<PAGE>
As filed with the Securities and Exchange Commission on February 23, 1999
Securities Act File No. 333-68451
Investment Company Act File No. 811-09133
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM N-2
[X] REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
[X]
PRE-EFFECTIVE AMENDMENT NO. 2
[_] POST-EFFECTIVE AMENDMENT NO.
AND/OR
[X] REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
[X]
AMENDMENT NO. 3
(check appropriate box or boxes)
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MuniHoldings Pennsylvania Insured Fund
(Exact Name of Registrant as Specified in Charter)
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800 Scudders Mill Road
Plainsboro, New Jersey 08536
(Address of Principal Executive Offices)
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(609) 282-2800
(Registrant's Telephone Number, Including Area Code)
--------------
Arthur Zeikel
MuniHoldings Pennsylvania Insured Fund
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)
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Copies to:
Michael J. Hennewinkel, Esq. Frank P. Bruno, Esq.
Fund Asset Management, L.P. Brown & Wood LLP
P.O. Box 9011 One World Trade Center
Princeton, New Jersey 08543-9011 New York, New York 10048-0557
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Approximate date of proposed public offering: As soon as practicable after the
effective date of this Registration Statement.
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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. [_]
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CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933
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<TABLE>
<CAPTION>
Proposed Proposed
Title of Amount Maximum Maximum Amount of
Securities Being Being Offering Price Aggregate Registration
Registered Registered(1) Per Unit Offering Price Fee(2)
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<S> <C> <C> <C> <C>
Common Shares of
Beneficial Interest
($.10 par value)....... 2,156,250 shares $15.00 $32,343,750 $8,992
</TABLE>
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(1) Includes 281,250 shares subject to the Underwriter's over-allotment option.
(2) Transmitted to the designated lockbox at Mellon Bank in Pittsburgh, PA.
$32,130 was previously paid.
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<PAGE>
PROSPECTUS
1,875,000 Shares
MuniHoldings Pennsylvania Insured Fund
Common Shares
---------------
MuniHoldings Pennsylvania Insured Fund (the "Fund") is a newly organized,
non-diversified, closed-end management investment company that seeks to provide
shareholders with current income exempt from Federal income tax and
Pennsylvania personal income taxes. The Fund seeks to achieve its 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 income tax and Pennsylvania personal income
taxes. The Fund intends to invest in municipal obligations that are rated
investment grade, or if unrated, are considered by the Fund's investment
adviser to be of comparable quality. Under normal circumstances, at least 80%
of the Fund's assets will be invested in municipal obligations with remaining
maturities of one year or more that are covered by insurance guaranteeing the
timely payment of principal at maturity and interest.
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. The Fund's common shares have been approved for listing on
the American Stock Exchange under the symbol "MPI." Trading of the Fund's
common shares on the exchange is expected to begin within two weeks of the date
of this prospectus. Before it begins trading, the underwriter does not intend
to make a market in the Fund's shares. Thus, investors may not be able to buy
and sell shares of the Fund during that time.
Within approximately three months after completion of this offering of common
shares, the Fund intends to offer preferred shares representing approximately
40% of the Fund's capital immediately after the issuance of such preferred
shares. There can be no assurance, however, that preferred shares representing
such percentage of the Fund's capital will actually be issued. The use of
preferred shares to leverage the common shares can create special risks.
---------------
This prospectus contains information you should know before investing,
including information about risks. Please read it before you invest and keep it
for future reference.
---------------
Investing in the common shares involves certain risks, which are described in
the "Risk Factors and Special Considerations" section beginning on page 7 of
this prospectus.
<TABLE>
<CAPTION>
Per Share Total
--------- -----
<S> <C> <C>
Public Offering Price.............................. $15.00 $28,125,000
Sales Load......................................... None None
Proceeds, before expenses, to Fund................. $15.00 $28,125,000
</TABLE>
The Fund's investment adviser or an affiliate will pay the underwriter a
commission in the amount of 2.00% of the public offering price per share in
connection with the sale of the common shares.
The underwriter may also purchase up to an additional 281,250 shares at the
public offering price within 45 days from the date of this prospectus to cover
over-allotments.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if
this prospectus is truthful or complete. Any representation to the contrary is
a criminal offense.
We expect that the common shares will be ready for delivery in New York, New
York on or about February 26, 1999.
---------------
Merrill Lynch & Co.
---------------
The date of this prospectus is February 23, 1999.
<PAGE>
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............................... 21
Investment Restrictions.................................................... 24
Trustees and Officers...................................................... 25
Investment Advisory and Management Arrangements............................ 28
Portfolio Transactions..................................................... 29
Dividends and Distributions................................................ 30
Taxes...................................................................... 31
Automatic Dividend Reinvestment Plan....................................... 35
Mutual Fund Investment Option.............................................. 37
Net Asset Value............................................................ 38
Description of Capital Shares.............................................. 38
Custodian.................................................................. 42
Underwriting............................................................... 42
Transfer Agent, Dividend Disbursing Agent and Registrar.................... 43
Legal Opinions............................................................. 43
Experts.................................................................... 43
Additional Information..................................................... 44
Independent Auditors' Report............................................... 45
Statement of Assets, Liabilities and Capital............................... 46
Appendix I--Economic and Financial Conditions in Pennsylvania.............. 47
Appendix II--Ratings of Municipal Bonds.................................... 59
Appendix III--Portfolio Insurance.......................................... 66
Appendix IV--Taxable Equivalent Yields for Individuals for 1999............ 68
</TABLE>
----------------
Information about the Fund can be reviewed and copied at the SEC's Public
Reference Room in Washington, D.C. Call 1-800-SEC-0330 for information on the
operation of the public reference room. This information is also available on
the SEC's Internet site at http://www.sec.gov and copies may be obtained upon
payment of a duplicating fee by writing the Public Reference Section of the
SEC, Washington, D.C. 20549-6009.
----------------
You should rely only on the information contained in this prospectus. We have
not, and the underwriter has not, authorized any other person to provide you
with different information. If anyone provides you with different or
inconsistent information, you should not rely on it. We are not, and the
underwriter is not, making an offer to sell these securities in any
jurisdiction where the offer or sale is not permitted. You should assume that
the information appearing in this prospectus is accurate as of the date on the
front cover of this prospectus only. Our business, financial condition, results
of operations and prospects may have changed since that date.
2
<PAGE>
PROSPECTUS SUMMARY
This summary is qualified in its entirety by reference to the detailed
information included in this prospectus.
The Fund MuniHoldings Pennsylvania Insured Fund (the "Fund") is a newly
organized, non-diversified, closed-end management investment
company.
The
Offering The Fund is offering 1,875,000 common shares at an initial offering
price of $15.00 per share. The common shares are being offered by
Merrill Lynch, Pierce, Fenner & Smith Incorporated, as underwriter.
The underwriter may also purchase up to an additional 281,250
common shares within 45 days of the date of this prospectus to
cover over-allotments.
Investment
Objective The investment objective of the Fund is to provide shareholders
and with current income exempt from Federal income tax and Pennsylvania
Policies personal income taxes. The Fund seeks to achieve its 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 income tax and
Pennsylvania personal income taxes.
Investment Grade Municipal Bonds. The Fund intends to invest in
municipal bonds that are rated investment grade by one or more
nationally recognized statistical rating agencies or, if unrated,
are considered by the investment adviser to be of comparable
quality.
Pennsylvania Municipal Bonds. The Fund will generally invest
substantially all (at least 80%) of its assets in Pennsylvania
municipal bonds. However, when the Fund's investment adviser
believes that investment grade Pennsylvania municipal bonds are not
available in sufficient amounts at an appropriate price, the Fund
may invest a lesser amount of its assets in these securities. At
all times, except during periods when the Fund is in the process of
investing its proceeds from a public offering or during temporary
defensive periods, the Fund intends to invest at least 65% of its
assets in Pennsylvania municipal bonds and at least 80% of its
assets in Pennsylvania municipal bonds and other long-term
municipal bonds. These other long-term municipal bonds that the
Fund may buy will be exempt from Federal income tax but not
Pennsylvania personal income taxes.
The Fund will normally invest at least 80% of its assets in insured
municipal obligations with remaining maturities of one year or
more. Insured municipal obligations are covered by insurance that
guarantees timely interest payments and the repayment of principal
on maturity.
In general, the Fund does not intend its investments to earn a
large amount of income that is not exempt from Federal income tax
and Pennsylvania personal income taxes.
Indexed and Inverse Floating Rate Securities. The Fund may invest
in securities whose potential returns are directly related to
changes in an underlying index or interest rate, known
3
<PAGE>
as indexed securities. The return on indexed securities will rise
when the underlying index or interest rate rises and fall when the
index or interest rate falls. The Fund may also invest in
securities whose return is inversely related to changes in an
interest rate (inverse floaters). In general, income on inverse
floaters will decrease when short term interest rates increase and
increase when short term interest rates decrease. Investments in
inverse floaters may subject the Fund to the risks of reduced or
eliminated interest payments and losses of principal. In addition,
certain indexed securities and inverse floaters may increase or
decrease in value at a greater rate than the underlying interest
rate, which effectively leverages the Fund's investment. As a
result, the market value of such securities will generally be more
volatile than that of fixed rate, tax exempt securities. Both
indexed securities and inverse floaters are derivative securities
and can be considered speculative.
Options and Futures Transactions. The Fund may seek to hedge its
portfolio against changes in interest rates using options and
financial futures contracts. The Fund's hedging transactions are
designed to reduce volatility, but come at some cost. For example,
the Fund may try to limit its risk of loss from a decline in price
of a portfolio security by purchasing a put option. However, the
Fund must pay for the option, and the price of the security may not
in fact drop. In large part, the success of the Fund's hedging
activities depends on its ability to forecast movements in
securities prices and interest rates. The Fund does not, however,
intend to enter into options and futures transactions for
speculative purposes. The Fund is not required to hedge its
portfolio and may not do so.
Leverage
Issuance of Preferred Shares. The Fund intends to offer preferred
shares within three months after completion of this offering. The
preferred shares will represent approximately 40% of the Fund's
capital, including the capital raised by issuing the preferred
shares. There can be no assurance, however, that preferred shares
will actually be issued. Issuing preferred shares will result in
the leveraging of the common shares. Although the Board of Trustees
has not yet determined the terms of the preferred shares offering,
the Fund expects that the preferred shares 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). The preferred shares dividend rate will be based upon
prevailing interest rates for debt obligations of comparable
maturity. The money raised by the preferred shares offering will be
invested in longer-term obligations in accordance with the Fund's
investment objective. The expenses of the preferred shares, which
will be borne by the Fund, will reduce the net asset value of the
common shares. In addition, at times when the Fund is required to
allocate taxable income to preferred shareholders, the terms of the
preferred shares may require the Fund to make an additional
distribution to them. The amount of this additional distribution
approximately equals the tax liability resulting from the
allocation (an "Additional Distribution"). During periods when the
Fund has preferred shares outstanding, the Fund will pay fees to
the investment adviser for its services that are higher than if the
Fund did not issue preferred shares because the fees will be
calculated on the basis of the Fund's average weekly net assets,
including proceeds from the sale of preferred shares.
4
<PAGE>
Potential Benefits of Leverage. Under normal market conditions,
longer term obligations produce higher yields than short and medium
term obligations. The Fund's investment adviser believes that the
interest income the Fund receives from its long term investments
will exceed the amount of interest the Fund must pay to the
preferred shareholders. Thus, the Fund's use of preferred shares
should provide common shareholders with a higher yield than they
would receive if the Fund were not leveraged.
Risks. The use of leverage creates certain risks for common
shareholders, including higher volatility of both the net asset
value and the market value of the common shares. Since any decline
in the value of the Fund's investments will affect only the common
shareholders, in a declining market the use of leverage will cause
the Fund's net asset value to decrease more than it would if the
Fund were not leveraged. This decrease in net asset value will
likely also cause a decline in the market price for common shares.
In addition, fluctuations in the dividend rates paid on, and the
amount of taxable income allocable to, the preferred shares will
affect the yield to common shareholders. There can be no assurance
that the Fund will earn a higher net return on its investments than
the then current dividend rate (and any Additional Distribution) it
pays on the preferred shares. Under certain conditions, the
benefits of leverage to common shareholders will be reduced, and
the Fund's leveraged capital structure could result in a lower rate
of return to common shareholders than if the Fund were not
leveraged.
Distributions. When the Fund issues preferred shares, common
shareholders will receive all of the Fund's net income that remains
after it pays dividends (and any Additional Distribution) on the
preferred shares and generally will be entitled to a pro rata share
of net realized capital gains. If the Fund is liquidated, preferred
shareholders will be entitled to receive liquidating distributions
before any distribution is made to common shareholders. These
liquidating distributions are expected to equal the original
purchase price per share of the preferred shares plus any
accumulated and unpaid dividends and Additional Distributions.
Redemption of Preferred Shares. The Fund may redeem the preferred
shares for any reason. For example, the Fund may redeem all or part
of the preferred shares if it believes that the Fund's leveraged
capital structure will cause common shareholders to obtain a lower
return than they would if the common shares were unleveraged for
any significant amount of time.
Voting Rights. Preferred shareholders, voting as a separate class,
will be entitled to elect two of the Fund's Trustees. Common and
preferred shareholders, voting together as a single class, will be
entitled to elect the remaining Trustees. If the Fund fails to pay
dividends to the preferred shareholders for two full years, the
holders of all outstanding shares of preferred shares, voting as a
separate class, would then be entitled to elect a majority of the
Fund's Trustees. The preferred shareholders also will vote
separately on certain other matters as required under the Fund's
Declaration of Trust, the Investment Company Act of 1940, as
amended, and Massachusetts law. Otherwise, common and preferred
shareholders will have equal voting rights (one vote per share) and
will vote together as a single class.
5
<PAGE>
Ratings. Before it offers the preferred shares, the Fund intends to
apply to one or more nationally recognized statistical ratings
organizations for ratings on the preferred shares. The Fund
believes that a rating for the preferred shares will make it easier
to market the shares, which should reduce the dividend rate.
Listing
Currently, there is no public market for the Fund's common shares.
However, the Fund's common shares have been approved for listing on
the American Stock Exchange. Trading of the Fund's common shares is
expected to begin within two weeks of the date of this prospectus.
Before it begins trading, the underwriter does not intend to make a
market in the Fund's common shares. Thus, investors may not be able
to buy and sell shares of the Fund during that period.
Investment Fund Asset Management, L.P. is the Fund's investment adviser and
Adviser provides investment advisory and management services to the Fund.
For its services, the Fund pays the investment adviser a fee at the
annual rate of 0.55% of the Fund's average weekly net assets,
including assets acquired from the sale of preferred shares.
Dividends
and
Distributions
The Fund intends to distribute dividends equal to substantially all
of its net investment income to common shareholders each month.
Once the Fund issues preferred shares, the monthly distributions to
common shareholders will consist of substantially all net
investment income that remains after the Fund pays dividends (and
any Additional Distribution) on the preferred shares. The Fund
expects to begin paying dividends to common shareholders within
approximately 90 days from the date of this prospectus. The Fund
will distribute net capital gains, if any, at least annually to
common shareholders and, after it issues the preferred shares, on a
pro rata basis to common and preferred shareholders. When the Fund
allocates capital gains or other taxable income to preferred
shareholders, under certain circumstances, the terms of the
preferred shares may require the Fund to make an Additional
Distribution. The Fund may not declare any cash dividend or other
distribution on its common shares unless the preferred shares have
asset coverage of at least 200%. If the Fund issues preferred
shares representing 40% of its total capital, the preferred share's
asset coverage will be approximately 250%. If the Fund's ability to
make distributions on its common shares is limited, the Fund may
not be able to qualify for taxation as a regulated investment
company. This would have adverse tax consequences for shareholders.
Automatic Dividend and capital gains distributions generally are used to
Dividend purchase additional common shares. However, an investor can choose
Reinvestmentto receive distributions in cash. Since not all investors can
Plan participate in the automatic dividend reinvestment plan, you should
call your broker or nominee to confirm that you are eligible to
participate in the plan.
Mutual Investors who purchase shares in this offering through the
Fund underwriter and later sell their shares have the option, subject to
Investment certain conditions, to purchase Class D shares of certain Merrill
Option Lynch funds with the proceeds from the sale.
6
<PAGE>
RISK FACTORS AND SPECIAL CONSIDERATIONS
Liquidity and Market Price of Shares. The Fund is newly organized and has no
operating history or history of public trading. Before the Fund's common shares
are listed on the American Stock Exchange, an investment in the Fund may be
illiquid.
Shares of closed-end funds that trade in a secondary market frequently trade
at a market price that is below their net asset value. This is commonly
referred to as "trading at a discount." Investors who sell their shares within
a relatively short period after completion of the public offering are more
likely to be exposed to this risk. The Fund is designed primarily for long-term
investors and should not be considered a vehicle for trading purposes.
Interest Rate and Credit Risk. The Fund invests in municipal bonds that are
subject to interest rate and credit risk. Interest rate risk is the risk that
prices of municipal bonds generally increase when interest rates decline and
decrease when interest rates increase. Prices of longer term securities
generally change more in response to interest rate changes than prices of
shorter term securities. Credit risk is the risk that the issuer will be unable
to pay the interest or principal when due. The degree of credit risk depends on
both the financial condition of the issuer and the terms of the obligation.
Pennsylvania Municipal Bonds. The Fund intends to invest the majority of its
portfolio in Pennsylvania municipal bonds. As a result, the Fund is more
exposed to risks affecting issuers of Pennsylvania municipal bonds than is a
municipal bond fund that invests more widely.
Non-diversification. The Fund is registered as a "non-diversified" investment
company. This means that the Fund may invest a greater percentage of its assets
in a single issuer than a diversified investment company. Even as a non-
diversified fund, the Fund must still meet the diversification requirements of
applicable Federal income tax laws. Since the Fund may invest a relatively high
percentage of its assets in a limited number of issuers, the Fund may be more
exposed to any single economic, political or regulatory occurrence than a more
widely-diversified fund.
Rating Categories. The Fund intends to invest in municipal bonds that are
rated investment grade by Standard & Poor's, Moody's Investors Service, Inc.
and Fitch IBCA, Inc. It may also invest in unrated municipal bonds that the
Fund's investment adviser believes are of comparable quality. Obligations rated
in the lowest investment grade category may have certain speculative
characteristics.
Private Activity Bonds. The Fund may invest in certain tax-exempt securities
classified as "private activity bonds." These bonds may subject certain
investors in the Fund to the alternative minimum tax. See "Taxes--General."
Portfolio Insurance and Rating Agencies. The Fund will be subject to certain
investment restrictions imposed by guidelines of the insurance companies that
issue portfolio insurance and to guidelines of one or more nationally
recognized statistical ratings organizations that may issue ratings for the
preferred shares. These guidelines may impose asset coverage or portfolio
composition requirements that are more stringent than those imposed by the
Investment Company Act of 1940, as amended. The Fund does not expect these
requirements or guidelines to prevent the investment adviser from managing the
Fund's portfolio in accordance with the Fund's investment objective and
policies.
7
<PAGE>
Leverage. The Fund plans to offer preferred shares. The preferred shares will
represent approximately 40% of the Fund's capital, including capital raised by
issuing the preferred shares. Leverage creates certain risks for common
shareholders, including higher volatility of both the net asset value and the
market value of the common shares. Leverage also creates the risk that the
investment return on the Fund's common shares will be reduced to the extent the
dividends paid on preferred shares and other expenses of the preferred shares
exceed the income earned by the Fund on its investments. If the Fund is
liquidated, preferred shareholders will be entitled to receive liquidating
distributions before any distribution is made to common shareholders.
Inverse Floating Obligations. The Fund's investments in "inverse floating
obligations" or "residual interest bonds" provide investment leverage because
their market value increases or decreases in response to market changes at a
greater rate than fixed rate, long term tax exempt securities. The market
values of such securities are more volatile than the market values of fixed
rate, tax exempt securities.
Options and Futures Transactions. The Fund may engage in certain options and
futures transactions to reduce its exposure to interest rate movements. If the
Fund incorrectly forecasts market values, interest rates or other factors, the
Fund's performance could suffer. The Fund also may suffer a loss if the other
party to the transaction fails to meet its obligations. The Fund is not
required to use hedging and may not do so.
Antitakeover Provisions. The Fund's Declaration of Trust includes provisions
that could limit the ability of other entities or persons to acquire control of
the Fund or to change the composition of its Board of Trustees. Such provisions
could limit the ability of shareholders to sell their shares at a premium over
prevailing market prices by discouraging a third party from seeking to obtain
control of the Fund.
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 Common
Stock):
Investment Advisory Fees(a)(b)........................................ 0.92%
Interest Payments on Borrowed Funds................................... None
Other Expenses(a)(b).................................................. 0.69%
----
Total Annual Expenses(a)(b)......................................... 1.61%
====
</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 1.61%
(assuming leverage of 40% of the Fund's total assets)
and (2) a 5% annual return throughout the periods: ..... $16 $51 $88 $191
</TABLE>
- --------
(a) Assumes leverage by issuing preferred shares in an amount of approximately
40% of the Fund's capital at a dividend rate of 3.375%. The Fund intends to
use leverage only if the Investment Adviser believes that it would result
in higher income to shareholders over time. See "Risks and Special
Considerations of Leverage." If the Fund does not utilize leverage, it is
estimated that, as a percentage of net assets attributable to common stock,
the Investment Advisory Fees would be 0.55%, Other Expenses would be 0.36%
and Total Annual Expenses would be 0.91%.
(b) See "Investment Advisory and Management Arrangements"--page 28.
The 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 uses 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 rates of return, and actual expenses or annual
rates of return may be more or less than those assumed for purposes of the
Example.
9
<PAGE>
THE FUND
MuniHoldings Pennsylvania Insured Fund (the "Fund") is a newly organized,
non-diversified, closed-end management investment company. The Fund was
organized under the laws of The Commonwealth of Massachusetts on December 3,
1998, 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 approximately $27,990,000 (or
approximately $32,208,750 assuming the Underwriter exercises the over-allotment
option in full) after payment of offering expenses estimated to be
approximately $135,000.
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 shares, 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 Fund's investment objective is to provide shareholders with current
income exempt from Federal income tax and Pennsylvania personal income taxes.
The Fund will seek to achieve its objective by investing primarily in a
portfolio of long-term, investment grade municipal obligations issued by or on
behalf of the Commonwealth of Pennsylvania, its political subdivisions,
agencies and instrumentalities, and other qualifying issuers, each of which
pays interest that, in the opinion of bond counsel to the issuer, is exempt
from Federal income tax and Pennsylvania personal income taxes ("Pennsylvania
Municipal Bonds"). The Fund intends to invest substantially all (at least 80%)
of its assets in Pennsylvania Municipal Bonds, except at times when the Fund's
investment adviser, Fund Asset Management, L.P. (the "Investment Adviser"),
considers that Pennsylvania Municipal Bonds of sufficient quality and quantity
are unavailable for investment at suitable prices by the Fund. To the extent
the Investment Adviser considers that suitable Pennsylvania Municipal Bonds are
not available for investment, the Fund may purchase other long-term municipal
obligations the interest on which is exempt from Federal income taxes but not
from Pennsylvania income taxes ("Municipal Bonds"). The Fund will maintain at
least 65% of its assets in Pennsylvania Municipal Bonds and at least 80% of its
assets in Pennsylvania Municipal Bonds and Municipal Bonds, except during
interim periods pending investment of the net proceeds of public offerings of
the Fund's securities and during temporary defensive periods. Under normal
circumstances, at least 80% of the Fund's assets will be invested in municipal
10
<PAGE>
obligations with remaining maturities of one year or more that are covered by
insurance guaranteeing the timely payment of principal at maturity and
interest. The Fund's investment objective 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
common shares.
The Fund ordinarily does not intend to realize significant investment income
that is subject to Federal income tax or Pennsylvania personal income taxes.
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 include securities issued by other
investment companies that invest in Pennsylvania Municipal Bonds and Municipal
Bonds, to the extent such investments are permitted by the Investment Company
Act of 1940, as amended (the "1940 Act"). Other Non-Municipal Tax-Exempt
Securities could include trust certificates or other instruments evidencing
interests in one or more long-term Pennsylvania Municipal Bonds or Municipal
Bonds. Certain Non-Municipal Tax-Exempt Securities may be characterized as
derivative instruments. Non-Municipal Tax-Exempt Securities are considered
"Pennsylvania Municipal Bonds" or "Municipal Bonds" for purposes of the Fund's
investment objective and policies.
Investment in common shares of the Fund offers several potential benefits.
The Fund offers investors the opportunity to receive income exempt from
Federal income tax and Pennsylvania personal income taxes by investing in a
professionally managed portfolio comprised primarily of investment grade
insured Pennsylvania Municipal Bonds. Investment in the Fund also relieves the
investor of the burdensome administrative details involved in managing a
portfolio of Pennsylvania Municipal Bonds. Additionally, the Investment
Adviser will seek to enhance the yield on the common shares by leveraging the
Fund's capital structure through the issuance of preferred shares. 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 Pennsylvania Municipal Bonds and Municipal Bonds in
which the Fund will primarily invest are those Pennsylvania Municipal Bonds
and Municipal Bonds rated at the date of purchase in the four highest rating
categories of Standard & Poor's ("S&P"), Moody's Investors Services, Inc.
("Moody's") or Fitch IBCA, Inc. ("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-3 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 Fitch. Obligations ranked in the lowest investment grade
rating category (BBB, SP-3 and A-3 for S&P; Baa, MIG-3 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
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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 Pennsylvania Municipal Bonds and Municipal
Bonds with respect to the foregoing requirements, the Investment Adviser will
take into account the portfolio insurance as well as the nature of any letters
of credit or similar credit enhancements to which particular Pennsylvania
Municipal Bonds and Municipal Bonds are entitled and the creditworthiness of
the insurance company or financial institution that provided such insurance or
credit enhancement. Consequently, if Pennsylvania Municipal Bonds or Municipal
Bonds are covered by insurance policies issued by insurers whose claims-paying
ability is rated AAA by S&P or Fitch or Aaa by Moody's, the Investment Adviser
may consider such municipal obligations to be equivalent to AAA- or Aaa- rated
securities, as the case may be, even though such Pennsylvania Municipal Bonds
or Municipal Bonds would generally be assigned a lower rating if the rating
were based primarily upon the credit characteristics of the issuers without
regard to the insurance feature. The insured Pennsylvania Municipal Bonds and
Municipal Bonds must also comply with the standards applied by the insurance
carriers in determining eligibility for portfolio insurance.
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 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 for Federal income
tax purposes.
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 common shares 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 Pennsylvania Municipal
Bonds and Municipal Bonds with a maturity of more than ten years. Also, the
Fund may invest in intermediate-term Pennsylvania 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 that is subject to Federal income tax or
Pennsylvania personal income taxes.
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The Fund is classified as non-diversified within the meaning of the 1940 Act,
which means that the Fund is not limited by the 1940 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 Federal tax laws.
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.
Portfolio Insurance
Under normal circumstances, at least 80% of the Fund's assets will be
invested in Pennsylvania Municipal Bonds and Municipal Bonds either (i) insured
under an insurance policy purchased by the Fund or (ii) insured under an
insurance policy obtained by the issuer thereof or any other party. The Fund
will seek to limit its investments to municipal bonds insured under insurance
policies issued by insurance carriers that have total admitted assets
(unaudited) of at least $75,000,000 and capital and surplus (unaudited) of at
least $50,000,000 and insurance claims-paying ability ratings of AAA from S&P
or Fitch or Aaa from Moody's. There can be no assurance that insurance from
insurance carriers meeting these criteria will be at all times available. See
Appendix III to this Prospectus for a brief description of S&P's, Fitch's and
Moody's insurance claims-paying ability ratings. Currently, it is anticipated
that a majority of the insured Pennsylvania Municipal Bonds and Municipal Bonds
in the Fund's portfolio will be insured by the following insurance companies
that satisfy the foregoing criteria: AMBAC Indemnity Corporation, Financial
Guaranty Insurance Company, Financial Security Assurance and Municipal Bond
Investors Assurance Corporation. The Fund also may purchase Pennsylvania
Municipal Bonds and Municipal Bonds covered by insurance issued by any other
insurance company that satisfies the foregoing criteria. It is anticipated that
initially a majority of insured Pennsylvania Municipal Bonds and Municipal
Bonds held by the Fund will be insured under policies obtained by parties other
than the Fund.
The Fund may purchase, but has no obligation to purchase, separate insurance
policies (the "Policies") from insurance companies meeting the criteria set
forth above that guarantee the payment of principal and interest on specified
eligible Pennsylvania Municipal Bonds and Municipal Bonds purchased by the
Fund. A Pennsylvania Municipal Bond and a Municipal Bond will be eligible for
coverage if it meets certain requirements of the insurance company set forth in
a Policy. In the event interest or principal on an insured Pennsylvania
Municipal Bond and Municipal Bond is not paid when due, the insurer will be
obligated under its Policy to make such payment not later than 30 days after it
has been notified by, and provided with documentation from, the Fund that such
nonpayment has occurred.
The Policies will be effective only as to insured Pennsylvania Municipal
Bonds and Municipal Bonds beneficially owned by the Fund. In the event of a
sale of any Pennsylvania Municipal Bonds and Municipal Bonds held by the Fund,
the issuer of the relevant Policy will be liable only for those payments of
interest and principal that are then due and owing. The Policies will not
guarantee the market value of the insured Pennsylvania Municipal Bonds and
Municipal Bonds or the value of the shares of the Fund.
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<PAGE>
The insurer will not have the right to withdraw coverage on securities
insured by their Policies and held by the Fund so long as such securities
remain in the Fund's portfolio. In addition, the insurer may not cancel its
Policies for any reason except failure to pay premiums when due. The Board of
Trustees of the Fund will reserve the right to terminate any of the Policies if
it determines that the benefits to the Fund of having its portfolio insured
under such policy are not justified by the expense involved.
The premiums for the Policies are paid by the Fund and the yield on the
Fund's portfolio is reduced thereby. The Investment Adviser estimates that the
cost of the annual premiums for the Policies currently ranges from
approximately .02 of 1% to .15 of 1% of the principal amount of the
Pennsylvania Municipal Bonds and Municipal Bonds covered by such Policies. The
estimate is based on the expected composition of the Fund's portfolio of
Pennsylvania Municipal Bonds and Municipal Bonds. Additional information
regarding the Policies is set forth in Appendix III to this Prospectus. In
instances in which the Fund purchases Pennsylvania Municipal Bonds and
Municipal Bonds insured under policies obtained by parties other than the Fund,
the Fund does not pay the premiums for such policies; rather, the cost of such
policies may be reflected in the purchase price of the Pennsylvania Municipal
Bonds and Municipal Bonds.
It is the intention of the Investment Adviser to retain any insured
securities that are in default or in significant risk of default and to place a
value on the insurance, which ordinarily will be the difference between the
market value of the defaulted security and the market value of similar
securities that are not in default. In certain circumstances, however, the
Investment Adviser may determine that an alternate value for the insurance,
such as the difference between the market value of the defaulted security and
its par value, is more appropriate. The Investment Adviser's ability to manage
the portfolio may be limited to the extent the Fund holds defaulted securities,
which may limit its ability in certain circumstances to purchase other
Pennsylvania Municipal Bonds and Municipal Bonds. See "Net Asset Value" below
for a more complete description of the Fund's method of valuing defaulted
securities and securities that have a significant risk of default.
There can be no assurance that insurance with the terms and issued by
insurance carriers meeting the criteria described above will continue to be
available to the Fund. In the event the Board of Trustees determines that such
insurance is unavailable or that the cost of such insurance outweighs the
benefits to the Fund, the Fund may modify the criteria for insurance carriers
or the terms of the insurance, or discontinue its policy of maintaining
insurance for all or any of the Pennsylvania Municipal Bonds and Municipal
Bonds held in the Fund's portfolio. Although the Investment Adviser
periodically reviews the financial condition of each insurer, there can be no
assurance that the insurers will be able to honor their obligations under all
circumstances.
The portfolio insurance reduces financial or credit risk (i.e., the
possibility that the owners of the insured Pennsylvania Municipal Bonds or
Municipal Bonds will not receive timely scheduled payments of principal or
interest). However, the insured Pennsylvania Municipal Bonds or Municipal Bonds
are subject to market risk (i.e., fluctuations in market value as a result of
changes in prevailing interest rates).
Description of Pennsylvania Municipal Bonds and Municipal Bonds
Pennsylvania 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,
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electricity, sewage or 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 are Pennsylvania Municipal Bonds if the interest
thereon is exempt from Federal income tax and Pennsylvania personal income
taxes, 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 Pennsylvania Municipal Bonds or Municipal Bonds.
The two principal classifications of Pennsylvania 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 are typically 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
typically 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. Pennsylvania 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 Pennsylvania 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 Pennsylvania 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
Pennsylvania Municipal Bonds and/or 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 typically 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 Pennsylvania Municipal Bonds and Municipal Bonds for
investment by the Fund.
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Special Considerations Relating to Pennsylvania Municipal Bonds
The Fund ordinarily will invest substantially all of its assets in
Pennsylvania Municipal Bonds, and therefore it is more susceptible to factors
adversely affecting issuers of Pennsylvania Municipal Bonds than is a municipal
bond mutual fund that is not concentrated in issuers of Pennsylvania Municipal
Bonds to this degree. Many different social, environmental and economic factors
may affect the financial condition of Pennsylvania and its political
subdivisions. From time to time Pennsylvania and certain of its political
subdivisions have encountered financial difficulties which adversely affected
their respective credit standings. Other factors which may negatively affect
economic conditions in Pennsylvania include adverse changes in employment
rates, Federal revenue sharing or laws with respect to tax-exempt financing.
The Investment Adviser does not believe that the current economic conditions in
Pennsylvania or other factors described above will have a significant adverse
effect on the Fund's ability to invest in high quality Pennsylvania Municipal
Bonds. As of December 1, 1998, Pennsylvania general obligation bonds were rated
AA by S&P, AA by Fitch and Aa3 by Moody's. See Appendix I, "Economic and
Financial Conditions in Pennsylvania."
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 shares pursuant to tender offers or otherwise
to redeem or repurchase preferred shares or for temporary, extraordinary or
emergency purposes. Borrowings by the Fund (commonly known, as with the
issuance of preferred shares, 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 Pennsylvania 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 Pennsylvania
Municipal Bonds and Municipal Bonds yielding a return based on a particular
index of value or interest rates. For example, the Fund may invest in
Pennsylvania 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 Pennsylvania 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 Pennsylvania 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 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
16
<PAGE>
agent, or by reference to a short-term tax-exempt interest rate index). The
Fund may purchase synthetically-created inverse floating rate bonds evidenced
by custodial or trust receipts. Generally, income on inverse floating rate
bonds will decrease when short-term interest rates increase, and will increase
when short-term interest 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 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 Pennsylvania Municipal Bond or Municipal
Bond issuer's right to call all or a portion of such Pennsylvania 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 Pennsylvania Municipal Bonds or Municipal Bonds,
subject to certain conditions. A Call Right that is not exercised prior to the
maturity of the related Pennsylvania Municipal Bond or Municipal Bond will
expire without value. The economic effect of holding both the Call Right and
the related Pennsylvania Municipal Bond or Municipal Bond is identical to
holding a Pennsylvania 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. Similarly, such amounts are not considered tax-exempt interest for
Pennsylvania tax purposes.
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 shares, the net asset value of the common
shares 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 shares, hedging transactions will result in a
larger impact on the net asset value of the common shares
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than would be the case if the common shares were not leveraged. Furthermore,
the Fund may only engage in hedging activities from time to time and may not
necessarily be engaging in hedging activities when movements in interest rates
occur. The Fund has no obligation to enter into hedging transactions and may
not do so.
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 shares from one or more nationally recognized
statistical ratings organizations ("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 Fund's use of such transactions
and risks associated with these transactions. The investment policies with
respect to the hedging transactions of the Fund are not fundamental policies
and may be modified by the Board of Trustees 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 Pennsylvania 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 may 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 Pennsylvania Municipal Bonds and
Municipal Bonds against declines in value and to hedge against increases in the
cost of
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securities it 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 Pennsylvania 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 Trustees, 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
Pennsylvania 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.
19
<PAGE>
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 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 Pennsylvania
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 does 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.
Certain risks are involved in options and futures transactions. The
Investment Adviser believes, however, that, because the Fund will engage in
options and futures transactions only for hedging purposes, the Fund's options
and futures portfolio strategies will not subject the Fund to those risks
associated with speculation in options and futures transactions.
The volume of trading in the exchange markets with respect to Pennsylvania
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.
20
<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 this offering, the
Fund intends to offer preferred shares representing approximately 40% of the
Fund's capital immediately after the issuance of such preferred shares. There
can be no assurance, however, that preferred shares representing such
percentage of the Fund's capital will actually be issued. Issuing the preferred
shares will result in the leveraging of the common shares. Although the Fund's
Board of Trustees has not yet determined the terms of the preferred shares
offering, the Fund anticipates that the preferred shares 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). The dividend rate
will be based upon prevailing interest rates for debt obligations of comparable
maturity. The proceeds of the preferred shares offering will be invested in
longer-term obligations in accordance with the Fund's investment objective. The
expenses of the preferred shares, which will be borne by the Fund, will reduce
the net asset value of the common shares. Additionally, under certain
circumstances, when the Fund is required to allocate taxable income to holders
of preferred shares, the Fund anticipates that the terms of the preferred
shares 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 (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 shares and the longer-term rates received by the Fund may provide
holders of common shares with a potentially higher yield.
The use of leverage, however, involves certain risks to the holders of common
shares. For example, issuance of the preferred shares may result in higher
volatility of the net asset value of the common shares and potentially more
volatility in the market value of the common shares. In addition, changes in
the short-term and
21
<PAGE>
medium-term dividend rates on, and the amount of taxable income allocable to,
the preferred shares will affect the yield to holders of common shares.
Leverage will allow holders of common shares to realize a higher current rate
of return than if the Fund were not leveraged as long as the Fund, while
accounting for its costs and 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 shares. Similarly, since a pro
rata portion of the Fund's net realized capital gains are generally payable to
holders of common shares, the effect of leverage will be to increase the amount
of such gains distributed to holders of common shares. However, short-term,
medium-term and long-term interest rates change from time to time as do their
relationships 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 shares
approaches the net return on the Fund's investment portfolio, the benefit of
leverage to holders of common shares will be decreased. If the current dividend
rate (and any Additional Distribution) on the preferred shares were to exceed
the net return on the Fund's portfolio, holders of common shares would receive
a lower rate of return than if the Fund were not leveraged. Similarly, since
both the cost of issuing the preferred shares and any decline in the value of
the Fund's investments (including investments purchased with the proceeds from
any preferred share offering) will be borne entirely by holders of common
shares, the effect of leverage in a declining market would result in a greater
decrease in net asset value to holders of common shares than if the Fund were
not leveraged. If the Fund is liquidated, holders of preferred shares will be
entitled to receive liquidating distributions before any distribution is made
to holders of common shares.
In an extreme case, a decline in net asset value could affect the Fund's
ability to pay dividends on the common shares. Failure to make such dividend
payments could adversely affect the Fund's qualification as a regulated
investment company under Federal tax laws. See "Taxes." However, the Fund
intends to take all measures necessary to make common shares dividend payments.
If the Fund's current investment income is ever insufficient to meet dividend
payments on either the common shares or the preferred shares, the Fund may have
to liquidate certain of its investments. In addition, the Fund will have the
authority to redeem the preferred shares for any reason and may redeem all or
part of the preferred shares under the following circumstances:
. if the Fund anticipates that the leveraged capital structure will result
in a lower rate of return for any significant amount of time to holders
of the common shares than that obtainable if the common shares were not
leveraged,
. if the asset coverage for the preferred shares 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 shares in tender offers, or
. in order to maintain the asset coverage guidelines established by the
NRSROs that have rated the preferred shares.
Redemption of the preferred shares or insufficient investment income to make
dividend payments, may reduce the net asset value of the common shares 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.
As discussed under "Investment Advisory and Management Arrangements," during
periods when the Fund has preferred shares outstanding, the fees paid the
Investment Adviser for investment advisory and
22
<PAGE>
management services will be higher than if the Fund did not issue preferred
shares because the fees paid will be calculated on the basis of the Fund's
average weekly net assets, including proceeds from the sale of preferred
shares.
Assuming the use of leverage by issuing preferred shares (paying 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 3.375%
payable on such preferred shares 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 1.35%.
The following table is designed to illustrate the effect on the return to a
holder of the Fund's common shares of the leverage obtained by the issuance of
preferred shares 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 shareholders
when portfolio return is positive and decreases the return when 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 Shares Return.................. (19)% (11)% (2)% 6% 14%
</TABLE>
Leveraging the common shares cannot be fully achieved until preferred shares
are issued and the proceeds of such offering have been invested in long-term
Pennsylvania Municipal Bonds and Municipal Bonds.
Portfolio Management and Other Considerations
If short-term or medium-term rates increase or other changes in market
conditions occur to the point where the Fund's leverage could adversely affect
holders of common shares as noted above (or in anticipation of such changes),
the Fund may attempt to shorten the average maturity of its investment
portfolio in order to offset the negative impact of leverage. The Fund also may
attempt to reduce the degree to which it is leveraged by redeeming preferred
shares pursuant to the Fund's Certificate of Designation, which establishes the
rights and preferences of the preferred shares, or otherwise by purchasing
preferred shares. Purchases and redemptions of preferred shares, whether on the
open market or in negotiated transactions, are subject to limitations under the
1940 Act. In determining whether or not it is in the best interest of the Fund
and its shareholders to redeem or repurchase outstanding preferred shares, the
Trustees will take into account a variety of factors, including the following:
. market conditions,
. the ratio of preferred shares to common shares, and
. the expenses associated with such redemption or repurchase.
If market conditions subsequently change, the Fund may sell previously unissued
preferred shares or preferred shares that the Fund had issued but later
repurchased or redeemed.
The Fund intends to apply for ratings of the preferred shares from one or
more NRSROs. In order to obtain these ratings, the Fund may be required to
maintain portfolio holdings that meet the specified guidelines of such
organizations. These guidelines may impose asset coverage requirements that are
more stringent than those imposed by the 1940 Act. The Fund does not anticipate
that these guidelines will impede the Investment Adviser
23
<PAGE>
from managing the Fund's portfolio in accordance with the Fund's investment
objective and policies. Ratings on the preferred shares issued by the Fund
should not be confused with ratings on the obligations held by the Fund.
Under the 1940 Act, the Fund is not permitted to issue preferred shares
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 shares (expected to equal the original purchase price of the
outstanding preferred shares 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 shares 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 such liquidation value. Under the Fund's
proposed capital structure, assuming the sale of preferred shares 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 shares. To the extent possible, the Fund intends to purchase
or redeem preferred shares from time to time to maintain coverage of preferred
shares of at least 200%.
INVESTMENT RESTRICTIONS
The following are fundamental investment restrictions of the Fund and, prior
to issuance of the preferred shares, may not be changed without the approval of
the holders of a majority of the Fund's outstanding common shares (which for
this purpose and under the 1940 Act means the lesser of (i) 67% of the common
shares represented at a meeting at which more than 50% of the outstanding
common shares are represented or (ii) more than 50% of the outstanding shares).
Subsequent to the issuance of the preferred shares, the following investment
restrictions may not be changed without the approval of a majority of the
outstanding common shares and of the outstanding preferred shares, voting
together as a class, and the approval of a majority of the outstanding
preferred shares, 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
Pennsylvania 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 Trustees 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
24
<PAGE>
other investment companies except if immediately thereafter not more than
(i) 3% of the total outstanding voting shares 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 shares 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 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 Pennsylvania 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 Pennsylvania Municipal Bonds and Municipal Bonds.
If a percentage restriction on 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, Pierce, Fenner & Smith
Incorporated ("Merrill Lynch") are owned and controlled by Merrill Lynch & Co.
("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.
TRUSTEES AND OFFICERS
Information about the Trustees, executive officers and 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
Trustee, executive officer and portfolio manager is 800 Scudders Mill Road,
Plainsboro, New Jersey 08536.
Arthur Zeikel (66)--President and Trustee (1)(2)--Chairman of the Investment
Adviser and MLAM (which terms, as used herein, include their corporate
predecessors) since 1997; President of the Investment Adviser and MLAM from
1977 to 1997; Chairman of Princeton Services, Inc. ("Princeton Services") since
1997, and Director thereof since 1993; President of Princeton Services from
1993 to 1997; Executive Vice President of ML & Co. since 1990.
25
<PAGE>
James H. Bodurtha (54)--Trustee (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.
Herbert I. London (59)--Trustee (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 (71)--Trustee (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 (69)--Trustee (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 (46)--Trustee (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 (58)--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 Princeton
Funds Distributor, Inc. since 1986 and Director thereof since 1991; President
of Princeton Administrators, L.P. since 1988.
Vincent R. Giordano (54)--Senior Vice President (1)(2)--Senior Vice President
of the Investment Adviser and MLAM since 1984; Senior Vice President of
Princeton Services since 1993.
Kenneth A. Jacob (47)--Vice President (1)(2)--First Vice President of MLAM
since 1997; Vice President of MLAM from 1984 to 1997; Vice President of the
Investment Adviser since 1984.
Robert A. DiMella, CFA (32)--Vice President and Portfolio Manager (1)(2)--
Vice President of MLAM since 1997; Assistant Portfolio Manager of MLAM from
1993 to 1995; Assistant Portfolio Manager with Prudential Investment Advisers
from 1991 to 1993.
26
<PAGE>
William R. Bock (62)--Vice President and Portfolio Manager (1)(2)--Vice
President of MLAM since 1989.
Donald C. Burke (38)--Vice President and Treasurer (1)(2)--Senior Vice
President and Treasurer of the Investment Adviser and MLAM since 1999; Senior
Vice President and Treasurer of Princeton Services since 1999; Vice President
of PFD since 1999; First Vice President of MLAM from 1997 to 1999; Vice
President of MLAM from 1990 to 1997; Director of Taxation of MLAM since 1990.
Alice A. Pellegrino (38)--Secretary (1)(2)--Vice President of MLAM since
1999; Attorney with MLAM since 1997; Associate with Kirkpatrick & Lockhart LLP
from 1992 to 1997.
- --------
(1) Interested person, as defined in the 1940 Act, of the Fund.
(2) Such Trustee 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.
In the event that the Fund issues preferred shares, in connection with the
election of the Fund's Trustees, holders of shares of preferred shares, voting
as a separate class, will be entitled to elect two of the Fund's Trustees, and
the remaining Trustees will be elected by all holders of capital shares, voting
as a single class. See "Description of Capital Shares."
Compensation of Trustees
Pursuant to an Investment Advisory Agreement with the Fund, the Investment
Adviser pays all compensation of officers and employees of the Fund as well as
the fees of all Trustees who are affiliated persons of ML & Co. or its
subsidiaries.
The Fund pays each Trustee not affiliated with the Investment Adviser (each,
a "non-affiliated Trustee") a fee of $2,500 per year plus $250 per meeting
attended, and pays all Trustee's out-of-pocket expenses relating to attendance
at meetings. The Fund also compensates members of the Board's audit and
nominating committee (the "Committee"), which consists of all of the non-
affiliated Trustees, an annual fee of $500 per year plus $125 per Committee
meeting attended.
The following table sets forth compensation to be paid by the Fund to the
non-affiliated Trustees projected through the end of the Fund's first full
fiscal year, and for the calendar year ended December 31, 1998 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
Trustees.
<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 Trustee from Fund Fund Expense Trustees
- --------------- ------------ ------------------- ------------------
<S> <C> <C> <C>
James H. Bodurtha (/1/)..... $4,500 None $163,500
Herbert I. London (/1/)..... $4,500 None $163,500
Robert R. Martin (/1/)...... $4,500 None $163,500
Joseph L. May (/1/)......... $4,500 None $163,500
Andre F. Perold (/1/)....... $4,500 None $163,500
</TABLE>
- --------
(1) The Trustees serve on the boards of MLAM/FAM Advised Funds as follows: Mr.
Bodurtha (28 registered investment companies consisting of 46 portfolios);
Mr. London (28 registered investment companies consisting of 46
portfolios); Mr. Martin (28 registered investment companies consisting of
46 portfolios); Mr. May (28 registered investment companies consisting of
46 portfolios); and Mr. Perold (28 registered investment companies
consisting of 46 portfolios).
27
<PAGE>
INVESTMENT ADVISORY AND MANAGEMENT ARRANGEMENTS
The Investment Adviser, which is owned and controlled by ML & Co., a
financial services holding company and the parent of Merrill Lynch, provides
the Fund with investment advisory and management services. The Merrill Lynch
Asset Management Group (which includes the Investment Adviser) acts as the
investment adviser to more than 100 registered investment companies and offers
investment advisory services to individuals and institutional accounts. As of
December 1998, the Asset Management Group had a total of approximately $501
billion in investment company and other portfolio assets under management
(approximately $38 billion of which was invested in municipal securities). This
amount includes assets managed for certain affiliates of the Investment
Adviser. The Investment Adviser is a limited partnership, the partners of which
are ML & Co. and Princeton Services, Inc. The principal business address of the
Investment Adviser is 800 Scudders Mill Road, Plainsboro, New Jersey 08536.
The Investment Advisory Agreement provides that, subject to the supervision
of the Board of Trustees of the Fund, the Investment Adviser is 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 Trustees.
The Investment Adviser provides the portfolio management for the Fund. Such
portfolio management 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. William R. Bock and Robert
A. DiMella are the portfolio managers of the Fund and are 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
preferred shares, minus the sum of accrued liabilities of the Fund and
accumulated dividends on the preferred shares). 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 Trustees 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, if any, share 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 shares, Securities and
Exchange Commission fees, fees and expenses of non-affiliated Trustees,
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.
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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 Trustees of the Fund or by a majority of the
outstanding shares of the Fund and (b) by a majority of the Trustees 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 an
advisory client when other 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 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. Transactions effected by the Investment Adviser (or
its affiliates) on behalf of more than one of its clients during the same
period may increase the demand for securities being purchased or the supply of
securities being sold, causing an adverse effect on price.
Code of Ethics
The Board of Trustees 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 Trustees 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.
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The Fund has no obligation to deal with any broker or dealer in the execution
of transactions in portfolio securities. Subject to providing the best price
and execution, securities firms that provide supplemental investment research
to the Investment Adviser, including Merrill Lynch, may receive orders for
transactions by the Fund. Research information provided to the Investment
Adviser by securities firms is supplemental. It does not replace or reduce the
level of services performed by the Investment Adviser and the expenses of the
Investment Adviser will not be reduced because it receives supplemental
research information.
The Fund invests in securities traded in the over-the-counter markets, and
the Fund intends to deal directly with 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, including Merrill Lynch, 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 principals for their own accounts, the Fund
does not deal with Merrill Lynch and its affiliates in connection with such
transactions except that, pursuant to exemptive orders 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." However, affiliated persons of the Fund, including Merrill
Lynch, serve as its brokers in certain over-the-counter transactions conducted
on an agency basis.
The Fund also may 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
The Fund may dispose of securities without regard to the time they have been
held when such action, for defensive or other reasons, if it appears advisable
to the Investment Adviser. While it is not possible to predict turnover rates
with any certainty, presently it is anticipated that the Fund's annual
portfolio turnover rate, under normal circumstances, should 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.)
A high portfolio turnover rate has certain tax consequences and results in
greater transaction costs, which are borne directly by the Fund.
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 shares. It is expected that the Fund will commence paying dividends to
holders of common shares within approximately 90 days of the date of this
prospectus. From and after issuance of the preferred shares, monthly
distributions to holders of common shares normally will consist of
substantially all net investment income remaining after the payment of
dividends (and any Additional Distribution) on the preferred shares. All net
realized capital gains, if any, will be distributed pro rata at least annually
to holders of common shares and any preferred shares. While any preferred
shares are outstanding, the Fund may not declare any cash dividend or other
distribution on its common shares, unless at the time of such declaration, (i)
all accumulated preferred share dividends, including any Additional
Distribution, have been paid, and (ii) the net asset value of the Fund's
portfolio (determined after deducting the
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amount of such dividend or other distribution) is at least 200% of the
liquidation value of the outstanding preferred shares (expected to equal the
original purchase price of the outstanding preferred shares 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 shares 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 shares. See "Taxes."
See "Automatic Dividend Reinvestment Plan" for information concerning the
manner in which dividends and distributions to holders of common shares may be
automatically reinvested in common shares 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.
TAXES
General
The Fund intends to elect and to qualify for the special tax treatment
afforded regulated investment companies ("RICs") under the Internal Revenue
Code of 1986, as amended (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.
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The portion of dividends paid from interest received by the Fund from
Pennsylvania Municipal Bonds also will be exempt from Pennsylvania personal
income tax. However, distributions attributable to capital gains derived by the
Fund as well as distributions derived from income from investments other than
Pennsylvania Municipal Bonds will be taxable for purposes of the Pennsylvania
personal income tax. In the case of residents of the City of Philadelphia,
distributions which are derived from interest received by the Fund from
Pennsylvania Municipal Bonds or which are designated as capital gain dividends
for Federal income tax purposes will be exempt from the Philadelphia School
District investment income tax. Interest on indebtedness incurred or continued
to purchase or carry shares of a RIC paying exempt interest dividends, such as
the Fund, will not be deductible by the investor for Federal or Pennsylvania
income tax purposes to the extent attributable to exempt interest dividends
(the Pennsylvania personal income tax is a tax on specified classes of income,
so that expenses and deductions are generally not permitted).
Shareholders subject to income taxation by states other than Pennsylvania
will realize a lower after tax rate of return than Pennsylvania 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 regarding the portion of the Fund's
distributions which constitutes exempt-interest dividends and the portion which
is exempt from Pennsylvania personal income taxes.
As a result of a pronouncement by the Pennsylvania Department of Revenue, an
investment in the Fund by a corporate shareholder will apparently qualify as an
exempt asset for purposes of the single asset apportionment fraction available
in computing the Pennsylvania capital stock/foreign franchise tax to the extent
that the portfolio securities of the Fund comprise investments in Pennsylvania
and/or United States Government Securities that would be exempt assets if owned
directly by the corporation. To the extent exempt-interest dividends are
excluded from taxable income for Federal corporate income tax purposes
(determined before net operating loss carryovers and special deductions), they
will not be subject to the Pennsylvania corporate net income tax. An investment
in or distributions from investment income and capital gains of the Fund,
including exempt-interest dividends, may be subject to state taxes in states
other than Pennsylvania (and, possibly, in Pennsylvania) and to local taxes
imposed by municipalities in states other than Pennsylvania (and, possibly,
municipalities in Pennsylvania). Accordingly, investors in the Fund should
consult their tax advisors with respect to the application of such taxes to an
investment in the Fund, to the receipt of Fund dividends and to their
Pennsylvania tax situation in general.
Shares of the Fund will be exempt from Pennsylvania county personal property
taxes to the extent the Fund's portfolio securities consist of Pennsylvania
Municipal Bonds on the annual assessment date. It should be noted, however,
that at present, Pennsylvania counties generally have stopped assessing
personal property taxes. This is due, in part, to ongoing litigation
challenging the validity of the tax.
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 income tax purposes.
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. Certain categories of
capital gains are 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
and capital gain dividends, as well as any amount of capital gain
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dividends in the different categories of capital gain referred to above.
Distributions by the Fund, whether from exempt-income, ordinary income or
capital gains, are not 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 for Federal income
tax purposes 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 (the "Service") has taken the position in a
revenue ruling that if a RIC has more than one class 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. 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 common shares and one or more series of preferred
shares are outstanding, the Fund intends to designate distributions made to the
classes as consisting of particular types of income in accordance with the
classes' proportionate shares of such income. Thus, the Fund will designate
dividends paid as exempt-interest dividends in a manner that allocates such
dividends among the holders of common shares and series of preferred shares in
proportion to the total dividends paid to each class during the taxable year,
or otherwise as required by applicable law. Capital gain dividends will
similarly be allocated among the 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 shares pursuant to the allocation rules described above,
the terms of the preferred shares 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 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 calendar 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.
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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 nontraditional
instruments could be recharacterized as taxable ordinary income.
If at any time when preferred shares 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 shares 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. If the Fund were to
fail to qualify as a RIC, some or all of the distributions paid by the Fund
would be fully taxable for Federal and Pennsylvania income tax purposes. Upon
any failure to meet the asset coverage requirements of the 1940 Act, the Fund,
in its sole discretion, may redeem preferred shares 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 shares that the Fund currently contemplates issuing may
raise an issue as to whether distributions on such preferred shares are
"preferential" under the Code and, therefore, not eligible for the dividends
paid deduction. The Fund intends to issue preferred shares 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 shares, there is
no assurance that the Service would agree that dividends on the preferred
shares are not preferential. If the Service successfully disallowed the
dividends paid deduction for dividends on the preferred shares, the Fund could
be disqualified as a RIC. In this case, dividends on the common shares 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 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, as well as dividend reinvestment plan participants, 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,
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shareholders subject to backup withholding are 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 Pennsylvania tax laws
presently in effect. For the complete provisions, reference should be made to
the pertinent Code sections, the Treasury Regulations promulgated thereunder
and Pennsylvania tax laws. The Code and the Treasury Regulations, as well as
the Pennsylvania 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 shares 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 common shares of the Fund. Holders of common shares 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
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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 common shares. 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 common shares from the Fund ("newly issued shares") or (ii) by
purchase of outstanding common shares on the open market ("open-market
purchases") on the American Stock Exchange (the "AMEX") or elsewhere. If on the
payment date for the dividend, the net asset value per share of the common
shares is equal to or less than the market price per common shares 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 shares 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
common shares commence trading on the AMEX, 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 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 common share 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.
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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.
MUTUAL FUND INVESTMENT OPTION
Purchasers of common shares 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
common shares 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 common shares commence trading on the
AMEX, the distributor for the mutual funds will advise Merrill Lynch Financial
Consultants as to those mutual funds that offer the investment option described
above.
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<PAGE>
NET ASSET VALUE
Net asset value per common share is determined as of 15 minutes after the
close of business on the New York Stock Exchange (generally, the New York Stock
Exchange closes at 4:00 p.m., Eastern time) on the last business day in each
week. For purposes of determining the net asset value of a common share, the
value of the securities held by the Fund plus any cash or other assets
(including interest accrued but not yet received) minus all liabilities
(including accrued expenses) and the aggregate liquidation value of the
outstanding preferred shares is divided by the total number of common shares
outstanding at such time. Expenses, including the fees payable to the
Investment Adviser, are accrued daily.
The Pennsylvania 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 Trustees. The pricing
service typically values portfolio securities at the bid price or the yield
equivalent when quotations are readily available. Pennsylvania 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 Trustees. The Board of Trustees 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 Trustees.
The Fund determines and makes available for publication the net asset value
of its common shares 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.
DESCRIPTION OF CAPITAL SHARES
The Fund is authorized to issue an unlimited number of shares of beneficial
interest, par value $.10 per share. The Board of Trustees may authorize
separate classes of shares together with such designations and powers,
preferences and rights, qualifications, limitations and restrictions as may be
determined from time to time by the Trustees. Pursuant to such authority, the
Trustees have authorized the issuance of an unlimited number of common shares
together with 1,000,000 preferred shares. Within approximately three months
after completion of the offering of the common shares described herein, the
Fund intends to offer preferred shares representing approximately 40% of the
Fund's capital immediately after the issuance of such preferred shares. There
is no assurance that such preferred shares will be issued.
The Fund is an entity of the type commonly known as a "Massachusetts business
trust." Under Massachusetts law, shareholders of such a trust may, under
certain circumstances, be held personally liable as partners for its
obligations. However, the Declaration of Trust of the Fund contains an express
disclaimer of shareholder liability for acts or obligations of the Fund and
provides for indemnification and reimbursement of expenses out of the Fund's
property for any shareholder held personally liable for the obligations of the
Fund. Thus, the risk of a shareholder incurring financial loss on account of
shareholder liability is limited to
38
<PAGE>
circumstances in which the Fund itself would be unable to meet its obligations.
Given the nature of the Fund's assets and operations, the possibility of the
Fund being unable to meet its obligations is remote and, in the opinion of
Massachusetts counsel to the Fund, the risk to Fund shareholders is remote.
The Declaration of Trust further provides that no Trustee, officer, employee
or agent of the Fund is liable to the Fund or to any shareholder, nor is any
Trustee, officer, employee of agent liable to any third persons in connection
with the affairs of the Fund, except as such liability may arise from his or
her own bad faith, willful misfeasance, gross negligence, or reckless disregard
of their duties. It also provides that all third persons shall look solely to
the Fund property for satisfaction of claims arising in connection with the
affairs of the Fund. With the exceptions stated, the Declaration of Trust
provides that a Trustee, officer, employee or agent is entitled to be
indemnified against all liability in connection with the affairs of the Fund.
Common Shares
Common shares, 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 shares are outstanding, holders
of common shares will not be entitled to receive any net income of or other
distributions from the Fund unless all accumulated dividends on preferred
shares have been paid and unless asset coverage (as defined in the 1940 Act)
with respect to preferred shares would be at least 200% after giving effect to
such distributions. See "Preferred Shares" 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 common shares of the Fund for $100,005. As of the date of this
prospectus, the Investment Adviser owned 100% of the outstanding common shares
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 Shares
It is anticipated that the Fund's preferred shares will be issued in one or
more series, with rights as determined by the Board of Trustees, by action of
the Board of Trustees without the approval of the holders of common shares.
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 shares have no preemptive right to purchase any
preferred shares that might be issued. It is anticipated that the net asset
value per the preferred shares will equal its original purchase price per share
plus accumulated dividends per share.
The Fund's Board of Trustees has declared its intention to authorize an
offering of preferred shares (representing approximately 40% of the Fund's
capital immediately after the issuance of such preferred shares) within
approximately three months after completion of the offering of common shares,
subject to market conditions and to the Board's continuing to believe that
leveraging the Fund's capital structure through the issuance of preferred
shares is likely to achieve the benefits to the holders of common shares
described in the
39
<PAGE>
prospectus. Although the terms of the preferred shares, including its dividend
rate, voting rights, liquidation preference and redemption provisions will be
determined by the Board of Trustees (subject to applicable law and the Fund's
Declaration of Trust), the initial series of preferred shares 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 shares, it is anticipated
that the terms of the preferred shares will require the Fund to make an
Additional Distribution (as defined in "Risks and Special Considerations of
Leverage--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 shares will be as stated below. The Fund's
Declaration of Trust, as amended, together with any Certificate of Designation,
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 preferred
shares 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 shares. After payment of the full amount of
the liquidating distribution to which they are entitled, the preferred
shareholders 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 preferred shares will have
equal voting rights with holders of common shares (one vote per share) and will
vote together with holders of common shares as a single class.
In connection with the election of the Fund's trustees, holders of preferred
shares, voting as a separate class, will be entitled to elect two of the Fund's
trustees, and the remaining trustees will be elected by all holders of capital
shares, voting as a single class. So long as any preferred shares are
outstanding, the Fund will have not less than five trustees. If at any time
dividends on the Fund's preferred shares shall be unpaid in an amount equal to
two full years' dividends thereon, the holders of all outstanding preferred
shares, voting as a separate class, will be entitled to elect a majority of the
Fund's trustees 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
preferred shares, voting as a separate class, will be required to (i)
authorize, create or issue any class or series of shares ranking prior to any
series of preferred shares 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 shares.
Redemption Provisions. It is anticipated that preferred shares 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. Preferred shares will
also be subject to
40
<PAGE>
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 Fund to maintain asset
coverage requirements for the preferred shares specified by the rating agencies
that issue ratings on the preferred shares.
Certain Provisions of the Declaration of Trust
The Fund's Declaration of Trust includes provisions that could have the
effect of limiting the ability of other entities or persons to acquire control
of the Fund or to change the composition of its Board of Trustees and could
have the effect of depriving shareholders of an opportunity to sell their
shares at a premium over prevailing market prices by discouraging a third party
from seeking to obtain control of the Fund. A trustee 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 trustee elected by all
the holders of capital shares may be removed only by action of such holders,
and a trustee elected by the holders of preferred shares may be removed only by
action of such holders.
In addition, the Declaration of Trust requires the favorable vote of the
holders of at least 66 2/3% of the Fund's capital shares then entitled to be
voted, voting as a single class, to approve, adopt or authorize the following:
. a merger or consolidation or statutory share exchange of the Fund with
other corporations,
. a sale of all or substantially all of the Fund's assets (other than in the
regular course of the Fund's investment activities), or
. a liquidation or dissolution of the Fund, unless such action has been
approved, adopted or authorized by the affirmative vote of two-thirds of
the total number of Trustees fixed in accordance with the by-laws, in
which case the affirmative vote of a majority of the Fund's capital shares
is required. Following the proposed issuance of the preferred shares, 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 preferred shares 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 Declaration of Trust. The amendment would
have to be declared advisable by the Board of Trustees prior to its submission
to shareholders. Such an amendment would require the favorable vote of the
holders of at least 66 2/3% of the Fund's outstanding capital shares (including
any preferred shares) 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 Trustees fixed in
accordance with the by-laws), and, assuming preferred shares are issued, the
affirmative vote of a majority of outstanding preferred shares 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 common shares 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 shares would no longer be listed
on a stock exchange.
Conversion to an open-end investment company would also require redemption of
all outstanding preferred shares 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.
41
<PAGE>
The Board of Trustees has determined that the 66 2/3% voting requirements
described above, which are greater than the minimum requirements under
Massachusetts 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, NY 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 1,875,000 common shares 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
common shares 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 common shares 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 common shares in the
offering in the amount of $.30 per share. Such payment is equal to 2.00% 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 $.30 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 common shares purchased in the offering on
or before February 26, 1999.
The Fund has granted the Underwriter an option, exercisable for 45 days after
the date hereof, to purchase up to 281,250 additional common shares to cover
over-allotments, if any, at the initial offering price.
The Underwriter may engage in certain transactions that stabilize the price
of the common shares. Such transactions consist of bids or purchases for the
purpose of pegging, fixing or maintaining the price of the common shares.
If the Underwriter creates a short position in the common shares in
connection with the offering, i.e., if it sells more common shares than are set
forth on the cover page of this prospectus, the Underwriter may reduce that
short position by purchasing common shares 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 common shares in the open
market to reduce the Underwriter's short position or to stabilize the price of
the common shares, it may reclaim the amount of the selling concession from the
selling group members who sold those common shares 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
42
<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 common
shares. The Fund's common shares have been approved for listing on the AMEX.
However, during an initial period which is not expected to exceed two weeks
from the date of this prospectus, the Fund's common shares will not be listed
on any securities exchange. Additionally, before it begins trading, the
Underwriter does not intend to make a market in the Fund's common shares,
although a limited market may develop. Thus, it is anticipated that investors
may not be able to buy and sell shares of the Fund 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 400 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 common
shares of the Fund is The Bank of New York, 101 Barclay Street, New York, NY
10286.
LEGAL OPINIONS
Certain legal matters in connection with the common shares offered hereby
will be passed upon for the Fund and the Underwriter by Brown & Wood LLP, New
York, New York. Brown & Wood LLP will rely as to matters of Massachusetts law
on the opinion of Bingham Dana LLP, Boston, Massachusetts.
EXPERTS
The statement of assets, liabilities and capital of the Fund as of January
13, 1999 included in this prospectus has been audited by Deloitte & Touche LLP,
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>
ADDITIONAL INFORMATION
The Fund is subject to the informational requirements of the Securities
Exchange Act of 1934 and the 1940 Act and in accordance therewith is required
to file reports, proxy statements and other information with the Securities and
Exchange Commission (the "Commission"). Any such reports, proxy statements and
other information can be inspected and copies at the public reference
facilities of the Commission at Room 1024, Judiciary Plaza, 450 Fifth Street,
N.W., Washington, D.C. 20549, and at the following regional offices of the
Commission: Regional Office, at Seven World Trade Center, Suite 1300, New York,
New York 10048; Pacific Regional Office, at 5670 Wilshire Boulevard, 11th
Floor, Los Angeles, California 90036; and Midwest Regional Office, at
Northwestern Atrium Center, 500 West Madison Street, Suite 1400, Chicago,
Illinois 60661-2511. Copies of such materials can be obtained from the public
reference section of the Commission at 450 Fifth Street, N.W., Washington, D.C.
20549, at prescribed rates. The Commission maintains a Web site at
http://www.sec.gov containing reports, proxy and information statements and
other information regarding registrants, including the Fund, that file
electronically with the Commission. Reports, proxy statements and other
information concerning the Fund can also be inspected at the offices of the
American Stock Exchange, 86 Trinity Place, New York, New York 10006.
Additional information regarding the Fund is contained in the Registration
Statement on Form N-2, including amendments, exhibits and schedules thereto,
relating to such shares filed by the Fund with the Commission in Washington,
D.C. This prospectus does not contain all of the information set forth in the
Registration Statement, including any amendments, exhibits and schedules
thereto. For further information with respect to the fund and the shares
offered hereby, reference is made to the Registration Statement. Statements
contained in this prospectus as to the contents of any contract or other
document referred to are not necessarily complete and in each instance
reference is made to the copy of such contract or other document filed as an
exhibit to the Registration Statement, each such statement being qualified in
all respects by such reference. A copy of the Registration Statement may be
inspected without charge at the Commission's principal office in Washington,
D.C., and copies of all or any part thereof may be obtained from the Commission
upon the payment of certain fees prescribed by the Commission.
Year 2000 Issues
Many computer systems were designed using only two digits to designate years.
These systems may not be able to distinguish the Year 2000 from the Year 1900
(commonly known as the "Year 2000 Problem"). The Fund could be adversely
affected if the computer systems used by the Fund's management or other Fund
service providers do not properly address this problem before January 1, 2000.
The Fund's management expects to have addressed this problem before then, and
does not anticipate that the services it provides will be adversely affected.
The Fund's other service providers have told the Fund management that they also
expect to resolve the Year 2000 Problem, and the Fund management will continue
to monitor the situation as the Year 2000 approaches. However, if the problem
has not been fully addressed, the Fund could be negatively affected. The Year
2000 Problem could also have a negative impact on the issuers of securities in
which the Fund invests, and this could hurt the Fund's investment returns.
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<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Trustees and Shareholder,
MuniHoldings Pennsylvania Insured Fund
We have audited the accompanying statement of assets, liabilities and capital
of MuniHoldings Pennsylvania Insured Fund as of January 13, 1999. 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, the statement of assets, liabilities and capital presents
fairly, in all material respects, the financial position of MuniHoldings
Pennsylvania Insured Fund as of January 13, 1999, in conformity with generally
accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
January 21, 1999
45
<PAGE>
MuniHoldings Pennsylvania Insured Fund
Statement of Assets, Liabilities and Capital
January 13, 1999
<TABLE>
<S> <C>
ASSETS
Cash................................................................ $100,005
Offering costs (Note 1)............................................. 139,000
--------
Total assets...................................................... 239,005
Less liabilities and accrued expenses (Note 1)...................... 139,000
--------
NET ASSETS............................................................ $100,005
========
CAPITAL
Common Shares, par value $.10 per share; unlimited 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 Common Share
(Note 1)........................................................... $100,005
========
</TABLE>
Notes to Financial Statements
Note 1. Organization
The Fund was organized under the laws of the Commonwealth of Massachusetts on
December 3, 1998 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 Common Shares for $100,005
on January 13, 1999. The General Partner of the Investment Adviser is an
indirectly wholly owned subsidiary of Merrill Lynch & Co., Inc.
The Investment Adviser, on behalf of the Fund, will incur organization costs
estimated at $11,250. Direct costs relating to the public offering of the
Fund's shares will be charged to capital at the time of issuance of shares.
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, at an annual rate of 0.55 of 1% of the average weekly net assets
of the Fund, including any proceeds from the issuance of Preferred Shares. The
Investment Adviser or an affiliate will pay Merrill Lynch, Pierce, Fenner &
Smith Incorporated a commission in the amount of 2.00% of the price to the
public per share in connection with the initial public offering of the Fund's
Common Shares.
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.
46
<PAGE>
APPENDIX I
ECONOMIC AND FINANCIAL CONDITIONS IN PENNSYLVANIA
The following information is a brief summary of factors affecting the economy
of the Commonwealth of Pennsylvania and does not purport to be a complete
description of such factors. Other factors will affect issuers. The summary is
based upon one or more of the most recent publicly available offering
statements relating to debt offerings of Pennsylvania issuers. The Fund has not
independently verified the information.
Many factors affect the financial condition of the Commonwealth of
Pennsylvania (also referred to herein as the "Commonwealth") and its political
subdivisions, such as social, environmental and economic conditions, many of
which are not within the control of such entities. Pennsylvania and certain of
its counties, cities and school districts and public bodies (most notably the
City of Philadelphia, sometimes referred to herein as the "City") have from
time to time in the past encountered financial difficulties which have
adversely affected their respective credit standings. Such difficulties could
affect outstanding obligations of such entities, including obligations held by
the Fund.
The General Fund, the Commonwealth's largest fund, receives all tax revenues,
non-tax revenues and Federal grants and entitlements that are not specified by
law to be deposited elsewhere. The majority of the Commonwealth's operating and
administrative expenses are payable from the General Fund. Debt service on all
bonded indebtedness of the Commonwealth, except that issued for highway
purposes or for the benefit of other special revenue funds, is payable from the
General Fund.
The period from fiscal year 1993 through fiscal 1997 was a time of steady,
modest economic growth and low rates of inflation. These economic conditions,
together with tax reductions in the several years following the tax rate
increases and tax base expansions enacted in fiscal 1991 for the General Fund,
produced tax revenue gains averaging 4.1% per year during the period. Total
revenues during the same period increased at a 4.7% average rate.
Intergovernmental revenue recorded the largest percentage gain during this
period, averaging 8.1% (due, in part, to an accounting change). Expenditures
and other uses during the fiscal 1993 through fiscal 1997 period rose at a 3.8%
rate, led by and average 13.8% annual increase for protection of persons and
property program costs. This high rate of increase reflects the costs to
acquire, staff and operate expanded prison facilities to house a larger prison
population. Public health and welfare program costs expanded an average 5.4%
annually during this period, the second largest rate of increase for program
categories.
The fund balance at June 30, 1997 (determined on a "Generally Accepted
Accounting Principals" basis) totaled $1,364.9 million, a $729.7 million
increase over the $635.2 million balance at June 30, 1996.
The unappropriated balance of Commonwealth revenues increased during the 1997
fiscal year by $432.9 million to $591.4 million (prior to reserves for transfer
to the Tax Stabilization Reserve Fund) at the close of the fiscal year. Higher
than estimated revenues and slightly lower expenditures than budgeted caused
the increase. Transfers to the Tax Stabilization Reserve Fund for fiscal 1997
operations were $88.7 million representing the normal fifteen percent of the
ending unappropriated balance, plus an additional $100 million authorized by
the General Assembly when it enacted the fiscal 1998 budget.
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<PAGE>
Commonwealth revenues (prior to tax refunds) during the fiscal year totaled
$17,320.6 million, $576.1 million (3.4%) above the estimate made at the time
the budget was enacted. Revenue from taxes was the largest contributor to
higher than estimated receipts. Tax revenue in fiscal 1997 grew 6.1% over tax
revenues in fiscal 1996. This rate of increase was not adjusted for legislated
tax reductions that affected receipts during both of those fiscal years and
therefore understates the actual underlying rate of growth of tax revenue
during fiscal 1997. Non-tax revenues were $19.8 million (5.8%) over estimate
mostly due to higher than anticipated interest earnings.
Expenditures from Commonwealth revenues (excluding pooled financing
expenditures) during fiscal 1997 totaled $16,347.7 million and were close to
the estimate made in February 1997 with the presentation of the Governor's
fiscal 1998 budget request. Total expenditures represent an increase over
fiscal 1996 expenditures of 1.7%. Lapses of appropriation authority during the
fiscal year totaled $200.6 million compared to an estimate of $100 million. The
higher amount of appropriation lapses was used to support $79.8 million in
fiscal 1997 supplemental appropriations over the February 1997 estimate.
Supplemental appropriations for fiscal 1997 totaled $169.3 million.
For GAAP purposes, assets increased $563.4 million and liabilities declined
$166.3 million to produce a $729.7 million increase in the fund balance at June
30, 1997. Total revenues and other sources rose 3.5% for fiscal 1997. An
increase of 5.5% in tax revenue aided by an improving state economy was
partially offset by a $175.2 million decline in intergovernmental revenues.
Expenditures and other uses increased by 1% for this fiscal year.
Operations during the 1998 fiscal year increased the unappropriated balance
of Commonwealth revenues during that period by $86.4 million to $488.7 million
at June 30, 1998 (prior to reserves for transfer to the Tax Stabilization
Reserve Fund). Higher than estimated revenues, offset in part by increased
reserves for tax refunds, and slightly lower expenditures than budgeted were
responsible for the increase. Transfers to the Tax Stabilization Reserve Fund
for fiscal 1998 operations will total $223.3 million consisting of $73.3
million representing the required transfer of fifteen percent of the ending
unappropriated surplus balance, plus an additional $150 million authorized by
the General Assembly when it enacted the fiscal 1999 budget. With these
transfers, the balance in the Tax Stabilization Reserve Fund will exceed $664
million and represent 3.7% of fiscal 1998 revenues.
Commonwealth revenues (prior to tax refunds) during the fiscal year totaled
$18,123.2 million, $676.1 million (3.9%) above the estimate made at the time
the budget was enacted. Tax revenue received in fiscal 1998 grew 4.8% over tax
revenues received during fiscal 1997. This rate of increase includes the effect
of legislated tax reductions that affected receipts during both fiscal years
and therefore understates the actual underlying rate of growth of tax revenue
during fiscal 1998. Receipts from the personal income tax produced the largest
single component of higher revenues during fiscal 1998.
Expenditures from all fiscal 1998 appropriations of Commonwealth revenues
totaled $17,229.8 million (excluding pooled financing expenditures and net of
current year lapses). This amount represents an increase of 4.5% over fiscal
1997 appropriation expenditures. Lapses of appropriation authority during the
fiscal year totaled $161.8 million including $58.8 million from fiscal 1998
appropriations. These appropriation lapses were used to fund $120.5 million of
supplemental fiscal 1998 appropriations.
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Reserves established during fiscal 1998 for tax refunds totaled $910 million.
This amount is a $370 million increase over tax refund reserves for fiscal 1997
representing an increase of 68.5%. The fiscal 1998 amount includes a one-time
addition intended to fund all fiscal 1998 tax refund liabilities, including
that portion to be paid during fiscal 1999. In prior fiscal years, tax refunds
generally were budgeted for the year in which the disbursement was anticipated
to occur. This change in the recognition of tax refund liabilities on a
budgetary basis is expected to reduce the difference between the budgetary
basis unappropriated balance and the GAAP basis unreserved and undesignated
balance (when computed) for the 1998 fiscal year.
The budget for fiscal 1999 was enacted in April 1998 at which time the
official revenue estimate for the 1999 fiscal year was established at $18,456.6
million. The estimate was reduced by 1.1 million in November 1998 due to
passage of tax legislation. Only Commonwealth funds are included in the
official revenue estimate. The official revenue estimate is based on an
economic forecast for national gross domestic product, on a year-over-year
basis, to slow from an estimated annualized 3.9% rate in the fourth quarter of
1997 to a projected 1.8% annualized growth rate by the second quarter of 1999.
The forecast of slowing economic activity is based on the expectation that
consumers will reduce their pace of spending, particularly on motor vehicles,
housing and other durable goods. Business is also expected to trim its spending
on fixed investments. Foreign demand for domestic goods is expected to decline
in reaction to economic difficulties in Asia and Latin America, while an
economic recovery in Europe is expected to proceed slowly. The underlying
growth rate, excluding any effect of scheduled or proposed tax changes, for the
General Fund fiscal 1999 official revenue estimate is 3.0% over actual fiscal
1998 revenues. When adjusted to include the estimated effect of enacted tax
changes, fiscal 1999 Commonwealth revenues are projected to increase by 1.66%
over actual Commonwealth revenues for fiscal 1998.
Tax reductions included in the enacted 1999 fiscal year budget totaled an
estimated $241.0 million for fiscal 1999. The major tax changes were enacted
with January 1, 1998 effective dates. Consequently, the first year's cost of
these changes may be above the expected annualized cost.
Reserves for tax refunds for fiscal 1999 total $603.9 million. This amount
includes $33.1 million of tax refunds anticipated to be due to the enacted
fiscal 1999 tax changes and included in the estimated cost of those changes.
Reserves for tax refunds for fiscal 1999 are $306.1 million below the reserve
established for fiscal 1998. The fiscal 1998 amount (described above) includes
a one-time addition intended to fund all fiscal 1998 tax refund liabilities,
including that portion to be paid during fiscal 1999. Without the necessity to
pay fiscal 1998 tax refund liabilities from fiscal 1999 reserves, the fiscal
1999 reserve need only be in an amount equal to the estimated fiscal 1999
estimate for tax refund liabilities.
Appropriations enacted for fiscal 1999 are 4.1% ($705.1 million) above the
appropriations enacted for fiscal 1998 (including supplemental appropriations).
The enacted fiscal 1999 budget assumes the drawn down of the $265.4 million
beginning budgetary balance by $143.9 million to an estimated closing balance,
prior to transfer of the required portion to the Tax Stabilization Reserve
Fund, of $124.3 million. The amount of the anticipated drawn down does not
consider the availability of appropriation lapses normally occurring during a
fiscal year that are used to fund supplemental appropriations or increase
unappropriated surplus.
For the fiscal year through October 1998, Commonwealth revenues were $69.2
million (1.3%) above estimate.
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On February 2, 1999, Pennsylvania Governor Ridge presented a proposed $18.6
billion General Fund budget which includes, among other things, proposed tax
reductions (relating principally to business taxes) totalling an estimated $273
million.
Pennsylvania has historically been identified as a heavy industry state
although that reputation has changed over the last thirty years as the coal,
steel and railroad industries declined and the Commonwealth's business
environment readjusted to reflect a more diversified industrial base. This
economic readjustment was a direct result of a long-term shift in jobs,
investment and workers away from the northeast part of the nation. Currently,
the major sources of growth in Pennsylvania are in the service sector,
including trade, medical and the health services, education and financial
institutions.
Nonagricultural employment in Pennsylvania over the ten year period that
ended in 1997 increased at an annual rate of 0.76%. This compares to a 0.17%
rate for the Middle Atlantic region and a 1.69% rate for the United States as a
whole during the period 1988 through 1997. For the five years ended with 1997,
employment in the Commonwealth has increased 5.4%. The growth in employment
during this period is higher than the 4.8% growth in the Middle Atlantic
region. The unemployment rate in Pennsylvania for October 1998 stood at a
seasonably adjusted rate of 4.7%. The seasonably adjusted national unemployment
rate for October 1998 was 4.6%.
The current Constitutional provisions pertaining to Commonwealth debt permit
the issuance of the following types of debt: (i) debt to suppress insurrection
or rehabilitate areas affected by disaster, (ii) electorate-approved debt,
(iii) debt for capital projects subject to an aggregate debt limit of 1.75
times the annual average tax revenues of the preceding five fiscal years and
(iv) tax anticipation notes payable in the fiscal year of issuance. All debt
except tax anticipation notes must be amortized in substantial and regular
amounts.
Debt service on all bonded indebtedness of Pennsylvania, except that issued
for highway purposes or the benefit of other special revenue funds, is payable
from Pennsylvania's General Fund, which receives all Commonwealth revenues that
are not specified by law to be deposited elsewhere. As of June 30, 1998, the
Commonwealth had $4,724.5 million of general obligation debt outstanding.
Other state-related obligations include "moral obligations." Moral obligation
indebtedness may be issued by the Pennsylvania Housing Finance Agency (the
"PHFA"), a state-created agency which provides financing for housing for lower
and moderate income families, and The Hospitals and Higher Education Facilities
Authority of Philadelphia, a municipal authority organized by the City of
Philadelphia to, among other things, acquire and prepare various sites for use
as intermediate care facilities for the mentally retarded. PHFA's bonds, but
not its notes, are partially secured by a capital reserve fund required to be
maintained by PHFA in an amount equal to the maximum annual debt service on its
outstanding bonds in any succeeding calendar year. PHFA is not permitted to
borrow additional funds as long as any deficiency exists in the capital reserve
fund.
The Commonwealth, through several of its departments and agencies, has
entered into various agreements to lease, as lessee, certain real property and
equipment, and to make lease payments for the use of such property and
equipment. Some of those leases and their respective lease payments are, with
the Commonwealth's approval, pledged as security for debt obligations issued by
certain public authorities or other entities within the state. All lease
payments due from Commonwealth departments and agencies are subject to and
dependent upon an annual spending authorization approved through the
Commonwealth's annual budget
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process. The Commonwealth is not required by law to appropriate or otherwise
provide monies from which the lease payments are to be made. The obligations to
be paid from such lease payments are not bonded debt of the Commonwealth.
Certain Commonwealth-created organizations have statutory authorization to
issue debt for which Commonwealth appropriations to pay debt service thereon
are not required. The debt of these agencies is funded by assets of, or
revenues derived from, the various projects financed and is not a statutory or
moral obligation of the Commonwealth. Some of these agencies, however, are
indirectly dependent on Commonwealth operating appropriations. In addition, the
Commonwealth may choose to take action to financially assist these
organizations. The Commonwealth also maintains pension plans covering all state
employees, public school employees and employees of certain state-related
organizations.
The City of Philadelphia is the largest city in the Commonwealth with an
estimated population of 1,585,577 according to the 1990 Census. Legislation
providing for the establishment of Pennsylvania Intergovernmental Cooperation
Authority (the "PICA") to assist Philadelphia in remedying fiscal emergencies
was enacted by the Pennsylvania General Assembly and approved by the Governor
in June 1991. PICA is designed to provide assistance through the issuance of
funding debt and to make factual findings and recommendations to Philadelphia
concerning its budgetary and fiscal affairs. At this time, Philadelphia is
operating under a five year fiscal plan approved by PICA on June 9, 1998.
PICA has issued $1.76 billion of its Special Tax Revenue Bonds. This
financial assistance has included the refunding of certain city general
obligation bonds, funding of capital projects and the liquidation of the
cumulative General Fund balance deficit as of June 30, 1992 of $224.9 million.
The audited General Fund balance of Philadelphia as of June 30, 1997 shows a
surplus of approximately $128.8 million.
No further bonds are to be issued by PICA for the purpose of financing a
capital project or deficit as the authority for such bond sales expired
December 31, 1994. PICA's authority to issue debt for the purpose of financing
a cash flow deficit expired on December 31, 1996. Its ability to refund
existing outstanding debt is unrestricted. PICA had $1,055 million in Special
Revenue bonds outstanding as of June 30, 1998.
There is various litigation pending against the Commonwealth, its officers
and employees. In 1978, the Pennsylvania General Assembly approved a limited
waiver of sovereign immunity. Damages for any loss are limited to $250,000 for
each person and $1 million for each accident. The Supreme Court held that this
limitation is constitutional. Approximately 3,500 suits against the
Commonwealth are pending.
The following are among the cases with respect to which the Office of
Attorney General and the Office of General Counsel have determined that an
adverse decision may have a material effect on government operations of the
Commonwealth:
Baby Neal v. Commonwealth, et al.
In 1990, the American Civil Liberties Union and other various named
plaintiffs filed an action against the Commonwealth, the City of Philadelphia
and others in federal court seeking an order that, among other things, would
require the Commonwealth to provide additional funding for child welfare
services. No figures for the amount of funding sought are available. A similar
lawsuit filed in the Commonwealth Court of Pennsylvania was resolved through a
court approved settlement which provides, among other things, for more
Commonwealth funding for such services in fiscal year 1991 and a commitment to
pay Pennsylvania counties $30 million over five years. The Commonwealth sought
dismissal of the federal action based, among other things, on the settlement of
the Commonwealth Court case. In December 1994, the Third Circuit Court of
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Appeals reversed the District Court's denial of the plaintiff's motion for
class certification. As a result, the District Court has recently certified the
class and the parties have resumed discovery. In July 1998, the plaintiffs
entered into a settlement agreement with the City of Philadelphia and related
parties and submitted the agreement to the district court for approval. The
district court has preliminarily approved the settlement. Recently, the
remaining parties, including the Commonwealth, have agreed to settle the claims
made against them. The Commonwealth has agreed to pay $100,000 to settle
plaintiffs' $1.4 million claim for attorneys' fees and to take other actions in
exchange for a full and final release and dismissal of the case against the
Commonwealth parties. The settlement has been presented to the court for
approval, and the court has scheduled a hearing for February 1999.
County of Allegheny v. Commonwealth of Pennsylvania
On December 7, 1987, the Supreme Court of Pennsylvania held that the
statutory scheme for county funding of the judicial system is in conflict with
the Pennsylvania Constitution. However, judgment was stayed in order to afford
the General Assembly an opportunity to enact appropriate funding legislation
consistent with its opinion. On December 7, 1992, the State Association of
County Commissioners filed a new action in mandamus seeking to compel the
Commonwealth to comply with the Supreme Court's decision in County of
Allegheny. The Court in Pennsylvania State Association of County Commissioners
v. Commonwealth of Pennsylvania issued the writ on July 26, 1996, and appointed
a special master to devise and submit a plan for implementation. Following the
issuance of the writ, the President Pro Tempore of the Senate and the Speaker
of the House filed a petition seeking reconsideration from the Court. The Court
has not acted on the petition. On January 28, 1997, the Supreme Court granted
an extension of time within which the special master must file his report and
announced the establishment of a committee comprised of members of the
Executive Department, the Legislative Department and the special master, to
develop an implementation plan. On July 26, 1997, the "Interim Report of the
Master" was filed setting forth a state funding proposal. Numerous objections
to the report were filed, but the Court has taken no action on them.
On April 22, 1998, the Pennsylvania General Assembly enacted legislation
appropriating approximately $12 million to the Supreme Court for the purpose of
funding county court administrators. The appropriation was designed to enable
the Commonwealth to implement Phase I of the special master's plan. However,
the legislation also provides that no funds from the appropriation may be
expended until legislation has been approved by the General Assembly providing
for the payment of Commonwealth compensation of county court administrators.
Because no such legislation has yet been enacted, the $12 million appropriated
to the Judicial Department cannot be used.
On May 11, 1998, the Administrative Governing Board of the First Judicial
District (comprising the Court of Common Pleas of Philadelphia, the
Philadelphia Municipal Court, and the Traffic Court of Philadelphia) filed an
action in mandamus in the Commonwealth Court of Pennsylvania against the City
of Philadelphia and several City officials, claiming that the City government
had failed to provide adequate funds for the operation of the courts of the
First Judicial District. The petitioners have demanded that the court order the
City of Philadelphia to disburse all funds reasonably necessary for the
continued operation of the courts during fiscal year 1998-99 in an amount
totaling at least $110 million. The case is captioned Alex Bonavitacola, et al.
v. Edward G. Rendell, et al.
Also on May 11, 1998, the City of Philadelphia and related respondents in
Bonavitacola filed a complaint joining the Commonwealth of Pennsylvania, the
General Assembly and its elected leadership as additional respondents. In their
complaint, the City respondents assert that under the Supreme Court's order
issued July
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26, 1996 in Pa. State Ass'n of County Commissioners v. Commonwealth of
Pennsylvania, the General Assembly was obligated to enact a funding scheme for
a unified court system no later than January 1, 1998. Because the General
Assembly has not done so, the City respondents allege, the Commonwealth has
failed to comply with the Supreme Court's order. Thus, the City respondents
have requested Commonwealth Court to require the General Assembly to comply
with the Supreme Court's mandamus order and to order the Commonwealth to pay
whatever sums are necessary to fund the cost of operating the courts in fiscal
1998-99. The First Judicial District Governing Board joined in the City
respondents' request as an alternative to its demanded relief against the City
defendants.
On July 15, 1998, the Supreme Court of Pennsylvania assumed extraordinary
jurisdiction over the case and directed Commonwealth Court, on an expedited
basis, to prepare proposed findings of fact and conclusions of law. Acting
pursuant to the Supreme Court's June 15, 1998 order, President Judge James
Gardner Colins of Commonwealth Court on June 17, 1998 issued findings of fact,
conclusions of law and a proposed order. In his proposed order, President Judge
Colins recommended that the Supreme Court order the President of the
Philadelphia Council immediately to introduce legislation to fund the courts of
the First Judicial District for fiscal year 1998-99 and to take all necessary
steps to ensure its passage. President Judge Colins also recommended that the
Supreme Court order the General Assembly to pass legislation, prior to June 30,
1999, to fund the entire state judicial system. By order entered June 23, 1998,
Commonwealth Court forwarded its findings of fact and conclusions of law and
proposed order to the Supreme Court for final disposition. The Commonwealth and
the General Assembly have objected to President Judge Colins' proposed order.
Subsequent to Commonwealth Court's issuance of its findings of fact,
conclusions of law and proposed order, the City Council and Mayor of
Philadelphia acceded (at least temporarily) to President Judge Colins' proposed
mandate that the City fund the First Judicial District's courts for fiscal year
1998-99, thus obviating the First Judicial District's request for emergency
relief. However, the First Judicial District petitioners and the City of
Philadelphia respondents continue to press their demands that the General
Assembly be required to enact legislation providing for state funding of the
courts. In addition, the County of Allegheny has petitioned the Supreme Court
for leave to intervene in the Bonavitacola case to secure the same relief
against the Commonwealth -- an order requiring Commonwealth to fund its courts.
The Bonavitacola case remains pending before the Supreme Court for disposition.
On November 25, 1998, the First Judicial District Governing Board filed with
the Supreme Court a renewed motion for entry of an order providing emergency
relief. In their renewed motion, the Bonavitacola plaintiffs asked the court to
order the City of Philadelphia to provide funds to the First Judicial
District's courts sufficient to maintain necessary judicial operations through
the end of the fiscal year.
Bank Shares Tax Litigation
On November 30, 1989, the Fidelity Bank, N.A. ("Fidelity") filed an action in
challenging the constitutional validity of a 1989 amendment increasing the bank
shares tax and related legislation. The Commonwealth Court ruled in favor of
the Commonwealth finding no constitutional deficiencies in the tax increase,
but invalidating one element of the legislation which provided a credit to new
banks (the "new bank tax credit"). Fidelity, the Commonwealth and certain
investment intervener banks appealed to the Pennsylvania Supreme Court.
However, pursuant to a Settlement Agreement dated as of April 21, 1995, the
Commonwealth agreed to enter a credit in favor of Fidelity in the amount of
$4,100,000 in settlement of the constitutional and
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non-constitutional issues. The credit represents approximately 5% of the
potential claim of Fidelity, had the constitutional issues been resolved in its
favor.
Pursuant to a separate Settlement Agreement dated as of April 21, 1995, the
Commonwealth also settled with the intervening banks with respect to issues
concerning the new bank tax credit.
Notwithstanding the foregoing settlements, other banks have filed petitions
challenging the validity of the 1989 tax increase. One of these banks, Royal
Bank of Pennsylvania, has filed a Stipulation of Facts and is in effect
proceeding forward on behalf of the other banks. Their appeals raise the issues
that were advanced by Fidelity, although not brought to resolution by the
Pennsylvania Supreme Court. By decision dated January 8, 1998, a panel of the
Commonwealth Court ruled in favor of the Commonwealth, finding no
constitutional violation. Royal Bank filed exceptions which were denied by the
Commonwealth Court on July 30, 1998. Royal Bank has appealed to the
Pennsylvania Supreme Court.
Pennsylvania Association of Rural and Small Schools (PARSS) v. Casey
In January 1991, an association of rural and small schools and several
parties filed a lawsuit against then Governor Robert P. Casey and former
Secretary of Education, Donald M. Carroll challenging the constitutionality of
the Commonwealth system for funding local school districts. The litigation
consists of two parallel cases, one in the Commonwealth Court of Pennsylvania
and one in the United States District Court for the Middle District of
Pennsylvania. The federal court case has been indefinitely stayed pending
resolution of the state court case. On July 9, 1998, Commonwealth Court Judge
Dan Pellegrini issued an opinion and decree nisi dismissing the petitioners'
claims in its entirety, holding that Pennsylvania's system for funding public
schools is constitutional under both the education clause and the equal
protection clause of the Pennsylvania Constitution.
On July 20, 1998, the petitioners filed a motion for post-trial relief,
taking exception to many of Judge Pellegrini's findings of fact and conclusions
of law, and again asking the Common wealth Court to declare Pennsylvania's
public school funding system to be unconstitutional. Also, the petitioners on
July 21, 1998 filed an application asking the Supreme Court of Pennsylvania to
assume extraordinary, plenary jurisdiction over the case to decide one legal
issue -- whether the petitioners' constitutional claims are justiciable in the
courts of the Commonwealth. The petitioners have asked the court to consider
the issue in conjunction with a separate appeal pending in another case,
Marrerro v. Commonwealth of Pennsylvania, involving the same provisions of the
Constitution and a similar issue of justiciability. On September 2, 1998, the
Supreme Court granted petitioners' application and directed the filing of
briefs. Recently, the respondents asked the Supreme Court to clarify its
assumption of jurisdiction. Specifically, the respondents have asked the Court
to state expressly that it will consider only the issue of justiciability, as
requested in the petitioners' application and not other issues presented in
petitioners' motion for post-trial relief pending in the Commonwealth Court.
Pennsylvania Human Relations Commission v. School District of Philadelphia, et
al. v. Commonwealth of Pennsylvania, et al.
On November 3, 1995, the Commonwealth of Pennsylvania and the Governor of
Pennsylvania, along with the City of Philadelphia and the Mayor of
Philadelphia, were joined as addition respondents in an enforcement
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action commenced in Commonwealth Court in 1973 by the Pennsylvania Human
Relations Commission against the School District of Philadelphia pursuant to
the Pennsylvania Human Relations Act. The enforcement action was pursued to
remedy unintentional conditions of segregation in the public schools of
Philadelphia. The Commonwealth and the City were joined in the "remedial phase"
of the proceeding "to determine their liability, if any, to pay additional
costs necessary to remedy the unlawful conditions found to exist in the
Philadelphia public schools."
On February 28, 1996, the School District of Philadelphia filed a third-party
complaint against the Commonwealth of Pennsylvania asking Commonwealth Court to
require the Commonwealth to "supply such funding as is necessary for full
compliance with the November 28, 1994 and other remedial orders of the
Commonwealth Court." In addition, a group of interveners on March 4, 1996 filed
a third-party complaint against the Commonwealth of Pennsylvania and the City
of Philadelphia requesting Commonwealth Court to declare that "it is the
obligation of the Commonwealth and the City to supply the additional funds
identified as necessary for the District to comply with the orders of the
Commonwealth Court," and to require the Commonwealth and the City to supply
such additional funding as is necessary for the District to comply with the
orders.
On April 30, 1996, Commonwealth Court Judge Doris A. Smith overruled the
Commonwealth's and City's preliminary objections seeking dismissal of the
claims against them. The Commonwealth and the City thereafter filed answers to
the complaints, asserting numerous defenses. The Commonwealth also asserted a
cross-claim against the City of Philadelphia claiming that if any party is
liable, sole liability rests with the City; in the alternative, the
Commonwealth argued that if it is held to be liable, it has a right of
indemnity of contribution against the City.
Trial commenced on May 30, 1996. During the course of the trial, upon motion
of the Commonwealth, the Pennsylvania Supreme Court on July 3, 1996 assumed
extraordinary plenary jurisdiction and directed Judge Smith to concluded the
proceedings within 60 days and to file with the Supreme Court findings of fact,
conclusions of law and a final opinion.
On August 20, 1996, Judge Smith issued an Opinion and Order pursuant to which
judgment was entered in favor of the School District of Philadelphia and the
interveners and against the Commonwealth of Pennsylvania and the Governor of
Pennsylvania. Judgment was also entered in favor of the City of Philadelphia
and the Mayor of Philadelphia with respect to the intervener's claim and on the
cross-claim filed by the Commonwealth and Governor. The Judge ordered the
Commonwealth and Governor to submit a plan to the Court within thirty days
detailing the means by which the Commonwealth will effectuate the transfer of
additional funds payable to the School District of Philadelphia to enable it to
comply with the remedial order during fiscal year 1996-1997 and any future
years during which the School District establishes its fiscal incapacity to
fund the remedial programs. Judge Smith specifically found that "[b]ecause of
the lack of adequate funds to comply with the remedial order, the School
District is entitled to additional resources for 1996-1997 of $45.1 million."
On August 30, 1996, the Commonwealth filed exceptions to the Findings of
Fact, Conclusions of Law and Opinion and Order of Judge Smith along with a
Motion to Vacate the purported Order and a Notice of Appeal and Jurisdictional
Statement.
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On September 10, 1996, the Pennsylvania Supreme Court issued an order
granting the Commonwealth's Motion to Vacate and directed its Prothonotary to
establish a briefing schedule and date for oral argument. It also issued a
further order limiting the issues to be addressed and stated that the
Commonwealth Court is divested of jurisdiction of the matter and all further
proceedings in the Commonwealth Court are stayed pending further order of the
Supreme Court. The Supreme Court retained jurisdiction in the matter. On
January 28, 1997, the Supreme Court issued an Order directing the parties to
brief certain specific issues relative to the lower court proceedings. The
Supreme Court heard oral argument on February 3, 1998 and took the matter under
advisement.
Ridge v. State Employees' Retirement Board
On December 29, 1993, Joseph H. Ridge, a former judge of the Allegheny Court
of Common Pleas, filed in the Commonwealth Court a Petition for Review in the
Nature of Complaint in Mandamus and for a Declaratory Judgment against the
State Employees' Retirement Board alleging that the use of gender distinct
actuarial factors for benefits based upon his pre-August 1, 1983 service
violates the equal protection and equal rights clauses of the Pennsylvania
Constitution. The lawsuit requests that the petitioner's benefits be "topped
up" to equal those that a similarly situated female would be receiving. A
decision adverse to the Retirement Board could be applicable to other members
of the State Employees' Retirement System and Public School Employees'
Retirement System. The Commonwealth Court granted the Retirement Board's
preliminary objection to Judge Ridge's claims for punitive damages, attorney's
fees and compensatory damages (other than a recalculation of his pension
benefits should he prevail). On November 20, 1996, the Commonwealth Court heard
oral arguments en banc on Judge Ridge's motion for judgment on the pleadings.
On February 13, 1997, the Commonwealth Court denied Judge Ridge's motion for
judgment on the pleadings. The case is currently in discovery.
Yesenia Marrerro, et al. v. Commonwealth, et al.
On February 24, 1997, five residents of the City of Philadelphia, on their
own behalf, and on behalf of their school-age children, joined by the City of
Philadelphia, the School District of Philadelphia, and two non-profit
organizations, filed in the Commonwealth Court a civil action for declaratory
judgment against the Commonwealth of Pennsylvania, the General Assembly of
Pennsylvania, the presiding officers of the General Assembly, the Governor of
Pennsylvania, the State Board of Education, the Department of Education, and
the Secretary of Education, claiming that the statutory education financing
system is unconstitutional as applied to the School District of Philadelphia
and the system of funding public education violates the constitutional mandate
to provide a thorough and efficient system of education in the City of
Philadelphia. The lawsuit also alleges that the scheme for financing public
education precludes the Commonwealth from providing the constitutionally
required "thorough and efficient system of public education" in the
circumstances faced by the School District of Philadelphia, and that the
defendants have failed to provide the School District of Philadelphia with
resources and other assistance necessary to provide all of its students with
the quality of education to which they are constitutionally entitled. Among
other things, the petitioners seek a declaration that the legislature must
amend the present or enact new education legislation so as to assure that
education funding for the School District of Philadelphia accounts and makes
adequate provision for the greater and special educational challenges and needs
of students in the School District in order to address their disadvantage. The
respondents filed preliminary objections seeking dismissal of the action. On
March 2, 1998, Commonwealth Court sustained the respondents' preliminary
objections and dismissed the case on the grounds that the issues presented are
not justiciable. An appeal to the Supreme Court of Pennsylvania is pending and
briefing is complete, but the Court has not scheduled oral argument.
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Powell v. Ridge
On March 9, 1998, several residents of the City of Philadelphia on behalf of
themselves and their school-aged children, along with the School District of
Philadelphia, the Philadelphia Superintendent of Schools, the chairman of the
Philadelphia Board of Education, the City of Philadelphia, the Mayor of
Philadelphia, and several membership organizations interested in the
Philadelphia public schools, brought suit in the United States District Court
for the Eastern District of Pennsylvania against the Governor, the Secretary of
Education, the chairman of the State Board of Education, and the State
Treasurer. The plaintiffs claimed that the defendants are violating a
regulation of the U.S. Department of Education promulgated under Title VI of
the Civil Rights Act of 1964 in that the Commonwealth's system for funding
public schools has the effect of discriminating on the basis of race. The
plaintiffs asked the court to declare the funding system to be illegal, to
enjoin the defendants from violating the regulation in the future, to award
counsel fees and costs, and to grant such other relief as the court might find
just and proper.
The Philadelphia Federation of Teachers intervened on the side of the
plaintiffs, while several leaders of the Pennsylvania General Assembly
intervened on the side of the defendants. In addition, the U.S. Department of
Justice intervened to defend against a claim made by the legislator intervenors
that a statute waiving states' immunity under the Eleventh Amendment to the
U.S. Constitution for Title VI claims is unconstitutional.
On November 18, 1998, the district court granted in part and denied in part
various motions by the parties. However, because the court found ultimately
that the plaintiffs had failed to state a claim under the Title VI regulation
at issue or under 42 U.S.C. (S)1983, the court dismissed the action in its
entirety with prejudice. An appeal is expected.
Rite Aid of Pennsylvania, Inc. v. Houstoun
On March 24, 1997, Rite Aid of Pennsylvania, Inc. (Rite Aid) filed in the
U.S. District Court for the Eastern District of Pennsylvania a civil action
against the Secretary of Public Welfare (Secretary). In its complaint, Rite Aid
alleged that in promulgating regulations on October 1, 1995 governing payment
rates for prescription drugs and related services provided to recipients of
benefits under the Pennsylvania Medical Assistance Program (Medicaid), the
Secretary violated various provisions of Title XIX of the Social Security Act
(commonly known as the Medicaid Act) and regulations of the U.S. Department of
Health and Human Services, as well as provisions of state law and federal
constitutional due process.
On November 3, 1997, the district court granted in part and denied in part
the parties' cross-motions for judgment on the pleadings. The court granted
judgement in favor of the secretary on Rite Aid's federal due process claim and
Rite Aid's claim that the secretary had violated a federal regulation (42 CFR
(S)447.205) requiring public notice 60 days prior to revising the reimbursement
rates. However, the court denied the Secretary's motion for judgment on the
pleadings regarding Rite Aid's procedural claim under 42 U.S.C.
(S)1396(a)(30)(A). The court also granted judgment on the pleadings in favor of
Rite Aid on its claim that the Secretary violated a federal regulation (42 CFR
(S)447.205(c)(4)) requiring the Secretary to identify a local agency where the
proposed reimbursement changes were available for public view.
After allowing the Pennsylvania Pharmacists Association (PPA) to intervene as
a plaintiff, the district court on May 8, 1998 granted a motion filed by Rite
Aid and PPA to limit its review of the Secretary's compliance with 42 U.S.C.
(S)1396(a)(30)(A) "to the information before [the Secretary] at the time [she]
made [her] decision to lower" the reimbursement rates.
57
<PAGE>
On August 31, 1998, the district court granted the motions of Rite Aid and
PPA for summary judgment and denied the cross-motion of the Secretary. The
court declared that the pharmacy reimbursement rates made effective after
October 1, 1995, were adopted by the Secretary in violation of section
1396(a)(30)(A) of the Medicaid Act and enjoined the Secretary from using those
rates to reimburse for any prescription drugs and related services provided to
Medicaid recipients on and after October 1, 1998. The court held that the
Secretary acted arbitrarily and capriciously by failing to consider whether the
revised rates were consistent with the statutory standards of efficiency,
economy, and quality of care.
The Secretary timely appealed the district court's orders, and Rite Aid and
PPA filed cross-appeals. The Secretary filed motions to stay the district
court's injunction order pending appeal. However, the district court denied the
motion on September 18, 1998, and the court of appeals denied the application
for stay on October 26, 1998. However, the court of appeals did grant the
Secretary's motion for expedited appeal, and briefing should have been
concluded by early January. The court has not scheduled oral argument. In the
meantime, the Department of Public Welfare has altered its reimbursement rates
consistent with the district court's ruling. The estimated annualized cost of
paying the higher reimbursement rates is $106 million.
As of December 1, 1998, Pennsylvania general obligation bonds were rate AA by
Standard & Poor's, AA by Fitch and Aa3 by Moody's. There can be no assurance
that the economic conditions on which these ratings are based will continue or
that particular bond issues will not be adversely affected by changes in
economic or political conditions.
58
<PAGE>
APPENDIX II
RATINGS OF MUNICIPAL BONDS
Description of Moody's Investors Service, Inc.'s ("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
payments and principal security appear adequate for the present, but
certain protective elements may be lacking or may be
characteristically unreliable over any great length of time. Such
bonds lack outstanding investment characteristics and in fact have
speculative characteristics as well.
Ba Bonds which are rated Ba are judged to have speculative elements;
their future cannot be considered as well assured. Often the
protection of interest and principal payments may be very moderate and
thereby not well safeguarded during both good and bad times over the
future. Uncertainty of position characterizes bonds in this class.
B Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or
of maintenance of other terms of the contract over any long period of
time may be small.
Caa
Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to
principal or interest.
Ca
Bonds which are rated Ca represent obligations which are speculative
in a high degree. Such issues are often in default or have other
marked shortcomings.
C
Bonds which are rated C are the lowest rated class of bonds and issues
so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
Note: Those bonds in the Aa, A, Baa, Ba and B groups which Moody's believes
possess the strongest investment attributes are designated by the symbols Aa1,
A1, Baa1, Ba1 and B1.
59
<PAGE>
Short-term Notes: The three ratings of Moody's for short-term notes are MIG
1/VMIG 1, MIG 2/VMIG 2, and MIG 3/VMIG 3; MIG 1/VMIG 1 denotes "best quality,
enjoying strong protection from established cash flows"; MIG 2/VMIG 2 denotes
"high quality" with "ample margins of protection"; MIG 3/VMIG 3 instruments are
of "favorable quality . . . but . . . lacking the undeniable strength of the
preceding grades."
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 capacity of
rated issuers:
Issuers rated Prime-1 (or supporting institutions) have a superior ability
for repayment of short-term promissory obligations. Prime-1 repayment ability
will often be evidenced by many of the following characteristics: leading
market positions in well established industries; high rates of return on funds
employed; conservative capitalization structures 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 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 effects of industry
characteristics and market composition may be more pronounced. Variability in
earnings and profitability may result in changes to 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, a Division of The McGraw-Hill Companies, Inc.
("Standard & Poor's"), Municipal Debt Ratings
A Standard & Poor's municipal debt 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 program. It takes into
consideration the creditworthiness of guarantors, insurers, or other forms of
credit enhancement on the obligation.
The debt 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.
The ratings are based on current information furnished by the obligors or
obtained by Standard & Poor's from other sources Standard & Poor's 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 circumstances.
60
<PAGE>
The ratings are based, in varying degrees, on the following considerations:
I. Likelihood of payment--capacity and willingness of the obligor as to
the timely payment of interest and repayment of principal in accordance
with the terms of the obligation;
II. Nature of and provisions of the obligation;
III. Protection afforded to, 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.
Capacity to meet its financial commitment on the obligation is
extremely strong.
AA Debt rated "AA" differs from the highest rated issues 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 on the obligation.
BB Debt rated "BB," "B," "CCC," "CC" and "C" are regarded as having
B significant speculative characteristics. "BB" indicates the least
CCC degree of speculation and "C" the highest degree of speculation. While
CC such debt will likely have some quality and protective
C characteristics, these may be outweighed by large uncertainties or
major risk 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 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.
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 designation 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."
61
<PAGE>
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.
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.
Description of Fitch IBCA, Inc.'s ("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 rating
represents 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 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 guarantees unless otherwise indicated.
62
<PAGE>
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
issuers 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.
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.
63
<PAGE>
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 "Positive" or
"Negative." The absence of a designation indicates a stable outlook.
Description of Fitch's 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 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.
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 basis
D 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.
64
<PAGE>
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's Short-Term Ratings
Fitch's short-term ratings apply to debt obligations that are payable on
demand or have original maturities of 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.
65
<PAGE>
APPENDIX III
PORTFOLIO INSURANCE
Set forth below is further information with respect to the insurance policies
(the "Policies") that the Fund may obtain from several insurance companies with
respect to insured Pennsylvania Municipal Bonds and Municipal Bonds held by the
Fund. The Fund has no obligation to obtain any such Policies, and the terms of
any Policies actually obtained may vary significantly from the terms discussed
below.
In determining eligibility for insurance, insurance companies will apply
their own standards. These standards correspond generally to the standards such
companies normally use in establishing the insurability of new issues of
Pennsylvania Municipal Bonds and Municipal Bonds and are not necessarily the
criteria that would be used in regard to the purchase of such bonds by the
Fund. The Policies do not insure (i) municipal securities ineligible for
insurance and (ii) municipal securities no longer owned by the Fund.
The Policies do not guarantee the market value of the insured Pennsylvania
Municipal Bonds and Municipal Bonds or the value of the shares of the Fund. In
addition, if the provider of an original issuance insurance policy is unable to
meet is obligations under such policy or if the rating assigned to the
insurance claims-paying ability of any such insurer deteriorates, the insurance
company will not have any obligation to insure any issue held by the Fund that
is adversely affected by either of the above described events. In addition to
the payment of premiums, the Policies may require that the Fund notify the
insurance company as to all Pennsylvania Municipal Bonds and Municipal Bonds in
the Fund's portfolio and permit the insurance company to audit their records.
The insurance premiums will be payable monthly by the Fund in accordance with a
premium schedule to be furnished by the insurance company at the time the
Policies are issued. Premiums are based upon the amounts covered and the
composition of the portfolio.
The insurance companies used by the Fund will have insurance claims-paying
ability ratings of AAA from Standard & Poor's ("S&P") or Fitch IBCA, Inc.
("Fitch") or Aaa from Moody's Investors Service, Inc. ("Moody's").
An S&P insurance claims-paying ability rating is an assessment of an
operating insurance company's financial capacity to meet obligations under an
insurance policy in accordance with the terms. An insurer with an insurance
claims-paying ability rating of AAA has the highest rating assigned by S&P or
Fitch. Capacity to honor insurance contracts is considered by S&P and Fitch to
be extremely strong and highly likely to remain so over a long period of time.
A Moody's insurance claims-paying ability rating is an opinion of the ability
of an insurance company to repay punctually senior policyholder obligations and
claims. An insurer with an insurance claims-paying ability rating of Aaa is
considered by Moody's to be of the best quality. In the opinion of Moody's, the
policy obligations of an insurance company with an insurance claims-paying
ability rating of Aaa carry the smallest degree of credit risk and, while the
financial strength of these companies is likely to change, such changes as can
be visualized are most unlikely to impair the company's fundamentally strong
position. A Fitch insurance claims-paying ability rating provides an assessment
of an insurance company's financial strength and, therefore, its ability to pay
policy and contract claims under the terms indicated. An insurer with an
insurance claims-paying ability rating of AAA has the highest rating assigned
by Fitch. The ability to pay claims is adjudged by Fitch to be extremely strong
for insurance companies with this highest rating. In the opinion of Fitch,
foreseeable business and economic risk factors should not have any material
adverse impact on the ability of these insurers to pay claims. In Fitch's
opinion, profitability, overall balance sheet strength, capitalization and
liquidity are all at very secure levels and are unlikely to be affected by
potential adverse underwriting, investment or cyclical events.
66
<PAGE>
An insurance claims-paying ability rating of S&P, Fitch or Moody's does not
constitute an opinion on any specific contract in that such an opinion can only
be rendered upon the review of the specific insurance contract. Furthermore, an
insurance claims-paying ability rating does not take into account deductibles,
surrender or cancellation penalties or the timeliness of payment; nor does it
address the ability of a company to meet nonpolicy obligations (i.e., debt
contracts).
The assignment of ratings by S&P, Fitch or Moody's to debt issues that are
fully or partially supported by insurance policies, contracts or guarantees is
a separate process from the determination of claims-paying ability ratings. The
likelihood of a timely flow of funds from the insurer to the trustee for the
bondholders is a key element in the rating determination for such debt issues.
67
<PAGE>
APPENDIX IV
TAXABLE EQUIVALENT YIELDS FOR INDIVIDUALS FOR 1999
<TABLE>
<CAPTION>
Taxable Income* 1999 A Tax-Exempt Yield of
- ------------------------------------ 1999 Federal Pennsylvania ---------------------------------------------
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>
$ 25,751-$ 62,450 $ 43,051-$104,050 28.00% 2.8% 7.144% 7.859% 8.573% 9.288% 10.002% 10.717%
$ 62,451-$130,250 $104,051-$158,550 31.00% 2.8% 7.455% 8.201% 8.946% 9.692% 10.437% 11,183%
$130,251-$283,150 $158,551-$283,150 36.00% 2.8% 8.038% 8.841% 9.645% 10.449% 11.253% 12.056%
Over $283,150 Over $283,150 39.60% 2.8% 8.517% 9.368% 10.220% 11.072% 11.923% 12.775%
</TABLE>
- --------
* 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. Income also may be subject to certain state and local taxes. For
investors who pay alternative minimum tax, tax-exempt yields may be
equivalent to lower taxable yields than those shown above. The tax rates
shown above do not apply to corporate taxpayers. 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>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Through and including May 24, 1999 (the 90th day after the date of this
prospectus), all dealers effecting transactions in these securities, whether or
not participating in this offering, may be required to deliver a prospectus.
This is in addition to the dealers' obligation to deliver a prospectus when
acting underwriters and with respect to their unsold allotments or
subscriptions.
1,875,000 Shares
MuniHoldings Pennsylvania Insured Fund
Common Shares
----------------
PROSPECTUS
----------------
Merrill Lynch & Co.
February 23, 1999
CODE 19052-0299
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<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 January 13, 1999
Notes to Statement of Assets, Liabilities and Capital
(2) Exhibits:
(a)--Declaration of Trust(a)
(b)--By-Laws(a)
(c)--Not applicable
(d)(1)--Portions of the Declaration of Trust and By-Laws of the
Registrant defining the rights of holders of shares of the
Registrant(c)
(d)(2)--Form of specimen certificate for Common Shares of the
Registrant(b)
(e)--Form of Automatic Dividend Reinvestment Plan(b)
(f)--Not applicable
(g)--Form of Investment Advisory Agreement between the Fund and Fund
Asset Management, L.P.(b)
(h)(1)--Form of Purchase Agreement between the Fund and Merrill Lynch,
Pierce, Fenner & Smith Incorporated(b)
(h)(2)--Merrill Lynch Standard Dealer Agreement(b)
(i)--Not applicable
(j)--Form of Custodian Contract between the Fund and The Bank of New
York(b)
(k)--Form of Registrar, Transfer Agency and Service Agreement between
the Fund and The Bank of New York(b)
(l)--Opinion and Consent of Brown & Wood LLP
(m)--Not applicable
(n)--Consent of Deloitte & Touche LLP, independent auditors for the Fund
(o)--Not applicable
(p)--Certificate of Fund Asset Management, L.P.
(q)--Not applicable
(r)--Not applicable
- --------
(a) Previously filed on December 7, 1998 as an Exhibit to the Registrant's
Registration Statement on Form N-2 (File No. 333-68451).
(b) Filed on December 15, 1998 as an Exhibit to Pre-Effective Amendment No. 1
to the Registrant's Registration Statement on Form N-2 (File No. 333-68451)
(c) Reference is made to Section 3.4, Article V, Article VI (sections 1, 2, 4,
5 and 7), Article VIII, Article IX and Article X of the Registrant's
Declaration of Trust, filed as Exhibit (a) 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.
Item 25. Marketing Arrangements.
See Exhibits (h)(1) and (h)(2).
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.................................................. $ 8,992
American Exchange listing fee...................................... 20,000
Printing (other than share certificates)........................... 35,000
Engraving and printing share certificates.......................... 20,000
Legal fees and expenses............................................ 40,000
Accounting fees and expenses....................................... 7,000
NASD fees.......................................................... 3,735
Miscellaneous...................................................... 273
--------
Total............................................................ $135,000
========
</TABLE>
Item 27. Persons Controlled by or Under Common Control with Registrant.
The information in the prospectus under the captions "Investment Advisory and
Management Arrangements" and "Description of Capital Shares--Common Shares" 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 shares, par value $0.10 per
share, as of the effective date of this Registration Statement.
Item 29. Indemnification.
Section 5.3 of the Registrant's Declaration of Trust provides as follows:
"The Trust shall indemnify each of its Trustees, officers, employees, and
agents (including persons who serve at its request as directors, officers
or trustees of another organization in which it has any interest as a
shareholder, creditor or otherwise) against all liabilities and expenses
(including amounts paid in satisfaction of judgments, in compromise, as
fines and penalties, and as counsel fees) reasonably incurred by him in
connection with the defense or disposition of any action, suit or other
proceeding, whether civil or criminal, in which he may be involved or with
which he may be threatened, while in office or thereafter, by reason of his
being or having been such a trustee, officer, employee or agent, except
with respect to any matter as to which he shall have been adjudicated to
have acted in bad faith, willful misfeasance, gross negligence or reckless
disregard of his duties; provided, however, that as to any matter disposed
of by a compromise payment by such person, pursuant to a consent decree or
otherwise, no indemnification either for said payment or for any other
expenses shall be provided unless the Trust shall have received a written
opinion from independent legal counsel approved by the Trustees to the
effect that if either the matter of willful misfeasance, gross negligence
or reckless disregard of duty, or the matter of good faith and reasonable
belief as to the best interests of the Trust, had been adjudicated, it
would have been adjudicated in favor of such person. The rights accruing to
any person under these provisions shall not exclude any other right to
which he may be lawfully entitled; provided that no person may satisfy any
right of indemnity or reimbursement granted herein or in Section 5.1 or to
which he may be otherwise entitled except out of the property of the Trust,
and no Shareholder shall be personally liable to any person with respect to
any claim for indemnity or reimbursement or otherwise. The Trustees may
make advance payments in connection with indemnification under this Section
5.3, provided that the indemnified person shall have given a written
undertaking to reimburse the Trust in the event it is subsequently
determined that he is not entitled to such indemnification."
The Registrant's By-Laws provide that insofar as the conditional advancing of
indemnification moneys pursuant to Section 5.3 of the Declaration of Trust for
actions based upon the Investment Company Act of
C-2
<PAGE>
1940 may be concerned, such payments will be made only on the following
conditions: (i) the advances must be limited to amounts used, or to be used,
for the preparation or presentation of a defense to the action, including costs
connected with the preparation of a settlement; (ii) advances may be made only
upon receipt of a written promise by, or on behalf of, the recipient to repay
that amount of the advance which exceeds the amount to which it is ultimately
determined he is entitled to receive from the Registrant by reason of
indemnification; and (iii) (a) such promise must be secured by a surety bond,
other suitable insurance or an equivalent form of security which assures that
any repayments may be obtained by the Registrant without delay or litigation,
which bond, insurance or other form of security must be provided by the
recipient of the advance, or (b) a majority of a quorum of the Registrant's
disinterested, non-party Trustees, or an independent legal counsel in a written
opinion, shall determine, based upon a review of readily available facts, that
the recipient of the advance ultimately will be found entitled to
indemnification.
In Section 8 of the Distribution Agreement relating to the securities being
offered hereby, the Registrant agrees to indemnify the Distributor and each
person, if any, who controls the Distributor within the meaning of the
Securities Act of 1933 (the "1933 Act"), against certain types of civil
liabilities arising in connection with the Registration Statement or
Prospectus.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933, as amended (the "1933 Act") may be provided to trustees, 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 trustee, 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
will be filed as Exhibit (h)(1) hereto, for provisions relating to the
indemnification of the underwriter.
Item 30. Business and Other Connections of the Investment Adviser.
Fund Asset Management, L.P. (the "Investment Adviser") 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 Corporate High Yield
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.,
Corporate High Yield Fund III, Inc., Debt Strategies Fund, Inc., Debt
Strategies Fund II, Inc., Debt Strategies Fund III, 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 Fund II, Inc., MuniHoldings California
Insured Fund, Inc., MuniHoldings California Insured Fund II, Inc., MuniHoldings
California Insured Fund III, Inc., MuniHoldings California Insured Fund IV,
Inc., MuniHoldings Florida Insured Fund, MuniHoldings Florida Insured Fund II,
MuniHolding Florida Insured Fund III, MuniHolding Florida Insured Fund IV,
MuniHoldings Insured Fund, Inc., MuniHoldings Insured Fund II, Inc.,
MuniHoldings Michigan Insured Fund, Inc., MuniHoldings New Jersey Insured Fund,
Inc., MuniHoldings New Jersey Insured Fund II, Inc., MuniHoldings New Jersey
Insured
C-3
<PAGE>
Fund III, Inc., MuniHoldings New York Fund, Inc., MuniHoldings New York Insured
Fund, Inc., MuniHoldings New York Insured Fund II, Inc., MuniHoldings New York
Insured Fund III, Inc., MuniHoldings Pennsylvania Insured Fund, MuniInsured
Fund, Inc., MuniVest Fund, Inc., MuniVest Fund II, Inc., MuniVest Florida Fund,
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. 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 Convertible Fund, Inc.,
Merrill Lynch Developing Capital Markets Fund, Inc., Merrill Lynch Dragon Fund,
Inc., Merrill Lynch EuroFund, Merrill Lynch Fundamental Growth Fund, Inc.,
Merrill Lynch Global Bond Fund for Investment and Retirement, Merrill Lynch
Global Allocation 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 Technology Fund, Inc., Merrill
Lynch Global Utility Fund, Inc., Merrill Lynch Global Value Fund, Inc., Merrill
Lynch Growth Fund, Merrill Lynch Healthcare Fund, Inc., Merrill Lynch Index
Funds, Inc., Merrill Lynch Intermediate Government Bond Fund, 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 Real Estate Fund, Inc., 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. MLAM also acts as sub-adviser to Merrill
Lynch World Strategy Portfolio and Merrill Lynch Basic Value Equity Portfolio,
two investment portfolios of EQ Advisors Trust.
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 02110-2646. The
address of the Investment Adviser, FAM, Princeton Services, Inc. ("Princeton
Services") and Princeton Administrators, L.P. is also P.O. Box 9011, Princeton,
New Jersey 08543-9011. The address of Princeton Funds Distributor, Inc. ("PFD")
and of Merrill Lynch Funds Distributor ("MLFD") is P.O. Box 9081, Princeton,
New Jersey 08543-9081. The address of Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("Merrill Lynch") and Merrill Lynch & Co., Inc. ("ML&Co.") is
World Financial Center, 250 Vesey Street, New York, New York 10281. The address
of Financial Data Services, Inc. ("FDS") is 4800 Deer Lake Drive East,
Jacksonville, Florida 32246-6484.
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
officers of one or more of such companies.
C-4
<PAGE>
<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 Services...... General Partner General Partner of MLAM
Arthur Zeikel........... Chairman Chairman of MLAM; President of the
Investment Adviser and MLAM (from 1977 to
1997); Chairman and Director of Princeton
Services; President of Princeton Services
(from 1993 to 1997); Executive Vice
President of ML & Co.
Jeffrey M. Peek......... President President of MLAM; President and Director
of Princeton Services; Executive Vice
President of ML & Co.; Managing Director
and Co-Head of the Investment Banking
Division of Merrill Lynch in 1997; Senior
Vice President and Director of the Global
Securities and Economics Division of
Merrill Lynch from 1995 to 1997.
Terry K. Glenn.......... Executive Vice President Executive Vice President of MLAM; Executive
Vice President and Director of Princeton
Services; President and Director of PFD;
Director of MLFDS; President of Princeton
Administrators, L.P.
Donald C. Burke......... Senior Vice President Senior Vice President, Treasurer and
and Treasurer Director of Taxation of MLAM; Senior Vice
President and Treasurer of Princeton
Services; Vice President of PFD; First Vice
President of MLAM from 1997 to 1999; Vice
President of MLAM from 1990 to 1997
Michael G. Clark........ Senior Vice President Senior Vice President of MLAM; Senior Vice
President of Princeton Services; Director
and Treasurer of PFD; First Vice President
of MLAM from 1997 to 1999; Vice President
of MLAM from 1996-1997
Mark A. DeSario......... Senior Vice President Senior Vice President of MLAM
Linda L. Federici....... Senior Vice President Senior Vice President of MLAM; Senior Vice
President of Princeton Services
Vincent R. Giordano..... Senior Vice President Senior Vice President of MLAM; Senior Vice
President of Princeton Services
Elizabeth A. Griffin.... Senior Vice President Senior Vice President of MLAM; Senior Vice
President of Princeton Services
Norman R. Harvey........ Senior Vice President Senior Vice President of MLAM; Senior Vice
President of Princeton Services
Michael J. Hennewinkel.. Senior Vice President, Senior Vice President, General Counsel and
General Counsel and Secretary of MLAM; Senior Vice President of
Secretary Princeton Services
Philip L. Kirstein...... Senior Vice President Senior Vice President of MLAM; Senior Vice
President, General Counsel, Director and
Secretary of Princeton Services
Ronald M. Kloss......... Senior Vice President Senior Vice President of MLAM; Senior Vice
President of Princeton Services
Debra W. Landsman- Senior Vice President of MLAM; Senior Vice
Yaros.................. President of Princeton Services; Vice
Senior Vice President President of PFD
Stephen M. M. Miller.... Senior Vice President Executive Vice President of Princeton
Administrators, L.P.; Senior Vice President
of Princeton Services
Joseph T. Monagle, Senior Vice President Senior Vice President of MLAM; Senior Vice
Jr. ................... President of Princeton Services
Brian A. Murdock........ Senior Vice President Senior Vice President of MLAM; Senior Vice
President of Princeton Services; Director
of PFD
Michael L. Quinn........ Senior Vice President Senior Vice President of MLAM; Senior Vice
President of Princeton Services
Gregory D. Upah......... Senior Vice President Senior Vice President of MLAM; Senior Vice
President of Princeton Services
Ronald L. Welburn....... Senior Vice President Senior Vice President of MLAM; Senior Vice
President of Princeton Services
</TABLE>
C-5
<PAGE>
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.
Item 33. Undertakings.
(a) Registrant undertakes to suspend the offering of the common shares
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 common share declines more than 10% from its net asset value per
common share as of the effective date of this Registration Statement, or (2)
its net asset value per common share 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-6
<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 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 23rd day of
February, 1999.
MuniHoldings Pennsylvania Insured Fund
(Registrant)
By /s/ Arthur Zeikel
-----------------------------------
(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 Registration
Statement has been signed below by the following person in the capacities and
on the dates indicated.
<TABLE>
<S> <C> <C>
Signatures Title Date
/s/ Arthur Zeikel President (Principal February 23,
- ------------------------------------- Executive Officer) 1999
(Arthur Zeikel) and Trustee
/s/ Donald C. Burke Vice President and February 23,
- ------------------------------------- Treasurer 1999
(Donald C. Burke) (Principal
Financial and
Accounting Officer)
/s/ James H. Bodurtha Trustee February 23,
- ------------------------------------- 1999
(James H. Bodurtha)
/s/ Herbert I. London Trustee February 23,
- ------------------------------------- 1999
(Herbert I. London)
/s/ Robert R. Martin Trustee February 23,
- ------------------------------------- 1999
(Robert R. Martin)
/s/ Joseph L. May Trustee February 23,
- ------------------------------------- 1999
(Joseph L. May)
/s/ Andre F. Perold Trustee February 23,
- ------------------------------------- 1999
(Andre F. Perold)
</TABLE>
C-7
<PAGE>
Exhibit Index
<TABLE>
<CAPTION>
Exhibit
Number Exhibit Name
------- ------------
<C> <C> <S>
(l) -- Opinion and consent of Brown & Wood LLP
(n) -- Consent of Deloitte & Touche LLP, independent auditors for the
Fund
(p) -- Certificate of Fund Asset Management, L.P.
</TABLE>
<PAGE>
EXHIBIT 99.(l)
BROWN & WOOD, LLP
One World Trade Center
New York, N.Y. 10048-0057
Telephone: 212-839-5300
Facsimile: 212-839-5599
February 23, 1999
MuniHoldings Pennsylvania Insured Fund
800 Scudders Mill Road
Plainsboro, New Jersey 08536
Ladies and Gentlemen:
This opinion is being furnished in connection with the registration by
MuniHoldings Pennsylvania Insured Fund, a Massachusetts business trust (the
"Fund"), of common shares of beneficial interests, par value $0.10 per share
(the "Shares"), under the Securities Act of 1933, as amended (the "Securities
Act"), pursuant to the Fund's registration statement on Form N-2, as amended
(the "Registration Statement"), under the Securities Act, in the amount set
forth under "Amount Being Registered" on the facing page of the Registration
Statement. The Shares will be issued pursuant to the Certificate of Designation
(the "Certificate of Designation") to be filed with the Secretary of the
Commonwealth of Massachusetts (the "State Department").
As counsel for the Fund, we are familiar with the proceedings taken by it
in connection with the authorization, issuance and sale of the Shares. In
addition, we have examined and are familiar with the Declaration of Trust of the
Fund, as amended, the By-laws of the Fund, and such other documents as we have
deemed relevant to the matters referred to in this opinion.
<PAGE>
Based upon the foregoing, we are of the opinion that the Shares, upon
issuance and sale in the manner referred to in the Registration Statement, will
be legally issued, fully paid and non-assessable shares of common stock of the
Fund.
We hereby consent to the filing of this opinion as an exhibit to the
Registration Statement and to the use of our name in the Prospectus constituting
a part thereof.
Very truly yours,
/s/ Brown & Wood LLP
<PAGE>
EXHIBIT 99(n)
INDEPENDENT AUDITORS' CONSENT
Muniholdings Pennsylvania Insured Fund
We consent to the use in Pre-Effective Amendment No. 2 to Registration Statement
No. 333-68451 of our report dated January 21, 1999 and to the reference to us
under the caption "Experts" both of which appear in the Prospectus, which is a
part of such Registration Statement.
/s/ Deloitte & Touche LLP
Deloitte & Touche LLP
Princeton, New Jersey
February 23, 1999
<PAGE>
EXHIBIT 99.(p)
CERTIFICATE OF THE SOLE SHAREHOLDER OF
MUNIHOLDINGS PENNSYLVANIA INSURED FUND
Fund Asset Management, L.P. ("FAM"), the holder of 6,667 common shares,
par value $0.10 per share, of MuniHoldings Pennsylvania Insured Fund (the
"Fund"), a Massachusetts business trust, does hereby confirm to the Fund its
representation that it purchased such shares for investment purposes, with no
present intention of redeeming or reselling any portion thereof, and further
agrees that if it redeems (by tender offer or otherwise) any portion of such
shares prior to the amortization of the Fund's organizational expenses, the
proceeds thereof will be reduced by the proportionate amount of unamortized
organizational expenses which the number of shares being redeemed bears to the
number of shares initially purchased and outstanding at the time of redemption.
FAM further agrees that, in the event such shares are sold or otherwise
transferred to any other party, prior to such sale or transfer FAM will obtain
on behalf of the Fund an agreement from such other party to comply with the
foregoing as to the reduction of redemption proceeds and to obtain a similar
agreement from any transferee of such party.
FUND ASSET MANAGEMENT, L.P.
By: /s/ Robert Harris
----------------------------------
Name: Robert Harris
Title: Assistant Secretary
Dated: February 23, 1999
