchased,
sold or exchanged and what portion of the assets of the Fund shall be held in
the various securities in which the Fund invests, options, futures, options on
futures or cash, subject always to the restrictions of the Articles of
Incorporation and the By-Laws of the Fund, as amended from time to time, the
provisions of the Investment Company Act and the statements relating to the
Fund's investment objective, investment policies and investment restrictions as
the same are set forth in filings made by the Fund under the Federal securities
laws. The Investment Adviser shall make decisions for the Fund as to the manner
in which voting rights, rights to consent to corporate action and any other
rights pertaining to the Fund's portfolio securities shall be exercised. Should
the Board of Directors at any time, however, make any definite determination as
to investment policy and notify the Investment Adviser thereof in writing, the
Investment Adviser shall be bound by such determination for the period, if any,
specified in such notice or until similarly notified that such determination has
been revoked. The Investment Adviser shall take, on behalf of the Fund, all
actions which it deems necessary to implement the investment policies determined
as provided above, and in particular to place all orders for the purchase or
sale of portfolio securities for the Fund's account with brokers or
3
<PAGE>
dealers selected by it, and to that end, the Investment Adviser is authorized as
the agent of the Fund to give instructions to the custodian of the Fund as to
deliveries of securities and payments of cash for the account of the Fund. In
connection with the selection of such brokers or dealers and the placing of such
orders with respect to assets of the Fund, the Investment Adviser is directed at
all times to seek to obtain execution and prices within the policy guidelines
determined by the Board of Directors and set forth in filings made by the Fund
under the Federal securities laws. Subject to this requirement and the
provisions of the Investment Company Act, the Securities Exchange Act of 1934,
as amended, and other applicable provisions of law, the Investment Adviser may
select brokers or dealers with which it or the Fund is affiliated.
(c) Notice Upon Change in Partners of the Investment Adviser. The
--------------------------------------------------------
Investment Adviser is a limited partnership and its limited partner is Merrill
Lynch & Co., Inc. and its general partner is Princeton Services, Inc. The
Investment Adviser will notify the Fund of any change in the membership of the
partnership within a reasonable time after such change.
ARTICLE II
----------
Allocation of Charges and Expenses
----------------------------------
(a) The Investment Adviser. The Investment Adviser shall provide the
----------------------
staff and personnel necessary to perform its obligations under this Agreement,
shall assume and pay or cause
4
<PAGE>
to be paid all expenses incurred in connection with the maintenance of such
staff and personnel, and, at its own expense, shall provide the office space,
facilities, equipment and necessary personnel which it is obligated to provide
under Article I hereof, and shall pay all compensation of officers of the Fund
and all Directors of the Fund who are affiliated persons of the Investment
Adviser.
(b) The Fund. The Fund assumes, and shall pay or cause to be paid, all
--------
other expenses of the Fund including, without limitation: taxes, expenses for
legal and auditing services, costs of printing proxies, stock certificates,
shareholder reports and prospectuses, charges of the custodian, any sub-
custodian and transfer agent, charges of any auction agent and broker dealers in
connection with preferred stock of the Fund, expenses of portfolio transactions,
Securities and Exchange Commission fees, expenses of registering the shares of
common stock and preferred stock under Federal, state and foreign laws, fees and
actual out-of-pocket expenses of Directors who are not affiliated persons of the
Investment Adviser, accounting and pricing costs (including the daily
calculation of the net asset value), insurance, interest, brokerage costs,
litigation and other extraordinary or nonrecurring expenses, and other expenses
properly payable by the Fund. It also is understood that the Fund will
reimburse the Investment Adviser for its costs incurred in providing accounting
services to the Fund.
5
<PAGE>
ARTICLE III
-----------
Compensation of the Investment Adviser
--------------------------------------
(a) Investment Advisory Fee. For the services rendered, the
-----------------------
facilities furnished and the expenses assumed by the Investment Adviser, the
Fund shall pay to the Investment Adviser at the end of each calendar month a fee
based upon the average weekly value of the net assets of the Fund at the annual
rate of 0.55% of 1.0% (0.55%) of the average weekly net assets of the Fund
(i.e., the average weekly value of the total assets of the Fund, minus the sum
of accrued liabilities of the Fund and accumulated dividends on shares of
outstanding preferred stock), commencing on the day following effectiveness
hereof. For purposes of this calculation, average weekly net assets are
determined at the end of each month on the basis of the average net assets of
the Fund for each week during the month. The assets for each weekly period are
determined by averaging the net assets at the last business day of a week with
the net assets at the last business day of the prior week. It is understood
that the liquidation preference of any outstanding preferred stock (other than
accumulated dividends) is not considered a liability in determining the Fund's
average weekly net assets. If this Agreement becomes effective subsequent to
the first day of a month or shall terminate before the last day of a month,
compensation for that part of the month this Agreement is in effect shall be
prorated in a manner consistent with the calculation of the fee as set forth
above. Subject to the
6
<PAGE>
provisions of subsection (b) hereof, payment of the Investment Adviser's
compensation for the preceding month shall be made as promptly as possible after
completion of the computations contemplated by subsection (b) hereof. During
any period when the determination of net asset value is suspended by the Board
of Directors, the average net asset value of a share for the last week prior to
such suspension for this purpose shall be deemed to be the net asset value at
the close of each succeeding week until it is again determined.
(b) Expense Limitations. In the event the operating expenses of the
-------------------
Fund, including amounts payable to the Investment Adviser pursuant to subsection
(a) hereof, for any fiscal year ending on a date on which this Agreement is in
effect exceed the expense limitations applicable to the Fund imposed by
applicable state securities laws or regulations thereunder, as such limitations
may be raised or lowered from time to time, the Investment Adviser shall reduce
its investment advisory fee by the extent of such excess and, if required
pursuant to any such laws or regulations, will reimburse the Fund in the amount
of such excess; provided, however, to the extent permitted by law, there shall
-------- -------
be excluded from such expenses the amount of any interest, taxes, distribution
fees, brokerage fees and commissions and extraordinary expenses (including but
not limited to legal claims and liabilities and litigation costs and any
indemnification related thereto) paid or payable by the Fund. Whenever the
expenses of the Fund exceed a pro rata portion of
7
<PAGE>
the applicable annual expense limitations, the estimated amount of reimbursement
under such limitations shall be applicable as an offset against the monthly
payment of the fee due to the Investment Adviser. Should two or more such
expense limitations be applicable as at the end of the last business day of the
month, that expense limitation which results in the largest reduction in the
Investment Adviser's fee shall be applicable.
ARTICLE IV
----------
Limitation of Liability of the Investment Adviser
-------------------------------------------------
The Investment Adviser shall not be liable for any error of judgment
or mistake of law or for any loss arising out of any investment or for any act
or omission in the management of the Fund, except for willful misfeasance, bad
faith or gross negligence in the performance of its duties, or by reason of
reckless disregard of its obligations and duties hereunder. As used in this
Article IV, the term "Investment Adviser" shall include any affiliates of the
Investment Adviser performing services for the Fund contemplated hereby and
directors, officers and employees of the Investment Adviser and of such
affiliates.
ARTICLE V
---------
Activities of the Investment Adviser
------------------------------------
The services of the Investment Adviser to the Fund are not to be
deemed to be exclusive; the Investment Adviser and any person controlled by or
under common control with the Investment
8
<PAGE>
Adviser (for purposes of this Article V referred to as "affiliates") are free to
render services to others. It is understood that Directors, officers, employees
and shareholders of the Fund are or may become interested in the Investment
Adviser and its affiliates, as directors, officers, employees, partners and
shareholders or otherwise, and that directors, officers, employees, partners and
shareholders of the Investment Adviser and of its affiliates are or may become
similarly interested in the Fund, and that the Investment Adviser and directors,
officers, employees, partners and shareholders of its affiliates may become
interested in the Fund as shareholders or otherwise.
ARTICLE VI
----------
Duration and Termination of this Agreement
------------------------------------------
This Agreement shall become effective as of the date first above
written and shall remain in force until _______________ and thereafter, but only
so long as such continuance specifically is approved at least annually by (i)
the Board of Directors of the Fund, or by the vote of a majority of the
outstanding voting securities of the Fund, and (ii) by the vote of a majority of
those Directors who are not parties to this Agreement or interested persons of
any such party cast in person at a meeting called for the purpose of voting on
such approval.
This Agreement may be terminated at any time, without the payment of
any penalty, by the Board of Directors or by vote of a
9
<PAGE>
majority of the outstanding voting securities of the Fund, or by the Investment
Adviser, on sixty (60) days' written notice to the other party. This Agreement
shall terminate automatically in the event of its assignment.
ARTICLE VII
-----------
Amendment of this Agreement
---------------------------
This Agreement may be amended by the parties only if such amendment
specifically is approved by the vote of (i) a majority of the outstanding voting
securities of the Fund, and (ii) a majority of those Directors who are not
parties to this Agreement or interested persons of any such party cast in person
at a meeting called for the purpose of voting on such approval.
ARTICLE VIII
------------
Definitions of Certain Terms
----------------------------
The terms "vote of a majority of the outstanding voting securities",
"assignment", "affiliated person" and "interested person", when used in this
Agreement, shall have the respective meanings specified in the Investment
Company Act and the rules and regulations thereunder, subject, however, to such
exemptions as may be granted by the Securities and Exchange Commission under
said Act.
10
<PAGE>
ARTICLE IX
----------
Governing Law
-------------
This Agreement shall be governed by and construed in accordance with
the laws of the State of New York and the applicable provisions of the
Investment Company Act. To the extent that the applicable laws of the State of
New York, or any of the provisions herein, conflict with the applicable
provisions of the Investment Company Act, the latter shall control.
11
<PAGE>
IN WITNESS WHEREOF, the parties hereto have
executed and delivered this Agreement as of the date first above written.
MUNIHOLDINGS CALIFORNIA FUND, INC.
By: ______________________________
Authorized Signatory
FUND ASSET MANAGEMENT, L.P.
By: ______________________________
Authorized Signatory
12
<PAGE>
EXHIBIT (h)(1)
Shares
------
MUNIHOLDINGS CALIFORNIA FUND, INC.
(a Maryland corporation)
Common Stock
(Par Value $0.10 Per Share)
PURCHASE AGREEMENT
------------------
, 1998
MERRILL LYNCH & CO.
MERRILL LYNCH, PIERCE, FENNER & SMITH
INCORPORATED
Merrill Lynch World Headquarters
World Financial Center
North Tower
New York, New York 10281-1201
Dear Sirs and Mesdames:
MuniHoldings California Fund, Inc., a Maryland corporation (the "Fund"),
and Fund Asset Management, L.P., a Delaware limited partnership (the "Adviser"),
each confirms its agreement with Merrill Lynch & Co., Merrill Lynch, Pierce,
Fenner & Smith Incorporated (the "Underwriter"), with respect to the sale by the
Fund and the purchase by the Underwriter of shares of common stock, par
value $.10 per share, of the Fund (the "Common Stock"), and, with respect to the
grant by the Fund to the Underwriter of the option described in Section 2 hereof
to purchase all or any part of additional shares of Common Stock to
cover over-allotments. The aforesaid shares (the "Initial Shares"),
together with all or any part of the additional shares of Common
Stock subject to the option described in Section 2 hereof (the "Option Shares"),
hereinafter are referred to collectively as the "Shares".
Prior to the purchase and public offering of the Shares by the Underwriter,
the Fund and the Underwriter shall enter into an agreement substantially in the
form of Exhibit A hereto (the "Pricing Agreement"). The Pricing Agreement may
take the form of an exchange of any standard form of written telecommunication
between the Fund and the Underwriter and shall specify such applicable
information as is indicated in Exhibit A hereto. The offering of the Shares
will be governed by this Agreement, as supplemented by the Pricing Agreement.
From and after the date
<PAGE>
of the execution and delivery of the Pricing Agreement, this Agreement shall be
deemed to incorporate the Pricing Agreement.
The Fund has filed with the Securities and Exchange Commission (the
"Commission") a notification on Form N-8A of registration of the Fund as an
investment company under the Investment Company Act of 1940, as amended (the
"Investment Company Act"), and a registration statement on Form N-2 (No. 333-
26889) and a related preliminary prospectus for the registration of the Shares
under the Securities Act of 1933, as amended (the "1933 Act"), the Investment
Company Act, and the rules and regulations of the Commission under the 1933 Act
and the Investment Company Act (together, the "Rules and Regulations"), and has
filed such amendments to such registration statement on Form N-2, if any, and
such amended preliminary prospectuses as may have been required to the date
hereof. The Fund will prepare and file such additional amendments thereto and
such amended prospectuses as hereafter may be required. Such registration
statement (as amended at the time it becomes effective, if applicable) and the
prospectus constituting a part thereof (including in each case the information,
if any, deemed to be a part thereof pursuant to Rule 430A(b) or Rule 434 of the
Rules and Regulations), as from time to time amended or supplemented pursuant to
the 1933 Act, are referred to hereinafter as the "Registration Statement" and
the "Prospectus", respectively; except that if any revised prospectus shall be
provided to the Underwriter by the Fund for use in connection with the offering
of the Shares which differs from the Prospectus on file at the Commission at the
time the Registration Statement becomes effective (whether such revised
prospectus is required to be filed by the Fund pursuant to Rule 497(c) or Rule
497(h) of the Rules and Regulations), the term "Prospectus" shall refer to each
such revised prospectus from and after the time it is first provided to the
Underwriter for such use. If the Fund elects to rely on Rule 434 under the
Rules and Regulations, all references to the Prospectus shall be deemed to
include, without limitation, the form of prospectus and the term sheet, taken
together, provided to the Underwriter by the Fund in reliance on Rule 434 under
the 1933 Act (the "Rule 434 Prospectus"). If the Fund files a registration
statement to register a portion of the Shares and relies on Rule 462(b) for such
registration statement to become effective upon filing with the Commission (the
"Rule 462 Registration Statement"), then any reference to "Registration
Statement" herein shall be deemed to include both the registration statement
referred to above (No. 333-26889) and the Rule 462 Registration Statement, as
each such registration statement may be amended pursuant to the 1933 Act.
The Fund understands that the Underwriter proposes to make a public
offering of the Shares as soon as the Underwriter deems advisable after the
Registration Statement becomes effective and the Pricing Agreement has been
executed and delivered.
2
<PAGE>
SECTION 1. Representations and Warranties. (a) The Fund and the Adviser
each severally represents and warrants to the Underwriter as of the date hereof
and as of the date of the Pricing Agreement (such later date hereinafter being
referred to as the "Representation Date") as follows:
(i) At the time the Registration Statement becomes effective and at
the Representation Date, the Registration Statement will comply in all
material respects with the requirements of the 1933 Act, the Investment
Company Act and the Rules and Regulations and will not contain an 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 not
misleading. At the time the Registration Statement becomes effective, at
the Representation Date and at Closing Time referred to in Section 2, the
Prospectus (unless the term "Prospectus" refers to a prospectus which has
been provided to the Underwriter by the Fund for use in connection with the
offering of the Shares which differs from the Prospectus on file with the
Commission at the time the Registration Statement becomes effective, in
which case at the time such prospectus first is provided to the Underwriter
for such use) will not contain an untrue statement of a material fact or
omit to state a material fact necessary in order to make the statements
therein, in the light of the circumstances under which they were made, not
misleading; provided, however, that the representations and warranties in
this subsection shall not apply to statements in or omissions from the
Registration Statement or the Prospectus made in reliance upon and in
conformity with information furnished to the Fund in writing by the
Underwriter expressly for use in the Registration Statement or in the
Prospectus.
(ii) The accountants who certified the statement of assets,
liabilities and capital included in the Registration Statement are
independent public accountants as required by the 1933 Act and the Rules
and Regulations.
(iii) The statement of assets, liabilities and capital included in the
Registration Statement presents fairly the financial position of the Fund
as at the date indicated and said statement has been prepared in conformity
with generally accepted accounting principles.
(iv) Since the respective dates as of which information is given in
the Registration Statement and in the Prospectus, except as otherwise
stated therein, (A) there has been no material adverse change in the
condition, financial or otherwise, of the Fund, or in the earnings,
business affairs or business prospects of the Fund, whether or not arising
in the ordinary course of business, (B) there
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have been no transactions entered into by the Fund which are material to
the Fund other than those in the ordinary course of business and (C) there
has been no dividend or distribution of any kind declared, paid or made by
the Fund on any class of its capital stock.
(v) The Fund has been duly incorporated and is validly existing as a
corporation in good standing under the laws of the State of Maryland with
corporate power and authority to own, lease and operate its properties and
conduct its business as described in the Registration Statement; the Fund
is duly qualified as a foreign corporation to transact business and is in
good standing in each jurisdiction in which such qualification is required;
and the Fund has no subsidiaries.
(vi) The Fund is registered with the Commission under the Investment
Company Act as a closed-end, non-diversified, management investment
company, and no order of suspension or revocation of such registration has
been issued or proceedings therefor initiated or threatened by the
Commission.
(vii) The authorized, issued and outstanding capital stock of the Fund
is as set forth in the Prospectus under the caption "Description of Capital
Stock"; the Shares have been duly authorized for issuance and sale to the
Underwriter pursuant to this Agreement and, when issued and delivered by
the Fund pursuant to this Agreement against payment of the consideration
set forth in the Pricing Agreement, will be validly issued and fully paid
and nonassessable; the Shares conform in all material respects to all
statements relating thereto contained in the Registration Statement; and
the issuance of the Shares to be purchased by the Underwriter is not
subject to preemptive rights.
(viii) The Fund is not in violation of its articles of incorporation, as
amended (the "Charter"), or its by-laws, as amended (the "By-Laws"), or in
default in the performance or observance of any material obligation,
agreement, covenant or condition contained in any material contract,
indenture, mortgage, loan agreement, note, lease or other instrument to
which it is a party or by which it or its properties may be bound; and the
execution and delivery of this Agreement, the Pricing Agreement and the
Investment Advisory Agreement and the Custody Agreement referred to in the
Registration Statement (as used herein, the "Advisory Agreement" and the
"Custody Agreement", respectively) and the consummation of the transactions
contemplated herein and therein have been duly authorized by all necessary
corporate action and will not conflict with or constitute a breach of,
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or a default under, or result in the creation or imposition of any lien,
charge or encumbrance upon any property or assets of the Fund pursuant to
any material contract, indenture, mortgage, loan agreement, note, lease or
other instrument to which the Fund is a party or by which it may be bound
or to which any of the property or assets of the Fund is subject, nor will
such action result in any violation of the provisions of the Charter or the
By-Laws of the Fund, or, to the best knowledge of the Fund and the Adviser,
any law, administrative regulation or administrative or court decree; and
no consent, approval, authorization or order of any court or governmental
authority or agency is required for the consummation by the Fund of the
transactions contemplated by this Agreement, the Pricing Agreement, the
Advisory Agreement and the Custody Agreement, except such as has been
obtained under the Investment Company Act or as may be required under the
1933 Act or state securities or Blue Sky laws in connection with the
purchase and distribution of the Shares by the Underwriter.
(ix) The Fund owns or possesses or has obtained all material
governmental licenses, permits, consents, orders, approvals and other
authorizations necessary to lease or own, as the case may be, and to
operate its properties and to carry on its businesses as contemplated in
the Prospectus and the Fund has not received any notice of proceedings
relating to the revocation or modification of any such licenses, permits,
covenants, orders, approvals or authorizations.
(x) There is no action, suit or proceeding before or by any court or
governmental agency or body, domestic or foreign, now pending, or, to the
knowledge of the Fund, threatened against or affecting, the Fund, which
might result in any material adverse change in the condition, financial or
otherwise, business affairs or business prospects of the Fund, or might
materially and adversely affect the properties or assets of the Fund; and
there are no material contracts or documents of the Fund which are required
to be filed as exhibits to the Registration Statement by the 1933 Act, the
Investment Company Act or the Rules and Regulations which have not been so
filed.
(xi) There are no contracts or documents which are required to be
described in the Registration Statement or the Prospectus or to be filed as
exhibits thereto which have not been so described and filed as required.
(xii) The Fund owns or possesses, or can acquire on reasonable terms,
adequate trademarks, service marks and trade names necessary to conduct its
business as described
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<PAGE>
in the Registration Statement, and the Fund has not received any notice of
infringement of or conflict with asserted rights of others with respect to
any trademarks, service marks or trade names which, singly or in the
aggregate, if the subject of an unfavorable decision, ruling or finding,
would materially adversely affect the conduct of the business, operations,
financial condition or income of the Fund.
(b) The Adviser represents and warrants to the Underwriter as of the date
hereof and as of the Representation Date as follows:
(i) The Adviser has been duly organized as a limited partnership
under the laws of the State of Delaware, with power and authority to
conduct its business as described in the Prospectus.
(ii) The Adviser is duly registered as an investment adviser under the
Investment Advisers Act of 1940, as amended (the "Investment Advisers
Act"), and is not prohibited by the Investment Advisers Act or the
Investment Company Act, or the rules and regulations under such acts, from
acting under the Advisory Agreement for the Fund as contemplated by the
Prospectus.
(iii) This Agreement has been duly authorized, executed and delivered
by the Adviser; the Advisory Agreement has been duly authorized, executed
and delivered by the Adviser and constitutes a valid and binding obligation
of the Adviser, enforceable in accordance with its terms, subject, as to
enforcement, to bankruptcy, insolvency, reorganization or other laws
relating to or affecting creditors' rights and to general equitable
principles; and neither the execution and delivery of this Agreement or the
Advisory Agreement, nor the performance by the Adviser of its obligations
hereunder or thereunder will conflict with, or result in a breach of any of
the terms and provisions of, or constitute, with or without the giving of
notice or the lapse of time or both, a default under, any agreement or
instrument to which the Adviser is a party or by which it is bound, or any
law, order, rule or regulation applicable to it of any jurisdiction, court,
Federal or state regulatory body, administrative agency or other
governmental body, stock exchange or securities association having
jurisdiction over the Adviser or its respective properties or operations.
(iv) The Adviser has the financial resources available to it necessary
for the performance of its services and obligations as contemplated in the
Prospectus.
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<PAGE>
(v) Any advertisement approved by the Adviser for use in the public
offering of the Shares pursuant to Rule 482 under the Rules and Regulations
(an "Omitting Prospectus") complies with the requirements of such Rule 482.
(c) Any certificate signed by any officer of the Fund or the Adviser and
delivered to the Underwriter or to counsel to the Fund and the Underwriter shall
be deemed a representation and warranty by the Fund or the Adviser, as the case
may be, to the Underwriter, as to the matters covered thereby.
SECTION 2. Sale and Delivery to the Underwriter; Closing.
(a) On the basis of the representations and warranties herein contained,
and subject to the terms and conditions herein set forth, the Fund agrees to
sell the Initial Shares to the Underwriter and the Underwriter agrees to
purchase the Initial Shares from the Fund, at the price per share set forth in
the Pricing Agreement.
(i) If the Fund has elected not to rely upon Rule 430A under the
Rules and Regulations, the initial public offering prices and the purchase
price per share to be paid by the Underwriter for the Shares have been
determined and set forth in the Pricing Agreement, dated the date hereof,
and an amendment to the Registration Statement and the Prospectus will be
filed before the Registration Statement becomes effective.
(ii) If the Fund has elected to rely upon Rule 430A under the Rules and
Regulations, the purchase price per share to be paid by the Underwriter for
the Shares shall be an amount equal to the applicable initial public
offering price, less an amount per share to be determined by agreement
between the Underwriter and the Fund. The initial public offering price
per share shall be a fixed price based upon the number of Shares purchased
in a single transaction to be determined by agreement between the
Underwriter and the Fund. The initial public offering price and the
purchase price, when so determined, shall be set forth in the Pricing
Agreement. In the event that such prices have not been agreed upon and the
Pricing Agreement has not been executed and delivered by all parties
thereto by the close of business on the fourth business day following the
date of this Agreement, this Agreement shall terminate forthwith, without
liability of any party to any other party, except as provided in Section 4,
unless otherwise agreed to by the Fund, the Adviser and the Underwriter.
In addition, on the basis of the representations and warranties herein
contained, and subject to the terms and conditions herein set forth, the Fund
hereby grants an option to
7
<PAGE>
the Underwriter to purchase all or any part of the Option Shares at the price
per share set forth above. The option hereby granted will expire 45 days after
the date hereof (or, if the Fund has elected to rely upon Rule 430A under the
Rules and Regulations, 45 days after the execution of the Pricing Agreement) and
may be exercised only for the purpose of covering over-allotments which may be
made in connection with the offering and distribution of the Initial Shares upon
notice by the Underwriter to the Fund setting forth the number of Option Shares
as to which the Underwriter is then exercising the option and the time, date and
place of payment and delivery for such Option Shares. Any such time and date of
delivery (a "Date of Delivery") shall be determined by the Underwriter but shall
not be later than seven full business days after the exercise of said option,
nor in any event prior to Closing Time, as hereinafter defined, unless otherwise
agreed upon by the Underwriter and the Fund.
(b) Payment of the purchase price for, and delivery of certificates for,
the Initial Shares shall be made at the office of Brown & Wood LLP, One World
Trade Center, New York, New York 10048-0557, or at such other place as shall be
agreed upon by the Underwriter and the Fund, at 9:00 A.M. on the third business
day following the date the Registration Statement becomes effective or, if the
Fund has elected to rely upon Rule 430A under the Rules and Regulations, the
third business day after execution of the Pricing Agreement (or, if pricing
takes place after 4:30 P.M. on either the date the Registration Statement
becomes effective or the date of execution of the Pricing Agreement, as
applicable, the fourth business day after such applicable date), or such other
time not later than ten business days after such date as shall be agreed upon by
the Underwriter and the Fund (such time and date of payment and delivery herein
being referred to as "Closing Time"). In addition, in the event that any or all
of the Option Shares are purchased by the Underwriter, payment of the purchase
price for, and delivery of certificates for, such Option Shares shall be made at
the above-mentioned office of Brown & Wood LLP, or at such other place as shall
be agreed upon mutually by the Fund and the Underwriter, on each Date of
Delivery as specified in the notice from the Underwriter to the Fund. Payment
shall be made to the Fund by a Federal Funds check or checks or similar same-day
funds payable to the order of the Fund, against delivery to the Underwriter of
certificates for the Shares to be purchased by it. Certificates for the Initial
Shares and Option Shares shall be in such denominations and registered in such
names as the Underwriter may request in writing at least two business days
before Closing Time or the Date of Delivery, as the case may be. The
certificates for the Initial Shares and the Option Shares will be made available
by the Fund for examination by the Underwriter not later than 10:00 A.M. on the
last business day prior to Closing Time or the Date of Delivery, as the case may
be.
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<PAGE>
SECTION 3. Covenants of the Fund. The Fund covenants with the Underwriter
as follows:
(a) The Fund will use its best efforts (i) to cause the Registration
Statement to become effective under the 1933 Act, and will advise the
Underwriter promptly as to the time at which the Registration Statement and
any amendments thereto (including any post-effective amendment) becomes so
effective and (ii) if required, to cause the issuance of any orders
exempting the Fund from any provisions of the Investment Company Act, and
the Fund will advise the Underwriter promptly as to the time at which any
such orders are granted.
(b) The Fund will notify the Underwriter immediately, and will
confirm the notice in writing, (i) of the effectiveness of the Registration
Statement and any amendments thereto (including any post-effective
amendment), (ii) of the receipt of any comments from the Commission, (iii)
of any request by the Commission for any amendment to the Registration
Statement or any amendment or supplement to the Prospectus or for
additional information, (iv) of the issuance by the Commission of any stop
order suspending the effectiveness of the Registration Statement or the
initiation of any proceedings for that purpose, and (v) of the issuance by
the Commission of an order of suspension or revocation of the notification
on Form N-8A of registration of the Fund as an investment company under the
Investment Company Act or the initiation of any proceeding for that
purpose. The Fund will make every reasonable effort to prevent the
issuance of any stop order described in subsection (vi) hereunder or any
order of suspension or revocation described in subsection (vii) hereunder
and, if any such stop order or order of suspension or revocation is issued,
to obtain the lifting thereof at the earliest possible moment. If the Fund
elects to rely on Rule 434 under the Rules and Regulations, the Fund will
prepare a term sheet that complies with the requirements of Rule 434 under
the Rules and Regulations and the Fund will provide the Underwriter with
copies of the form of Rule 434 Prospectus, in such number as the
Underwriter may reasonably request by the close of business in New York on
the business day immediately succeeding the date of the Pricing Agreement.
(c) The Fund will give the Underwriter notice of its intention to
file any amendment to the Registration Statement (including any post-
effective amendment) or any amendment or supplement to the Prospectus
(including any revised prospectus which the Fund proposes for use by the
Underwriter in connection with the offering of the Shares, which differs
from the prospectus on file at the Commission at the time the Registration
Statement becomes effective,
9
<PAGE>
whether such revised prospectus is required to be filed pursuant to Rule
497(c) or Rule 497(h) of the Rules and Regulations or any term sheet
prepared in reliance on Rule 434 of the Rules and Regulations), whether
pursuant to the Investment Company Act, the 1933 Act, or otherwise, and
will furnish the Underwriter with copies of any such amendment or
supplement a reasonable amount of time prior to such proposed filing or
use, as the case may be, and will not file any such amendment or supplement
to which the Underwriter reasonably shall object.
(d) The Fund will deliver to the Underwriter, as soon as practicable,
two signed copies of the notification of registration and registration
statement as originally filed and of each amendment thereto, in each case
with two sets of the exhibits filed therewith, and also will deliver to the
Underwriter a conformed copy of the registration statement as originally
filed and of each amendment thereto (but without exhibits to the
registration statement or any such amendment) for the Underwriter.
(e) The Fund will furnish to the Underwriter, from time to time
during the period when the Prospectus is required to be delivered under the
1933 Act, such number of copies of the Prospectus (as amended or
supplemented) as the Underwriter reasonably may request for the purposes
contemplated by the 1933 Act, or the Rules and Regulations.
(f) If any event shall occur as a result of which it is necessary, in
the opinion of counsel to the Fund and the Underwriter, to amend or
supplement the Prospectus in order to make the Prospectus not misleading in
the light of the circumstances existing at the time it is delivered to a
purchaser, the Fund forthwith will amend or supplement the Prospectus by
preparing and furnishing to the Underwriter a reasonable number of copies
of an amendment or amendments of or a supplement or supplements to, the
Prospectus (in form and substance satisfactory to counsel to the Fund and
the Underwriter), so that, as so amended or supplemented, the Prospectus
will not contain an untrue statement of a material fact or omit to state a
material fact necessary in order to make the statements therein, in the
light of the circumstances existing at the time the Prospectus is delivered
to a purchaser, not misleading.
(g) The Fund will endeavor, in cooperation with the Underwriter, to
qualify the Shares for offering and sale under the applicable securities
laws of such states and other jurisdictions of the United States as the
Underwriter may designate, and will maintain such qualifications in effect
for a period of not less than one year after the date hereof. The Fund
will file such statements and reports as
10
<PAGE>
may be required by the laws of each jurisdiction in which the Shares have
been qualified as above provided.
(h) The Fund will make generally available to its security holders as
soon as practicable, but no later than 60 days after the close of the
period covered thereby, an earnings statement (in form complying with the
provisions of Rule 158 of the Rules and Regulations) covering a twelve-
month period beginning not later than the first day of the Fund's fiscal
quarter next following the "effective" date (as defined in said Rule 158)
of the Registration Statement.
(i) Between the date of this Agreement and the termination of any
trading restrictions or Closing Time, whichever is later, the Fund will
not, without your prior consent, offer or sell, or enter into any agreement
to sell, any equity or equity related securities of the Fund other than the
Shares and shares of Common Stock issued in reinvestment of dividends or
distributions.
(j) If, at the time that the Registration Statement becomes
effective, any information shall have been omitted therefrom in reliance
upon Rule 430A of the Rules and Regulations, then immediately following the
execution of the Pricing Agreement, the Fund will prepare, and file or
transmit for filing with the Commission in accordance with such Rule 430A
and Rule 497(h) of the Rules and Regulations, copies of the amended
Prospectus, or, if required by such Rule 430A, a post-effective amendment
to the Registration Statement (including an amended Prospectus), containing
all information so omitted.
(k) The Fund will use its best efforts to effect the listing of the
Shares on the New York Stock Exchange so that trading on such Exchange will
begin no later than four weeks from the date of the Prospectus.
SECTION 4. Payment of Expenses. The Fund will pay all expenses incident
to the performance of its obligations under this Agreement, including, but not
limited to, expenses relating to (i) the printing and filing of the registration
statement as originally filed and of each amendment thereto, (ii) the printing
of this Agreement and the Pricing Agreement, (iii) the preparation, issuance and
delivery of the certificates for the Shares to the Underwriter, (iv) the fees
and disbursements of the Fund's counsel and accountants, (v) the qualification
of the Shares under securities laws in accordance with the provisions of Section
3(g) of this Agreement, including filing fees and any reasonable fees or
disbursements of counsel in connection therewith and in connection with the
preparation of the Blue Sky Survey, (vi) the printing and delivery to the
Underwriter of copies of the registration statement as originally filed and of
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<PAGE>
each amendment thereto, of the preliminary prospectus, and of the Prospectus and
any amendments or supplements thereto, (vii) the printing and delivery to the
Underwriter of copies of the Blue Sky Survey, (viii) the fees and expenses
incurred with respect to the filing with the National Association of Securities
Dealers, Inc. and (ix) the fees and expenses incurred with respect to the
listing of the Shares on the New York Stock Exchange.
If this Agreement is terminated by the Underwriter in accordance with the
provisions of Section 5 or Section 9(a)(i), the Fund or the Adviser shall
reimburse the Underwriter for all of its reasonable out-of-pocket expenses,
including the reasonable fees and disbursements of counsel to the Fund and the
Underwriter. In the event the transactions contemplated hereunder are not
consummated, the Adviser agrees to pay all of the costs and expenses set forth
in the first paragraph of this Section 4 which the Fund would have paid if such
transactions had been consummated.
SECTION 5. Conditions of Underwriter's Obligations. The obligations of
the Underwriter hereunder are subject to the accuracy of the representations and
warranties of the Fund and the Adviser herein contained, to the performance by
the Fund and the Adviser of their respective obligations hereunder, and to the
following further conditions:
(a) The Registration Statement shall have become effective not later
than 5:30 P.M., on the date of this Agreement, or at a later time and date
not later, however, than 5:30 P.M. on the first business day following the
date hereof, or at such later time and date as may be approved by the
Underwriter, and at Closing Time no stop order suspending the effectiveness
of the Registration Statement shall have been issued under the 1933 Act or
proceedings therefor initiated or threatened by the Commission. If the
Fund has elected to rely upon Rule 430A of the Rules and Regulations, the
price of the Shares and any price-related information previously omitted
from the effective Registration Statement pursuant to such Rule 430A shall
have been transmitted to the Commission for filing pursuant to Rule 497(h)
of the Rules and Regulations within the prescribed time period, and prior
to Closing Time the Fund shall have provided evidence satisfactory to the
Underwriter of such timely filing, or a post-effective amendment providing
such information shall have been filed promptly and declared effective in
accordance with the requirements of Rule 430A of the Rules and Regulations.
(b) At Closing Time, the Underwriter shall have received:
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<PAGE>
(1) The favorable opinion, dated as of Closing Time, of Brown &
Wood LLP, counsel to the Fund and the Underwriter, to the effect that:
(i) The Fund has been duly incorporated and is validly
existing as a corporation in good standing under the laws of the
State of Maryland.
(ii) The Fund has corporate power and authority to own,
lease and operate its properties and conduct its business as
described in the Registration Statement and in the Prospectus.
(iii) The Fund is duly qualified as a foreign corporation to
transact business and is in good standing in each jurisdiction in
which such qualification is required.
(iv) The Shares have been duly authorized for issuance and
sale to the Underwriter pursuant to this Agreement and, when
issued and delivered by the Fund pursuant to this Agreement
against payment of the consideration set forth in the Pricing
Agreement, will be validly issued and fully paid and
nonassessable; the issuance of the Shares is not subject to
preemptive rights; and the authorized capital stock conforms as
to legal matters in all material respects to the description
thereof in the Registration Statement under the caption
"Description of Capital Stock".
(v) This Agreement and the Pricing Agreement each has been
duly authorized, executed and delivered by the Fund and each
complies with all applicable provisions of the Investment Company
Act.
(vi) The Registration Statement is effective under the 1933
Act and, to the best of their knowledge and information, no stop
order suspending the effectiveness of the Registration Statement
has been issued under the 1933 Act or proceedings therefor
initiated or threatened by the Commission.
(vii) At the time the Registration Statement became effective
and at the Representation Date, the Registration Statement (other
than the financial statements included therein, as to which no
opinion need be rendered) complied as to form in all material
respects with the requirements of the 1933 Act and the Investment
Company Act and
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<PAGE>
the Rules and Regulations. The Rule 434 Prospectus conforms to
the requirements of Rule 434 in all material respects.
(viii) To the best of their knowledge and information, there
are no legal or governmental proceedings pending or threatened
against the Fund which are required to be disclosed in the
Registration Statement, other than those disclosed therein.
(ix) To the best of their knowledge and information, there
are no contracts, indentures, mortgages, loan agreements, notes,
leases or other instruments of the Fund required to be described
or referred to in the Registration Statement or to be filed as
exhibits thereto other than those described or referred to
therein or filed as exhibits thereto, the descriptions thereof
are correct in all material respects, references thereto are
correct, and no default exists in the due performance or
observance of any material obligation, agreement, covenant or
condition contained in any contract, indenture, mortgage, loan
agreement, note, lease or other instrument so described, referred
to or filed.
(x) No consent, approval, authorization or order of any
court or governmental authority or agency is required in
connection with the sale of the Shares to the Underwriter, except
such as has been obtained under the 1933 Act, the Investment
Company Act or the Rules and Regulations or such as may be
required under state securities laws; and to the best of their
knowledge and information, the execution and delivery of this
Agreement, the Pricing Agreement, the Advisory Agreement and the
Custody Agreement and the consummation of the transactions
contemplated herein and therein will not conflict with or
constitute a breach of, or a default under, or result in the
creation or imposition of any lien, charge or encumbrance upon
any property or assets of the Fund pursuant to, any contract,
indenture, mortgage, loan agreement, note, lease or other
instrument to which the Fund is a party or by which it may be
bound or to which any of the property or assets of the Fund is
subject, nor will such action result in any violation of the
provisions of the Charter or the By-Laws of the Fund, or any law
or administrative regulation, or,
14
<PAGE>
to the best of their knowledge and information, administrative or
court decree.
(xi) The Advisory Agreement and the Custody Agreement have
each been duly authorized and approved by the Fund and comply as
to form in all material respects with all applicable provisions
of the Investment Company Act, and each has been duly executed by
the Fund.
(xii) The Fund is registered with the Commission under the
Investment Company Act as a closed-end, non-diversified
management investment company, and all required action has been
taken by the Fund under the 1933 Act, the Investment Company Act
and the Rules and Regulations to make the public offering and
consummate the sale of the Shares pursuant to this Agreement; the
provisions of the Charter and the By-Laws of the Fund comply as
to form in all material respects with the requirements of the
Investment Company Act; and, to the best of their knowledge and
information, no order of suspension or revocation of such
registration under the Investment Company Act, pursuant to
Section 8(e) of the Investment Company Act, has been issued or
proceedings therefor initiated or threatened by the Commission.
(xiii) The information in the Prospectus under the caption
"Taxes", to the extent that it constitutes matters of law or
legal conclusions, has been reviewed by them and is correct in
all material respects.
(2) The favorable opinion, dated as of Closing Time, of Philip
L. Kirstein, Esq., General Counsel to the Adviser, in form and
substance satisfactory to counsel to the Underwriter, to the effect
that:
(i) The Adviser has been duly organized as a limited
partnership under the laws of the State of Delaware, with power
and authority to conduct its business as described in the
Registration Statement and in the Prospectus.
(ii) The Adviser is duly registered as an investment adviser
under the Investment Advisers Act and is not prohibited by the
Investment Advisers Act or the Investment Company Act, or the
rules and regulations under such Acts, from acting
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<PAGE>
under the Advisory Agreement for the Fund as contemplated by the
Prospectus.
(iii) This Agreement and the Advisory Agreement have been
duly authorized, executed and delivered by the Adviser, and the
Advisory Agreement constitutes a valid and binding obligation of
the Adviser, enforceable in accordance with its terms, subject,
as to enforcement, to bankruptcy, insolvency, reorganization or
other laws relating to or affecting creditors' rights and to
general equity principles; and, to the best of his knowledge and
information, neither the execution and delivery of this Agreement
or the Advisory Agreement nor the performance by the Adviser of
its obligations hereunder or thereunder will conflict with, or
result in a breach of, any of the terms and provisions of, or
constitute, with or without the giving of notice or the lapse of
time or both, a default under, any agreement or instrument to
which the Adviser is a party or by which the Adviser is bound, or
any law, order, rule or regulation applicable to the Adviser of
any jurisdiction, court, Federal or state regulatory body,
administrative agency or other governmental body, stock exchange
or securities association having jurisdiction over the Adviser or
its properties or operations.
(iv) To the best of his knowledge and information, the
description of the Adviser in the Registration Statement and in
the Prospectus does not contain 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 not
misleading.
(3) In giving their opinion required by subsection (b)(1) of this
Section, Brown & Wood LLP additionally shall state that nothing has come to
their attention that would lead them to believe that the Registration
Statement (other than the financial statements included therein, as to
which no opinion need be rendered), at the time it became effective or at
the Representation Date, contained an untrue statement of a material fact
or omitted to state a material fact required to be stated therein or
necessary to make the statements therein not misleading or that the
Prospectus (other than the financial statements included therein, as to
which no opinion need be rendered), at the Representation Date (unless the
term "Prospectus" refers to a prospectus which has been provided to the
Underwriter by the Fund for
16
<PAGE>
use in connection with the offering of the Shares which differs from the
Prospectus on file at the Commission at the time the Registration Statement
becomes effective, in which case at the time it first is provided to the
Underwriter for such use) or at Closing Time, included an untrue statement
of a material fact or omitted to state a material fact necessary in order
to make the statements therein, in the light of the circumstances under
which they were made, not misleading. In giving their opinion, Brown &
Wood LLP may rely as to matters of fact, upon certificates and written
statements of officers and employees of and accountants for the Fund and
the Adviser and of public officials.
(c) At Closing Time, (i) the Registration Statement and the
Prospectus shall contain all statements which are required to be stated
therein in accordance with the 1933 Act, the Investment Company Act and the
Rules and Regulations and in all material respects shall conform to the
requirements of the 1933 Act, the Investment Company Act and the Rules and
Regulations, and neither the Registration Statement nor the Prospectus
shall contain any untrue statement of a material fact or omit to state any
material fact necessary to make the statements therein, in the light of the
circumstances under which they were made, not misleading, and no action,
suit or proceeding at law or in equity shall be pending or, to the
knowledge of the Fund or the Adviser, threatened against the Fund or the
Adviser which would be required to be set forth in the Prospectus other
than as set forth therein, (ii) there shall not have been, since the date
as of which information is given in the Prospectus, any material adverse
change in the condition, financial or otherwise, of the Fund or in its
earnings, business affairs or business prospects, whether or not arising in
the ordinary course of business, from that set forth in the Prospectus,
(iii) the Adviser shall have the financial resources available to it
necessary for the performance of its services and obligations as
contemplated in the Prospectus, and (iv) no proceedings shall be pending
or, to the knowledge of the Fund or the Adviser, threatened against the
Fund or the Adviser before or by any Federal, state or other commission,
board or administrative agency wherein an unfavorable decision, ruling or
finding would materially and adversely affect the business, property,
financial condition or income of either the Fund or the Adviser other than
as set forth in the Prospectus, and the Underwriter shall have received, at
Closing Time, a certificate of the President or the Treasurer of the Fund
and of the President or a Vice President of the Adviser dated as of Closing
Time, evidencing compliance with the appropriate provisions of this
subsection (c).
17
<PAGE>
(d) At Closing Time, the Underwriter shall have received
certificates, dated as of Closing Time, (i) of the President or the
Treasurer of the Fund to the effect that the representations and warranties
of the Fund contained in Section 1(a) are true and correct with the same
force and effect as though expressly made at and as of Closing Time and,
(ii) of the President or a Vice President of the Adviser to the effect that
the representations and warranties of the Adviser contained in Sections
1(a) and (b) are true and correct with the same force and effect as though
expressly made at and as of Closing Time.
(e) At the time of execution of this Agreement, the Underwriter shall
have received from Deloitte & Touche LLP a letter, dated such date in form
and substance satisfactory to the Underwriter, to the effect that:
(i) they are independent accountants with respect to the Fund
within the meaning of the 1933 Act and the Rules and Regulations;
(ii) in their opinion, the statement of assets, liabilities and
capital examined by them and included in the Registration Statement
complies as to form in all material respects with the applicable
accounting requirements of the 1933 Act and the Investment Company Act
and the Rules and Regulations; and
(iii) they have performed specified procedures, not constituting
an audit, including a reading of the latest available interim
financial statements of the Fund, a reading of the minute books of the
Fund, inquiries of officials of the Fund responsible for financial
accounting matters and such other inquiries and procedures as may be
specified in such letter, and on the basis of such inquiries and
procedures nothing came to their attention that caused them to believe
that at the date of the latest available statement of assets,
liabilities and capital read by such accountants, or at a subsequent
specified date not more than three days prior to the date of this
Agreement, there was any change in the capital stock or net assets of
the Fund as compared with amounts shown on the statement of assets,
liabilities and capital included in the Prospectus.
(f) At Closing Time, the Underwriter shall have received from
Deloitee & Touche LLP a letter, dated as of Closing Time, to the effect
that they reaffirm the statements made in the letter furnished pursuant to
subsection (e) of this Section, except that the "specified
18
<PAGE>
date" referred to shall be a date not more than three days prior to Closing
Time.
(g) At Closing Time, counsel to the Underwriter shall have been
furnished with such documents and opinions as they may reasonably require
for the purpose of enabling them to pass upon the issuance and sale of the
Shares as herein contemplated and to pass upon related proceedings, or in
order to evidence the accuracy of any of the representations or warranties,
or the fulfillment of any of the conditions, herein contained; and all
proceedings taken by the Fund and the Adviser in connection with the
organization and registration of the Fund under the Investment Company Act
and the issuance and sale of the Shares as herein and therein contemplated
shall be satisfactory in form and substance to the Underwriter.
(h) In the event the Underwriter exercises its option provided in
Section 2 hereof to purchase all or any portion of the Option Shares, the
representations and warranties of the Fund and the Adviser contained herein
and the statements in any certificate furnished by the Fund and the Adviser
hereunder shall be true and correct as of each Date of Delivery, and the
Underwriter shall have received:
(i) Certificates, dated the Date of Delivery, of the President
or the Treasurer of the Fund and of the President or a Vice President
of the Adviser confirming that the information contained in the
certificate delivered by each of them at Closing Time pursuant to
Section 5(c) or 5(d), as the case may be, remains true as of such Date
of Delivery.
(ii) The favorable opinions of Brown & Wood LLP, counsel to the
Fund and the Underwriter and Philip L. Kirstein, Esq., General Counsel
of the Adviser, each in form and substance satisfactory to the
Underwriter, dated such Date of Delivery, relating to the Option
Shares and otherwise to the same effect as the opinions required by
Sections 5(b)(1) and (2), respectively.
(iii) A letter from Deloitte & Touche LLP, in form and substance
satisfactory to the Underwriter and dated such Date of Delivery,
substantially the same in scope and substance as the letter furnished
to the Underwriter pursuant to Section 5(e), except that the
"specified date" in the letter furnished pursuant to this Section 5(h)
shall be a date not more than three days prior to such Date of
Delivery.
If any condition specified in this Section shall not have been fulfilled
when and as required to be fulfilled, this
19
<PAGE>
Agreement may be terminated by the Underwriter by notice to the Fund at any time
at or prior to Closing Time, and such termination shall be without liability of
any party to any other party except as provided in Section 4.
SECTION 6. Indemnification. (a) The Fund and the Adviser jointly and
severally agree to indemnify and hold harmless the Underwriter and each person,
if any, who controls the Underwriter within the meaning of Section 15 of the
1933 Act as follows:
(i) against any and all loss, liability, claim, damage and expense
whatsoever, as incurred, arising out of any untrue statement or alleged
untrue statement of a material fact contained in the Registration Statement
(or any amendment thereto), including the information deemed to be part of
the Registration Statement pursuant to Rule 430A or Rule 434 of the Rules
and Regulations, if applicable, or the omission or alleged omission
therefrom of a material fact required to be stated therein or necessary to
make the statements therein not misleading or arising out of any untrue
statement or alleged untrue statement of a material fact contained in any
preliminary prospectus or the Prospectus (or any amendment or supplement
thereto) or the omission or alleged omission therefrom of a material fact
necessary in order to make the statements therein, in the light of the
circumstances under which they were made, not misleading;
(ii) against any and all loss, liability, claim, damage and expense
whatsoever, as incurred, to the extent of the aggregate amount paid in
settlement of any litigation, or any investigation or proceeding by any
governmental agency or body, commenced or threatened, or of any claim
whatsoever based upon any such untrue statement or omission, provided that
(subject to Section 6(d) below) any such settlement is effected with the
written consent of the indemnifying party; and
(iii) against any and all expense whatsoever (including the fees and
disbursements of counsel chosen by the Underwriter) reasonably incurred in
investigating, preparing or defending against any litigation, or
investigation or proceeding by any governmental agency or body, commenced
or threatened, or any claim whatsoever based upon any such untrue statement
or omission, or any such alleged untrue statement or omission, to the
extent that any such expense is not paid under (i) or (ii) above;
provided, however, that this indemnity agreement does not apply to any loss,
liability, claim, damage or expense to the extent arising out of any untrue
statement or omission or alleged untrue statement or omission made in reliance
upon and in conformity
20
<PAGE>
with written information furnished to the Fund by the Underwriter expressly for
use in the Registration Statement (or any amendment thereto), including the
information deemed to be part of the Registration Statement pursuant to Rule
430A or Rule 434 of the Rules and Regulations, or any preliminary prospectus or
in the Prospectus (or any amendment or supplement thereto).
Insofar as this indemnity agreement may permit indemnification for
liabilities under the 1933 Act of any person who is a partner of the Underwriter
or who controls the Underwriter within the meaning of Section 15 of the 1933 Act
and who, at the date of this Agreement, is a director, officer or controlling
person of the Fund, such indemnity agreement is subject to the undertaking of
the Fund in the Registration Statement.
(b) The Underwriter agrees to indemnify and hold harmless the Fund and the
Adviser, their respective directors, each of the Fund's officers who signed the
Registration Statement, and each person, if any, who controls the Fund or the
Adviser within the meaning of Section 15 of the 1933 Act, against any and all
loss, liability, claim, damage and expense described in the indemnity contained
in subsection (a) of this Section, as incurred, but only with respect to untrue
statements or omissions, or alleged untrue statements or omissions, made in the
Registration Statement (or any amendment thereto) or in any preliminary
prospectus or in the Prospectus (or any amendment or supplement thereto) in
reliance upon and in conformity with written information furnished to the Fund
by the Underwriter expressly for use in the Registration Statement (or any
amendment thereto), including the information deemed to be part of the
Registration Statement pursuant to Rule 430A or Rule 434 of the Rules and
Regulations, or any preliminary prospectus or the Prospectus (or any amendment
or supplement thereto) in reliance upon and in conformity with written
information furnished to the Fund by the Underwriter expressly for use in the
Registration Statement (or any amendment thereto) or any preliminary prospectus
or the Prospectus (or any amendment or supplement thereto).
(c) Each indemnified party shall give notice as promptly as reasonably
practicable to each indemnifying party of any action commenced against it in
respect of which indemnity may be sought hereunder, but failure to so notify an
indemnifying party shall not relieve such indemnifying party from any liability
hereunder to the extent it is not materially prejudicial as a result thereof and
in any event shall not relieve it from any liability which it may have otherwise
than on account of this indemnity agreement. An indemnifying party may
participate at its own expense in the defense of any such action; provided,
however, that counsel to the indemnifying party shall not (except with the
consent of the indemnified party) also be counsel to the indemnified party. In
no event shall the indemnifying parties be
21
<PAGE>
liable for the fees and expenses of more than one counsel (in addition to any
local counsel) separate from their own counsel for all indemnified parties in
connection with any one action or separate but similar or related actions in the
same jurisdiction arising out of the same general allegations or circumstances.
No indemnifying party shall, without the prior written consent of the
indemnified parties, settle or compromise or consent to the entry of any
judgment with respect to any litigation, or any investigation or proceeding by
any governmental agency or body, commenced or threatened, or any claim
whatsoever in respect of which indemnification or contribution could be sought
under this Section 6 or Section 7 hereof (whether or not the indemnified parties
are actual or potential parties thereto), unless such settlement, compromise or
consent (i) includes an unconditional release of each indemnified party from all
liability arising out of such litigation, investigation, proceeding or claim and
(ii) does not include a statement as to or an admission of fault, culpability or
a failure to act by or on behalf of any indemnified party.
(d) If at any time an indemnified party shall have requested an
indemnifying party to reimburse the indemnified party for fees and expenses of
counsel, such indemnifying party agrees that it shall be liable for any
settlement of the nature contemplated by Section 6 (a)(ii) effected without its
written consent if (i) such settlement is entered into more than 45 days after
receipt by such indemnifying party of the aforesaid request, (ii) such
indemnifying party shall have received notice of the terms of such settlement at
least 30 days prior to such settlement being entered into and (iii) such
indemnifying party shall not have reimbursed such indemnified party in
accordance with such request prior to the date of such settlement.
SECTION 7. Contribution. If the indemnification provided for in Section 6
hereof is for any reason unavailable to or insufficient to hold harmless an
indemnified party in respect of any losses, liabilities, claims, damages or
expenses incurred by such indemnified party, as incurred, (i) in such proportion
as is appropriate to reflect the relative benefits received by the Fund and the
Adviser on the one hand and the Underwriter on the other hand from the offering
of the Shares pursuant to this Agreement or (ii) if the allocation provided by
clause (i) is not permitted by applicable law, in such proportion as is
appropriate to reflect not only the relative benefits referred to in clause (i)
above but also the relative fault of the Fund and the Adviser on the one hand
and of the Underwriter on the other hand in connection with the statements or
omissions which resulted in such losses, liabilities, claims, damages or
expenses, as well as any other relevant equitable considerations.
The relative benefits received by the Fund and the Adviser on the one hand
and the Underwriter on the other hand in
22
<PAGE>
connection with the offering of the Shares pursuant to this Agreement shall be
deemed to be in the same respective proportions as the total net proceeds from
the offering of the Shares pursuant to this Agreement (before deducting
expenses) received by the Fund, less the total underwriting commission received
by the Underwriter, and the total underwriting commission received by the
Underwriter, in each case as set forth on the cover of the Prospectus, or, if
Rule 434 is used, the corresponding location on the term sheet, bear to the
aggregate initial public offering price of the Shares as set forth on such
cover.
The relative fault of the Fund and the Adviser on the one hand and the
Underwriter on the other hand shall be determined by reference to, among other
things, whether any such untrue or alleged untrue statement of a material fact
or omission or alleged omission to state a material fact relates to information
supplied by the Fund and the Adviser or by the Underwriter and the parties'
relative intent, knowledge, access to information and opportunity to correct or
prevent such statement or omission.
The Fund, the Adviser and the Underwriter agree that it would not be just
and equitable if contribution pursuant to this Section 7 were determined by pro
rata allocation (even if the Underwriter were treated as one entity for such
purpose) or by any other method of allocation which does not take account of the
equitable considerations referred to above in this Section 7. The aggregate
amount of losses, liabilities, claims, damages and expenses incurred by an
indemnified party and referred to above in this Section 7 shall be deemed to
include any legal or other expenses reasonably incurred by such indemnified
party in investigating, preparing or defending against any litigation, or any
investigation or proceeding by any governmental agency or body, commenced or
threatened, or any claim whatsoever based upon any such untrue or alleged untrue
statement or omission or alleged omission.
Notwithstanding the provisions of this Section 7, the Underwriter shall not
be required to contribute any amount in excess of the amount by which the total
price at which the Shares underwritten by it and distributed to the public were
offered to the public exceeds the amount of any damages which the Underwriter
has otherwise been required to pay by reason of any such untrue or alleged
untrue statement or omission or alleged omission.
No person guilty of fraudulent misrepresentation (within the meaning of
Section 11(f) of the 1933 Act) shall be entitled to contribution from any person
who was not guilty of such fraudulent misrepresentation.
23
<PAGE>
For purposes of this Section 7, each person, if any, who controls the
Underwriter within the meaning of Section 15 of the 1933 Act shall have the same
rights to contribution as the Underwriter, and each officer or director of the
Fund and the Adviser, respectively, each director of the Fund who signed the
Registration Statement, and each person, if any, who controls the Fund and the
Adviser within the meaning of Section 15 of the 1933 Act shall have the same
rights to contribution as the Fund.
SECTION 8. Representations, Warranties and Agreements to Survive Delivery.
All representations, warranties and agreements contained in this Agreement or in
the Pricing Agreement, or contained in certificates of officers of the Fund or
of the Adviser submitted pursuant hereto, shall remain operative and in full
force and effect, regardless of any investigation made by or on behalf of the
Underwriter or controlling person, or by or on behalf of the Fund or the Adviser
and shall survive delivery of the Shares to the Underwriter.
SECTION 9. Termination of Agreement. (a) The Underwriter, may terminate
this Agreement by written notice to the Fund, at any time at or prior to Closing
Time (i) if there has been, since the time of execution of this Agreement or
since the respective dates as of which information is given in the Prospectus,
any material adverse change in the condition, financial or otherwise, or in the
earnings, business affairs or business prospects of the Fund or the Adviser,
whether or not arising in the ordinary course of business, or (ii) if there has
occurred any material adverse change in the financial markets in the United
States, any outbreak of hostilities or escalation thereof or other calamity or
crisis or any change or development involving a prospective change in national
or international political, financial or economic conditions, in each case the
effect of which is such as to make it, in the judgment of the Underwriter
impracticable to market the Shares or enforce contracts for the sale of the
Shares, or (iii) if trading in the Common Stock has been suspended or materially
limited by the Commission or if trading generally on either the New York Stock
Exchange or the American Stock Exchange or in the NASDAQ National Market has
been suspended or materially limited, or minimum or maximum prices for trading
have been fixed, or maximum ranges for prices for securities have been required,
by any of said exchanges or by such system or by order of the Commission, the
National Association of Securities Dealers, Inc. or any other governmental
authority, or (iv) if a banking moratorium has been declared by Federal or New
York authorities. As used in this subsection (a), the term "Prospectus" means
the Prospectus in the form first used to confirm sales of the Shares.
(b) If this Agreement is terminated pursuant to this Section, such
termination shall be without liability of any party to any other party except as
provided in Section 4 hereof, and
24
<PAGE>
provided further that Sections 1, 6, 7 and 8 shall survive such termination and
remain in full force and effect.
SECTION 10. Notices. All notices and other communications hereunder shall
be in writing and shall be deemed to have been duly given if mailed or
transmitted by any standard form of written telecommunication. Notices to the
Underwriter shall be directed to Merrill Lynch & Co., Merrill Lynch, Pierce,
Fenner & Smith Incorporated at Merrill Lynch World Headquarters, World Financial
Center, North Tower, New York, New York 10281-1201, Attention: Richard Bruce,
Vice President; notices to the Fund or to the Adviser shall be directed to each
of them at 800 Scudders Mill Road, Plainsboro, New Jersey 08536, Attention:
Arthur Zeikel, President.
SECTION 11. Parties. This Agreement and the Pricing Agreement shall inure
to the benefit of and be binding upon the Underwriter, the Fund, the Adviser and
their respective successors. Nothing expressed or mentioned in this Agreement
or in the Pricing Agreement is intended or shall be construed to give any
person, firm or corporation, other than the parties hereto and their respective
successors and the controlling persons and officers and directors referred to in
Sections 6 and 7 and their heirs and legal representatives, any legal or
equitable right, remedy or claim under or in respect of this Agreement or any
provision herein contained. This Agreement and the Pricing Agreement and all
conditions and provisions hereof are intended to be for the sole and exclusive
benefit of the parties hereto and thereto and their respective successors, and
said controlling persons and officers and directors and their heirs and legal
representatives, and for the benefit of no other person, firm or corporation.
No purchaser of Shares from the Underwriter shall be deemed to be a successor
merely by reason of such purchase.
SECTION 12. Governing Law and Time. This Agreement and the Pricing
Agreement shall be governed by and construed in accordance with the laws of the
State of New York applicable to agreements made and to be performed in said
State. Specified times of day refer to New York City time.
25
<PAGE>
If the foregoing is in accordance with your understanding of our Agreement,
please sign and return to us a counterpart hereof, whereupon this instrument,
along with all counterparts, will become a single binding agreement between the
Underwriter and the Fund and the Adviser in accordance with its terms.
Very truly yours,
MUNIHOLDINGS CALIFORNIA FUND, INC.
By: ___________________________
Authorized Officer
FUND ASSET MANAGEMENT, L.P.
By: ___________________________
Authorized Officer
Confirmed and Accepted, as of the
date first above written:
MERRILL LYNCH, PIERCE, FENNER & SMITH
INCORPORATED
By: __________________________
Authorized Officer
26
<PAGE>
Exhibit A
Shares
MuniHoldings California Fund, Inc.
(a Maryland corporation)
Common Stock
(Par Value $.10 Per Share)
PRICING AGREEMENT
-----------------
, 1998
MERRILL LYNCH & CO.
MERRILL LYNCH, PIERCE, FENNER & SMITH
INCORPORATED
Merrill Lynch World Headquarters
North Tower
World Financial Center
New York, New York 10281-1201
Dear Sirs and Mesdames:
Reference is made to the Purchase Agreement, dated , 1998
(the "Purchase Agreement"), relating to the purchase by Merrill Lynch & Co.,
Merrill Lynch, Pierce, Fenner & Smith Incorporated (the "Underwriter") of the
above shares of common stock, par value $.10 per share (the "Initial Shares"),
of MuniHoldings California Fund, Inc. (the "Fund") and relating to the option
granted to the Underwriter to purchase up to an additional shares of
common stock, par value $.10 per share, of the Fund to cover over-allotments in
connection with the sale of the Initial Shares (the "Option Shares"). The
Initial Shares and all or any part of the Option Shares collectively are
referred to herein as the "Shares".
Pursuant to Section 2 of the Purchase Agreement, the Fund agrees with the
Underwriter as follows:
1. The initial public offering price per share for the Shares,
determined as provided in said Section 2, and the purchase price per share
for the Shares to be paid by the Underwriter, shall be $15.00.
2. Fund Asset Management, L.P. will pay, or arrange for an affiliate
to pay, a commission to the Underwriter in the amount of $0.30 per share
for the Shares purchased by the Underwriter.
A-1
<PAGE>
If the foregoing is in accordance with your understanding of our agreement,
please sign and return to the Fund a counterpart hereof, whereupon this
instrument, along with all counterparts, will become a binding agreement between
the Underwriter and the Fund in accordance with its terms.
Very truly yours,
MUNIHOLDINGS CALIFORNIA FUND, INC.
By:___________________________
Authorized Officer
FUND ASSET MANAGEMENT, L.P.
By: __________________________
Authorized Officer
Confirmed and Accepted, as of the
date first above written:
MERRILL LYNCH, PIERCE, FENNER & SMITH
INCORPORATED
By: ___________________________
Authorized Officer
A-2
<PAGE>
EXHIBIT (h)(2)
Revised October 29, 1990
[LOGO]
MERRILL LYNCH & CO.
MERRILL LYNCH, PIERCE, FENNER & SMITH INCORPORATED
MERRILL LYNCH WORLD HEADQUARTERS
NORTH TOWER WORLD FINANCIAL CENTER
NEW YORK, N.Y. 10281-1305
STANDARD DEALER AGREEMENT
-------------------------
Dear Sirs:
In connection with public offerings of securities underwritten by us, or by
a group of underwriters (the "Underwriters") represented by us, you may be
offered the opportunity to purchase a portion of such securities, as principal,
at a discount from the offering price representing a selling concession or
reallowance granted as consideration for services rendered by you in the sale of
such securities. We request that you agree to the following terms and
provisions, and make the following representations, which, together with any
additional terms and provisions set forth in any wire or letter sent to you in
connection with a particular offering, will govern all such purchases of
securities and the reoffering thereof by you.
Your subscription to, or purchase of, such securities will constitute your
reaffirmation of this Agreement.
1. When we are acting as representative (the "Representative") of the
Underwriters in offering securities to you, it should be understood that all
offers are made subject to prior sale of the subject securities, when, as and if
such securities are delivered to and accepted by the Underwriters and subject to
the approval of legal matters by their counsel. In such cases, any order from
you for securities will be strictly subject to confirmation and we reserve the
right in our uncontrolled discretion to reject any order in whole or in part.
Upon release by us, you may reoffer such securities at the offering price fixed
by us. With our consent, you may allow a discount, not in excess of the
reallowance fixed by us, in selling such securities to other dealers, provided
that in doing so you comply with the Rules of Fair Practice of the National
Association of Securities Dealers, Inc. (the "NASD"). Upon our request, you
will advise us of the identity of any dealer to whom you allow such a discount
and any Underwriter or dealer from whom you receive such a discount. After the
securities are released for sale to the public, we may vary the offering price
and other selling terms.
<PAGE>
2. You represent that you are a dealer actually engaged in the investment
banking or securities business and that you are either (i) a member in good
standing of the NASD or (ii) a dealer with its principal place of business
located outside the United States, its territories or possessions and not
registered under the Securities Exchange Act of 1934 (a "non-member foreign
dealer") or (iii) a bank not eligible for membership in the NASD. If you are a
non-member foreign dealer, you agree to make no sales of securities within the
United States, its territories or its possessions or to persons who are
nationals thereof or residents therein. Non-member foreign dealers and banks
agree, in making any sales, to comply with the NASD's interpretation with
respect to free-riding and withholding. In accepting a selling concession where
we are acting as Representative of the Underwriters, in accepting a reallowance
from us whether or not we are acting as such Representative, and in allowing a
discount to any other person, you agree to comply with the provisions of Section
24 of Article III of the Rules of Fair Practice of the NASD, and, in addition,
if you are a non-member foreign dealer or bank, you agree to comply, as though
you were a member of the NASD, with the provisions of Sections 8 and 36 of
Article III of such Rules of Fair Practice and to comply with Section 25 of
Article III thereof as that Section applies to a non-member foreign dealer or
bank. You represent that you are fully familiar with the above provisions of
the Rules of Fair Practice of the NASD.
3. If the securities have been registered under the Securities Act of 1933
(the "1933 Act"), in offering and selling such securities, you are not
authorized to give any information or make any representation not contained in
the prospectus relating thereto. You confirm that you are familiar with the
rules and policies of the Securities and Exchange Commission relating to the
distribution of preliminary and final prospectuses, and you agree that you will
comply therewith in any offering covered by this Agreement. If we are acting as
Representative of the Underwriters, we will make available to you, to the extent
made available to us by the issuer of the securities, such number of copies of
the prospectus or offering documents, for securities not registered under the
1933 Act, as you may reasonably request.
4. If we are acting as Representative of the Underwriters of securities of
an issuer that is not required to file reports under the Securities Exchange Act
of 1934 (the "1934 Act"), you agree that you will not sell any of the securities
to any account over which you have discretionary authority.
5. Payment for securities purchased by you is to be made at our office,
One Liberty Plaza, 165 Broadway, New York, N.Y. 10006 (or at such other place
as we may advise), at the offering price less the concession allowed to you, on
such date as we may
2
<PAGE>
advise, by certified or official bank check in New York Clearing House funds (or
such other funds as we may advise), payable to our order, against delivery of
the securities to be purchased by you. We shall have authority to make
appropriate arrangements for payment for and/or delivery through the facility of
The Depository Trust Company or any such other depository or similar facility
for the securities.
6. In the event that, prior to the completion of the distribution of
securities covered by this Agreement, we purchase in the open market or
otherwise any securities delivered to you, if we are acting as Representative of
the Underwriters, you agree to repay to us for the accounts of the Underwriters
the amount of the concession allowed to you plus brokerage commissions and any
transfer taxes paid in connection with such purchase.
7. At any time prior to the completion of the distribution of securities
covered by this Agreement you will, upon our request as Representative of the
Underwriters, report to us the amount of securities purchased by you which then
remains unsold and will, upon our request, sell to us for the account of one or
more of the Underwriters such amount of such unsold securities as we may
designate, at the offering price less an amount to be determined by us not in
excess of the concession allowed to you.
8. If we are acting as Representative of the Underwriters, upon
application to us, we will inform you of the states and other jurisdictions of
the United States in which it is believed that the securities being offered are
qualified for sale under, or are exempt from the requirements of, their
respective securities laws, but we assume no responsibility with respect to your
right to sell securities in any jurisdiction. We shall have authority to file
with the Department of State of the State of New York a Further State Notice
with respect to the securities, if necessary.
9. You agree that in connection with any offering of securities covered by
this Agreement you will comply with the applicable provisions of the 1933 Act
and the 1934 Act and the applicable rules and regulations of the Securities and
Exchange Commission thereunder, the applicable rules and regulations of the
NASD, and the applicable rules of any securities exchange having jurisdiction
over the offering.
10. We shall have full authority to take such action as we may deem
advisable in respect of all matters pertaining to any offering covered by this
Agreement. We shall be under no liability to you except for our lack of good
faith and for obligations assumed by us in this Agreement, except that you do
not waive any rights that you may have under the 1933 Act or the rules and
regulations thereunder.
3
<PAGE>
11. Any notice from us shall be deemed to have been duly given if mailed
or transmitted by any standard form of written telecommunications to you at the
above address or at such other address as you shall specify to us in writing.
12. With respect to any offering of securities covered by this Agreement,
the price restrictions contained in Paragraph 1 hereof and the provisions of
Paragraphs 6 and 7 hereof shall terminate as to such offering at the close of
business on the 45th day after the securities are released for sale or, as to
any or all such provisions, at such earlier time as we may advise. All other
provisions of this Agreement shall remain operative and in full force and effect
with respect to such offering.
13. This Agreement shall be governed by the laws of the State of New York.
Please confirm your agreement hereto by signing the enclosed duplicate copy
hereof in the place provided below and returning such signed duplicate copy to
us at World Headquarters, North Tower, World Financial Center, New York, N.Y.
10281-1305, Attention: Corporate Syndicate. Upon receipt thereof, this
instrument and such signed duplicate copy will evidence the agreement between
us.
Very truly yours,
MERRILL LYNCH, PIERCE, FENNER & SMITH
INCORPORATED
By: /s/ Fred F. Hessinger
--------------------------------
Name: Fred F. Hessinger
Confirmed and accepted as of the
day of , 19
- ----------------------------------
Name of Dealer
- ----------------------------------
Authorized Officer or Partner
(if not Officer or Partner, attach
copy of Instrument of Authorization)
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