<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 20, 1999
SECURITIES ACT FILE NO. 333-77531
INVESTMENT COMPANY ACT FILE NO. 811-09313
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM N-2
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
[X]
PRE-EFFECTIVE AMENDMENT NO. 3
[X]
POST-EFFECTIVE AMENDMENT NO.
[ ]
AND/OR
REGISTRATION STATEMENT UNDER THE
INVESTMENT COMPANY ACT OF 1940 [X]
AMENDMENT NO. 4 [X]
(Check appropriate box or boxes)
------------------------
MUNIHOLDINGS CALIFORNIA INSURED FUND V, INC.
(Exact Name of Registrant as Specified
in Charter)
------------------------
800 SCUDDERS MILL ROAD, PLAINSBORO, NEW JERSEY 08536
(Address of Principal Executive Offices)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (609) 282-2800
TERRY K. GLENN
MUNIHOLDINGS CALIFORNIA INSURED FUND V, INC.
800 SCUDDERS MILL ROAD
PLAINSBORO, NEW JERSEY 08536
MAILING ADDRESS: P.O. BOX 9011, PRINCETON, NEW JERSEY 08543-9011
(Name and Address of Agent for Service)
------------------------
COPIES TO:
<TABLE>
<S> <C>
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
</TABLE>
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Approximate date of proposed public offering: As soon as practicable after the
effective date of this Registration Statement.
------------------------
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, as amended (the "Securities Act"), other than securities offered only in
connection with dividend or interest reinvestment plans, check the following
box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration number of the earlier effective registration statement for the same
offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434
under the Securities Act, please check the following box. [ ]
------------------------
CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933
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<TABLE>
<S> <C> <C> <C>
PROPOSED PROPOSED
AMOUNT MAXIMUM MAXIMUM
TITLE OF BEING OFFERING PRICE AGGREGATE
SECURITIES BEING REGISTERED REGISTERED(1) PER UNIT OFFERING PRICE
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Common Stock ($.10 par value)............................... 5,635,000 shares $15.00 $84,525,000
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<CAPTION>
<S> <C>
AMOUNT OF
TITLE OF REGISTRATION
SECURITIES BEING REGISTERED FEE(2)
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Common Stock ($.10 par value)............................... $23,498
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</TABLE>
(1) Includes 735,000 shares subject to the underwriter's over-allotment option.
(2) Transmitted to the designated lockbox at Mellon Bank in Pittsburgh, PA.
$23,498 was previously paid.
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<PAGE> 2
PROSPECTUS
4,900,000 SHARES
MUNIHOLDINGS CALIFORNIA INSURED FUND V, INC.
COMMON STOCK
------------------------
MuniHoldings California Insured Fund V, Inc. (the "Fund") is a newly
organized, non-diversified, closed-end management investment company that seeks
to provide shareholders with current income exempt from Federal and California
income taxes. The Fund seeks to achieve its objective by investing primarily in
a portfolio of long-term, investment grade municipal obligations the interest on
which, in the opinion of bond counsel to the issuer, is exempt from Federal and
California income taxes. The Fund intends to 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 stock has been approved for listing on
the New York Stock Exchange under the symbol "CAF." Trading of the Fund's common
stock 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 stock, the Fund intends to offer shares of preferred stock representing
approximately 40% of the Fund's capital immediately after the issuance of such
preferred stock. There can be no assurance, however, that preferred stock
representing such percentage of the Fund's capital will actually be issued. The
use of preferred stock to leverage the common stock 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 STOCK INVOLVES CERTAIN RISKS, WHICH ARE DESCRIBED
IN THE "RISK FACTORS AND SPECIAL CONSIDERATIONS" SECTION BEGINNING ON PAGE 8 OF
THIS PROSPECTUS.
<TABLE>
<CAPTION>
PER SHARE TOTAL
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<S> <C> <C>
Public Offering Price.............. $15.00 $73,500,000
Sales Load......................... None None
Proceeds, before expenses, to
Fund............................. $15.00 $73,500,000
</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 stock.
The underwriter may also purchase up to an additional 735,000 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.
The shares of common stock will be ready for delivery in New York, New York
on or about July 23, 1999.
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MERRILL LYNCH & CO.
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The date of this prospectus is July 20, 1999.
<PAGE> 3
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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Prospectus Summary.......................................... 3
Risk Factors and Special Considerations..................... 8
Fee Table................................................... 10
The Fund.................................................... 11
Use of Proceeds............................................. 11
Investment Objective and Policies........................... 11
Risks and Special Considerations of Leverage................ 23
Investment Restrictions..................................... 26
Directors and Officers...................................... 27
Investment Advisory and Management Arrangements............. 29
Portfolio Transactions...................................... 31
Dividends and Distributions................................. 32
Taxes....................................................... 33
Automatic Dividend Reinvestment Plan........................ 38
Mutual Fund Investment Option............................... 40
Net Asset Value............................................. 40
Description of Capital Stock................................ 41
Custodian................................................... 44
Underwriting................................................ 44
Transfer Agent, Dividend Disbursing Agent and Registrar..... 46
Legal Opinions.............................................. 46
Experts..................................................... 46
Additional Information...................................... 46
Independent Auditors' Report................................ 48
Statement of Assets, Liabilities and Capital................ 49
Appendix I -- Economic and Other Conditions in California... 50
Appendix II -- Ratings of Municipal Bonds................... 65
Appendix III -- Portfolio Insurance......................... 72
Appendix IV -- Taxable Equivalent Yields for 1999........... 74
</TABLE>
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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> 4
PROSPECTUS SUMMARY
This summary is qualified in its entirety by reference to the detailed
information included in this prospectus.
THE FUND MuniHoldings California Insured Fund V, Inc. is a newly
organized, non-diversified, closed-end management investment
company.
THE OFFERING The Fund is offering 4,900,000 shares of common stock at an
initial offering price of $15.00 per share. The common stock is
being offered by Merrill Lynch, Pierce, Fenner & Smith
Incorporated, as underwriter. The underwriter may also purchase
up to an additional 735,000 shares of common stock within 45 days
of the date of this prospectus to cover over-allotments.
INVESTMENT
OBJECTIVE
AND POLICIES The investment objective of the Fund is to provide shareholders
with current income exempt from Federal and California income
taxes. The Fund seeks to achieve its objective by investing
primarily in a portfolio of long-term, investment grade municipal
obligations the interest on which, in the opinion of bond counsel
to the issuer, is exempt from Federal and California income
taxes.
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 Fund's investment adviser to be of
comparable quality.
California Municipal Bonds. The Fund will generally invest
substantially all (at least 80%) of its assets in California
municipal bonds. However, when the Fund's investment adviser
believes that investment grade California 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 California municipal bonds and at least 80%
of its assets in California 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
California income tax.
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 at maturity.
In general, the Fund does not intend its investments to earn a
large amount of income that is subject to Federal and California
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 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
3
<PAGE> 5
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 choose not to do so. The Fund
cannot guarantee that any hedging strategies it uses will work.
LEVERAGE Issuance of Preferred Stock. The Fund intends to offer shares of
preferred stock within three months after completion of this
offering. The preferred stock will represent approximately 40% of
the Fund's capital, including the capital raised by issuing the
preferred stock. There can be no assurance, however, that
preferred stock will actually be issued. Issuing preferred stock
will result in the leveraging of the common stock. Although the
Board of Directors has not yet determined the terms of the
preferred stock offering, the Fund expects that the preferred
stock will pay dividends that will be adjusted over either
relatively short-term periods (generally seven to 28 days) or
medium-term periods (up to five years). The preferred stock
dividend rate will be based upon prevailing interest rates for
debt obligations of comparable maturity. The money raised by the
preferred stock offering will be invested in longer-term
obligations in accordance with the Fund's investment objective.
The expenses of the preferred stock, which will be borne by the
Fund, will reduce the net asset value of the common stock. In
addition, at times, when the Fund is required to allocate taxable
income to preferred stockholders, the terms of the preferred
stock 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 stock outstanding, the Fund will pay fees to the
investment adviser for its services that are higher than if the
Fund did not issue preferred stock because the fees will be
calculated on the basis of the Fund's average weekly net assets,
including proceeds from the sale of preferred stock.
Potential Benefits of Leverage. Under normal market conditions,
longer term obligations produce higher yields than short and
medium term obligations. The Fund's
4
<PAGE> 6
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 stockholders. Thus,
the Fund's use of preferred stock should provide common
stockholders with a higher yield than they would receive if the
Fund were not leveraged.
Risks. The use of leverage creates certain risks for common
stockholders, including higher volatility of both the net asset
value and the market value of the common stock. Since any decline
in the value of the Fund's investments will affect only the
common stockholders, 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
shares of common stock. In addition, fluctuations in the dividend
rates paid on, and the amount of taxable income allocable to, the
preferred stock will affect the yield to common stockholders.
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 stock.
Under certain conditions, the benefits of leverage to common
stockholders will be reduced, and the Fund's leveraged capital
structure could result in a lower rate of return to common
stockholders than if the Fund were not leveraged.
Distributions. When the Fund issues preferred stock, common
stockholders will receive all of the Fund's net income that
remains after it pays dividends (and any Additional Distribution)
on the preferred stock and generally will be entitled to a pro
rata share of net realized capital gains. If the Fund is
liquidated, preferred stockholders will be entitled to receive
liquidating distributions before any distribution is made to
common stockholders. These liquidating distributions are expected
to equal the original purchase price per share of the preferred
stock plus any accumulated and unpaid dividends and Additional
Distributions.
Redemption of Preferred Stock. The Fund may redeem the preferred
stock for any reason. For example, the Fund may redeem all or
part of the preferred stock if it believes that the Fund's
leveraged capital structure will cause common stockholders to
obtain a lower return than they would if the common stock were
unleveraged for any significant amount of time.
Voting Rights. Preferred stockholders, voting as a separate
class, will be entitled to elect two of the Fund's Directors.
Common and preferred stockholders, voting together as a single
class, will be entitled to elect the remaining Directors. If the
Fund fails to pay dividends to the preferred stockholders for two
full years, the holders of all outstanding shares of preferred
stock, voting as a separate class, would then be entitled to
elect a majority of the Fund's Directors. The preferred
stockholders also will vote separately on certain other matters
as required under the Fund's Articles of Incorporation, the
Investment Company Act of 1940, as amended, and Maryland law.
Otherwise, common and preferred stockholders will have equal
voting rights (one vote per share) and will vote together as a
single class.
5
<PAGE> 7
Ratings. Before it offers the preferred stock, the Fund intends
to apply to one or more nationally recognized statistical ratings
organizations for ratings on the preferred stock. The Fund
believes that a rating for the preferred stock will make it
easier to market the stock, which should reduce the dividend
rate.
LISTING Currently, there is no public market for the Fund's common stock.
However, the Fund's common stock has been approved for listing on
the New York Stock Exchange. Trading of the Fund's common stock
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 of common stock.
Thus, investors may not be able to buy and sell shares of the
Fund during that period.
INVESTMENT
ADVISER Fund Asset Management, L.P. is the Fund's investment adviser and
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 stock.
DIVIDENDS
AND
DISTRIBUTIONS The Fund intends to distribute dividends of all or a portion of
its net investment income to common stockholders each month. Once
the Fund issues preferred stock, the monthly dividends to common
stockholders will consist of all or a portion of net investment
income that remains after the Fund pays dividends (and any
Additional Distribution) on the preferred stock. At times, in
order to maintain a stable level of monthly dividends to common
stockholders, the Fund may pay out less than all of its net
investment income or pay out accumulated undistributed income in
addition to net investment income. The Fund expects to begin
paying dividends to common stockholders within approximately 90
days from the date of this prospectus. The Fund will distribute
net capital gains, if any, at least annually to common
stockholders and, after it issues the preferred stock, on a pro
rata basis to common and preferred stockholders. When the Fund
allocates capital gains or other taxable income to preferred
stockholders, under certain circumstances, the terms of the
preferred stock may require the Fund to make an Additional
Distribution. The Fund may not declare any cash dividend or other
distribution on its common stock unless the preferred stock has
asset coverage of at least 200%. If the Fund issues preferred
stock representing 40% of its total capital, the preferred
stock's asset coverage will be approximately 250%. If the Fund's
ability to make distributions on its common stock is limited, the
Fund may not be able to qualify for taxation as a regulated
investment company. This would have adverse tax consequences for
common stockholders.
YIELD
CONSIDERATIONS The yield on the Fund's common stock will vary from period to
period depending on factors including, but not limited to, market
conditions, the timing of the Fund's investment in portfolio
securities, the securities comprising the Fund's portfolio,
changes in tax-exempt interest rates (which may not change to the
same extent or in the same direction as taxable rates) including
changes in the relationship between short-term rates and
long-term rates, the amount and timing of the issuance of the
Fund's preferred stock, the effects of preferred stock leverage
on the common stock discussed above under "Leverage", the timing
of the investment of preferred stock
6
<PAGE> 8
\proceeds in portfolio securities, the Fund's net assets and its
operating expenses. Consequently, the Fund cannot guarantee any
particular yield on its shares and the yield for any given period
is not an indication or representation of future yields on Fund
shares. The Fund's ability to achieve any particular yield level
after it commences operations depends on future interest rates
and other factors mentioned above and the initial yield and later
yields may be lower. Any statements as to the estimated yield are
as of the date made and no guarantee can be given that the Fund
will achieve or maintain any particular yield level.
AUTOMATIC
DIVIDEND
REINVESTMENT
PLAN Dividend and capital gains distributions generally are used to
purchase additional shares of the Fund's common stock. However,
an investor can choose to receive distributions in cash. Since
not all investors can 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 FUND
INVESTMENT
OPTION Investors who purchase shares in this offering through the
underwriter and later sell their shares have the option, subject
to certain conditions, to purchase Class D shares of certain
Merrill Lynch funds with the proceeds from the sale.
7
<PAGE> 9
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
stock is listed on the New York 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.
California Municipal Bonds. The Fund intends to invest the majority of its
portfolio in California municipal bonds. As a result, the Fund is more exposed
to risks affecting issuers of California municipal bonds than is a municipal
bond fund that invests more widely.
Interest Rate and Credit Risk. The Fund invests in municipal bonds, which
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.
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. 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. Even as a
non-diversified fund, the Fund must still meet the diversification requirements
of applicable Federal income tax laws.
Rating Categories. The Fund intends to invest in municipal bonds that are
rated investment grade by Standard & Poor's, Moody's Investors Service, Inc. or
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 Federal alternative minimum tax.
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 stock. 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.
8
<PAGE> 10
Leverage. The Fund plans to offer shares of preferred stock. The preferred
stock will represent approximately 40% of the Fund's capital, including capital
raised by issuing the preferred stock. Leverage creates certain risks for common
stockholders, including higher volatility of both the net asset value and the
market value of the common stock. Leverage also creates the risk that the
investment return on shares of the Fund's common stock will be reduced to the
extent the dividends paid on preferred stock and other expenses of the preferred
stock exceed the income earned by the Fund on its investments. If the Fund is
liquidated, preferred stockholders will be entitled to receive liquidating
distributions before any distribution is made to common stockholders.
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 choose not to do so.
Antitakeover Provisions. The Fund's Articles of Incorporation include
provisions that could limit the ability of other entities or persons to acquire
control of the Fund or to change the composition of its Board of Directors. 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.
9
<PAGE> 11
FEE TABLE
<TABLE>
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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)......................... .92%
Interest Payments on Borrowed Funds.................... None
Other Expenses(a)(b)................................... .42%
----
Total Annual Expenses(a)(b)....................... 1.34%
====
</TABLE>
<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
EXAMPLE ------ ------- ------- --------
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An investor would pay the following expenses on a
$1,000 investment, assuming total annual expenses of
1.34% (assuming leverage of 40% of the Fund's total
assets) and a 5% annual return throughout the
periods:............................................ $14 $42 $73 $161
</TABLE>
- ------------
(a) Assumes leverage by issuing preferred stock in an amount of approximately
40% of the Fund's capital at a dividend rate of 3.25%. 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 use 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 0.19%
and Total Annual Expenses would be 0.74%.
(b) See "Investment Advisory and Management Arrangements" -- page 29.
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. 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.
10
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THE FUND
MuniHoldings California Insured Fund V, Inc. (the "Fund") is a newly
organized, non-diversified, closed-end management investment company. The Fund
was incorporated under the laws of the State of Maryland on April 5, 1999, 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.
The Board of Directors of the Fund may at any time consider a merger,
consolidation or other form of reorganization of the Fund with one or more other
closed-end investment companies advised by the Fund's investment adviser with
similar investment objectives and policies as the Fund. Any such merger,
consolidation or other form of reorganization would require the prior approval
of the Board of Directors and the stockholders of the Fund. See "Description of
Capital Stock -- Certain Provisions of the Articles of Incorporation."
USE OF PROCEEDS
The net proceeds of this offering will be approximately $73,285,000 (or
approximately $84,310,000 assuming the Underwriter exercises the over-allotment
option in full) after payment of offering expenses estimated to be approximately
$215,000.
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 stock, depending on market conditions and
the availability of appropriate securities. Pending such investment, it is
anticipated that the proceeds will be invested in short-term, tax-exempt
securities. See "Investment Objective and Policies."
INVESTMENT OBJECTIVE AND POLICIES
The Fund's investment objective is to provide shareholders with current
income exempt from Federal and California 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 State of
California, its political subdivisions, agencies and instrumentalities, and
other qualifying issuers, each of which pays interest which, in the opinion of
bond counsel to the issuer, is exempt from Federal and California income taxes
("California Municipal Bonds"). The Fund intends to invest substantially all (at
least 80%) of its assets in California Municipal Bonds, except at times when the
Fund's investment adviser, Fund Asset Management, L.P. (the "Investment
Adviser"), considers that California Municipal
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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 California Municipal Bonds are not available for investment, the Fund
may purchase other long-term municipal obligations exempt from Federal but not
California income taxes ("Municipal Bonds"). The Fund will maintain at least 65%
of its assets in California Municipal Bonds and at least 80% of its assets in
California Municipal Bonds and 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 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 options and futures transactions
to reduce volatility in the net asset value of its shares of common stock.
The Fund ordinarily does not intend to realize significant investment
income that is subject to Federal and California 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 a
Federal 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 California 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 California Municipal Bonds or Municipal
Bonds. Certain Non-Municipal Tax-Exempt Securities may be characterized as
derivative instruments. Non-Municipal Tax-Exempt Securities are considered
"California Municipal Bonds" or "Municipal Bonds" for purposes of the Fund's
investment objective and policies.
Investment in shares of the Fund's common stock offers several potential
benefits. The Fund offers investors the opportunity to receive income exempt
from Federal and California income taxes by investing in a professionally
managed portfolio comprised primarily of investment grade insured California
Municipal Bonds. Investment in the Fund also relieves the investor of the
burdensome administrative details involved in managing a portfolio of California
Municipal Bonds. Additionally, the Investment Adviser will seek to enhance the
yield on the common stock by leveraging the Fund's capital structure through the
issuance of preferred stock. The benefits are at least partially offset by the
expenses involved in operating an investment company. Such expenses primarily
consist of the advisory fee and operational costs. Additionally, the use of
leverage involves certain expenses and special risk considerations. See "Risks
and Special Considerations of Leverage."
The investment grade California Municipal Bonds and Municipal Bonds in
which the Fund will primarily invest are those California Municipal Bonds and
Municipal Bonds rated at the date of purchase in the four highest rating
categories of Standard & Poor's ("S&P"), Moody's Investors Services, Inc.
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<PAGE> 14
("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 within the rating categories set forth above. See Appendix II to this
Prospectus for a description of S&P's, Moody's and Fitch's ratings of Municipal
Bonds. In assessing the quality of California Municipal Bonds and Municipal
Bonds with respect to the foregoing requirements, the Investment Adviser will
take into account the portfolio insurance as well as the nature of any letters
of credit or similar credit enhancements to which particular California
Municipal Bonds and Municipal Bonds are entitled and the creditworthiness of the
insurance company or the financial institution that provided such insurance or
credit enhancements. Consequently, if California 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 California 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 California 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 may invest are tax-
exempt obligations, in the opinion of counsel to the issuer, that contain a
floating or variable interest rate adjustment formula and a 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 shares of common stock of a closed-end investment
company, such as the Fund, which invests primarily in fixed-income securities,
changes as the general levels of interest rates fluctuate. When interest rates
decline, the value of a fixed-income portfolio generally can be expected to
rise. Conversely, when interest rates rise, the value of a fixed-income
portfolio generally 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
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<PAGE> 15
changes in net asset value are likely to be greater in the case of a fund having
a leveraged capital structure, as proposed for the Fund. See "Risks and Special
Considerations of Leverage."
The Fund intends to invest primarily in long-term California Municipal
Bonds and Municipal Bonds with a maturity of more than ten years. Also, the Fund
may invest in intermediate-term California Municipal Bonds and Municipal Bonds
with a maturity of between three years and ten years. The Fund may invest in
short-term, tax-exempt securities, short-term U.S. Government securities,
repurchase agreements or cash. Such short-term securities or cash will not
exceed 20% of its total assets except during interim periods pending investment
of the net proceeds of public offerings of the Fund's securities or in
anticipation of the repurchase or redemption of the Fund's securities and
temporary periods when, in the opinion of the Investment Adviser, prevailing
market or economic conditions warrant. The Fund does not ordinarily intend to
realize significant interest income that is subject to Federal and California
income taxes.
The Fund is classified as non-diversified within the meaning of the 1940
Act, which means that the Fund is not limited by 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 California 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 California Municipal Bonds and Municipal Bonds in
the Fund's portfolio will be insured by the following insurance companies that
satisfy the foregoing criteria: Ambac Assurance Corporation, Financial Guaranty
Insurance Company, Financial Security Assurance and MBIA Insurance Corporation.
The Fund also may purchase California 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
California Municipal Bonds and Municipal Bonds held by the Fund will be insured
under policies obtained by parties other than the Fund.
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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 California Municipal Bonds and Municipal Bonds purchased by
the Fund. A California Municipal Bond or 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 California 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 California Municipal
Bonds and Municipal Bonds beneficially owned by the Fund. In the event of a sale
of any California 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 California Municipal Bonds and Municipal Bonds or
the value of the shares of the Fund.
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 Directors
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 California Municipal Bonds
and Municipal Bonds covered by such Policies. The estimate is based on the
expected composition of the Fund's portfolio of California 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
California 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 California 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 it holds defaulted securities, which may
limit its ability in certain circumstances to purchase other California
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 Directors 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 may discontinue its policy of maintaining
insurance for all or any of the California Municipal Bonds and
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<PAGE> 17
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 California Municipal Bonds or
Municipal Bonds will not receive timely scheduled payments of principal or
interest). However, the insured California 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 or other market conditions).
DESCRIPTION OF CALIFORNIA MUNICIPAL BONDS AND MUNICIPAL BONDS
California Municipal Bonds and Municipal Bonds include debt obligations
issued to obtain funds for various public purposes, including construction of a
wide range of public facilities, refunding of outstanding obligations and
obtaining funds for general operating expenses and loans to other public
institutions and facilities. In addition, certain types of private activity
bonds("PABs") are issued by or on behalf of public authorities to finance
various privately operated facilities, including, among other things, airports,
public ports, mass commuting facilities, multifamily housing projects, as well
as facilities for water supply, gas, 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
California Municipal Bonds if the interest thereon is exempt from Federal and
California income taxes, even though such bonds may be industrial development
bonds or PABs as discussed below. Also, for purposes of this prospectus, Non-
Municipal Tax-Exempt securities as discussed above will be considered California
Municipal Bonds or Municipal Bonds.
The two principal classifications of California Municipal Bonds and
Municipal Bonds are "general obligation" bonds and "revenue" bonds, which latter
category includes PABs and, for bonds issued on or before August 15, 1986,
industrial development bonds or "IDBs". General obligation bonds (other than
those of the State of California which has limited taxing powers) 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. PABs are in most cases revenue bonds and do not
generally constitute the pledge of the credit or taxing power of the issuer of
such bonds. The repayment of principal and the payment of interest on such
industrial development bonds depends solely on the ability of the user of the
facility financed by the bonds to meet its financial obligations and the pledge,
if any, of real and personal property so financed as security for such payment.
California Municipal Bonds and Municipal Bonds may also include "moral
obligation" bonds, which are normally issued by special purpose public
authorities. If an issuer of moral obligation bonds is unable to meet its
obligations, the repayment of such bonds becomes a moral commitment but not a
legal obligation of the state or municipality in question.
The Fund may purchase California Municipal Bonds and Municipal Bonds
classified as PABs. Interest received on certain PABs is treated as an item of
"tax preference" for purposes of the Federal alternative minimum tax and may
impact the overall tax liability of certain investors in the Fund. There is no
limitation on the percentage of the Fund's assets that may be invested in
California Municipal Bonds
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and Municipal Bonds the interest on which is treated as an item of "tax
preference" for purposes of the Federal alternative minimum tax. See
"Taxes -- General." Also included within the general category of California
Municipal Bonds and/or Municipal Bonds are certificates of participation
("COPs") executed and delivered for the benefit of government authorities or
entities to finance the acquisition or construction of equipment, land and/or
facilities. COPs 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.
Federal tax legislation has limited and may continue to limit the types and
volume of such bonds the interest on which is excludable from income for Federal
income tax purposes. Such legislation may affect the availability of California
Municipal Bonds and Municipal Bonds for investment by the Fund.
SPECIAL CONSIDERATIONS RELATING TO CALIFORNIA MUNICIPAL BONDS
The Fund ordinarily will invest at least 80% of its total assets in
California Municipal Bonds, and therefore it is more susceptible to factors
adversely affecting issuers of California Municipal Bonds than is a municipal
bond mutual fund that is not concentrated in issuers of California Municipal
Bonds to this degree. Beginning in the 1990-91 fiscal year, the State of
California faced the worst economic, fiscal and budget conditions since the
1930's. On July 5, 1994, all three of the rating agencies rating the State of
California's long-term debt lowered their ratings of the State of California's
general obligation bonds. Moody's lowered its rating from "Aa" to "A1", S&P
lowered its rating from "A+" to "A" and Fitch lowered its rating from "AA" to
"A". A steady upturn has been under way since 1994 and as of the date of this
Prospectus, S&P and Fitch have upgraded their ratings to A+ and AA-,
respectively. No assurance can be given that ratings will not be lowered in the
future. FAM does not believe that the current economic conditions in California
will have a significant adverse effect on the ability of the Fund to invest in
high quality California Municipal Bonds. For a discussion of economic and other
conditions in the State of California, see Appendix I, "Economic and Other
Conditions in California."
OTHER INVESTMENT POLICIES
The Fund has adopted certain other policies as set forth below:
Borrowings. The Fund is authorized to borrow money in amounts of up to 5%
of the value of its total assets at the time of such borrowings; provided,
however, that the Fund is authorized to borrow moneys in amounts of up to
33 1/3% of the value of its total assets at the time of such borrowings to
finance the repurchase of its own common stock pursuant to tender offers or
otherwise to redeem or repurchase shares of preferred stock or for temporary,
extraordinary or emergency purposes. Borrowings by the Fund (commonly known, as
with the issuance of preferred stock, as "leveraging") create an opportunity for
greater total return since the Fund will not be required to sell portfolio
securities to repurchase or redeem
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<PAGE> 19
shares but, at the same time, increase exposure to capital risk. In addition,
borrowed funds are subject to interest costs that may offset or exceed the
return earned on the borrowed funds.
When-Issued Securities and Delayed Delivery Transactions. The Fund may
purchase or sell California Municipal Bonds and Municipal Bonds on a delayed
delivery basis or on a when-issued basis at fixed purchase or sale terms. These
transactions arise when securities are purchased or sold by the Fund with
payment and delivery taking place in the future. The purchase will be recorded
on the date the Fund enters into the commitment, and the value of the obligation
will thereafter be reflected in the calculation of the Fund's net asset value.
The value of the obligation on the delivery day may be more or less than its
purchase price. A separate account of the Fund will be established with its
custodian consisting of cash, cash equivalents or liquid securities having a
market value at all times at least equal to the amount of the commitment.
Indexed and Inverse Floating Obligations. The Fund may invest in
California Municipal Bonds and Municipal Bonds yielding a return based on a
particular index of value or interest rates. For example, the Fund may invest in
California Municipal Bonds and Municipal Bonds that pay interest based on an
index of Municipal Bond interest rates. The principal amount payable upon
maturity of certain California Municipal Bonds and Municipal Bonds also may be
based on the value of an index. To the extent the Fund invests in these types of
Municipal Bonds, the Fund's return on such California Municipal Bonds and
Municipal Bonds will be subject to risk with respect to the value of the
particular index. Also, the Fund may invest in so-called "inverse floating
obligations" or "residual interest bonds" on which the interest rates typically
vary inversely with a short-term floating rate (which may be reset periodically
by a dutch auction, a remarketing agent, or by reference to a short-term
tax-exempt interest rate index). The Fund may purchase in the secondary market
synthetically-created inverse floating rate bonds evidenced by custodial or
trust receipts. Generally, 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, as an illustration, in market interest rates at a rate that is a
multiple (typically two) of the rate at which fixed-rate, long-term, tax-exempt
securities increase or decrease in response to such changes. As a result, the
market values of such securities generally will be more volatile than the market
values of fixed-rate tax-exempt securities. To seek to limit the volatility of
these securities, the Fund may purchase inverse floating obligations with
shorter-term maturities or limitations on the extent to which the interest rate
may vary. The Investment Adviser believes that indexed and inverse floating
obligations represent a flexible portfolio management instrument for the Fund
that allows the Investment Adviser to vary the degree of investment leverage
relatively efficiently under different market conditions.
Call Rights. The Fund may purchase a California Municipal Bond or
Municipal Bond issuer's right to call all or a portion of such California
Municipal Bond or Municipal Bond for mandatory tender for purchase (a "Call
Right"). A holder of a Call Right may exercise such right to require a mandatory
tender for the purchase of related California Municipal Bonds or Municipal
Bonds, subject to certain conditions. A Call Right that is not exercised prior
to the maturity of the related California Municipal Bond or Municipal Bond will
expire without value. The economic effect of holding both the Call Right and the
related California Municipal Bond or Municipal Bond is identical to holding a
California Municipal Bond or Municipal Bond as a non-callable security.
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Repurchase Agreements. The Fund may invest in securities pursuant to
repurchase agreements. Repurchase agreements may be entered into only with a
member bank of the Federal Reserve System or a primary dealer in U.S. Government
securities or an affiliate thereof. Under such agreements, the seller agrees,
upon entering into the contract, to repurchase the security at a mutually
agreed-upon time and price, thereby determining the yield during the term of the
agreement. The Fund may not invest in repurchase agreements maturing in more
than seven days if such investments, together with all other illiquid
investments, would exceed 15% of the Fund's net assets. In the event of default
by the seller under a repurchase agreement, the Fund may suffer time delays and
incur costs or possible losses in connection with the disposition of the
underlying securities.
In general, for Federal income tax purposes, repurchase agreements are
treated as collateralized loans secured by the securities "sold." Therefore,
amounts earned under such agreements will not be considered tax-exempt interest.
OPTIONS AND FUTURES TRANSACTIONS
The Fund may hedge all or a portion of its portfolio investments against
fluctuations in interest rates through the use of options and certain financial
futures contracts and options thereon. While the Fund's use of hedging
strategies is intended to reduce the volatility of the net asset value of the
common stock, the net asset value of the common stock will fluctuate. There can
be no assurance that the Fund's hedging transactions will be effective. In
addition, because of the anticipated leveraged nature of the common stock,
hedging transactions will result in a larger impact on the net asset value of
the common stock than would be the case if the common stock 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 choose not to 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 stock 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 Directors of the Fund without the approval of
the Fund's shareholders.
Writing Covered Call Options. The Fund may write (i.e., sell) covered call
options with respect to California Municipal Bonds and Municipal Bonds it owns,
thereby giving the holder of the option the right to buy the underlying security
covered by the option from the Fund at the stated exercise price until the
option expires. The Fund writes only covered call options, which means that so
long as the Fund is obligated as the writer of a call option, it will own the
underlying securities subject to the option. The Fund may not write covered call
options on underlying securities in an amount exceeding 15% of the market value
of its total assets.
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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 California Municipal Bonds and
Municipal Bonds against declines in value and to hedge against increases in the
cost of 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 California Municipal
Bonds and Municipal Bonds that the Fund holds or anticipates purchasing against
adverse changes in interest rates. The Fund also may purchase and sell financial
futures contracts on U.S.
20
<PAGE> 22
Government securities and purchase and sell put and call options on such
financial futures contracts for such hedging purposes. With respect to U.S.
Government securities, currently there are financial futures contracts based on
long-term U.S. Treasury bonds, U.S. Treasury notes, GNMA Certificates and three-
month U.S. Treasury bills.
Subject to policies adopted by the Board of Directors, the Fund also may
engage in transactions in other financial futures contracts, such as financial
futures contracts on other municipal bond indices that may become available, if
the Investment Adviser should determine that there is normally sufficient
correlation between the prices of such financial futures contracts and the
California Municipal Bonds and Municipal Bonds in which the Fund invests to make
such hedging appropriate.
Over-The-Counter Options. The Fund may engage in options and futures
transactions on exchanges and in the over-the-counter markets ("OTC options").
In general, exchange-traded contracts are third-party contracts (i.e.,
performance of the parties' obligations is guaranteed by an exchange or clearing
corporation) with standardized strike prices and expiration dates. OTC options
transactions are two-party contracts with prices and terms negotiated by the
buyer and seller. See "Restrictions on OTC Options" below for information as to
restrictions on the use of OTC options.
Restrictions on OTC Options. The Fund will engage in transactions in OTC
options only with banks or dealers that have capital of at least $50 million or
whose obligations are guaranteed by an entity having capital of at least $50
million. Certain OTC options and assets used to cover OTC options written by the
Fund may be considered to be illiquid. The illiquidity of such options or assets
may prevent a successful sale of such options or assets, result in a delay of
sale, or reduce the amount of proceeds that might otherwise be realized.
Risk Factors in Options and Futures Transactions. Use 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 California Municipal Bonds and
Municipal Bonds may be adversely affected by economic, political, legislative or
other developments that have a disparate impact on the respective markets for
such securities.
Under regulations of the Commodity Futures Trading Commission ("CFTC"), the
futures trading activities described herein will not result in the Fund being
deemed a "commodity pool," as defined under such regulations, provided that the
Fund adheres to certain restrictions. In particular, the Fund may purchase and
sell financial futures contracts and options thereon (i) for bona fide hedging
purposes, without regard to the percentage of the Fund's assets committed to
margin and option premiums, and (ii) for non-hedging purposes if, immediately
thereafter, the sum of the amount of initial margin deposits on the Fund's
existing futures positions and option premiums entered into for non-hedging
purposes does not exceed 5% of the market value of the liquidation value of the
Fund's portfolio, after taking into
21
<PAGE> 23
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 California
Municipal Bond or Municipal Bond options may be limited, and it is impossible to
predict the amount of trading interest that may exist in such options. In
addition, there can be no assurance that viable exchange markets will continue
to be available.
The Fund intends to enter into options and futures transactions, on an
exchange or in the over-the-counter market, only if there appears to be a liquid
secondary market for such options or futures. There can be no assurance,
however, that a liquid secondary market will exist at any specific time. Thus,
it may not be possible to close an options or futures transaction. The inability
to close options and futures positions also could have an adverse impact on the
Fund's ability to effectively hedge its portfolio. There is also the risk of
loss by the Fund of margin deposits or collateral in the event of bankruptcy of
a broker with which the Fund has an open position in an option or financial
futures contract.
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.
22
<PAGE> 24
RISKS AND SPECIAL CONSIDERATIONS OF LEVERAGE
EFFECTS OF LEVERAGE
Within approximately three months after the completion of this offering,
the Fund intends to offer shares of preferred stock representing approximately
40% of the Fund's capital immediately after the issuance of such preferred
stock. There can be no assurance, however, that preferred stock representing
such percentage of the Fund's capital will actually be issued. Issuing the
preferred stock will result in the leveraging of the common stock. Although the
Fund's Board of Directors has not yet determined the terms of the preferred
stock offering, the Fund anticipates that the preferred stock will pay dividends
that will be adjusted over either relatively short-term periods (generally seven
to 28 days) or medium-term periods (up to five years). The dividend rate will be
based upon prevailing interest rates for debt obligations of comparable
maturity. The proceeds of the preferred stock offering will be invested in
longer-term obligations in accordance with the Fund's investment objective. The
expenses of the preferred stock, which will be borne by the Fund, will reduce
the net asset value of the common stock. Additionally, under certain
circumstances, when the Fund is required to allocate taxable income to holders
of preferred stock, the Fund anticipates that the terms of the preferred stock
will require the Fund to make an additional distribution to such holders in an
amount approximately equal to the tax liability resulting from such allocation
(an "Additional Distribution"). Because under normal market conditions,
obligations with longer maturities produce higher yields than short-term and
medium-term obligations, the Investment Adviser believes that the spread
inherent in the difference between the short-term and medium-term rates (and any
Additional Distribution) paid by the Fund as dividends on the preferred stock
and the longer-term rates received by the Fund may provide holders of common
stock with a potentially higher yield.
The use of leverage, however, involves certain risks to the holders of
common stock. For example, issuance of the preferred stock may result in higher
volatility of the net asset value of the common stock and potentially more
volatility in the market value of the common stock. In addition, changes in the
short-term and medium-term dividend rates on, and the amount of taxable income
allocable to, the preferred stock will affect the yield to holders of common
stock. Leverage will allow holders of common stock 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) paid on the preferred stock. Similarly, since a pro
rata portion of the Fund's net realized capital gains are generally payable to
holders of common stock, the use of leverage will increase the amount of such
gains distributed to holders of common stock. However, short-term, medium-term
and long-term interest rates change from time to time as 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 stock approaches the net return on the
Fund's investment portfolio, the benefit of leverage to holders of common stock
will be decreased. If the current dividend rate (and any Additional
Distribution) on the preferred stock were to exceed the net return on the Fund's
portfolio, holders of common stock would receive a lower rate of return than if
the Fund were not leveraged. Similarly, since both the cost of issuing the
preferred stock
23
<PAGE> 25
and any decline in the value of the Fund's investments (including investments
purchased with the proceeds from any preferred stock offering) will be borne
entirely by holders of common stock, the effect of leverage in a declining
market would result in a greater decrease in net asset value to holders of
common stock than if the Fund were not leveraged. If the Fund is liquidated,
holders of preferred stock will be entitled to receive liquidating distributions
before any distribution is made to holders of common stock.
In an extreme case, a decline in net asset value could affect the Fund's
ability to pay dividends on the common stock. Failure to make such dividend
payments could adversely affect the Fund's qualification as a regulated
investment company under the Federal tax laws. See "Taxes." However, the Fund
intends to take all measures necessary to make common stock dividend payments.
If the Fund's current investment income is ever insufficient to meet dividend
payments on either the common stock or the preferred stock, the Fund may have to
liquidate certain of its investments. In addition, the Fund will have the
authority to redeem the preferred stock for any reason and may redeem all or
part of the preferred stock 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 common stock than it can obtain if the common stock were not
leveraged,
- if the asset coverage for the preferred stock declines below 200% either
as a result of a decline in the value of the Fund's portfolio investments
or as a result of the repurchase of common stock in tender offers, or
- in order to maintain the asset coverage guidelines established by the
NRSROs that have rated the preferred stock.
Redemption of the preferred stock or insufficient investment income to make
dividend payments, may reduce the net asset value of the common stock and
require the Fund to liquidate a portion of its investments at a time when it may
be disadvantageous to do so.
As discussed under "Investment Advisory and Management Arrangements,"
during periods when the Fund has preferred stock outstanding, the fees paid to
the Investment Adviser for investment advisory and management services will be
higher than if the Fund did not issue preferred stock 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 stock.
Assuming the use of leverage by issuing preferred stock (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 3.25% payable on such preferred stock based on market rates as of the date of
this prospectus, the annual return that the Fund's portfolio must experience
(net of expenses) in order to cover such dividend payments would be 1.30%.
The following table is designed to illustrate the effect on the return to a
holder of common stock of the leverage obtained by the issuance of preferred
stock representing approximately 40% of the Fund's capital, assuming
hypothetical annual returns on the Fund's portfolio of minus 10% to plus 10%. As
the table shows, leverage generally increases the return to stockholders when
portfolio return is positive and
24
<PAGE> 26
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 Stock Return................... (19)% (11)% (2)% 6% 15%
</TABLE>
Leveraging the common stock cannot be fully achieved until preferred stock
is issued and the proceeds of such offering have been invested in long-term
California 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 stock 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 stock pursuant
to the Fund's Articles Supplementary, which establish the rights and preferences
of the preferred stock, or otherwise by purchasing shares of preferred stock.
Purchases and redemptions of preferred stock, whether on the open market or in
negotiated transactions, are subject to limitations under the 1940 Act. In
determining whether or not it is in the best interest of the Fund and its
stockholders to redeem or repurchase outstanding preferred stock, the Board of
Directors will take into account a variety of factors, including the following:
- market conditions,
- the ratio of preferred stock to common stock, and
- the expenses associated with such redemption or repurchase.
If market conditions subsequently change, the Fund may sell previously unissued
shares of preferred stock or shares of preferred stock that the Fund had issued
but later repurchased or redeemed.
The Fund intends to apply for ratings of the preferred stock from one or
more NRSROs. In order to obtain these ratings, the Fund may be required to
maintain portfolio holdings 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 from managing the
Fund's portfolio in accordance with the Fund's investment objective and
policies. Ratings on preferred stock issued by the Fund should not be confused
with ratings on the obligations held by the Fund.
Under the 1940 Act, the Fund is not permitted to issue shares of preferred
stock unless immediately after such issuance the net asset value of the Fund's
portfolio is at least 200% of the liquidation value of the outstanding preferred
stock (expected to equal the original purchase price of the outstanding shares
of preferred stock plus any accumulated and unpaid dividends thereon and any
accumulated and unpaid Additional Distribution). In addition, the Fund is not
permitted to declare any cash dividend or other distribution on its common stock
unless, at the time of such declaration, the net asset value of the Fund's
portfolio (determined after deducting the amount of such dividend or
distribution) is at least 200% of the liquidation value of the outstanding
preferred stock. Under the Fund's proposed capital structure, assuming the sale
of shares of preferred stock representing approximately 40% of the Fund's
capital, the net asset value of the Fund's portfolio is expected to be
approximately 250% of the liquidation value of the Fund's
25
<PAGE> 27
preferred stock. To the extent possible, the Fund intends to purchase or redeem
shares of preferred stock from time to time to maintain coverage of preferred
stock of at least 200%.
INVESTMENT RESTRICTIONS
The following are fundamental investment restrictions of the Fund and,
prior to issuance of the preferred stock, may not be changed without the
approval of the holders of a majority of the Fund's outstanding shares of common
stock (which for this purpose and under the 1940 Act means the lesser of (i) 67%
of the shares of common stock represented at a meeting at which more than 50% of
the outstanding shares of common stock are represented or (ii) more than 50% of
the outstanding shares). Subsequent to the issuance of the preferred stock, the
following investment restrictions may not be changed without the approval of a
majority of the outstanding shares of common stock and of the outstanding shares
of preferred stock, voting together as a class, and the approval of a majority
of the outstanding shares of preferred stock, voting separately as a class. The
Fund may not:
1. Make investments for the purpose of exercising control or
management.
2. Purchase or sell real estate, commodities or commodity contracts;
provided that the Fund may invest in securities secured by real estate or
interests therein or issued by entities that invest in real estate or
interest therein, and the Fund may purchase and sell financial futures
contracts and options thereon.
3. Issue senior securities or borrow money except as permitted by
Section 18 of the 1940 Act.
4. Underwrite securities of other issuers except insofar as the Fund
may be deemed an underwriter under the Securities Act of 1933, as amended,
in selling portfolio securities.
5. Make loans to other persons, except that the Fund may purchase
California Municipal Bonds, Municipal Bonds and other debt securities and
enter into repurchase agreements in accordance with its investment
objective, policies and limitations.
6. Invest more than 25% of its total assets (taken at market value at
the time of each investment) in securities of issuers in a single industry;
provided that, for purposes of this restriction, states, municipalities and
their political subdivisions are not considered to be part of any industry.
Additional investment restrictions adopted by the Fund, which may be changed by
the Board of Directors without shareholder approval, provide that the Fund may
not:
a. Purchase securities of other investment companies, except to the
extent that such purchases are permitted by applicable law. Applicable law
currently prohibits the Fund from purchasing the securities of other
investment companies except if immediately thereafter not more than (i) 3%
of the total outstanding voting stock of such company is owned by the Fund,
(ii) 5% of the Fund's total assets, taken at market value, would be
invested in any one such company, (iii) 10% of the Fund's total assets,
taken at market value, would be invested in such securities, and (iv) the
Fund, together with other investment companies having the same investment
adviser and companies controlled by such companies, owns not more than 10%
of the total outstanding stock of any one closed-end investment company.
b. Mortgage, pledge, hypothecate or in any manner transfer, as
security for indebtedness, any securities owned or held by the Fund except
as may be necessary in connection with borrowings
26
<PAGE> 28
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 California Municipal Bonds,
Municipal Bonds, U.S. Government obligations and related indices or
otherwise in connection with bona fide hedging activities and may purchase
and sell Call Rights to require mandatory tender for the purchase of
related California Municipal Bonds and Municipal Bonds.
If a percentage restriction on 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.
DIRECTORS AND OFFICERS
Information about the Directors, executive officers and the portfolio
managers of the Fund, including their ages and their principal occupations
during the last five years is set forth below. Unless otherwise noted, the
address of each Director, executive officer and portfolio manager is 800
Scudders Mill Road, Plainsboro, New Jersey 08536.
TERRY K. GLENN (58) -- President and Director(1)(2) -- Executive Vice
President of the Investment Adviser and Merrill Lynch Asset Management, L.P.
("MLAM") (which terms as used herein include their corporate predecessors) since
1983; Executive Vice President and Director of Princeton Services, Inc.
("Princeton Services") since 1993; President of Princeton Funds Distributor,
Inc. ("PFD") since 1986 and Director thereof since 1991; President of Princeton
Administrators, L.P. since 1988.
RONALD W. FORBES (58) -- Director(2) -- 1400 Washington Avenue, Albany, New
York 12222. Professor of Finance, School of Business, State University of New
York at Albany since 1989; Consultant, Urban Institute, Washington, D.C. since
1995.
CYNTHIA A. MONTGOMERY (46) -- Director(2) -- Harvard Business School,
Soldiers Field Road, Boston, Massachusetts 02163. Professor, Harvard Business
School since 1989; Associate Professor, J.L.
27
<PAGE> 29
Kellogg Graduate School of Management, Northwestern University from 1985 to
1989; Assistant Professor, Graduate School of Business Administration, The
University of Michigan from 1979 to 1985; Director, UNUM Corporation since 1990
and Director of Newell Co. since 1995.
CHARLES C. REILLY (67) -- Director(2) -- 9 Hampton Harbor Road, Hampton
Bays, New York 11946. Self-employed financial consultant since 1990; President
and Chief Investment Officer of Verus Capital, Inc. from 1979 to 1990; Senior
Vice President of Arnhold and S. Bleichroeder, Inc. from 1973 to 1990; Adjunct
Professor, Columbia University Graduate School of Business from 1990 to 1991;
Adjunct Professor, Wharton School, The University of Pennsylvania from 1989 to
1990.
KEVIN A. RYAN (66) -- Director(2) -- 127 Commonwealth Avenue, Chestnut
Hill, Massachusetts 02167. Founder and current Director of The Boston University
Center for the Advancement of Ethics and Character; Professor of Education at
Boston University since 1982; formerly taught on the faculties of The University
of Chicago, Stanford University and Ohio State University.
RICHARD R. WEST (61) -- Director(2) -- Box 604, Genoa, Nevada 89411.
Professor of Finance since 1984, and Dean from 1984 to 1993, and currently Dean
Emeritus of New York University, Leonard N. Stern School of Business
Administration; Director of Bowne & Co., Inc., Vornado Realty Trust, Inc.,
Vornado Operating Company and Alexander's Inc.
ARTHUR ZEIKEL (66) -- Director(1)(2) -- Chairman of the Investment Adviser
and MLAM from 1997 to 1999; President of the Investment Adviser and MLAM from
1977 to 1997; Chairman of Princeton Services from 1997 to 1999, Director thereof
from 1993 to 1999 and President thereof 1993 to 1997; Executive Vice President
of ML & Co. from 1990 to 1999.
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 (48) -- 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 Vice President of
MLAM from 1995 to 1997; Assistant Portfolio Manager of MLAM from 1993 to 1995.
WALTER O'CONNOR (37) -- Vice President and Portfolio
Manager(1)(2) -- Director (Municipal Tax Exempt) of MLAM since 1997; Vice
President of MLAM from 1993 to 1997.
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.
WILLIAM E. ZITELLI, JR. (30) -- Secretary(1)(2) -- Attorney associated with
the Investment Adviser since 1998; Attorney associated with Pepper Hamilton LLP
from 1997 to 1998; Attorney associated with Reboul, MacMurray, Hewitt, Maynard
and Kristol from 1994 to 1997.
- ------------
(1) Interested person, as defined in the 1940 Act, of the Fund.
(2) Such Director or officer is a director, trustee or officer of one or more
additional investment companies for which the Investment Adviser or its
affiliate, MLAM, acts as investment adviser or manager.
In the event that the Fund issues preferred stock, in connection with the
election of the Fund's Directors, holders of shares of preferred stock, voting
as a separate class, will be entitled to elect two of
28
<PAGE> 30
the Fund's Directors, and the remaining Directors will be elected by all holders
of capital stock, voting as a single class. See "Description of Capital Stock."
COMPENSATION OF DIRECTORS
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 Directors who are affiliated persons of ML & Co. or its
subsidiaries.
The Fund pays each Director not affiliated with the Investment Adviser
(each a "non-affiliated Director") a fee of $2,000 per year plus $200 per
meeting attended, and pays all Director's out-of-pocket expenses relating to
attendance at meetings. The Fund also pays members of the Board's audit and
nominating committee (the "Committee"), which consists of all the non-affiliated
Directors, an annual fee of $800. The Chairman of the Committee receives an
additional annual fee of $1,000.
The following table sets forth compensation to be paid by the Fund to the
non-affiliated Directors projected through the end of the Fund's first full
fiscal year and, for the calendar year ended December 31, 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
Directors.
<TABLE>
<CAPTION>
TOTAL
PENSION OR COMPENSATION
RETIREMENT FROM FUND AND
AGGREGATE BENEFITS FAM/MLAM
COMPENSATION ACCRUED AS PART OF ADVISED FUNDS PAID
NAME OF DIRECTOR FROM FUND FUND EXPENSE TO DIRECTORS
- ---------------- ------------ ------------------ ------------------
<S> <C> <C> <C>
Ronald W. Forbes(1).......................... $3,600 None $192,567
Cynthia A. Montgomery(1)..................... $3,600 None $192,567
Charles C. Reilly(1)......................... $4,600 None $362,858
Kevin A. Ryan(1)............................. $3,600 None $192,567
Richard R. West(1)........................... $3,600 None $334,125
</TABLE>
- ------------
(1) The Directors serve on the boards of MLAM/FAM Advised Funds as follows: Mr.
Forbes (37 registered investment companies consisting of 50 portfolios); Ms.
Montgomery (37 registered investment companies consisting of 50 portfolios);
Mr. Reilly (56 registered investment companies consisting of 69 portfolios);
Mr. Ryan (37 registered investment companies consisting of 50 portfolios);
and Mr. West (58 registered investment companies consisting of 83
portfolios).
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 Asset Management
Group of ML & Co. (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 June 1999,
the Asset Management Group had a total of approximately $516 billion in
investment company and other portfolio assets under management (approximately
$36 billion of which were 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. The principal business address of the Investment Adviser
is 800 Scudders Mill Road, Plainsboro, New Jersey 08536.
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<PAGE> 31
The Investment Advisory Agreement provides that, subject to the supervision
of the Board of Directors 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 Directors.
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. Robert A. DiMella and
Walter O'Connor 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 shares of
preferred stock, minus the sum of accrued liabilities of the Fund and
accumulated dividends on the shares of preferred stock). For purposes of this
calculation, average weekly net assets are determined at the end of each month
on the basis of the average net assets of the Fund for each week during the
month. The assets for each weekly period are determined by averaging the net
assets at the last business day of a week with the net assets at the last
business day of the prior week.
The Investment Advisory Agreement obligates the Investment Adviser to
provide investment advisory services and to pay all compensation of and furnish
office space for officers and employees of the Fund connected with investment
and economic research, trading and investment management of the Fund, as well as
the compensation of all Directors of the Fund who are affiliated persons of the
Investment Adviser or any of its affiliates. The Fund pays all other expenses
incurred in the operation of the Fund, including, among other things, expenses
for legal and auditing services, taxes, costs of printing proxies, listing fees,
if any, stock certificates and shareholder reports, charges of the custodian and
the transfer and dividend disbursing agent and registrar, fees and expenses with
respect to the issuance of preferred stock, Securities and Exchange Commission
fees, fees and expenses of non-interested Directors, accounting and pricing
costs, insurance, interest, brokerage costs, litigation and other extraordinary
or non-recurring expenses, mailing and other expenses properly payable by the
Fund. Accounting services are provided to the Fund by the Investment Adviser,
and the Fund reimburses the Investment Adviser for its costs in connection with
such services.
Unless earlier terminated as described below, the Investment Advisory
Agreement will remain in effect for a period of two years from the date of
execution and will remain in effect from year to year thereafter if approved
annually (a) by the Board of Directors of the Fund or by a majority of the
outstanding shares of the Fund and (b) by a majority of the Directors who are
not parties to such contract or interested persons (as defined in the 1940 Act)
of any such party. Such contract is not assignable and may be terminated without
penalty on 60 days' written notice at the option of either party thereto or by
the vote of the shareholders of the Fund.
Securities held by the Fund may also be held by, or be appropriate
investments for, other funds or investment advisory clients for which the
Investment Adviser or its affiliates act as an adviser. Because of different
objectives or other factors, a particular security may be bought for an advisory
client when other
30
<PAGE> 32
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 Directors of the Fund has adopted a Code of Ethics pursuant to
Rule 17j-1 under the 1940 Act that incorporates the Code of Ethics of the
Investment Adviser (together, the "Codes"). The Codes significantly restrict the
personal investing activities of all employees of the Investment Adviser and, as
described below, impose additional, more onerous, restrictions on Fund
investment personnel.
The Codes require that all employees of the Investment Adviser preclear any
personal securities investment (with limited exceptions, such as U.S. Government
securities). The preclearance requirement and associated procedures are designed
to identify any substantive prohibition or limitation applicable to the proposed
investment. The substantive restrictions applicable to all employees of the
Investment Adviser include a ban on acquiring any securities in a "hot" initial
public offering and a prohibition from profiting on short-term trading
securities. In addition, no employee may purchase or sell any security that at
the time is being purchased or sold (as the case may be), or to the knowledge of
the employee is being considered for purchase or sale, by any fund advised by
the Investment Adviser. Furthermore, the Codes provide for trading "blackout
periods" that prohibit trading by investment personnel of the Fund within
periods of trading by the Fund in the same (or equivalent) security (15 or 30
days depending upon the transaction).
PORTFOLIO TRANSACTIONS
Subject to policies established by the Board of Directors of the Fund, the
Investment Adviser is primarily responsible for the execution of the Fund's
portfolio transactions. In executing such transactions, the Investment Adviser
seeks to obtain the best results for the Fund, taking into account such factors
as price (including the applicable brokerage commission or dealer spread), size
of order, difficulty of execution and operational facilities of the firm
involved and the firm's risk in positioning a block of securities. While the
Investment Adviser generally seeks reasonably competitive commission rates, the
Fund does not necessarily pay the lowest commission or spread available.
The Fund has no obligation to deal with any broker or dealer in the
execution of transactions in portfolio securities. Subject to providing the best
price and execution, securities firms that provide 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.
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<PAGE> 33
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, 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 results in greater transaction costs, which are
borne directly by the Fund and also has certain tax consequences for
stockholders.
DIVIDENDS AND DISTRIBUTIONS
The Fund intends to distribute dividends of all or a portion of its net
investment income monthly to holders of common stock. It is expected that the
Fund will commence paying dividends to holders of common stock within
approximately 90 days of the date of this prospectus. From and after issuance of
the preferred stock, monthly dividends to holders of common stock normally will
consist of all or a portion of its net investment income remaining after the
payment of dividends (and any Additional Distribution) on the preferred stock.
The Fund may at times pay out less than the entire amount of net investment
income earned in any particular period and may at times pay out such accumulated
undistributed income in addition to net investment income earned in other
periods in order to permit the Fund to maintain a more stable level of dividends
to holders of common stock. As a result, the dividend paid by the Fund to
holders of common stock for any particular period may be more or less than the
amount of net investment income earned by the Fund during such period. For
Federal tax purposes, the Fund is required to distribute substantially all of
its net investment income for each year. All net realized capital gains, if any,
will be distributed pro rata at least annually to holders of common stock and
any preferred stock. While any shares of preferred stock are outstanding, the
Fund may not declare any cash dividend or other distribution
32
<PAGE> 34
on its common stock, unless at the time of such declaration, (i) all accumulated
preferred stock dividends, including any Additional Distribution, have been
paid, and (ii) the net asset value of the Fund's portfolio (determined after
deducting the amount of such dividend or other distribution) is at least 200% of
the liquidation value of the outstanding preferred stock (expected to equal the
original purchase price of the outstanding shares of preferred stock plus any
accumulated and unpaid dividends thereon and any accumulated but unpaid
Additional Distribution). If the Fund's ability to make distributions on its
common stock is limited, such limitation could under certain circumstances
impair the ability of the Fund to maintain its qualification for taxation as a
regulated investment company, which would have adverse tax consequences for
holders of common stock. See "Taxes."
See "Automatic Dividend Reinvestment Plan" for information concerning the
manner in which dividends and distributions to holders of common stock may be
automatically reinvested in shares of common stock of the Fund. Dividends and
distributions may be taxable to shareholders under certain circumstances as
discussed below, whether they are reinvested in shares of the Fund or received
in cash.
The yield on the Fund's common stock will vary from period to period
depending on factors including, but not limited to, market conditions, the
timing of the Fund's investment in portfolio securities, the securities
comprising the Fund's portfolio, changes in tax-exempt interest rates (which may
not change to the same extent or in the same direction as taxable rates)
including changes in the relationship between short-term rates and long-term
rates, the amount and timing of the issuance of the Fund's preferred stock, the
effects of preferred stock leverage on the common stock discussed above under
"Risks and Special Considerations of Leverage", the timing of the investment of
preferred stock proceeds in portfolio securities, the Fund's net assets and its
operating expenses. Consequently, the Fund cannot guarantee any particular yield
on its shares and the yield for any given period is not an indication or
representation of future yields on Fund shares.
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
33
<PAGE> 35
of its total assets consists of obligations the interest on which is excludable
from gross income for Federal income tax purposes ("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 excludable from gross income for
Federal income tax purposes 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 PABs or IDBs if any, held by the Fund.
So long as, at the close of each quarter the Fund's taxable year, at least
50% of the value of the Fund's total assets consists of California Municipal
Bonds, the portion of exempt-interest dividends paid from interest received by
the Fund from California Municipal Bonds also will be exempt from California
income tax. However, exempt-interest dividends paid to a corporate shareholder
subject to California state franchise tax will not be exempt from California
taxation. Shareholders subject to income taxation by states other than
California will realize a lower after-tax rate of return than California
shareholders since the dividends distributed by the Fund generally will not be
exempt, to any significant degree, from income taxation by such other states.
The Fund will inform shareholders annually as to the portion of the Fund's
distributions that constitutes exempt-interest dividends and the portion that is
exempt from California income taxes. Interest on indebtedness incurred or
continued to purchase or carry Fund shares is not deductible for Federal or
California income tax purposes to the extent attributable to exempt-interest
dividends.
To the extent that the Fund's distributions are derived from interest on
its taxable investments or from an excess of net short-term capital gains over
net long-term capital losses ("ordinary income dividends"), such distributions
will be considered taxable ordinary income for Federal and California income tax
purposes. Distributions, if any, from an excess of net long-term capital gains
over net short-term capital losses derived from the sale of securities or from
certain transactions in futures or options ("capital gain dividends") are
taxable as long-term capital gains for Federal income tax purposes, regardless
of the length of time the shareholder has owned Fund shares and, for California
income tax purposes, are treated as capital gains which are taxed at ordinary
income tax rates. 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 or capital gain dividends, as well as any
amount of capital gain dividends in the different categories of capital gain
referred to above. Distributions by the Fund, whether from exempt-income,
ordinary income or capital gains, are not eligible for the dividends received
deduction allowed to corporations under the Code.
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<PAGE> 36
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 ("Service") has taken the position in a
revenue ruling that if a RIC has two or more classes of shares, it may designate
distributions made to each class in any year as consisting of no more than such
class's proportionate share of particular types of income, including
exempt-interest income and net long-term capital gains. 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 stock and one or more series of preferred stock are
outstanding, the Fund intends to designate distributions made to the classes as
consisting of particular types of income in accordance with each class's
proportionate share of such income. Thus, the Fund will designate dividends paid
as exempt-interest dividends in a manner that allocates such dividends among the
holders of common stock and series of preferred stock in proportion to the total
dividends paid to each class during the taxable year, or otherwise as required
by applicable law. Capital gain dividends 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 stock pursuant to the
allocation rules described above, the terms of the preferred stock may require
the Fund to make an additional distribution to or otherwise compensate such
holders for the tax liability resulting from such allocation.
The Code subjects interest received on certain otherwise tax-exempt
securities to a Federal alternative minimum tax. The Federal alternative minimum
tax applies 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," which could subject certain
investors in such bonds, including shareholders of the Fund, to an increased
Federal 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 Federal alternative minimum tax purposes. The Code
further provides that corporations are subject to a Federal 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
35
<PAGE> 37
included in adjusted current earnings, a corporate shareholder may be required
to pay a Federal alternative minimum tax on exempt-interest dividends paid by
the Fund.
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 shares of preferred stock are outstanding the Fund does
not meet the asset coverage requirements of the 1940 Act, the Fund will be
required to suspend distributions to holders of common stock until the asset
coverage is restored. See "Dividends and Distributions." This may prevent the
Fund from distributing at least 90% of its net investment income and may,
therefore, jeopardize the Fund's qualification for taxation as a RIC. 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 income tax and California income tax
purposes. Upon any failure to meet the asset coverage requirements of the 1940
Act, the Fund, in its sole discretion, may redeem shares of preferred stock in
order to maintain or restore the requisite asset coverage and avoid the adverse
consequences to the Fund and its shareholders of failing to qualify as a RIC.
There can be no assurance, however, that any such action would achieve such
objectives.
As noted above, the Fund must distribute annually at least 90% of its net
taxable and tax-exempt interest income. A distribution will only be counted for
this purpose if it qualifies for the dividends paid deduction under the Code.
Some types of preferred stock that the Fund currently contemplates issuing may
raise an issue as to whether distributions on such preferred stock are
"preferential" under the Code and, therefore, not eligible for the dividends
paid deduction. The Fund intends to issue preferred stock that counsel advises
will not result in the payment of a preferential dividend and may seek a private
letter ruling from the Service to that effect. If the Fund ultimately relies
solely on a legal opinion when it issues such preferred stock, there is no
assurance that the Service would agree that dividends on the preferred stock are
not preferential. If the Service successfully disallowed the dividends paid
deduction for dividends on the preferred stock, the Fund could be disqualified
as a RIC. In this case, dividends on the common stock would not be exempt from
Federal income taxes. Additionally, the Fund would be subject to the Federal
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.
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<PAGE> 38
Ordinary income dividends paid to shareholders who are nonresident aliens
or foreign entities will be subject to a 30% United States withholding tax under
existing provisions of the Code applicable to foreign individuals and entities
unless a reduced rate of withholding or a withholding exemption is provided
under applicable treaty law. Nonresident shareholders are urged to consult their
own tax advisers concerning the applicability of the United States withholding
tax.
Under certain Code provisions, some taxpayers may be subject to 31%
withholding tax on certain ordinary income dividends and on capital gain
dividends and redemption payments ("backup withholding"). Generally,
shareholders subject to backup withholding 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 California income and
corporate franchise tax laws presently in effect. For the complete provisions,
reference should be made to the pertinent Code sections, the Treasury
Regulations promulgated thereunder and California income and corporate franchise
tax laws. The Code and the Treasury Regulations, as well as the California tax
laws, are subject to change by legislative, judicial or administrative action
either prospectively or retroactively.
Shareholders are urged to consult their tax advisers regarding specific
questions as to Federal, state, local or foreign taxes.
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<PAGE> 39
AUTOMATIC DIVIDEND REINVESTMENT PLAN
Pursuant to the Fund's Automatic Dividend Reinvestment Plan (the "Plan"),
unless a holder of common stock otherwise elects, all dividend and capital gains
distributions will be automatically reinvested by State Street Bank and Trust
Company, as agent for shareholders in administering the Plan (the "Plan Agent"),
in additional shares of common stock of the Fund. Holders of common stock who
elect not to participate in the Plan will receive all distributions in cash paid
by check mailed directly to the shareholder of record (or, if the shares are
held in street or other nominee name, then to such nominee) by State Street Bank
and Trust Company, 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 State Street Bank and
Trust Company, as dividend paying agent, at the address set forth below.
Participation in the Plan is completely voluntary and may be terminated or
resumed at any time without penalty by written notice if received by the Plan
Agent not less than ten days prior to any dividend record date; otherwise, such
termination or resumption will be effective with respect to any subsequently
declared dividend or distribution.
Whenever the Fund declares an income dividend or a capital gains
distribution (collectively, referred to as "dividends") payable either in shares
or in cash, non-participants in the Plan will receive cash, and participants in
the Plan will receive the equivalent in shares of common stock. The shares will
be acquired by the Plan Agent for the participant's account, depending upon the
circumstances described below, either (i) through receipt of additional unissued
but authorized shares of common stock from the Fund ("newly issued shares") or
(ii) by purchase of outstanding shares of common stock on the open market
("open-market purchases") on the New York Stock Exchange (the "NYSE") or
elsewhere. If on the payment date for the dividend, the net asset value per
share of the common stock is equal to or less than the market price per share of
the common stock plus estimated brokerage commissions (such condition being
referred to herein as "market premium"), the Plan Agent will invest the dividend
amount in newly issued shares on behalf of the participant. The number of newly
issued shares of common stock to be credited to the participant's account will
be determined by dividing the dollar amount of the dividend by the net asset
value per share on the date the shares are issued, provided that the maximum
discount from the then current market price per share on the date of issuance
may not exceed 5%. If on the dividend payment date the net asset value per share
is greater than the market value (such condition being referred to herein as
"market discount"), the Plan Agent will invest the dividend amount in shares
acquired on behalf of the participant in open-market purchases. Prior to the
time the shares of common stock commence trading on the NYSE, 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 share of common stock exceeds the
net asset value per share, the average per share purchase prices paid by the
Plan Agent may exceed the net asset value of the Fund's shares, resulting in the
acquisition of fewer shares than if the dividend had been paid in newly issued
shares on
38
<PAGE> 40
the dividend payment date. Because of the foregoing difficulty with respect to
open-market purchases, the Plan provides that if the Plan Agent is unable to
invest the full dividend amount in open-market purchases during the purchase
period or if the market discount shifts to a market premium during the purchase
period, the Plan Agent will cease making open-market purchases and will invest
the uninvested portion of the dividend amount in newly issued shares at the
close of business on the last purchase date.
The Plan Agent maintains all shareholders' accounts in the Plan and
furnishes written confirmation of all transactions in the account, including
information needed by shareholders for tax records. Shares in the account of
each Plan participant will be held by the Plan Agent in non-certificated form in
the name of the participant and each shareholder's proxy will include those
shares purchased or received pursuant to the Plan. The Plan Agent will forward
all proxy solicitation materials to participants and vote proxies for shares
held pursuant to the Plan in accordance with the instructions of the
participants.
In the case of shareholders such as banks, brokers or nominees that hold
shares for others who are the beneficial owners, the Plan Agent will administer
the Plan on the basis of the number of shares certified from time to time by the
record shareholders as representing the total amount registered in the record
shareholder's name and held for the account of beneficial owners who are to
participate in the Plan.
There will be no brokerage charges with respect to shares issued directly
by the Fund as a result of dividends or capital gains distributions payable
either in shares or in cash. However, each participant will pay a pro rata share
of brokerage commissions incurred with respect to the Plan Agent's open-market
purchases in connection with the reinvestment of dividends.
The automatic reinvestment of dividends and distributions will not relieve
participants of any Federal, state or local income tax that may be payable (or
required to be withheld) on such dividends. See "Taxes."
Shareholders participating in the Plan may receive benefits not available
to shareholders not participating in the Plan. If the market price plus
commissions of the Fund's shares is above the net asset value, participants in
the Plan will receive shares of the Fund at less than they could otherwise
purchase them and will have shares with a cash value greater than the value of
any cash distribution they would have received on their shares. If the market
price plus commissions is below the net asset value, participants will receive
distributions in shares with a net asset value greater than the value of any
cash distribution they would have received on their shares. However, there may
be insufficient shares available in the market to make distributions in shares
at prices below the net asset value. Also, since the Fund does not redeem its
shares, the price on resale may be more or less than the net asset value. See
"Taxes" for a discussion of tax consequences of the Plan.
Experience under the Plan may indicate that changes are desirable.
Accordingly, the Fund reserves the right to amend or terminate the Plan. There
is no direct service charge to participants in the Plan; however, the Fund
reserves the right to amend the Plan to include a service charge payable by the
participants.
All correspondence concerning the Plan should be directed to the Plan Agent
at 225 Franklin Street, Boston, Massachusetts 02110.
39
<PAGE> 41
MUTUAL FUND INVESTMENT OPTION
Purchasers of shares of common stock of the Fund through Merrill Lynch in
this offering will have an investment option consisting of the right to reinvest
the net proceeds from a sale of such shares (the "Original Shares") in Class D
initial sales charge shares of certain Merrill Lynch-sponsored open-end mutual
funds ("Eligible Class D Shares") at their net asset value, without the
imposition of the initial sales charge, if the conditions set forth below are
satisfied. First, the sale of the Original Shares must be made through Merrill
Lynch, and the net proceeds therefrom must be immediately reinvested in Eligible
Class D Shares. Second, the Original Shares must have been either acquired in
this offering or be shares representing reinvested dividends from shares of
common stock acquired in this offering. Third, the Original Shares must have
been continuously maintained in a Merrill Lynch securities account. Fourth,
there must be a minimum purchase of $250 to be eligible for the investment
option. Class D shares of the mutual funds are subject to an account maintenance
fee at an annual rate of up to 0.25% of the average daily net asset value of
such mutual fund. The Eligible Class D Shares may be redeemed at any time at the
next determined net asset value, subject in certain cases to a redemption fee.
Prior to the time the shares of common stock commence trading on the NYSE, the
distributor for the mutual funds will advise Merrill Lynch Financial Consultants
as to those mutual funds that offer the investment option described above.
NET ASSET VALUE
Net asset value per share of common stock is determined as of 15 minutes
after the close of business on the NYSE (generally, the NYSE 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 share of common stock, the value of the
securities held by the Fund plus any cash or other assets (including interest
accrued but not yet received) minus all liabilities (including accrued expenses)
and the aggregate liquidation value of the outstanding shares of preferred stock
is divided by the total number of shares of common stock outstanding at such
time. Expenses, including the fees payable to the Investment Adviser, are
accrued daily.
The California Municipal Bonds and Municipal Bonds in which the Fund
invests are traded primarily in the over-the-counter markets. In determining net
asset value, the Fund utilizes the valuations of portfolio securities furnished
by a pricing service approved by the Board of Directors. The pricing service
typically values portfolio securities at the bid price or the yield equivalent
when quotations are readily available. California Municipal Bonds and Municipal
Bonds for which quotations are not readily available are valued at fair market
value on a consistent basis as determined by the pricing service using a matrix
system to determine valuations. The procedures of the pricing service and its
valuations are reviewed by the officers of the Fund under the general
supervision of the Board of Directors. The Board of Directors has determined in
good faith that the use of a pricing service is a fair method of determining the
valuation of portfolio securities. Positions in futures contracts are valued at
closing prices for such contracts established by the exchange on which they are
traded, or if market quotations are not readily available, are valued at fair
value on a consistent basis using methods determined in good faith by the Board
of Directors.
The Fund determines and makes available for publication the net asset value
of its common stock weekly. Currently, the net asset values of shares of
publicly traded closed-end investment companies
40
<PAGE> 42
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 STOCK
The Fund is authorized to issue 200,000,000 shares of capital stock, par
value $.10 per share, all of which shares are initially classified as common
stock. The Board of Directors is authorized, however, to classify or reclassify
any unissued shares of capital stock by setting or changing the preferences,
conversion or other rights, voting powers, restrictions, limitations as to
dividends, qualifications, or terms or conditions of redemption. Within
approximately three months after completion of the offering of the common stock
described herein, the Fund intends to reclassify an amount of unissued common
stock as preferred stock and at that time to offer shares of preferred stock
representing approximately 40% of the Fund's capital immediately after the
issuance of such preferred stock. There is no assurance that such preferred
stock will be issued.
COMMON STOCK
Shares of common stock, when issued and outstanding, will be fully paid and
non-assessable. Shareholders are entitled to share pro rata in the net assets of
the Fund available for distribution to shareholders upon liquidation of the
Fund. Shareholders are entitled to one vote for each share held.
So long as any shares of the Fund's preferred stock are outstanding,
holders of common stock will not be entitled to receive any net income of or
other distributions from the Fund unless all accumulated dividends on preferred
stock have been paid and unless asset coverage (as defined in the 1940 Act) with
respect to preferred stock would be at least 200% after giving effect to such
distributions. See "Preferred Stock" below.
The Fund will send unaudited reports at least semi-annually and audited
annual financial statements to all of its shareholders.
The Investment Adviser provided the initial capital for the Fund by
purchasing 6,667 shares of common stock of the Fund for $100,005. As of the date
of this prospectus, the Investment Adviser owned 100% of the outstanding shares
of common stock of the Fund. The Investment Adviser may be deemed to control the
Fund until such time as it owns less than 25% of the outstanding shares of the
Fund.
PREFERRED STOCK
It is anticipated that the Fund's shares of preferred stock will be issued
in one or more series, with rights as determined by the Board of Directors, by
action of the Board of Directors without the approval of the holders of common
stock. Under the 1940 Act, the Fund is permitted to have outstanding more than
one series of preferred stock so long as no single series has a priority over
another series as to the distribution of assets of the Fund or the payment of
dividends. Holders of common stock have no preemptive right to purchase any
shares of preferred stock that might be issued. It is anticipated that the net
asset value per share of the preferred stock will equal its original purchase
price per share plus accumulated dividends per share.
41
<PAGE> 43
The Fund's Board of Directors has declared its intention to authorize an
offering of shares of preferred stock (representing approximately 40% of the
Fund's capital immediately after the issuance of such preferred stock) within
approximately three months after completion of the offering of common stock,
subject to market conditions and to the Board's continuing to believe that
leveraging the Fund's capital structure through the issuance of preferred stock
is likely to achieve the benefits to the holders of common stock described in
the prospectus. Although the terms of the preferred stock, including its
dividend rate, voting rights, liquidation preference and redemption provisions
will be determined by the Board of Directors (subject to applicable law and the
Fund's Articles of Incorporation), the initial series of preferred stock will be
structured to carry either a relatively short-term dividend rate, in which case
periodic redetermination of the dividend rate will be made at relatively short
intervals (generally seven or 28 days), or a medium-term dividend rate, in which
case periodic redetermination of the dividend rate will be made at intervals of
up to five years. In either case, such redetermination of the dividend rate will
be made through an auction or remarketing procedure. Additionally, under certain
circumstances, when the Fund is required to allocate taxable income to holders
of the preferred stock, it is anticipated that the terms of the preferred stock
will require the Fund to make an Additional Distribution (as defined in "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 stock will be as stated
below. The Fund's Articles of Incorporation, as amended, together with any
Articles Supplementary, is referred to below as the "Charter."
Liquidation Preference. In the event of any voluntary or involuntary
liquidation, dissolution or winding up of the Fund, the holders of shares of
preferred stock will be entitled to receive a preferential liquidating
distribution (expected to equal the original purchase price per share plus an
amount equal to accumulated and unpaid dividends whether or not earned or
declared and any accumulated and unpaid Additional Distribution) before any
distribution of assets is made to holders of common stock. After payment of the
full amount of the liquidating distribution to which they are entitled, the
preferred stockholders will not be entitled to any further participation in any
distribution of assets by the Fund. A consolidation or merger of the Fund with
or into any other corporation or corporations or a sale of all or substantially
all of the assets of the Fund will not be deemed to be a liquidation,
dissolution or winding up of the Fund.
Voting Rights. Except as otherwise indicated in this prospectus and except
as otherwise required by applicable law, holders of shares of preferred stock
will have equal voting rights with holders of shares of common stock (one vote
per share) and will vote together with holders of common stock as a single
class.
In connection with the election of the Fund's directors, holders of shares
of preferred stock, voting as a separate class, will be entitled to elect two of
the Fund's directors, and the remaining directors will be elected by all holders
of capital stock, voting as a single class. So long as any preferred stock is
outstanding, the Fund will have not less than five directors. If at any time
dividends on shares of the Fund's preferred stock shall be unpaid in an amount
equal to two full years' dividends thereon, the holders of all outstanding
shares of preferred stock, voting as a separate class, will be entitled to elect
a majority of the Fund's directors until all dividends in default have been paid
or declared and set apart for payment.
The affirmative vote of the holders of a majority of the outstanding shares
of the preferred stock, voting as a separate class, will be required to (i)
authorize, create or issue any class or series of stock ranking prior to any
series of preferred stock with respect to payment of dividends or the
distribution of
42
<PAGE> 44
assets on liquidation or (ii) amend, alter or repeal the provisions of the
Charter, whether by merger, consolidation or otherwise, so as to adversely
affect any of the contract rights expressly set forth in the Charter of holders
of preferred stock.
Redemption Provisions. It is anticipated that shares of preferred stock
will generally be redeemable at the option of the Fund at a price equal to their
liquidation preference plus accumulated but unpaid dividends to the date of
redemption plus, under certain circumstances, a redemption premium. Shares of
preferred stock will also be subject to mandatory redemption at a price equal to
their liquidation preference plus accumulated but unpaid dividends to the date
of redemption upon the occurrence of certain specified events, such as the
failure of the Fund to maintain asset coverage requirements for the preferred
stock specified by the rating agencies that issue ratings on the preferred
stock.
CERTAIN PROVISIONS OF THE ARTICLES OF INCORPORATION
The Fund's Articles of Incorporation include provisions that could have the
effect of limiting the ability of other entities or persons to acquire control
of the Fund or to change the composition of its Board of Directors and could
have the effect of depriving shareholders of an opportunity to sell their shares
at a premium over prevailing market prices by discouraging a third party from
seeking to obtain control of the Fund. A director may be removed from office
with or without cause, but only by vote of the holders of at least 66 2/3% of
the votes entitled to be voted on the matter. A director elected by all the
holders of capital stock may be removed only by action of such holders, and a
director elected by the holders of preferred stock may be removed only by action
of such holders.
In addition, the Articles of Incorporation require the favorable vote of
the holders of at least 66 2/3% of the Fund's shares of capital stock then
entitled to be voted, voting as a single class, to approve, adopt or authorize
the following:
- 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 Directors fixed in accordance with the by-laws, in
which case the affirmative vote of a majority of the Fund's shares of
capital stock is required. Following the proposed issuance of the
preferred stock, it is anticipated that the approval, adoption or
authorization of the foregoing would also require the favorable vote of a
majority of the Fund's shares of preferred stock then entitled to be
voted, voting as a separate class.
In addition, conversion of the Fund to an open-end investment company would
require an amendment to the Fund's Articles of Incorporation. The amendment
would have to be declared advisable by the Board of Directors prior to its
submission to shareholders. Such an amendment would require the favorable vote
of the holders of at least 66 2/3% of the Fund's outstanding shares of capital
stock (including any preferred stock) entitled to be voted on the matter, voting
as a single class (or a majority of such shares if the amendment was previously
approved, adopted or authorized by two-thirds of the total number of Directors
fixed in accordance with the by-laws), and, assuming preferred stock is issued,
the affirmative vote of a majority of outstanding shares of preferred stock of
the Fund, voting as a separate class. Such a vote also
43
<PAGE> 45
would satisfy a separate requirement in the 1940 Act that the change be approved
by the shareholders. Shareholders of an open-end investment company may require
the company to redeem their shares of common stock at any time (except in
certain circumstances as authorized by or under the 1940 Act) at their net asset
value, less such redemption charge, if any, as might be in effect at the time of
a redemption. All redemptions will be made in cash. If the Fund is converted to
an open-end investment company, it could be required to liquidate portfolio
securities to meet requests for redemption, and the common stock would no longer
be listed on a stock exchange.
Conversion to an open-end investment company would also require redemption
of all outstanding shares of preferred stock and would require changes in
certain of the Fund's investment policies and restrictions, such as those
relating to the issuance of senior securities, the borrowing of money and the
purchase of illiquid securities.
The Board of Directors has determined that the 66 2/3% voting requirements
described above, which are greater than the minimum requirements under Maryland
law or the 1940 Act, are in the best interests of shareholders generally.
Reference should be made to the Charter on file with the Securities and Exchange
Commission for the full text of these provisions.
CUSTODIAN
The Fund's securities and cash are held under a custodial agreement with
State Street Bank and Trust Company, 225 Franklin Street, Boston, Massachusetts
02110.
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 4,900,000 shares of common stock
from the Fund. The Underwriter is committed to purchase all of such shares if
any are purchased.
The Underwriter has advised the Fund that it proposes initially to offer
the shares of common stock to the public at the public offering price set forth
on the cover page of this prospectus. There is no sales charge or underwriting
discount charged to investors on purchases of shares of common stock in the
offering. The Investment Adviser or an affiliate has agreed to pay the
Underwriter from its own assets a commission in connection with the sale of
shares of common stock in the offering in the amount of $.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 shares of common
stock purchased in the offering on or before July 23, 1999.
The Fund has granted the Underwriter an option, exercisable for 45 days
after the date hereof, to purchase up to 735,000 additional shares of common
stock to cover over-allotments, if any, at the initial offering price.
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<PAGE> 46
The Underwriter may engage in certain transactions that stabilize the price
of the shares of common stock. Such transactions consist of bids or purchases
for the purpose of pegging, fixing or maintaining the price of the shares of
common stock.
If the Underwriter creates a short position in the shares of common stock
in connection with the offering, i.e., if it sells more shares of common stock
than are set forth on the cover page of this prospectus, the Underwriter may
reduce that short position by purchasing shares of common stock in the open
market. The Underwriter also may elect to reduce any short position by
exercising all or part of the over-allotment option described above.
The Underwriter also may impose a penalty bid on certain selling group
members. This means that if the Underwriter purchases shares of common stock in
the open market to reduce the Underwriter's short position or to stabilize the
price of the shares of common stock, it may reclaim the amount of the selling
concession from the selling group members who sold those shares of common stock
as part of the offering.
In general, purchases of a security for the purpose of stabilization or to
reduce a short position could cause the price of the security to be higher than
it might be in the absence of such purchases. The imposition of a 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
stock. The Fund's common stock have been approved for listing on the NYSE.
However, during an initial period which is not expected to exceed two weeks from
the date of this prospectus, the Fund's common stock will not be listed on any
securities exchange. Additionally, before it begins trading, the Underwriter
does not intend to make a market in the Fund's common stock, 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 2,000 beneficial owners.
The Fund anticipates that the Underwriter may from time to time act as a
broker in connection with the execution of its portfolio transactions. The Fund
has obtained an exemptive order permitting it to engage in certain principal
transactions with the Underwriter involving high quality, short-term, tax-exempt
securities subject to certain conditions. See "Investment Restrictions" and
"Portfolio Transactions."
The Underwriter is an affiliate of the Investment Adviser of the Fund.
The Fund and the Investment Adviser have agreed to indemnify the
Underwriter against certain liabilities, including liabilities under the
Securities Act of 1933.
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<PAGE> 47
TRANSFER AGENT, DIVIDEND DISBURSING AGENT AND REGISTRAR
The transfer agent, dividend disbursing agent and registrar for the shares
of common stock of the Fund is State Street Bank and Trust Company, 225 Franklin
Street, Boston, Massachusetts 02110.
LEGAL OPINIONS
Certain legal matters in connection with the common stock offered hereby
will be passed upon for the Fund and the Underwriter by Brown & Wood LLP, New
York, New York.
EXPERTS
The statement of assets, liabilities and capital of the Fund as of June 15,
1999 included in this prospectus has been so included in reliance on the report
of 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.
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 copied 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 New York Stock Exchange, 20 Broad Street, New
York, New York 10005.
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
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<PAGE> 48
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 Investment Adviser or other Fund
service providers do not properly address this problem before January 1, 2000.
The Investment Adviser 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 Investment Adviser that they
also expect to resolve the Year 2000 Problem, and the Investment Adviser 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.
The State of California relies on information technology in every aspect of
its operation and the risks posed by the Year 2000 Problem are not confined to
computer systems. They also include problems presented by embedded microchips
(products or systems that contain microchips to perform functions such as
traffic control, controlling instruments used in hospitals, and monitoring of
the California Aquaduct). Although the State reports it is making substantial
progress overall, the State cannot predict whether all critical systems will be
ready and tested by late 1999 or what impact failure of any information
technology system might have. The State Treasurer's Office (which operates the
system responsible for debt service payments on State debt) has reported that it
is scheduled to complete its remediation efforts by December 31, 1999. However,
there is no centralized mechanism for reporting on the Year 2000 Problem
remediation efforts of the over 1,200 other public agencies in California.
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<PAGE> 49
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholder,
MuniHoldings California Insured Fund V, Inc.:
We have audited the accompanying statement of assets, liabilities and capital of
MuniHoldings California Insured Fund V, Inc. as of June 15, 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, such statement of assets, liabilities and capital presents
fairly, in all material respects, the financial position of MuniHoldings
California Insured Fund V, Inc. as of June 15, 1999 in conformity with generally
accepted accounting principles.
DELOITTE & TOUCHE LLP
Princeton, New Jersey
July 19, 1999
48
<PAGE> 50
MUNIHOLDINGS CALIFORNIA INSURED FUND V, INC.
STATEMENT OF ASSETS, LIABILITIES AND CAPITAL
JUNE 15, 1999
<TABLE>
<S> <C>
ASSETS
Cash................................................... $100,005
Offering costs (Note 1)................................ 190,000
--------
Total assets...................................... 290,005
--------
LIABILITIES
Liabilities and accrued expenses (Note 1).............. 190,000
--------
NET ASSETS.................................................. $100,005
========
CAPITAL
Common Stock, par value $.10 per share; 200,000,000
shares authorized; 6,667 shares issued and outstanding
(Note 1).............................................. $ 667
Paid-in Capital in excess of par....................... 99,338
--------
Total Capital-Equivalent to $15.00 net asset value per
share of Common Stock (Note 1)........................ $100,005
========
</TABLE>
NOTES TO STATEMENT OF ASSETS, LIABILITIES AND CAPITAL
NOTE 1. ORGANIZATION
The Fund was incorporated under the laws of the State of Maryland on April
5, 1999 as a closed-end, non-diversified management investment company and has
had no operations other than the sale to Fund Asset Management, L.P. (the
"Investment Adviser") of an aggregate of 6,667 shares of common stock for
$100,005 on June 15, 1999. The General Partner of the Investment Adviser is an
indirect wholly-owned subsidiary of Merrill Lynch & Co., Inc.
The Investment Adviser, on behalf of the Fund, will incur organization
costs estimated at $26,250. 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 for advisory services at the annual rate of 0.55 of 1% of the Fund's
average weekly net assets of the Fund, including any proceeds from the issuance
of Preferred Stock. The Investment Adviser or affiliate will pay Merrill Lynch,
Pierce, Fenner & Smith Incorporated a commission in the amount of 2.00% of the
price to the public in connection with the initial public offering of the Fund's
Common Stock.
NOTE 3. FEDERAL INCOME TAXES
The Fund intends to qualify as a "regulated investment company" and as such
(and by complying with the applicable provisions of the Internal Revenue Code of
1986, as amended) will not be subject to Federal income tax on taxable income
(including realized capital gains) that is distributed to shareholders.
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<PAGE> 51
APPENDIX I
ECONOMIC AND OTHER CONDITIONS IN CALIFORNIA
The following information is a brief summary of factors affecting the
economy of the State of California and does not purport to be a complete
description of such factors. Other factors will affect issuers. The summary is
based primarily upon one or more of the most recent publicly available offering
statements relating to debt offerings of California issuers, however, it has not
been updated. The Fund has not independently verified the information.
GENERAL ECONOMIC CONDITIONS
The economy of the State of California (sometimes referred to herein as the
"State") is the largest among the 50 states and one of the largest in the world.
This diversified economy has major components in agriculture, manufacturing,
high technology, trade, entertainment, tourism, construction and services.
California's July 1, 1998 population of over 33.2 million represented over
13% of the total United States population. As of July 1, 1990, the population of
29,944,000 represented an increase of over 6 million persons, or 26%, during the
decade of the 1980s.
California's population is concentrated in metropolitan areas. As of the
April 1, 1990 census, 96% of the State's population resided in the 23
Metropolitan Statistical Areas in the State. As of July 1, 1997, the five-county
Los Angeles area accounted for 49%, with 16.0 million residents. The 10-county
San Francisco Bay Area represented 21%, with a population of 6.9 million.
From 1990-1993, the State suffered through a severe recession, the worst
since the 1930s, heavily influenced by large cutbacks in defense/aerospace
industries and military base closures and by a major drop in real estate
construction. California's economy has been recovering and growing steadily
since the start of 1994. The current economic expansion is marked by strong
growth in high technology manufacturing and services, including computer
software, electronic manufacturing and motion picture/television production;
growth is also strong in other business services, both nonresidential and
residential construction and local education.
In the Governor's Budget released on January 8, 1999, the Department of
Finance projected that the California economy will show moderate growth through
2000, at a slower pace than in 1998. The economic expansion has been marked by
strong growth in high technology business services (including computer
software), construction, and computer and electronic components manufacturing.
The Asian economic crisis, which began in 1997, has had some dampening effects
on the State's economy, particularly in high technology manufacturing. The
widening trade deficit, continuing weakness in Asia, initial signs of economic
weakness in Latin America, and uncertainty in stock prices worldwide all support
moderating growth in 1999. Other impacts of the international situation may help
California, such as the reduction in long-term interest rates.
THE STATE
Fiscal Years Prior to 1995-1996. The State's budget problems in the early
1990s were caused by a combination of external economic conditions and a
structural imbalance in that the largest general fund programs (K-14 education,
health, welfare and corrections) were increasing faster than the revenue base,
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driven by the State's rapid population growth. These pressures are expected to
continue as population trends maintain strong demand for health and welfare
services, as the school age population continues to grow, and as the State's
corrections program responds to a "Three Strikes" law enacted in 1994, which
requires mandatory life prison terms for certain third-time felony offenders. In
addition, the State's health and welfare programs are in a transition period as
a result of recent federal and state welfare reform initiatives.
As a result of these factors and others, and especially because the severe
recession between 1990-1994 reduced revenues and increased expenditures for
social welfare programs, from the late 1980s until 1992-93, the State had a
period of budget imbalance. During this period, expenditures exceeded revenues
in four out of six years, and the State accumulated and sustained a budget
deficit in its budget reserve, the Special Fund for Economic Uncertainties
("SFEU") approaching $2.8 billion at its peak at June 30, 1993. Starting in the
1990-91 Fiscal Year and for each fiscal year thereafter, each budget required
multibillion dollar actions to bring projected revenues and expenditures into
balance. The State Legislature and the Governor of the State (the "Governor")
agreed on the following principal steps to produce Budget Acts in the years
1991-92 to 1994-95, although not all these actions were taken in each year.
1. significant cuts in health and welfare program expenditures;
2. transfers of program responsibilities and funding from the State
to local governments (referred to as "realignment"), coupled with some
reduction in mandates on local government;
3. transfer of about $3.6 billion in local property tax revenues from
cities, counties, redevelopment agencies and some other districts to local
school districts, thereby reducing State funding for schools under
Proposition 98 (discussed below);
4. reduction in growth of support for higher education programs,
coupled with increases in student fees, through the 1994-95 Fiscal Year;
5. maintenance of the minimum Proposition 98 funding guarantee for
K-14 schools, and the disbursement of additional funds to keep a constant
level of about $4,200 per K-12 pupils through the 1993-94 Fiscal Year;
6. revenue increases, most of which were for a short duration;
7. increased reliance on aid from the federal government to offset
the costs of incarcerating, educating and providing health and welfare
services to illegal immigrants, although during this time frame, most of
the additional aid requested by the Administration was not received; and
8. various one-time adjustments and accounting changes.
Despite these budget actions, as noted, the effects of the recession led to
large, unanticipated deficits in the budget reserve, the SFEU, as compared to
projected positive balances. By the 1993-94 Fiscal Year, the accumulated deficit
was so large that it was impractical to budget to retire it in one year, so a
two-year program was implemented, using the issuance of revenue anticipation
warrants to carry a portion of the deficit over the end of the fiscal year. When
the economy failed to recover sufficiently in 1993-94, a second two-year plan
was implemented in 1994-95, again using cross-fiscal year revenue anticipation
warrants to partly finance the deficit into the 1995-96 fiscal year.
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Another consequence of the accumulated budget deficits, together with other
factors such as disbursement of funds to local school districts "borrowed" from
future fiscal years and hence not shown in the annual budget, was to
significantly reduce the State's cash resources available to pay its ongoing
obligations. For several years during the recession, the State was forced to
rely increasingly on external debt markets to meet its cash needs, as a
succession of notes and revenue anticipation warrants were issued in the period
from June 1992 to July 1994, often needed to pay previously maturing notes or
warrants. These borrowings were used also in part to spread out the repayment of
the accumulated budget deficit over the end of a fiscal year, as noted earlier.
The last and largest of these borrowings was $4.0 billion of revenue
anticipation warrants which were issued in July 1994 and matured on April 25,
1996. However, the State's improved cash position in 1995-96 allowed it to repay
the $4.0 billion Revenue Anticipation Warrant issue on April 25, 1996, and to
issue only $2.0 billion of revenue anticipation notes during the fiscal year,
which matured on June 28, 1996.
1995-96 THROUGH 1997-98 FISCAL YEARS
The State's financial condition improved markedly during the 1995-96,
1996-97 and 1997-98 fiscal years, with a combination of better than expected
revenues, slowdown in growth of social welfare programs, and continued spending
restraint based on the actions taken in earlier years. The State's cash position
also improved, and no external deficit borrowing has occurred over the end of
these three fiscal years.
The economy grew strongly during these fiscal years, and as a result, the
General Fund took in substantially greater tax revenues (around $2.2 billion in
1995-96, $1.6 billion in 1996-97 and $2.2 billion in 1997-98) than were
initially planned when the budgets were enacted. These additional funds were
largely directed to school spending as mandated by Proposition 98, and to make
up shortfalls from reduced federal health and welfare aid in 1995-96 and
1996-97. The accumulated budget deficit from the recession years was finally
eliminated. The Department of Finance estimates that the State's budget reserve
(the SFEU) totaled $639.8 million as of June 30, 1997 and $1.782 billion at June
30, 1998.
On August 18, 1997, the Governor signed the 1997-98 Budget Act, but vetoed
about $314 million of specific spending items, primarily in health and welfare
and education areas from both the General Fund and Special Funds. The Governor
announced that he was prepared to restore about $200 million of education
spending upon satisfactory completion of legislation on an education testing
program.
The 1997-98 Budget Act anticipated General Fund revenues and transfers of
$52.5 billion (a 6.8% increase over the final 1996-97 amount), and expenditures
of $52.8 billion (an 8.0% increase from the 1996-97 levels). On a budgetary
basis, the SFEU was projected to decrease from $408 million at June 30, 1997 to
$112 million at June 30, 1998. As of January 9, 1998, the State Director of
Finance estimated a reserve of $329 million at June 30, 1998. (The expenditure
figure assumes restoration of $200 million in vetoed funding.) The Budget Act
also included Special Fund expenditures of $14.4 billion (as against estimated
Special Fund revenues of $14.0 billion), and $2.1 billion of expenditures from
various Bond Funds. The State implemented its normal annual cash flow borrowing
program, issuing $3 billion of notes which matured on June 30, 1998.
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The following were major features of the 1997-98 Budget Act:
1. The 1997-98 Budget contained a large increase in funding for K-14
education under Proposition 98, reflecting strong revenues which exceeded
initial budgeted amounts. Part of the nearly $1.75 billion in increased
spending was allocated to prior fiscal years. Funds were provided to fully
pay for the cost-of-living increase component of Proposition 98, and to
extend class size reduction and reading initiatives.
2. The 1997-98 Budget Act reflected the $1.235 billion pension case
judgment payment, and brought funding of the State's pension contribution
back to the quarterly basis which existed prior to the deferral actions
which were invalidated by the courts. There was no provision for any
additional payments relating to this court case.
3. Continuing the third year of a four-year "compact" which the
Administration made with higher education units, funding from the General
Fund for the University of California and California State University has
increased by about six percent ($121 million and $107 million,
respectively), and there was no increase in student fees.
4. Because of the effect of the pension payment, most other State
programs were continued at 1996-97 levels.
5. Health and welfare costs were contained, continuing generally the
grant levels from prior years, as part of the initial implementation of the
new CalWORKs program.
6. Unlike prior years, the 1997-98 Budget Act did not depend on
federal budget actions. About $300 million in federal funds, already
included in the federal FY 1997 and 1998 budgets, were included in the
1997-98 Budget Act, to offset incarceration costs for illegal aliens.
7. The 1997-98 Budget Act contained no tax increases, and no tax
reductions. The Renters Tax Credit was suspended for another year, saving
approximately $500 million.
Pursuant to Article IV, Section 13(c) of the Constitution of the State of
California, the State Legislature is required to adopt its budget for the
upcoming fiscal year (July 1-June 30) by midnight of June 15th, and in the
absence of which, the Legislature may not send to the Governor for consideration
any bill appropriating funds for expenditure during the fiscal year for which
the budget bill is to be enacted, except emergency bills or appropriations for
the salaries and expenses of the Legislature. For the current fiscal year, as
has been true since the late 1980's, the State Legislature did not adhere to
this deadline. Due to the Legislature's failure to comply with this
constitutional requirement, the Howard Jarvis Taxpayers Association sought an
injunction in a Los Angeles Superior Court to prohibit the State from making
certain types of payments in the absence of an adopted budget. On July 21, 1998,
a preliminary injunction was issued. Under the terms of the injunction order,
until such time as the budget was adopted, the State was precluded from making
any payments from the State treasury for Fiscal Year 1998-99 except for certain
enumerated expenditures.
On July 22, 1998, the Legislature unanimously passed an $18.9 billion
emergency-spending bill to cover the costs of, among others, bond payments,
paychecks for state workers, retirement pensions, prisons, school and welfare
payments from July 1st through August 5th. However, before a final resolution of
the
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legal issues raised by the plaintiff, a budget for Fiscal Year 1998-99 was
passed by the Legislature on August 11, 1998, and the Governor signed it on
August 21, 1998.
In signing the 1998-99 Budget Bill, the Governor used his line-item veto
power to reduce expenditures by $1.360 billion from the General Fund, and $160
million from Special Funds. Of this total, the Governor indicated that about
$250 million of vetoed funds were "set aside" to fund programs for education.
Vetoed items included education funds, salary increases and many individual
resources and capital projects.
The 1998-99 Budget Act is based on projected general fund revenues and
transfers of $57.0 billion (after giving effect to various tax reductions
enacted in 1997 and 1998), a 4.2% increase from the revised 1997-98 figures.
Special Fund revenues were estimated at $14.3 billion. The revenue projections
were based on the May Revision. Economic problems overseas since that time may
affect the May Revision projections.
After giving effect to the Governor's vetoes, the 1998-99 Budget Act
provides authority for expenditures of $57.3 billion from the General Fund (a
7.3% increase from 1997-98), $14.7 billion from Special Funds, and $3.4 billion
from bond funds. The 1998-99 Budget Act projects a balance in the SFEU at June
30, 1999 (but without including the "set aside" veto amount) of $1.255 billion,
a little more than 2% of general fund revenues. The Budget Act assumes the State
will carry out its normal intra-year cash flow borrowing in the amount of $1.7
billion of revenue anticipation notes, which were issued on October 1, 1998.
The most significant feature of the 1998-99 Budget was agreement on a total
of $1.4 billion of tax cuts. The central element is a bill which provides for a
phased-in reduction of the VLF. Since the VLF is currently transferred to cities
and counties, the bill provides for the general fund to replace the lost
revenues. Starting on January 1, 1999, the VLF will be reduced by 25%, at a cost
to the general fund of approximately $500 million in the 1998-99 Fiscal Year and
about $1 billion annually thereafter.
In addition to the cut in VLF, the 1998-99 Budget included both temporary
and permanent increases in the personal income tax dependent credit ($612
million General Fund cost in 1998-99, but less in future years), a nonrefundable
renters tax credit ($133 million), and various targeted business tax credits
($106 million).
Other significant elements of the 1998-99 Budget Act were as follows:
1. Proposition 98 funding for K-12 schools is increased by $1.7
billion in General Fund moneys over revised 1997-98 levels, about $300
million higher than the minimum Proposition 98 guaranty. An additional $600
million was appropriated to "settle up" prior years' Proposition 98
entitlements, and was primarily devoted to one-time uses such as block
grants, deferred maintenance, and computer and laboratory equipment. Of the
1998-99 funds, major new programs include money for instructional and
library materials, deferred maintenance, support for increasing the school
year to 180 days and reduction of class sizes in Grade 9. The Governor held
$250 million of education funds which were vetoed as set-aside for
enactment of additional reforms. Overall, per-pupil spending for K-12
schools under Proposition 98 is increased to $5,695, more than one-third
higher than the level in the last recession year of 1993-94. The 1998-99
Budget also includes $250 million as repayment of prior years' loans to
schools, as part of the settlement of the CTA v. Gould lawsuit.
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2. Funding for higher education increased substantially above the
level called for in the Governor's four-year compact. General Fund support
was increased by $340 million (15.6%) for the University of California and
$267 million (14.1%) for the California State University system. In
addition, Community Colleges received a $300 million (6.6%) increase under
Proposition 98.
3. The 1998-99 Budget includes increased funding for health, welfare
and social services programs. A 4.9% grant increase was included in the
basic welfare grants, the first increase in those grants in 9 years. Future
increases will depend on sufficient general fund revenue to trigger the
phased cuts in VLF described above.
4. Funding for the judiciary and criminal justice programs increased
by about 11% over 1997-98, primarily to reflect increased State support for
local trial courts and rising prison population.
5. Various other highlights of the 1998-99 Budget included new
funding for resources projects, dedication of $376 million of general fund
moneys for capital outlay projects, funding of a three percent State
employee salary increase, funding of 2,000 new Department of Transportation
positions to accelerate transportation construction projects, and funding
of the Infrastructure and Economic Development Bank ($50 million).
6. The State of California received approximately $167 million of
federal reimbursements to offset costs related to the incarceration of
undocumented alien felons for federal fiscal year 1997. The State
anticipates receiving approximately $195 million in federal reimbursements
for federal fiscal year 1998.
After the 1998-99 Budget Act was signed, and prior to the close of the
Legislative session on August 31, 1998, the Legislature passed a variety of
fiscal bills. The Governor had until September 30, 1998 to sign or veto these
bills. The bills with the most significant fiscal impact which the Governor
signed include $235 million for certain water system improvements in Southern
California, $243 million for the State's share of the purchase of
environmentally sensitive forest lands, $178 million for state prisons, $160
million for housing assistance, and $125 million for juvenile facilities. The
Governor also signed bills totaling $223 million for education programs which
were part of the Governor's $250 million veto "set aside," and $32 million for
local governments' fiscal relief. In addition, he signed a bill reducing by $577
million the State's obligation to contribute to the State Teachers' Retirement
System in the 1998-99 Fiscal Year.
Based solely on the legislation enacted, on a net basis, the reserve for
June 30, 1999 was reduced by $256 million. On the other hand, 1997-98 revenues
have been increased by $160 million. The revised June 30, 1999 reserve is
projected to be $1,159 million or $96 million below the level originally
projected by the 1998-99 Budget Act. The reserve projected in the 1998-99 Budget
Act was $1,255 million.
Subsequent Events. On May 17, 1999, the Legislative Analyst released an
updated report (the "LAO Report") on the Governor's proposal for fiscal year
1999-2000 Budget which concluded that for the fourth year in a row, California's
budget outlook shows a major improvement in the May revision. The LAO's report
determined that the revenue outlook was decidedly stronger because of (1) a
brighter near-term economic outlook than previously assumed and (2)
higher-than-expected personal income tax receipts, especially during April
although a significant portion of the new revenues will be necessary to cover
cost increases in Proposition 98 education and other state programs.
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The original budget's economic forecast was prepared in late 1998 when it
appeared that the Asian economic crisis was resulting in a significant slowdown
in economic activity. However, according to the LAO Report, since that time, the
economic picture has brightened considerably, as both the nation and California
appear to have avoided a major slowdown emanating from Asia's problems. Based on
continued growth in real gross domestic product (GDP), strong consumer
confidence, and other factors, the consensus economic outlook for 1999 now calls
for real GDP growth of over 3.5%, or nearly double the projection contained in
earlier budget forecasts. In California, employment data revisions revealed that
instead of slowing in late 1998 and early 1999, as assumed, wage and salary jobs
in the state continued to expand at a healthy pace. This more positive trend is
expected to continue through 1999.
On June 29, 1999, the Governor signed into law the State's budget for the
1999-2000 Fiscal Year (the "1999-2000 Budget").
The 1999-2000 general fund Budget is as follows:
1999-2000 GENERAL FUND
BUDGET SUMMARY
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
1999-00
-------
<S> <C>
Prior Year Balance.......................................... $ 2,412
Revenues and Transfers...................................... $62,981
-------
Total Resources Available................................... $65,393
Expenditures................................................ $63,732
=======
Fund Balance................................................ $ 1,661
Budget Reserves:
Reserve for Liquidation of Encumbrances................... $ 480
Set aside for Employee Compensation and Litigation........ $ 300
Special Fund for Economic Uncertainties................... $ 881
</TABLE>
The 1999-2000 Budget is based on the Rolling revenue assumptions.
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1999-2000 REVENUE SOURCES
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
GENERAL SPECIAL
FUND FUND
------- -------
<S> <C> <C>
Personal Income Tax......................................... $32,914 --
Sales Tax................................................... 19,960 $ 2,185
Bank and Corporation Tax.................................... 5,751 --
Highway Users Taxes......................................... -- 3,015
Motor Vehicle Fees.......................................... 28 4,831
Insurance Tax............................................... 1,246 --
Estate Taxes................................................ 907 --
Liquor Tax.................................................. 269 --
Tobacco Taxes............................................... 130 1,091
Horseracing Fees............................................ -- 39
Other....................................................... 1,776 3,615
------- -------
Total....................................................... $62,981 $14,776
</TABLE>
Education continues to be the single biggest expenditure item in the
1999-2000 Budget. All budgeted expenditures are as follows:
1999-2000 EXPENDITURES BY FUND
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
GENERAL SPECIAL BOND
FUNCTION FUND FUNDS FUNDS TOTAL
-------- ------- ------- ------ -------
<S> <C> <C> <C> <C>
Education (K-12)............................. $26,418 $ 49 $ 36 $26,503
Health and Human Services.................... 16,921 4,002 5 20,928
Higher Education............................. 8,012 686 816 9,514
Business, Transportation and Housing......... 412 5,390 454 6,256
Trade and Commerce........................... 482 1 -- 483
Tax Relief................................... 1,868 -- -- 1,868
Local Government Subventions................. 322 3,255 -- 3,577
Youth and Adult Corrections.................. 4,738 17 7 4,762
Resources.................................... 1,270 918 97 2,286
Environmental Protection..................... 176 547 75 798
State and Consumer Services.................. 482 485 42 1,009
Other........................................ 2,631 732 -- 3,363
------- ------- ------ -------
Total........................................ $63,732 $16,082 $1,532 $81,346
</TABLE>
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WELFARE REFORM
Congress passed and the President signed on August 22, 1996 the Personal
Responsibility and Work Opportunity Reconciliation Act of 1996 (the "Law")
fundamentally reforming the nation's welfare system. Among its many provisions,
the Law includes: (i) conversion to Aid to Families with Dependent Children from
an entitlement program to a block grant titled Temporary Assistance for Needy
Families (TANF), with lifetime time limits on TANF recipients, work requirements
and other changes; (ii) provisions denying certain federal welfare and public
benefits to legal noncitizens (this provision has been amended by subsequent
federal law), allowing states to elect to deny additional benefits (including
TANF) to legal noncitizens, and generally denying almost all benefits to illegal
immigrants; and (iii) changes in the Food Stamp program, including reducing
maximum benefits and imposing work requirements.
California's response to the federal welfare reforms is a new basic state
welfare program called California Work Opportunity and Responsibility to Kids
("CalWORKs"), which replaced the former Aid to Families with Dependent Children
(AFDC) and Greater Avenues to Independence (GAIN) programs, effective January 1,
1998. Consistent with the federal law, CalWORKs contains new time limits on
receipt of welfare aid, both lifetime as well as for any current period on aid.
The centerpiece of CalWORKs is the linkage of eligibility to work participation
requirements. Administration of the new CalWORKs program is largely at the
county level, and counties are given financial incentives for success in this
program.
The long-term impact of the new federal Law and CalWORKs cannot be
determined until there has been more experience and until an independent
evaluation of the CalWORKs program is completed. In the short-term, the
implementation of the CalWORKS program has continued the trend of declining
welfare caseloads. The CalWORKs caseload trend is projected to be 651,350 in
1998-99 and 598,000 in 1999-00, down from a high of 921,000 cases in 1994-95.
The 1999-00 Governor's Budget limits CalWORKs expenditures to the annual
$3.7 billion federal TANF Block Grant and prior year carryover amounts, and the
state General Fund and county General Fund combined Maintenance of Effort
Requirement of $2.9 billion. Any decision to maintain or exceed the Maintenance
of Effort Requirement would need to be made in the context of available
resources and competing budget demands.
LOCAL GOVERNMENTS
The primary units of local government in California are the counties,
ranging in population from 1,300 (Alpine) to over 9,000,000 (Los Angeles).
Counties are responsible for the provision of many basic services, including
indigent healthcare, welfare, courts, jails and public safety in unincorporated
areas. There are also about 480 incorporated cities and thousands of other
special districts formed for education, utility and other services. The fiscal
condition of local governments has been constrained since the enactment of
"Proposition 13" in 1978, which reduced and limited the future growth of
property taxes and limited the ability of local governments to impose "special
taxes" (those devoted to a specific purpose) without two-thirds voter approval.
Counties, in particular, have had fewer options to raise revenues than many
other local governmental entities, and have been required to maintain many
services.
The entire statewide welfare system has been changed in response to the
change in federal welfare law enacted in 1996 (see "Federal Welfare Reform"
above). Under the CalWORKs program, counties are given flexibility to develop
their own plans, consistent with State law, to implement Welfare-to-Work and
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to administer many of its elements and their costs for administrative and
support services are capped at 1996-97 levels. Counties are also given financial
incentives if, at the individual county level or statewide, the CalWORKs program
produces savings associated with specified Welfare-to-Work outcomes; counties
may also suffer penalties for failing to meet federal standards. Under CalWORKs,
counties will still be required to provide "general assistance" aid to certain
persons who cannot obtain welfare from other programs.
Historically, funding for the State's trial court system was divided
between the State and the counties. However, Chapter 850, Statutes of 1997,
implements a restructuring of the State's trial court funding system. Funding
for the courts, with the exception of costs for facilities, local judicial
benefits, and revenue collection, was consolidated at the State level. County
contribution for both their general fund and fine and penalty amounts is capped
at the 1994-95 level and becomes part of the Trial Court Trust Fund, which
supports all trial court operations. The State assumed responsibility for future
growth in trial court funding. The consolidation of funding is intended to
streamline the operation of the courts, provide a dedicated revenue source, and
relieve fiscal pressure on the counties. Beginning in 1998-99, county general
fund contribution for court operations is reduced by $300 million, including
$10.7 million to buy out the contribution of the 20 smallest counties, and
cities will retain $62 million in fine and penalty revenue previously remitted
to the State; the State's general fund backfilled the $362 million revenue loss
to the Trial Court Trust Fund. In addition to this general fund backfill, a $50
million augmentation is included in the 1998 Budget Act for the trial courts to
fund workload increases and high priority issues such as court security. In
1999-2000, county general fund contributions will be further reduced by an
additional $92 million to buy out the next 17 smallest counties and reduce by
ten percent the general fund contribution of the remaining 21 counties.
In the aftermath of Proposition 13, the State provided aid from the general
fund to make up some of the loss of property tax moneys, including taking over
the principal responsibility for funding local K-12 schools and community
colleges. Under the pressure of the recent recession, the Legislature has
eliminated remnants of this post-Proposition 13 aid to entities other than K-14
education districts, although it has also provided additional funding sources
(such as sales taxes) and reduced mandates for local services. Many counties
continue to be under severe fiscal stress. While such stress has in recent years
most often been experienced by smaller, rural counties, larger urban counties,
such as Los Angeles, have also been affected. Orange County implemented
significant reductions in services and personnel, and continues to face fiscal
constraints in the aftermath of its bankruptcy, which has been caused by large
investment losses in its pooled investment funds.
On November 5, 1996, voters approved Proposition 218, entitled the "Right
to Vote on Taxes Act," which incorporates new Articles XIIIC and XIIID into the
California Constitution. These new provisions enact limitations on the ability
of local government agencies to impose or raise various taxes, fees, charges and
assessments without voter approval. Certain "general taxes" imposed after
January 1, 1995 must be approved by voters in order to remain in effect. In
addition, Article XIIIC clarifies the right of local voters to reduce taxes,
fees, and assessments to changes through local initiatives. There are a number
of ambiguities concerning the Proposition and its impact on local governments
and their bonded debt which will require interpretation by the courts or the
State Legislature. The State Legislature Analyst estimated that enactment of
Proposition 218 would reduce local government revenues statewide by over $100
million
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a year, and that over time revenues to local government would be reduced by
several hundred million dollars. Proposition 218 does not affect the State or
its ability to levy or collect taxes.
On December 23, 1997, a consortium of California counties filed a test
claim with the Commission on State Mandates (the "Commission") asking the
Commission to determine whether the property tax shift from counties to the
Educational Revenue Augmentation Fund, which is a funding source for schools, is
a reimbursable state mandated cost. The test claim was heard on October 29,
1998, and the Commission on State Mandates found in favor the State. However,
the case is now expected to be appealed through the court system. Should the
courts find in favor of the counties, the impact to the State General Fund could
be as high as $10.0 billion with an annual Proposition 98 General Fund cost of
at least $3.6 billion. This cost would grow in accordance with the annual
assessed value growth rate.
CONSTITUTIONAL AND STATUTORY LIMITATIONS; RECENT AND PENDING INITIATIVES;
PENDING LEGISLATION
Constitutional and Statutory Limitations. Article XIIIA of the California
Constitution (which resulted from the voter-approved Proposition 13 in 1978)
limits the taxing powers of California public agencies, Article XIIIA, provides
that the maximum ad valorem tax on real property cannot exceed 1% of the "full
cash value" of the property and effectively prohibits the levying of any other
ad valorem tax on real property for general purposes. However, on May 3, 1986,
Proposition 46, an amendment to Article XIIIA, was approved by the voters of the
State of California, creating a new exemption under Article XIIIA permitting an
increase in ad valorem taxes on real property in excess of 1% for bonded
indebtedness approved by two-thirds of the voters voting on the proposed
indebtedness, "Full cash value" is defined as "the County Assessor's valuation
of real property as shown on the 1975-76 Fiscal Year tax bill under "full cash
value" or, thereafter, the appraised value of real property when purchased,
newly constructed, or a change in ownership has occurred after the 1975
assessment." The "full cash value" is subject to annual adjustment to reflect
increases (not to exceed 2%) or decreases in the consumer price index or
comparable local data, or to reflect reductions in property value caused by
damage, destruction or other factors.
Article XIIIB of the California Constitution limits the amount of
appropriations of the State and of the local governments to the amount of
appropriations of the entity for the prior year, adjusted for changes in the
cost of living, population and the services that local government has financial
responsibility for providing. To the extent that the revenues of the State
and/or local government exceed its appropriations, the excess revenues must be
rebated to the public either directly or through a tax decrease. Expenditures
for voter-approved debt services are not included in the appropriations limit.
At the November 9, 1988 general election, California voters approved an
initiative known as Proposition 98. This initiative amends Article XIIIB to
require that (i) the California Legislature establish a prudent state reserve
fund in an amount it shall deem reasonable and necessary and (ii) revenues in
excess of amounts permitted to be spent and which would otherwise be returned
pursuant to Article XIIIB by revision of tax rates or fee schedules be
transferred and allocated (up to a maximum of 40%) to the State School Fund and
be expended solely for purposes of instructional improvement and accountability.
Proposition 98 also amends Article XVI to require that the State of California
provide a minimum level of funding for public schools and community colleges.
Commencing with the 1988-89 Fiscal Year, money to be applied by the State for
the support of school districts and community college districts shall not be
less than the greater of: (i) the amount which, as a percentage of the State
general fund revenues which may
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be appropriated pursuant to Article XIIIB, equals the percentage of such State
general fund revenues appropriated for school districts and community college
districts, respectively, in the 1986-87 Fiscal Year or (ii) the amount required
to insure that the total allocations to school districts and community college
districts from the State general fund proceeds of taxes appropriated pursuant to
Article XIIIB and allocated local proceeds of taxes shall not be less than the
total amount from these sources in the prior year, adjusted for increases in
enrollment and adjusted for changes in the cost of living pursuant to the
provisions of Article XIIIB. The initiative permits the enactment of
legislation, by a two-thirds vote, to suspend the minimum funding requirements
for one year. As a result of Proposition 98, funds that the State might
otherwise make available to its political subdivisions may be allocated instead
to satisfy such minimum funding level.
During the recent recession, general fund revenues for several years were
less than originally projected, so that the original Proposition 98
appropriations turned out to be higher than the minimum percentage provided in
the law. The Legislature responded to these developments by designating the
"extra" Proposition 98 payments in one year as a "loan" from future years'
Proposition 98 entitlements and also intended that the "extra" payments would
not be included in the Proposition 98 "base" for calculating future years'
entitlements. By implementing these actions, per-pupil funding from Proposition
98 sources stayed almost constant at approximately $4,220 from the 1991-92
Fiscal Year to the 1993-94 Fiscal Year.
In 1992, a lawsuit was filed, called California Teachers' Association v.
Gould, which challenged the validity of these off-budget loans. The settlement
of this case, finalized in July, 1996, provides, among other things, that both
the State and K-14 schools share in the repayment of prior years' emergency
loans to schools. Of the total $1.76 billion in loans, the State will repay $935
million by forgiveness of the amount owed, while schools will repay $825
million. The State share of the repayment will be reflected as an appropriation
above the current Proposition 98 base calculation. The schools' share of the
repayment will count either as appropriations that count toward satisfying the
Proposition 98 guarantee, or as appropriations from "below" the current base.
Repayments are spread over the eight-year period of the 1994-95 Fiscal Year
through the 2001-02 Fiscal Year to mitigate any adverse fiscal impact.
Substantially increased general fund revenues, above initial budget
projections, in the 1994-95, 1995-96 and 1996-97 fiscal years have resulted or
will result in retroactive increases in Proposition 98 appropriations from
subsequent fiscal years' budgets.
On November 8, 1994, the voters approved Proposition 187, an initiative
statute ("Proposition 187"). Proposition 187 specifically prohibits funding by
the State of social services, health care services and public school education
for the benefit of any person not verified as either a United States citizen or
a person legally admitted to the United States. Among the provisions in
Proposition 187 pertaining to public school education, the measure requires,
commencing January 1, 1995, that every school district in the State verify the
legal status of every child enrolling in the district for the first time. By
January 1, 1996, each school district must also verify the legal status of
children already enrolled in the district and of all parents or guardians of all
students. If the district "reasonably suspects" that a student, parent or
guardian is not legally in the United States, that district must report the
student to the United States Immigration and Naturalization Service and certain
other parties. The measure also prohibits a school district from providing
education to a student it does not verify as either a United States citizen or a
person legally admitted to the United States. The State Legislative Analyst
estimates that verification costs could be in
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the tens of millions of dollars on a statewide level (including verification
costs incurred by other local governments), with first-year costs potentially in
excess of $100 million.
The reporting requirements may violate the Family Educational Rights and
Privacy Act ("FERPA"), which generally prohibits schools that receive federal
funds from disclosing information in student records without parental consent.
Compliance with FERPA is a condition of receiving federal education funds, which
total $2.3 billion annually to California school districts. The Secretary of the
United States Department of Education has indicated that the reporting
requirements in Proposition 187 could jeopardize the ability of school districts
to receive these funds.
Opponents of Proposition 187 filed at least eight lawsuits (which were
subsequently consolidated) challenging the constitutionality and validity of the
measure. On March 18, 1998, a United States District Court judge entered as
final judgment in the case, holding key portions of the measure unconstitutional
and permanently enjoining the State from implementing those sections which would
have required law enforcement, teachers and social services and health care
workers to verify a person's immigration status and subsequently report illegal
immigrants to authorities and deny them social services, health care and
education benefits. An appeal by the State Attorney General was filed with the
Ninth Circuit Court of Appeals on March 25, 1998 and is pending.
Pending Litigation. The State is a party to numerous legal proceedings,
many of which normally occur in governmental operations. Some of the more
significant lawsuits pending against the State are described herein.
The State is involved in a lawsuit, Thomas Hayes v. Commission on State
Mandates, related to the state-mandated costs. The action involves an appeal by
the Director of Finance from a 1984 decision by the State Board of Control (now
succeeded by the Commission on State Mandates). The Board of Control decided in
favor of local school districts' claims for reimbursement for special education
programs for handicapped students. The case was then brought to the trial court
by the State and later remanded to the Commission on State Mandates for
redetermination. The Commission on State Mandates issued a decision in December
1998 determining that a portion, but not all, of the claims constituted state
mandated local costs. The Commission is now developing parameters and guidelines
for claims for reimbursement. The Department of Finance has not yet determined
whether to seek judicial review of the Commission's decision.
The State is involved in a lawsuit related to contamination at the
Stringfellow toxic waste site. In United States, People of the State of
California v. J. B. Stringfellow, Jr., et. al., the State is seeking recovery
for post costs of cleanup of the site, a declaration that the defendants are
jointly and severally liable for future costs, and an injunction ordering
completion of the cleanup. However, the defendants have filed a counterclaim
against the State for alleged negligent acts. Because the State is the present
owner of the site, the State may be found liable. Present estimates of the
cleanup range from $300 million to $800 million.
The State is a defendant in a coordinated action involving 3,000 plaintiffs
seeking recovery for damages caused by the Yuba River flood of February 1986.
The appellate court affirmed the trial court finding of liability in inverse
condemnation and awarded damages of $500,000 to 12 sample plaintiffs. Potential
liability to the remaining 300 plaintiffs, from claims filed, ranges from $800
million to $1.5 billion. An appeal has been filed.
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The State is a defendant in Just Say No To Tobacco Dough Campaign v. State
of California, where the petitioners challenge the appropriation of
approximately $166 million of Proposition 99 funds in the Cigarette and Tobacco
Products Surtax Fund for years ended June 30, 1990, through June 30, 1995 for
programs which were allegedly not health education or tobacco-related disease
research. The superior court issued an order in December 1998, granting the
State's demurrer to the entire action and dismissing the case. Plaintiffs have
asked the court to reconsider its ruling.
In Capitola Land v. Anderson and other related state and federal cases,
plaintiffs sought payments from the State under the AFDC-Foster Care program.
Judgment was rendered against the State in Capitola, which the State appealed
and lost. The State then filed a state plan amendment with the federal
Department of Health and Human Services to enable the State to comply with the
Capitola ruling and receive federal funding. The DHHS denied the state plan
amendment, and the State has filed suit against DHHS. The Legislature also
enacted a statute which required federal funding in order to comply with the
Capitola judgment. The State then refused to implement the Capitola judgment
based on the new statute. Certain plaintiffs moved for an order of contempt
against the State, which was granted by the trial court, but was stayed and
annulled by the Court of Appeal. The plaintiffs are petitioning the California
Supreme Court for review. If, as a result of this litigation, compliance with
the Capitola judgment is required and the judgment is applied retroactively,
liability to the State could exceed $200 million.
In late 1998, the State signed a settlement agreement with the four major
cigarette manufacturers, which was later ratified by a State court judge having
jurisdiction over a pending lawsuit brought by the State against these
companies. Under the settlement, the companies will pay California governments a
total of approximately $25 billion over a period of 25 years, starting with some
payments in the spring of 1999. Under the State's settlement, half of these
moneys will be paid to the State, and half to local governments (cities and
counties). The specific amount to be received by the State and local governments
is, however, subject to adjustment for a number of reasons. First, the federal
government has indicated that it may seek recovery of part of the State's
settlement as reimbursement for federal Medicaid funding in prior years. The
State expects to resist such a claim, which may ultimately be resolved by
Congress. Second, various details in the settlement allow reduction of the
companies' payments because of events such as certain federal government
actions, reductions in cigarette sales, or bankruptcy of any settling companies.
On June 24, 1998, plaintiffs in Howard Jarvis Taxpayers Association et al.
v. Kathleen Connell filed a complaint for certain declaratory and injunctive
relief challenging the authority of the State Controller to make payments from
the State Treasury in the absence of a state budget. On July 21, 1998, the trial
court issued a preliminary injunction prohibiting the State Controller from
paying moneys from the State Treasury for fiscal year 1998-99, with certain
limited exceptions, in the absence of a state budget. The preliminary
injunction, among other things, prohibited the State Controller from making any
payments pursuant to any continuing appropriation.
On July 22 and 27, 1998, various employee unions which had intervened in
the case appealed the trial court's preliminary injunction and asked the Court
of Appeal to stay the preliminary injunction. On July 28, 1998, the Court of
Appeal granted the unions' requests and stayed the preliminary injunction
pending the Court of Appeal's decision on the merits of the appeal. On August 5,
1998, the Court of Appeal denied the plaintiffs' request to reconsider the stay.
Also on July 22, 1998, the State Controller asked the California Supreme Court
to immediately stay the trial court's preliminary injunction and to
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overrule the order granting the preliminary injunction on the merits. On July
29, 1998, the Supreme Court transferred the State Controller's request to the
Court of Appeal. The matters are now pending before the Court of Appeal.
In Jordan v. Department of Motor Vehicles, plaintiff challenged the
validity and constitutionality of the State's smog impact fee and requested a
refund of the fee. In October 1997, the trial court ruled in favor of the
plaintiff and, in addition, ordered the State to provide refunds to all persons
who paid the smog impact fee from the years before the filing of the lawsuit in
1995 to the present. The Plaintiff asserts that the total amount required to be
refunded will exceed $350 million. The State has appealed.
A judgment was entered for the plaintiff in August 1998 in the case of
Ceridian Corporation v. Franchise Tax Board, a suit which challenged the
validity of two sections of the California Tax laws. The first related to
deduction from corporate taxes for dividends received from insurance companies
to the extent the insurance companies have California activities. The second
related to corporate deduction of dividends to the extent the earnings of the
dividend-paying corporation have already been included in the measure of their
California tax. If both sections of the California Tax law are ultimately
invalidated, and all dividends become deductible, then the General Fund can
become liable for approximately $200 to $250 million annually. The State has
appealed the decision.
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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.
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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.
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.
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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.
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
B
CCC
CC
C Debt rated "BB," "B," "CCC," "CC" and "C" are regarded as having
significant speculative characteristics. "BB" indicates the least
degree of speculation and "C" the highest degree of speculation.
While such debt will likely have some quality and protective
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.
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DESCRIPTION OF STANDARD & POOR'S COMMERCIAL PAPER RATINGS
A Standard & Poor's commercial paper rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of no more than
365 days. Ratings are graded into several categories, ranging from "A-1" for the
highest-quality obligations to "D" for the lowest. These categories are as
follows:
A-1 This 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."
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.
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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.
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.
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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.
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.
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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
DD
D Bonds are in default on interest and/or principal payments. Such
bonds are extremely speculative and should be valued on the basis
of their ultimate recovery value in liquidation or reorganization
of the obligor. "DDD" represents the highest potential for
recovery on these bonds, and "D" represents the lowest potential
for recovery.
Plus (+) or Minus (-): Plus and minus signs are used with a rating symbol
to indicate the relative position of a credit within the rating category. Plus
and minus signs, however, are not used in the "DDD," "DD," or "D" categories.
DESCRIPTION OF FITCH'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.
71
<PAGE> 73
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 California 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
California 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 California
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 its 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 California 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 fund will seek to utilize insurance companies that 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 ("Moody's"). There
can be no assurance however, that insurance from insurance carriers meeting
these criteria will be at all times available.
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.
Capacity to honor insurance contracts is considered by S&P to be extremely
strong and highly likely to remain so over a long period of time. 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. 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
72
<PAGE> 74
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.
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.
73
<PAGE> 75
APPENDIX IV
TAXABLE EQUIVALENT YIELDS FOR 1999
<TABLE>
<CAPTION>
1999
TAXABLE INCOME* CALIFORNIA A TAX-FREE YIELD OF
- ------------------------------------ 1999 FEDERAL TAX ---------------------------------------------
SINGLE RETURN JOINT RETURN TAX BRACKET BRACKET 5.00% 5.50% 6.00% 6.50% 7.00% 7.50%
- ----------------- ----------------- ------------ ---------- ----- ----- ----- ----- ----- -----
IS EQUAL TO A TAXABLE YIELD OF
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
$ 26,645-$ 33,673 $ 53,288-$ 67,346 28.00% 8.0% 7.55 8.30 9.06 9.81 10.57 11.32
$ 33,674-$ 62,450 $ 67,347-$104,050 28.00% 9.3% 7.66 8.42 9.19 9.95 10.72 11.48
$ 62,451-$130,250 $104,051-$158,550 31.00% 9.3% 7.99 8.79 9.59 10.39 11.19 11.98
$130,251-$283,150 $158,551-$283,150 36.00% 9.3% 8.61 9.47 10.34 11.20 12.06 12.92
Over $283,150 Over $283,150 39.60% 9.3% 9.13 10.04 10.95 11.87 12.78 13.69
</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. For investors who pay Federal alternative minimum tax, tax-free
yields may be equivalent to lower taxable yields than those shown above.
Shareholders subject to income taxation by states other than California will
realize a lower after-tax return than California shareholders. This table is a
combination of the Federal and California taxable income brackets, which are
adjusted annually for inflation. The California taxable income brackets have
not yet been adjusted for 1999. The California taxable yields set forth in the
above table presume that taxpayers in each Federal tax bracket are in the
highest California tax bracket corresponding to that Federal bracket. The tax
rates shown above do not apply to corporate taxpayers subject to the
California corporate franchise tax. The tax characteristics of the Fund are
described more fully elsewhere in this prospectus. Consult your tax adviser
for further details. This chart is for illustrative purposes only and cannot
be taken as an indication of anticipated Fund performance.
74
<PAGE> 76
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<PAGE> 77
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<PAGE> 78
(This page intentionally left blank.)
<PAGE> 79
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Through and including October 18, 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 as underwriters and with respect to their unsold allotments or
subscriptions.
4,900,000 SHARES
MUNIHOLDINGS CALIFORNIA INSURED FUND V, INC.
COMMON STOCK
---------------------
PROSPECTUS
---------------------
MERRILL LYNCH & CO.
JULY 20, 1999
CODE 19061-0799
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 80
PART C. OTHER INFORMATION
ITEM 24. FINANCIAL STATEMENTS AND EXHIBITS.
(1) Financial Statements
Independent Auditors' Report
Statement of Assets, Liabilities and Capital as of June 15, 1999
Notes to Statement of Assets, Liabilities and Capital as of June 15,
1999
(2) Exhibits:
<TABLE>
<CAPTION>
DESCRIPTION
-----------
<S> <C> <C>
(a)(1) -- Articles of Incorporation of the Fund(a)
(b) -- By-Laws of the Fund(a)
(c) -- Not applicable.
(d)(1) -- Portions of the Articles of Incorporation and By-Laws of the
Fund defining the rights of holders of shares of common
stock of the Fund(b)
(d)(2) -- Form of specimen certificate for shares of common stock of
the Fund(c)
(e) -- Form of Dividend Reinvestment Plan(c)
(f) -- Not applicable
(g) -- Form of Investment Advisory Agreement between the Fund and
Fund Asset Management, L.P.(c)
(h)(1) -- Form of Purchase Agreement between the Fund and Merrill
Lynch, Pierce, Fenner & Smith Incorporated(c)
(h)(2) -- Merrill Lynch Standard Dealer Agreement(c)
(i) -- Not applicable
(j) -- Form of Custodian Contract between the Fund and State Street
Bank and Trust Company
(k) -- Form of Registrar, Transfer Agency and Service Agreement
between the Fund and State Street Bank and Trust Company
(l) -- Opinion and Consent of Brown & Wood LLP
(m) -- Not applicable
(n)(2) -- 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
</TABLE>
- ---------------
(a) Filed on April 30, 1999 as an exhibit to the Registrant's Registration
Statement on Form N-2 (File No. 333-77531).
(b) Reference is made to Article V, Article VI (sections 2, 3, 4, 5 and 6),
Article VII, Article VIII, Article X, Article XI, Article XII and Article
XIII of the Registrant's Articles of Incorporation, filed as Exhibit (a) 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.
(c) Filed on May 18, 1999 as an exhibit to the Registrant's Registration
Statement on Form N-2 (File No. 333-77531).
C-1
<PAGE> 81
ITEM 25. MARKETING ARRANGEMENTS.
See Exhibits (h)(1) and (2).
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........................................... $ 23,498
New York Stock Exchange listing fee......................... 88,100
Printing (other than stock certificates).................... 35,000
Engraving and printing stock certificates................... 20,000
Legal fees and expenses..................................... 35,000
NASD fees................................................... 8,953
Miscellaneous............................................... 4,449
--------
Total............................................. $215,000
========
</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 Stock-Common Stock" and
in Note 1 to the Statement of Assets, Liabilities and Capital is incorporated
herein by reference.
ITEM 28. NUMBER OF HOLDERS OF SECURITIES.
There will be one record holder of the Common Stock, par value $0.10 per
share, as of the effective date of this Registration Statement.
ITEM 29. INDEMNIFICATION.
Section 2-418 of the General Corporation Law of the State of Maryland,
Article VI of the Registrant's Articles of Incorporation, filed as Exhibit
(a)(1) to this Registration Statement, Article VI of the Registrant's By-Laws,
filed as Exhibit (b) to this Registration Statement, and the Investment Advisory
Agreement, a form of which is filed as Exhibit (g)(1) to this Registration
Statement, provide for indemnification.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933, as amended (the "1933 Act"), may be provided to directors, officers and
controlling persons of the Fund, pursuant to the foregoing provisions or
otherwise, the Fund has been advised that in the opinion of the Securities and
Exchange Commission, such indemnification is against public policy as expressed
in the 1933 Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the Fund of
expenses incurred or paid by a director, officer or controlling person of the
Fund in connection with any successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the Fund will, unless in the
opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the 1933 Act and
will be governed by the final adjudication of such issue.
C-2
<PAGE> 82
Reference is made to Section Six of the Purchase Agreement, a form of which
is filed as Exhibit (h)(1) hereto, for provisions relating to the
indemnification of the underwriter.
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, MuniHoldings Florida
Insured Fund III, MuniHoldings Florida Insured Fund IV, MuniHoldings Insured
Fund, Inc., MuniHoldings Insured Fund II, Inc., MuniHoldings Insured Fund III,
Inc., MuniHoldings Michigan Insured Fund, Inc., MuniHoldings New Jersey Insured
Fund, Inc., MuniHoldings New Jersey Insured Fund II, Inc., MuniHoldings New
Jersey Insured 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 Florida Fund, MuniVest Fund, Inc.,
MuniVest Fund II, Inc., MuniVest Michigan Insured Fund, Inc., MuniVest New
Jersey Fund, Inc., MuniVest Pennsylvania Insured Fund, MuniYield Arizona Fund,
Inc., MuniYield California Fund, Inc., MuniYield California Insured Fund, Inc.,
MuniYield California Insured Fund II, Inc., MuniYield Florida Fund, MuniYield
Florida Insured Fund, MuniYield Fund, Inc., MuniYield Insured Fund, Inc.,
MuniYield Michigan Fund, Inc., MuniYield Michigan Insured Fund, Inc., MuniYield
New Jersey Fund, Inc., MuniYield New Jersey Insured Fund, Inc., MuniYield New
York Insured Fund, Inc., MuniYield New York Insured Fund II, Inc., MuniYield
Pennsylvania Fund, MuniYield Quality Fund, Inc., MuniYield Quality Fund II,
Inc., Senior High Income Portfolio, Inc., 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
Disciplined Equity Fund, Inc., Merrill Lynch Dragon Fund, Inc., Merrill Lynch
EuroFund, Merrill Lynch Fundamental Growth Fund, Inc., Merrill Lynch Global
C-3
<PAGE> 83
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 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., Merrill Lynch
Senior Floating Rate Fund, Inc., and Merrill Lynch Senior Floating Rate Fund II,
Inc. MLAM also acts as sub-adviser to Merrill Lynch World Strategy Portfolio and
Merrill Lynch Basic Equity Portfolio, two investment portfolios of EQ Advisors
Trust.
The address of each of these registered investment companies is P.O. Box
9011, Princeton, New Jersey 08543-9011, except that the address of Merrill Lynch
Funds for Institutions Series and Merrill Lynch Intermediate Government Bond
Fund is One Financial Center, 23rd Floor, Boston, Massachusetts 02111-2665.
The address of the Investment Adviser, MLAM, 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, North Tower, 250 Vesey Street, New York, New York
10281-1201.
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. Glenn is
President and Mr. Burke is Vice President and Treasurer of all or substantially
all of the investment companies described in the first two paragraphs of this
Item 30 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 and Monagle are officers of one or more of
such companies.
<TABLE>
<CAPTION>
POSITION(S) WITH OTHER SUBSTANTIAL BUSINESS,
NAME INVESTMENT ADVISER PROFESSION, VOCATION OR EMPLOYMENT
---- ---------------------------- ----------------------------------
<S> <C> <C>
ML&Co.................................. Limited Partner Financial Services Holding
Company; Limited Partner of FAM
Princeton Services..................... General Partner General Partner of MLAM
</TABLE>
C-4
<PAGE> 84
<TABLE>
<CAPTION>
POSITION(S) WITH OTHER SUBSTANTIAL BUSINESS,
NAME INVESTMENT ADVISER PROFESSION, VOCATION OR EMPLOYMENT
---- ---------------------------- ----------------------------------
<S> <C> <C>
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.
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 FDS; President of
Princeton Administrators, L.P.
Donald C. Burke........................ Senior Vice President and Senior Vice President, Treasurer
Treasurer and 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; Treasurer and Director
of PFD; First Vice President of
MLAM from 1997 to 1999; Vice
President of MLAM from 1996 to
1997
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
Michael J. Hennewinkel................. Senior Vice President, Senior Vice President of MLAM;
General Counsel and Senior Vice President, Director
Secretary and Secretary of Princeton
Services
</TABLE>
C-5
<PAGE> 85
<TABLE>
<CAPTION>
POSITION(S) WITH OTHER SUBSTANTIAL BUSINESS,
NAME INVESTMENT ADVISER PROFESSION, VOCATION OR EMPLOYMENT
---- ---------------------------- ----------------------------------
<S> <C> <C>
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-Yaros................ Senior Vice President Vice President of PFD
Joseph T. Monagle, Jr.................. Senior Vice President Senior Vice President of MLAM;
Senior Vice President of Princeton
Services
Brian A. Murdock....................... Senior Vice President Senior Vice President of MLAM;
Senior Vice President of Princeton
Services Senior Vice President and
Treasurer of MLAM;
Gregory D. Upah........................ Senior Vice President Senior Vice President of MLAM;
Senior Vice President of Princeton
Services
</TABLE>
ITEM 31. LOCATION OF ACCOUNT AND RECORDS.
All accounts, books and other documents required to be maintained by
Section 31(a) of the Investment Company Act of 1940, as amended, and the Rules
promulgated thereunder are maintained at the offices of the Registrant (800
Scudders Mill Road, Plainsboro, New Jersey 08536), its investment adviser (800
Scudders Mill Road, Plainsboro, New Jersey 08536), and its custodian and
transfer agent.
ITEM 32. MANAGEMENT SERVICES.
Not applicable.
ITEM 33. UNDERTAKINGS.
(a) Registrant undertakes to suspend the offering of the shares of common
stock covered hereby until it amends its prospectus contained herein if (1)
subsequent to the effective date of this Registration Statement, its net asset
value per share of common stock declines more than 10% from its net asset value
per share of common stock as of the effective date of this Registration
Statement, or (2) its net asset value per share of common stock increases to an
amount greater than its net proceeds as stated in the prospectus contained
herein.
(b) Registrant undertakes that:
(1) For purposes of determining any liability under the 1933 Act, the
information omitted from the form of prospectus filed as part of this
Registration Statement in reliance upon Rule 430A and contained in the form
of prospectus filed by the registrant pursuant to Rule 497(h) under the
1933 Act shall be deemed to be part of this Registration Statement as of
the time it was declared effective.
C-6
<PAGE> 86
(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-7
<PAGE> 87
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant has duly caused this
Pre-Effective Amendment to its 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 20(th) day of July, 1999.
MUNIHOLDINGS CALIFORNIA INSURED FUND V,
INC.
(Registrant)
By: /s/ TERRY K. GLENN
--------------------------------------
(Terry K. Glenn, President)
Each person whose signature appears below hereby authorizes Terry K. Glenn,
Donald C. Burke or William E. Zitelli, Jr., 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 date indicated.
<TABLE>
<CAPTION>
SIGNATURES TITLE DATE
---------- ----- ----
<C> <S> <C>
/s/ TERRY K. GLENN President (Principal Executive July 20, 1999
- --------------------------------------------------- Officer) and Director
(Terry K. Glenn)
/s/ DONALD C. BURKE Treasurer (Principal Financial and July 20, 1999
- --------------------------------------------------- Accounting Officer)
(Donald C. Burke)
/s/ RONALD W. FORBES Director July 20, 1999
- ---------------------------------------------------
(Ronald W. Forbes)
/s/ CYNTHIA A. MONTGOMERY Director July 20, 1999
- ---------------------------------------------------
(Cynthia A. Montgomery)
/s/ CHARLES C. REILLY Director July 20, 1999
- ---------------------------------------------------
(Charles C. Reilly)
/s/ KEVIN A. RYAN Director July 20, 1999
- ---------------------------------------------------
(Kevin A. Ryan)
/s/ RICHARD R. WEST Director July 20, 1999
- ---------------------------------------------------
(Richard R. West)
/s/ ARTHUR ZEIKEL Director July 20, 1999
- ---------------------------------------------------
(Arthur Zeikel)
</TABLE>
C-8
<PAGE> 88
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBITS DESCRIPTION
- -------- -----------
<C> <S>
(j) Form of Custodian Contract between the Fund and State Street
Bank and Trust Company.
(k) Form of Registrar, Transfer Agency and Service Agreement
between the Fund and State Street Bank and Trust Company.
(l) Opinion and Consent of Brown & Wood LLP.
(n)(2) Consent of Deloitte & Touche LLP, independent auditors for
the Fund.
(p) Certificate of Fund Asset Management, L.P.
</TABLE>
C-9
<PAGE> 1
CUSTODIAN CONTRACT
Between
MUNIHOLDINGS CALIFORNIA INSURED FUND V, INC.
and
STATE STREET BANK AND TRUST COMPANY
<PAGE> 2
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
------
<S> <C>
1. Employment of Custodian and Property to be Held By
It......................................................... 1
2. Duties of the Custodian with Respect to Property
of the Fund Held by the Custodian in the United States 1
2.1 Holding Securities................................... 1
2.2 Delivery of Securities............................... 2
2.3 Registration of Securities........................... 4
2.4 Bank Accounts........................................ 4
2.5 Availability of Federal Funds........................ 4
2.6 Collection of Income................................. 4
2.7 Payment of Fund Monies............................... 5
2.8 Liability for Payment in Advance of
Receipt of Securities Purchased...................... 6
2.9 Appointment of Agents................................ 6
2.10 Deposit of Fund Assets in Securities System.......... 6
2.10A Fund Assets Held in the Custodian's Direct
Paper System......................................... 7
2.11 Segregated Account................................... 8
2.12 Ownership Certificates for Tax Purposes.............. 9
2.13 Proxies.............................................. 9
2.14 Communications Relating to Portfolio Securities...... 9
2.15 Reports to Fund by Independent Public Accountants.... 9
3. Duties of the Custodian with Respect to Property of
the Fund Held Outside of the United States 9
3.1 Appointment of Foreign Sub-Custodians................ 9
3.2 Assets to be Held.................................... 10
3.3 Foreign Securities Systems........................... 10
3.4 Agreements with Foreign Banking Institutions......... 10
3.5 Access of Independent Accountants of the Fund........ 10
3.6 Reports by Custodian................................. 10
3.7 Transactions in Foreign Custody Account.............. 11
3.8 Liability of Foreign Sub-Custodians.................. 11
3.9 Liability of Custodian............................... 11
3.10 Reimbursement for Advances........................... 12
3.11 Monitoring Responsibilities.......................... 12
3.12 Branches of U.S. Banks............................... 12
3.13 Tax Law.............................................. 12
</TABLE>
<PAGE> 3
<TABLE>
<S> <C>
4. Proper Instructions..................................................... 13
5. Actions Permitted Without Express Authority............................. 13
6. Evidence of Authority................................................... 13
7. Duties of Custodian With Respect to the Books of Account and Calculation
of Net Asset Value and Net Income....................................... 14
8. Records................................................................. 14
9. Opinion of Fund's Independent Accountants............................... 14
10. Compensation of Custodian............................................... 15
11. Responsibility of Custodian............................................. 15
12. Effective Period, Termination and Amendment............................. 16
13. Successor Custodian..................................................... 16
14. Interpretive and Additional Provisions.................................. 17
15. Massachusetts Law to Apply.............................................. 17
16. Prior Contracts......................................................... 17
17. Shareholder Communications Election..................................... 18
</TABLE>
<PAGE> 4
This Contract between MuniHoldings California Insured Fund V,
Inc., a corporation organized and existing under the laws of Maryland,
having its principal place of business at 800 Scudders Mill Road,
Plainsboro, New Jersey 08536 hereinafter called the "Fund", and State
Street Bank and Trust Company, a Massachusetts trust company, having
its principal place of business at 225 Franklin Street, Boston,
Massachusetts, 02110, hereinafter called the "Custodian", in
consideration of the mutual covenants and agreements hereinafter
contained, the parties hereto agree as follows:
1. Employment of Custodian and Property to be Held by It
The Fund hereby employs the Custodian as the custodian of the
assets of the Fund, including securities which the Fund desires to be
held in places within the United States ("domestic securities") and
securities it desires to be held outside the United States ("foreign
securities") pursuant to the provisions of the Articles of
Incorporation. For purposes of this Contract, "domestic securities"
and "foreign securities" each shall include agreements representing
corporate loans and interests therein. The Fund agrees to deliver to
the Custodian all securities and cash of the Fund, and all payments of
income, payments of principal or capital distributions received by it
with respect to all securities owned by the Fund from time to time,
and the cash consideration received by it for such new or treasury
shares of capital stock of the Fund ("Shares") as may be issued or
sold from time to time. The Custodian shall not be responsible for any
property of the Fund held or received by the Fund and not
delivered to the Custodian.
Upon receipt of "Proper Instructions" (within the meaning of
Article 4), the Custodian shall on behalf of the Fund from time to
time employ one or more sub-custodians, located in the United States
but only in accordance with an applicable vote by the Board of
Directors of the Fund. The Custodian covenants with the Fund that each
agreement whereby the Custodian employs any such sub-custodian shall
provide that the sub-custodian will be liable to the Custodian for
losses and liabilities caused by the negligence, misfeasance, or
willful misconduct of the sub-custodian. The Fund agrees that, so
long as the Custodian has complied with its obligation set forth in
the preceding sentence, the Custodian shall have no more or less
responsibility or liability to the Fund on account of any actions or
omissions of any U.S. sub-custodian employed by it on behalf of the
Fund than any such sub-custodian has to the Custodian. The Custodian
may employ as sub-custodian for the Fund's foreign securities the
foreign banking institutions and foreign securities depositories
designated in Schedule A hereto but only in accordance with the
provisions of Article 3.
2. Duties of the Custodian with Respect to Property of the Fund Held
By the Custodian in the United States
2.1 Holding Securities. The Custodian shall hold and physically
segregate for the account of the Fund all non-cash property, to
be held by it in the United States including all domestic
securities owned by the Fund, other than (a) securities which are
maintained pursuant to Section 2.10 in a clearing agency which
acts as a securities depository or in a book-entry system
authorized by the U.S. Department of the Treasury (collectively
referred to herein as "Securities System") and (b) commercial
paper of an issuer for which State Street Bank and Trust Company
acts as issuing and paying agent ("Direct Paper") which is
deposited and/or maintained in the Direct Paper System of the
Custodian (the "Direct Paper System") pursuant to Section 2.10A.
<PAGE> 5
2.2 Delivery of Securities. The Custodian shall release and deliver
domestic securities owned by the Fund held by the Custodian or in
a Securities System account of the Custodian or in the
Custodian's Direct Paper book entry system account ("Direct Paper
System Account") only upon receipt of Proper Instructions from
the Fund, which may be continuing instructions when deemed
appropriate by the parties, and only in the following cases:
1) Upon sale of such securities for the account of the Fund and
receipt of payment therefor;
2) Upon the receipt of payment in connection with any
repurchase agreement related to such securities entered into
by the Fund;
3) In the case of a sale effected through a Securities System,
in accordance with the provisions of Section 2.10 hereof;
4) To the depository agent in connection with tender or other
similar offers for securities of the Fund;
5) To the issuer thereof or its agent when such securities are
called, redeemed, retired or otherwise become payable;
provided that, in any such case, the cash or other
consideration is to be delivered to the Custodian;
6) To the issuer thereof, or its agent, for transfer into the
name of the Fund or into the name of any nominee or nominees
of the Custodian or into the name or nominee name of any
agent appointed pursuant to Section 2.9 or into the name or
nominee name of any sub-custodian appointed pursuant to
Article 1; or for exchange for a different number of bonds,
certificates or other evidence representing the same
aggregate face amount or number of units; provided that, in
any such case, the new securities are to be delivered to the
Custodian;
7) Upon the sale of such securities for the account of the
Fund, to the broker or its clearing agent, against a
receipt, for examination in accordance with "street
delivery" custom; provided that in any such case, the
Custodian shall have no responsibility or liability for any
loss arising from the delivery of such securities prior to
receiving payment for such securities except as may arise
from the Custodian's own negligence or willful misconduct;
8) For exchange or conversion pursuant to any plan of merger,
consolidation, recapitalization, reorganization or
readjustment of the securities of the issuer of such
securities, or pursuant to provisions for conversion
contained in such securities, or pursuant to any deposit
agreement; provided that, in any such case, the new
securities and cash, if any, are to be delivered to the
Custodian;
9) In the case of warrants, rights or similar securities, the
surrender thereof in the exercise of such warrants, rights
or similar securities or the surrender of interim
2
<PAGE> 6
receipts or temporary securities for definitive securities;
provided that, in any such case, the new securities and
cash, if any, are to be delivered to the Custodian;
10) For delivery in connection with any loans of securities made
by the Fund, but only against receipt of adequate collateral
as agreed upon from time to time by the Custodian and the
Fund, which may be in the form of cash or obligations issued
by the United States government, its agencies or
instrumentalities, except that in connection with any loans
for which collateral is to be credited to the Custodian's
account in the book-entry system authorized by the U.S.
Department of the Treasury, the Custodian will not be held
liable or responsible for the delivery of securities owned
by the Fund prior to the receipt of such collateral except
as may arise from the Custodian's own negligence or willful
misconduct;
11) For delivery as security in connection with any borrowings
by the Fund requiring a pledge of assets by the Fund, but
only against receipt of amounts borrowed;
12) For delivery in accordance with the provisions of any
agreement among the Fund, the Custodian and a broker-dealer
registered under the Securities Exchange Act of 1934 (the
"Exchange Act") and a member of The National Association of
Securities Dealers, Inc. ("NASD"), relating to compliance
with the rules of The Options Clearing Corporation and of
any registered national securities exchange, or of any
similar organization or organizations, regarding escrow or
other arrangements in connection with transactions by the
Fund;
13) For delivery in accordance with the provisions of any
agreement among the Fund, the Custodian, and a Futures
Commission Merchant registered under the Commodity Exchange
Act, relating to compliance with the rules of the Commodity
Futures Trading Commission and/or any contract market, or
any similar organization or organizations, regarding account
deposits in connection with transactions by the Fund; and
14) For any other proper corporate purpose, but only upon
receipt of, in addition to Proper Instructions from the
Fund, a certified copy of a resolution of the Board of
Directors or of the Executive Committee signed by an officer
of the Fund and certified by the Secretary or an Assistant
Secretary, specifying the securities of the Fund to be
delivered, setting forth the purpose for which such delivery
is to be made, declaring such purpose to be a proper
corporate purpose, and naming the person or persons to whom
delivery of such securities shall be made.
2.3 Registration of Securities. Domestic securities held by the
Custodian (other than bearer securities) shall be registered in
the name of the Fund or in the name of any nominee of the Fund or
of any nominee of the Custodian which nominee shall be assigned
exclusively to the Fund, unless the Fund has authorized in
writing the appointment of a nominee to be used in common with
other registered investment companies having the same investment
adviser as the Fund, or in the name or nominee name of any agent
appointed pursuant to Section 2.9 or in the name or nominee name
of any sub-custodian appointed pursuant to
3
<PAGE> 7
Article 1. All securities accepted by the Custodian on behalf of
the Fund under the terms of this Contract shall be in "street
name" or other good delivery form. If, however, the Fund directs
the Custodian to maintain securities in "street name", the
Custodian shall utilize all reasonable efforts to timely collect
income due the Fund on such securities and to notify the Fund of
relevant corporate actions including, without limitation,
pendency of calls, maturities, tender or exchange offers.
2.4 Bank Accounts. The Custodian shall open and maintain a separate
bank account or accounts in the United States in the name of the
Fund, subject only to draft or order by the Custodian acting
pursuant to the terms of this Contract, and shall hold in such
account or accounts, subject to the provisions hereof, all cash
received by it from or for the account of the Fund, other than
cash maintained by the Fund in a bank account established and
used in accordance with Rule 17f-3 under the Investment Company
Act of 1940. Funds held by the Custodian for the Fund may be
deposited by it to its credit as Custodian in the Banking
Department of the Custodian or in such other banks or trust
companies as it may in its discretion deem necessary or
desirable; provided, however, that every such bank or trust
company shall be qualified to act as a custodian under the
Investment Company Act of 1940 and that each such bank or trust
company and the funds to be deposited with each such bank or
trust company shall be approved by vote of a majority of the
Board of Directors of the Fund. Such funds shall be deposited by
the Custodian in its capacity as Custodian and shall be
withdrawable by the Custodian only in that capacity.
2.5 Availability of Federal Funds. Upon mutual agreement between the
Fund and the Custodian, the Custodian shall, upon the receipt of
Proper Instructions from the Fund, make federal funds available
to the Fund as of specified times agreed upon from time to time
by the Fund and the Custodian in the amount of checks received in
payment for Shares of the Fund which are deposited into the
Fund's account.
2.6 Collection of Income. Subject to the provisions of Section 2.3,
the Custodian shall collect on a timely basis all income and
other payments with respect to registered domestic securities
held hereunder to which the Fund shall be entitled either by law
or pursuant to custom in the securities business, and shall
collect on a timely basis all income and other payments with
respect to bearer domestic securities if, on the date of payment
by the issuer, such securities are held by the Custodian or its
agent thereof and shall credit such income, as collected, to such
Fund's custodian account. Without limiting the generality of the
foregoing, the Custodian shall detach and present for payment all
coupons and other income items requiring presentation as and when
they become due and shall collect interest when due on securities
held hereunder. Income due the Fund on securities loaned
pursuant to the provisions of Section 2.2(10) shall be the
responsibility of the Fund. The Custodian will have no duty or
responsibility in connection therewith, other than to exercise
reasonable care in providing the Fund with such information or
data as may be necessary to assist the Fund in arranging for the
timely delivery to the Custodian of the income to which the Fund
is properly entitled.
4
<PAGE> 8
2.7 Payment of Fund Monies. Upon receipt of Proper Instructions from
the Fund, which may be continuing instructions when deemed
appropriate by the parties, the Custodian shall pay out monies of
the Fund in the following cases only:
1) Upon the purchase of domestic securities, options, futures
contracts or options on futures contracts for the Fund but
only (a) against the delivery of such securities or evidence
of title to such options, futures contracts or options on
futures contracts to the Custodian (or any bank, banking
firm or trust company doing business in the United States or
abroad which is qualified under the Investment Company Act
of 1940, as amended, to act as a custodian and has been
designated by the Custodian as its agent for this purpose)
registered in the name of the Fund or in the name of a
nominee of the Custodian referred to in Section 2.3 hereof
or in proper form for transfer; (b) in the case of a
purchase effected through a Securities System, in accordance
with the conditions set forth in Section 2.10 hereof; (c) in
the case of a purchase involving the Direct Paper System, in
accordance with the conditions set forth in Section 2.10A
hereof; (d) in the case of repurchase agreements entered
into between the Fund and the Custodian, or another bank, or
a broker-dealer which is a member of NASD, (i) against
delivery of the securities either in certificate form or
through an entry crediting the Custodian's account at the
Federal Reserve Bank with such securities or (ii) against
delivery of the receipt evidencing purchase by the Fund of
securities owned by the Custodian along with written
evidence of the agreement by the Custodian to repurchase
such securities from the Fund or (e) for transfer to a time
deposit account of the Fund in any bank, whether domestic or
foreign; such transfer may be effected prior to receipt of a
confirmation from a broker and/or the applicable bank
pursuant to Proper Instructions as defined in Article 4;
2) In connection with conversion, exchange or surrender of
securities owned by the Fund as set forth in Section 2.2
hereof;
3) For the payment of any expense or liability incurred by the
Fund, including but not limited to the following payments
for the account of the Fund: interest, taxes, management,
accounting, transfer agent and legal fees, and operating
expenses of the Fund whether or not such expenses are to be
in whole or part capitalized or treated as deferred
expenses;
4) For the payment of any dividends on Shares of the Fund
declared pursuant to the governing documents of the Fund;
5) For payment of the amount of dividends received in respect
of securities sold short;
6) For any other proper purpose, but only upon receipt of, in
addition to Proper Instructions from the Fund, a certified
copy of a resolution of the Board of Directors or of the
Executive Committee of the Fund signed by an officer of the
Fund and certified by its Secretary or an Assistant
Secretary, specifying the amount of such payment, setting
forth the purpose for which such payment is to be made,
declaring
5
<PAGE> 9
such purpose to be a proper purpose, and naming the person
or persons to whom such payment is to be made.
2.8 Liability for Payment in Advance of Receipt of Securities
Purchased. Except as specifically stated otherwise in this
Contract, in any and every case where payment for purchase of
domestic securities for the account of the Fund is made by the
Custodian in advance of receipt of the securities purchased in
the absence of specific written instructions from the Fund to so
pay in advance, the Custodian shall be absolutely liable to the
Fund for such securities to the same extent as if the securities
had been received by the Custodian.
2.9 Appointment of Agents. The Custodian may at any time or times in
its discretion appoint (and may at any time remove) any other
bank or trust company which is itself qualified under the
Investment Company Act of 1940, as amended, to act as a
custodian, as its agent to carry out such of the provisions of
this Article 2 as the Custodian may from time to time direct;
provided, however, that the appointment of any agent shall not
relieve the Custodian of its responsibilities or liabilities
hereunder.
2.10 Deposit of Fund Assets in Securities Systems. The Custodian may
deposit and/or maintain securities owned by the Fund in a
clearing agency registered with the Securities and Exchange
Commission under Section 17A of the Securities Exchange Act of
1934, which acts as a securities depository, or in the book-entry
system authorized by the U.S. Department of the Treasury and
certain federal agencies, collectively referred to herein as
"Securities System" in accordance with applicable Federal Reserve
Board and Securities and Exchange Commission rules and
regulations, if any, and subject to the following provisions:
1) The Custodian may keep securities of the Fund in a
Securities System provided that such securities are
represented in an account ("Account") of the Custodian in
the Securities System which shall not include any assets of
the Custodian other than assets held as a fiduciary,
custodian or otherwise for customers;
2) The records of the Custodian with respect to securities of
the Fund which are maintained in a Securities System shall
identify by book-entry those securities belonging to the
Fund;
3) The Custodian shall pay for securities purchased for the
account of the Fund upon (i) receipt of advice from the
Securities System that such securities have been transferred
to the Account, and (ii) the making of an entry on the
records of the Custodian to reflect such payment and
transfer for the account of the Fund. The Custodian shall
transfer securities sold for the account of the Fund upon
(i) receipt of advice from the Securities System that
payment for such securities has been transferred to the
Account, and (ii) the making of an entry on the records of
the Custodian to reflect such transfer and payment for the
account of the Fund. Copies of all advices from the
Securities System of transfers of securities for the account
of the Fund shall identify the Fund, be maintained for the
Fund by the Custodian and be provided to the Fund at its
request. Upon request, the Custodian shall furnish the
6
<PAGE> 10
Fund confirmation of each transfer to or from the account of
the Fund in the form of a written advice or notice and shall
furnish to the Fund copies of daily transaction sheets
reflecting each day's transactions in the Securities System
for the account of the Fund;
4) The Custodian shall provide the Fund with any report
obtained by the Custodian on the Securities System's
accounting system, internal accounting control and
procedures for safeguarding securities deposited in the
Securities System;
5) The Custodian shall have received from the Fund the initial
or annual certificate, as the case may be, required by
Article 12 hereof;
6) Anything to the contrary in this Contract notwithstanding,
the Custodian shall be liable to the Fund for any loss or
damage to the Fund resulting from use of the Securities
System by reason of any negligence, misfeasance or
misconduct of the Custodian or any of its agents or of any
of its or their officers or employees or from failure of the
Custodian or any such agent to enforce effectively such
rights as it may have against the Securities System; at the
election of the Fund, it shall be entitled to be subrogated
to the rights of the Custodian with respect to any claim
against the Securities System or any other person which the
Custodian may have as a consequence of any such loss or
damage if and to the extent that the Fund has not been made
whole for any such loss or damage.
2.10A Fund Assets Held in the Custodian's Direct Paper System. The
Custodian may deposit and/or maintain securities owned by the
Fund in the Direct Paper System of the Custodian subject to the
following provisions:
1) No transaction relating to securities in the Direct Paper
System will be effected in the absence of Proper
Instructions from the Fund;
2) The Custodian may keep securities of the Fund in the Direct
Paper System only if such securities are represented in an
account ("Account") of the Custodian in the Direct Paper
System which shall not include any assets of the Custodian
other than assets held as a fiduciary, custodian or
otherwise for customers;
3) The records of the Custodian with respect to securities of
the Fund which are maintained in the Direct Paper System
shall identify by book entry those securities belonging to
the Fund;
4) The Custodian shall pay for securities purchased for the
account of the Fund upon the making of an entry on the
records of the Custodian to reflect such payment and
transfer of securities to the account of the Fund. The
Custodian shall transfer securities sold for the account of
the Fund upon the making of an entry on the records of the
Custodian to reflect such transfer and receipt of payment
for the account of the Fund;
7
<PAGE> 11
5) The Custodian shall furnish the Fund confirmation of each
transfer to or from the Fund, in the form of a written
advice or notice, of Direct Paper on the next business day
following such transfer and shall furnish to the Fund copies
of daily transaction sheets reflecting each day's
transaction in the Securities System for the account of the
Fund;
6) The Custodian shall provide the Fund with any report on its
system of internal accounting control as the Fund may
reasonably request from time to time.
2.11 Segregated Account. The Custodian shall upon receipt of Proper
Instructions from the Fund establish and maintain a segregated
account or accounts for and on behalf of the Fund, into which
account or accounts may be transferred cash and/or securities,
including securities maintained in an account by the Custodian
pursuant to Section 2.10 hereof, (i) in accordance with the
provisions of any agreement among the Fund, the Custodian and a
broker-dealer registered under the Exchange Act and a member of
the NASD (or any futures commission merchant registered under the
Commodity Exchange Act), relating to compliance with the rules of
The Options Clearing Corporation and of any registered national
securities exchange (or the Commodity Futures Trading Commission
or any registered contract market), or of any similar
organization or organizations, regarding escrow or other
arrangements in connection with transactions by the Fund, (ii)
for purposes of segregating cash or government securities in
connection with options purchased, sold or written by the Fund or
commodity futures contracts or options thereon purchased or sold
by the Fund, (iii) for the purposes of compliance by the Fund
with the procedures required by Investment Company Act Release
No. 10666, or any subsequent release or releases of the
Securities and Exchange Commission relating to the maintenance of
segregated accounts by registered investment companies and (iv)
for other proper corporate purposes, but only, in the case of
clause (iv), upon receipt of, in addition to Proper Instructions
from the Fund, a certified copy of a resolution of the Board of
Directors or of the Executive Committee signed by an officer of
the Fund and certified by the Secretary or an Assistant
Secretary, setting forth the purpose or purposes of such
segregated account and declaring such purposes to be proper
corporate purposes.
2.12 Ownership Certificates for Tax Purposes. The Custodian shall
execute ownership and other certificates and affidavits for all
federal and state tax purposes in connection with receipt of
income or other payments with respect to domestic securities of
the Fund held by it and in connection with transfers of
securities.
2.13 Proxies. The Custodian shall, with respect to the domestic
securities held hereunder, cause to be promptly executed by the
registered holder of such securities, if the securities are
registered otherwise than in the name of the Fund or a nominee of
the Fund, all proxies, without indication of the manner in which
such proxies are to be voted, and shall promptly deliver to the
Fund such proxies, all proxy soliciting materials and all notices
relating to such securities.
2.14 Communications Relating to Portfolio Securities. Subject to the
provisions of Section 2.3, the Custodian shall transmit promptly
to the Fund all written information (including,
8
<PAGE> 12
without limitation, pendency of calls and maturities of domestic
securities and expirations of rights in connection therewith and
notices of exercise of call and put options written by the Fund
and the maturity of futures contracts purchased or sold by the
Fund) received by the Custodian from issuers of the securities
being held for the Fund. With respect to tender or exchange
offers, the Custodian shall transmit promptly to the Fund all
written information received by the Custodian from issuers of the
securities whose tender or exchange is sought and from the party
(or his agents) making the tender or exchange offer. If the Fund
desires to take action with respect to any tender offer, exchange
offer or any other similar transaction, the Fund shall notify the
Custodian at least three business days prior to the date on which
the Custodian is to take such action.
2.15 Reports to Fund by Independent Public Accountants. The Custodian
shall provide the Fund, at such times as the Fund may reasonably
require, with reports by independent public accountants on the
accounting system, internal accounting control and procedures for
safeguarding securities, futures contracts and options on futures
contracts, including securities deposited and/or maintained in a
Securities System, relating to the services provided by the
Custodian under this Contract; such reports, shall be of
sufficient scope and in sufficient detail, as may reasonably be
required by the Fund to provide reasonable assurance that any
material inadequacies would be disclosed by such examination,
and, if there are no such inadequacies, the reports shall so
state.
3. Duties of the Custodian with Respect to Property of the Fund Held
Outside of the United States
3.1 Appointment of Foreign Sub-Custodians. The Fund hereby
authorizes and instructs the Custodian to employ as
sub-custodians for the Fund's securities and other assets
maintained outside the United States the foreign banking
institutions and foreign securities depositories designated on
Schedule A hereto ("foreign sub-custodians"). Upon receipt of
"Proper Instructions", as defined in Section 4 of this Contract,
together with a certified resolution of the Fund's Board of
Directors, the Custodian and the Fund may agree to amend Schedule
A hereto from time to time to designate additional foreign
banking institutions and foreign securities depositories to act
as sub-custodian. Upon receipt of Proper Instructions, the Fund
may instruct the Custodian to cease the employment of any one or
more such sub-custodians for maintaining custody of the Fund's
assets.
3.2 Assets to be Held. The Custodian shall limit the securities and
other assets maintained in the custody of the foreign
sub-custodians to: (a) "foreign securities", as defined in
paragraph (c)(1) of Rule 17f-5 under the Investment Company Act
of 1940, and (b) cash and cash equivalents in such amounts as the
Custodian or the Fund may determine to be reasonably necessary to
effect the Fund's foreign securities transactions. The Custodian
shall identify on its books as belonging to the Fund, the foreign
securities of the Fund held by each foreign sub-custodian.
3.3 Foreign Securities Depositories. Except as may otherwise be
agreed upon in writing by the Custodian and the Fund, assets of
the Fund shall be maintained in foreign securities depositories
only through arrangements implemented by the foreign banking
institutions
9
<PAGE> 13
serving as sub-custodians pursuant to the terms hereof. Where
possible, such arrangements shall include entry into agreements
containing the provisions set forth in Section 3.4 hereof.
3.4 Agreements with Foreign Banking Institutions. Each agreement
with a foreign banking institution shall be substantially in the
form set forth in Exhibit 1 hereto and shall provide that: (a)
the assets of the Fund will not be subject to any right, charge,
security interest, lien or claim of any kind in favor of the
foreign banking institution or its creditors or agent, except a
claim of payment for their safe custody or administration; (b)
beneficial ownership for the assets of the Fund will be freely
transferable without the payment of money or value other than for
custody or administration; (c) adequate records will be
maintained identifying the assets as belonging to the Fund; (d)
officers of or auditors employed by, or other representatives of
the Custodian, including to the extent permitted under applicable
law the independent public accountants for the Fund, will be
given access to the books and records of the foreign banking
institution relating to its actions under its agreement with the
Custodian; and (e) assets of the Fund held by the foreign
sub-custodian will be subject only to the instructions of the
Custodian or its agents.
3.5 Access of Independent Accountants of the Fund. Upon request of
the Fund, the Custodian will use all reasonable efforts to
arrange for the independent accountants of the Fund to be
afforded access to the books and records of any foreign banking
institution employed as a foreign sub-custodian insofar as such
books and records relate to the performance of such foreign
banking institution under its agreement with the Custodian.
3.6 Reports by Custodian. The Custodian will supply to the Fund from
time to time, as mutually agreed upon, statements in respect of
the securities and other assets of the Fund held by foreign
sub-custodians, including but not limited to an identification of
entities having possession of the Fund securities and other
assets and advices or notifications of any transfers of
securities to or from each custodial account maintained by a
foreign banking institution for the Custodian indicating, as to
securities acquired for the Fund, the identity of the entity
having physical possession of such securities.
3.7 Transactions in Foreign Custody Account. (a) Except as otherwise
provided in paragraph (b) of this Section 3.7, the provision of
Sections 2.2 and 2.7 of this Contract shall apply, mutatis
mutandis to the foreign securities of the Fund held outside the
United States by foreign sub-custodians; (b) notwithstanding any
provision of this Contract to the contrary, settlement and
payment for securities received for the account of the Fund and
delivery of securities maintained for the account of the Fund may
be effected in accordance with the customary established
securities trading or securities processing practices and
procedures in the jurisdiction or market in which the transaction
occurs, including, without limitation, delivering securities to
the purchaser thereof or to a dealer therefor (or an agent for
such purchaser or dealer) against a receipt with the expectation
of receiving later payment for such securities from such
purchaser or dealer; and (c) Securities maintained in the custody
of a foreign sub-custodian may be maintained in the name of such
entity's nominee to the same extent as set forth in Section 2.3
of this Contract, and the Fund agrees to hold any such nominee
harmless from any liability as a holder of record of such
securities.
10
<PAGE> 14
3.8 Liability of Foreign Sub-Custodians. Each agreement pursuant to
which the Custodian employs a foreign banking institution as a
foreign sub-custodian shall require the institution to exercise
reasonable care in the performance of its duties and to
indemnify, and hold harmless, the Custodian and the Fund from and
against any loss, damage, cost, expense, liability or claim
arising out of or in connection with the institution's
performance of such obligations. At the election of the Fund, it
shall be entitled to be subrogated to the rights of the Custodian
with respect to any claims against a foreign banking institution
as a consequence of any such loss, damage, cost, expense,
liability or claim if and to the extent that the Fund has not
been made whole for any such loss, damage, cost, expense,
liability or claim.
3.9 Liability of Custodian. The Custodian shall be liable for the
acts or omissions of a foreign banking institution to the same
extent if such acts or omissions were those of the Custodian
directly, provided that, regardless of whether assets are
maintained in the custody of a foreign banking institution, a
foreign securities depository or a branch of a U.S. bank as
contemplated by paragraph 3.12 hereof, the Custodian shall not be
liable for any loss, damage, cost, expense, liability or claim
resulting from nationalization, expropriation, currency
restrictions, or acts of war or terrorism, acts of God, or other
occurrences beyond the sub-custodian's reasonable control.
Notwithstanding the foregoing provisions of this paragraph 3.9,
in delegating custody duties to State Street London Ltd., the
Custodian shall not be relieved of any responsibility to the Fund
for any loss due to such delegation, except such loss as may
result from (a) political risk (including, but not limited to,
exchange control restrictions, confiscation, expropriation,
nationalization, insurrection, civil strife or armed hostilities)
or (b) other losses (excluding a bankruptcy or insolvency of
State Street London Ltd. not caused by political risk) due to
acts of God, nuclear incident or other losses under circumstances
where the Custodian and State Street London Ltd. have exercised
reasonable care.
3.10 Reimbursement for Advances. If the Fund requires the Custodian
to advance cash or securities for any purpose including the
purchase or sale of foreign exchange or of contracts for foreign
exchange, or in the event that the Custodian or its nominee shall
incur or be assessed any taxes, charges, expenses, assessments,
claims or liabilities in connection with the performance of this
Contract, except such as may arise from its or its nominee's own
negligent action, negligent failure to act or willful misconduct,
any property at any time held for the account of the Fund shall
be security therefor and should the Fund fail to repay the
Custodian promptly, the Custodian shall be entitled to utilize
available cash and to dispose of the Fund's assets to the extent
necessary to obtain reimbursement.
3.11 Monitoring Responsibilities. The Custodian shall furnish
annually to the Fund, during the month of June, information
concerning the foreign sub-custodians employed by the Custodian.
Such information shall be similar in kind and scope to that
furnished to the Fund in connection with the initial approval of
this Contract. In addition, the Custodian will promptly inform
the Fund in the event that the Custodian learns of a material
adverse change in the financial condition of a foreign
sub-custodian or any material loss of the assets of the Fund or
in the case of any foreign
11
<PAGE> 15
sub-custodian not the subject of an exemptive order from the
Securities and Exchange Commission is notified by such foreign
sub-custodian that there appears to be a substantial likelihood
that its shareholders' equity will decline below $200 million
(U.S. dollars or the equivalent thereof) or that its
shareholders' equity has declined below $200 million (in each
case computed in accordance with generally accepted U.S.
accounting principles).
3.12 Branches of U.S. Banks. (a) Except as otherwise set forth in
this Contract, the provisions hereof shall not apply where the
custody of the Fund's assets are maintained in a foreign branch
of a banking institution which is a "bank" as defined by Section
2(a)(5) of the Investment Company Act of 1940 meeting the
qualification set forth in Section 26(a) of said Act. The
appointment of any such branch as a sub-custodian shall be
governed by paragraph 1 of this Contract. (b) Cash held for the
Fund in the United Kingdom shall be maintained in an interest
bearing account established for the Fund with the Custodian's
London branch, which account shall be subject to the direction of
the Custodian, State Street London Ltd. or both.
3.13 Tax Law. The Custodian shall have no responsibility or liability
for any obligations now or hereafter imposed on the Fund or the
Custodian as custodian of the Fund by the tax law of the United
States of America or any state or political subdivision thereof
except for liabilities arising from the Custodian's failure to
exercise reasonable care in the execution of any instructions
received from the Fund with respect to withholding or payment of
taxes. It shall be the responsibility of the Fund to notify the
Custodian of the obligations imposed on the Fund or the Custodian
as custodian of the Fund by the tax law of jurisdictions other
than those mentioned in the above sentence, including
responsibility for withholding and other taxes, assessments or
other governmental charges, certifications and governmental
reporting. The sole responsibility of the Custodian with regard
to such tax law shall be to use reasonable efforts to assist the
Fund with respect to any claim for exemption or refund under the
tax law of jurisdictions for which the Fund has provided such
information.
4. Proper Instructions
Proper Instructions as used throughout this Contract means a
writing signed or initialed by one or more person or persons as the
Board of Directors shall have from time to time authorized. Each such
writing shall set forth the specific transaction or type of
transaction involved, including a specific statement of the purpose
for which such action is requested. Oral instructions will be
considered Proper Instructions if the Custodian reasonably believes
them to have been given by a person authorized to give such
instructions with respect to the transaction involved. The Fund shall
cause all oral instructions to be confirmed in writing. Upon receipt
of a certificate of the Secretary or an Assistant Secretary as to the
authorization by the Board of Directors of the Fund accompanied by a
detailed description of procedures approved by the Board of Directors,
Proper Instructions may include communications effected directly
between electro-mechanical or electronic devices provided that the
Board of Directors and the Custodian are satisfied that such
procedures afford adequate safeguards for the Fund's assets. For
purposes of this Section, Proper Instructions shall include
instructions received by the Custodian pursuant to any three-party
agreement which requires a segregated asset account in accordance with
Section 2.11.
5. Actions Permitted without Express Authority
12
<PAGE> 16
The Custodian may in its discretion, without express authority
from the Fund:
1) make payments to itself or others for minor expenses of
handling securities or other similar items relating to its
duties under this Contract, provided that all such payments
shall be accounted for to the Fund and provided that the
Fund shall not object to such payments;
2) surrender securities in temporary form for securities in
definitive form;
3) endorse for collection checks, drafts and other negotiable
instruments; and
4) in general, attend to all non-discretionary details in
connection with the sale, exchange, substitution, purchase,
transfer and other dealings with the securities and property
of the Fund except as otherwise directed by the Board of
Directors of the Fund.
6. Evidence of Authority
The Custodian shall be protected in acting upon any instructions,
notice, request, consent, certificate or other instrument or paper
reasonably believed by it to be genuine and to have been properly
executed by or on behalf of the Fund. The Custodian may receive and
accept a certified copy of a vote of the Board of Directors of the
Fund as conclusive evidence (a) of the authority of any person to act
in accordance with such vote or (b) of any determination or of any
action by the Board of Directors pursuant to the Articles of
Incorporation as described in such vote, and such vote may be
considered as in full force and effect until receipt by the Custodian
of written notice to the contrary.
7. Duties of Custodian with Respect to the Books of Account and
Calculation of Net Asset Value and Net Income
The Custodian shall cooperate with and supply necessary
information to the entity or entities appointed by the Board of
Directors of the Fund to keep the books of account of the Fund and/or
compute the net asset value per share of the outstanding Shares of the
Fund or, if directed in writing to do so by the Fund, shall itself
keep such books of account and/or compute such net asset value per
share. If so directed, the Custodian shall also calculate weekly the
net income of the Fund as described in the Fund's currently effective
prospectus and shall advise the Fund and the Transfer Agent weekly of
the total amounts of such net income and, if instructed in writing by
an officer of the Fund to do so, shall advise the Transfer Agent
periodically of the division of such net income among its various
components. The calculations of the net asset value per share and the
weekly income of the Fund shall be made at the time or times described
from time to time in the Fund's currently effective prospectus.
8. Records
13
<PAGE> 17
The Custodian shall with respect to the Fund create and maintain
all records relating to its activities and obligations under this
Contract in such manner as will meet the obligations of the Fund under
the Investment Company Act of 1940, as amended, with particular
attention to Section 31 thereof and Rules 31a-1 and 31a-2 thereunder.
All such records shall be the property of the Fund and shall at all
times during the regular business hours of the Custodian be open for
inspection by duly authorized officers, employees or agents of the
Fund and employees and agents of the Securities and Exchange
Commission. The Custodian shall, at the Fund's request, supply the
Fund with a tabulation of securities owned by the Fund and held by the
Custodian and shall, when requested to do so by the Fund and for such
compensation as shall be agreed upon between the Fund and the
Custodian, include certificate numbers in such tabulations.
9. Opinion of Fund's Independent Accountant
The Custodian shall take all reasonable action, as the Fund may
from time to time request, to obtain from year to year favorable
opinions from the Fund's independent accountants with respect to its
activities hereunder in connection with the preparation of the Fund's
Form N-2, and Form N-SAR or other annual reports to the Securities and
Exchange Commission and with respect to any other requirements of such
Commission.
10. Compensation of Custodian
The Custodian shall be entitled to reasonable compensation for
its services and expenses as Custodian, as agreed upon from time to
time between the Fund and the Custodian.
11. Responsibility of Custodian
So long as and to the extent that it is in the exercise of
reasonable care, the Custodian shall not be responsible for the title,
validity or genuineness of any property or evidence of title thereto
received by it or delivered by it pursuant to this Contract and shall
be held harmless in acting upon any notice, request, consent,
certificate or other instrument reasonably believed by it to be
genuine and to be signed by the proper party or parties, including any
futures commission merchant acting pursuant to the terms of a
three-party futures or options agreement. The Custodian shall be held
to the exercise of reasonable care in carrying out the provisions of
this Contract, but shall be kept indemnified by and shall be without
liability to the Fund for any action taken or omitted by it in good
faith without negligence, misfeasance or willful misconduct. It shall
be entitled to rely on and may act upon advice of counsel (who may be
counsel for the Fund) on all matters, and shall be without liability
for any action reasonably taken or omitted pursuant to such advice.
The Custodian shall be liable for the acts or omissions of a
foreign banking institution appointed pursuant to the provisions of
Article 3 as provided in Section 3.9 hereof and, regardless of whether
assets are maintained in the custody of a foreign banking institution,
a foreign securities depository or a branch of a U.S. bank as
contemplated by paragraph 3.12 hereof, the Custodian shall not be
liable for any loss, damage, cost, expense, liability or claim
resulting from, or caused by nationalization, expropriation, currency
restrictions, or acts of war or terrorism, acts of God, or other
occurrences beyond the Custodian's or sub-custodian's reasonable
control.
14
<PAGE> 18
If the Fund requires the Custodian to take any action with
respect to securities, which action involves the payment of money or
which action may, in the opinion of the Custodian, result in the
Custodian or its nominee assigned to the Fund being liable for the
payment of money or incurring liability of some other form, the Fund,
as a prerequisite to requiring the Custodian to take such action,
shall provide indemnity to the Custodian in an amount and form
satisfactory to it.
If the Fund requires the Custodian, its affiliates, subsidiaries
or agents, to advance cash or securities for any purpose (including
but not limited to securities settlements, foreign exchange contracts
and assumed settlement) for the benefit of the Fund including the
purchase or sale of foreign exchange or of contracts for foreign
exchange or in the event that the Custodian or its nominee shall incur
or be assessed any taxes, charges, expenses, assessments, claims or
liabilities in connection with the performance of this Contract,
except such as may arise from its or its nominee's own negligent
action, negligent failure to act or willful misconduct, any property
at any time held for the account of the Fund shall be security
therefor and should the Fund fail to repay the Custodian promptly, the
Custodian shall be entitled to utilize available cash and to dispose
of the Fund's assets to the extent necessary to obtain reimbursement.
12. Effective Period, Termination and Amendment
This Contract shall become effective as of its execution, shall
continue in full force and effect until terminated as hereinafter
provided, may be amended at any time by mutual agreement of the
parties hereto and may be terminated by either party by an instrument
in writing delivered or mailed, postage prepaid to the other party,
such termination to take effect not sooner than thirty (30) days after
the date of such delivery or mailing; provided, however that the
Custodian shall not act under Section 2.10 hereof in the absence of
receipt of an initial certificate of the Secretary or an Assistant
Secretary of the Fund that the Board of Directors of the Fund has
approved the initial use of a particular Securities System by the
Fund, as required by Rule 17f-4 under the Investment Company Act of
1940, as amended, and that the Custodian shall not act under Section
2.10A hereof in the absence of receipt of an initial certificate of
the Secretary or an Assistant Secretary of the Fund that the Board of
Directors of the Fund has approved the initial use of the Direct Paper
System by the Fund; provided further, however, that the Fund shall not
amend or terminate this Contract in contravention of any applicable
federal or state regulations, or any provision of the Articles of
Incorporation, and further provided, that the Fund may at any time by
action of its Board of Directors (i) substitute another bank or trust
company for the Custodian by giving notice as described above to the
Custodian, or (ii) immediately terminate this Contract in the event of
the appointment of a conservator or receiver for the Custodian by the
Comptroller of the Currency or upon the happening of a like event at
the direction of an appropriate regulatory agency or court of
competent jurisdiction.
Upon termination of the Contract, the Fund shall pay to the
Custodian such compensation as may be due as of the date of such
termination and shall likewise reimburse the Custodian for its costs,
expenses and disbursements.
13. Successor Custodian
15
<PAGE> 19
If a successor custodian for the Fund shall be appointed by the
Board of Directors of the Fund, the Custodian shall, upon termination,
deliver to such successor custodian at the office of the Custodian,
duly endorsed and in the form for transfer, all securities of the Fund
then held by it hereunder and shall transfer to an account of the
successor custodian all of the securities of the Fund held in a
Securities System.
If no such successor custodian shall be appointed, the Custodian
shall, in like manner, upon receipt of a certified copy of a vote of
the Board of Directors of the Fund, deliver at the office of the
Custodian and transfer such securities, funds and other properties in
accordance with such vote.
In the event that no written order designating a successor
custodian or certified copy of a vote of the Board of Directors of the
Fund shall have been delivered to the Custodian on or before the date
when such termination shall become effective, then the Custodian shall
have the right to deliver to a bank or trust company, which is a
"bank" as defined in the Investment Company Act of 1940, as amended,
doing business in Boston, Massachusetts, of its own selection, having
an aggregate capital, surplus, and undivided profits, as shown by its
last published report, of not less than $25,000,000, all securities,
funds and other properties held by the Custodian on behalf of the Fund
and all instruments held by the Custodian relative thereto and all
other property held by it under this Contract on behalf of the Fund
and to transfer to an account of such successor custodian all of the
securities of each the Fund held in any Securities System.
Thereafter, such bank or trust company shall be the successor of the
Custodian under this Contract.
In the event that securities, funds and other properties remain
in the possession of the Custodian after the date of termination
hereof owing to failure of the Fund to procure the certified copy of
the vote referred to or of the Board of Directors of the Fund to
appoint a successor custodian, the Custodian shall be entitled to fair
compensation for its services during such period as the Custodian
retains possession of such securities, funds and other properties and
the provisions of this Contract relating to the duties and obligations
of the Custodian shall remain in full force and effect.
14. Interpretive and Additional Provisions
In connection with the operation of this Contract, the Custodian
and the Fund may from time to time agree on such provisions
interpretive of or in addition to the provisions of this Contract as
may in their joint opinion be consistent with the general tenor of
this Contract. Any such interpretive or additional provisions shall
be in a writing signed by both parties and shall be annexed hereto,
provided that no such interpretive or additional provisions shall
contravene any applicable federal or state regulations or any
provision of the Articles of Incorporation of the Fund. No
interpretive or additional provisions made as provided in the
preceding sentence shall be deemed to be an amendment of this
Contract.
15. Massachusetts Law to Apply
This Contract shall be construed and the provisions thereof
interpreted under and in accordance with laws of The Commonwealth of
Massachusetts.
16
<PAGE> 20
16. Prior Contracts
This Contract supersedes and terminates, as of the date hereof,
all prior contracts between the Fund and the Custodian relating to
the custody of the Fund's assets.
17
<PAGE> 21
17. Shareholder Communications Election
Securities and Exchange Commission Rule 14b-2 requires banks
which hold securities for the account of customers to respond to
requests by issuers of securities for the names, addresses and
holdings of beneficial owners of securities of that issuer held by the
bank unless the beneficial owner has expressly objected to disclosure
of this information. In order to comply with the rule, the Custodian
needs the Fund to indicate whether it authorizes the Custodian to
provide the Fund's name, address, and share position to requesting
companies whose securities the Fund owns. If the Fund tells the
Custodian "no", the Custodian will not provide this information to
requesting companies. If the Fund tells the Custodian "yes" or does
not check either "yes" or "no" below, the Custodian is required by the
rule to treat the Fund as consenting to disclosure of this information
for all securities owned by the Fund or any funds or accounts
established by the Fund. For the Fund's protection, this rule
prohibits the requesting company from using the Fund's name and
address for any purpose other than corporate communications. Please
indicate below whether the Fund consents or objects by checking one of
the alternatives below.
YES [ ] The Custodian is authorized to release the Fund's
name, address, and share positions.
NO [X] The Custodian is not authorized to release the
Fund's name, address, and share positions.
18
<PAGE> 22
IN WITNESS WHEREOF, each of the parties has caused this
instrument to be executed in its name and on its behalf by its duly
authorized representative and its seal to be hereunder affixed as of
the_____________day of______________, 1998.
ATTEST MUNIHOLDINGS CALIFORNIA INSURED FUND V, INC.
By:
Name:
--------------------------------------------
Name:
Title:
ATTEST STATE STREET BANK AND TRUST COMPANY
By:
Name:
--------------------------------------------
Ronald E. Logue
Executive Vice President
<PAGE> 23
ADDENDUM TO CUSTODIAN CONTRACT
WHEREAS, the Board of Directors (the "Board") of MuniHoldings
California Insured Fund V, Inc. (the "Fund") has adopted a resolution
appointing the Custodian as Foreign Custody Manager of the Fund
pursuant to the Rule 17f-5 Procedures and Guidelines previously
adopted by the Board (the "Procedures and Guidelines"), a copy of
which is attached hereto as Exhibit A, MuniHoldings New Jersey Insured
Fund II, Inc. (the "Fund") and State Street Bank and Trust Company
(the "Custodian") hereby enter into this Addendum to the Custody
Contract dated ______________, 1998 between the Fund and the Custodian
(the "Contract");
WHEREAS, each party wishes to enter into this Addendum to the
Contract;
NOW, THEREFORE, for such good and valuable consideration as is recited
in the Contract, the Fund and the Custodian agree that:
Article III of the Contract is hereby amended, revised and superceded
to the extent that such Article is inconsistent with the Procedures
and Guidelines. Each of the Fund and the Custodian acknowledge that
they are currently developing further mutually agreeable contract
procedures and provisions pursuant to the Procedures and Guidelines.
IN WITNESS WHEREOF, each of the parties has caused this
instrument to be executed in its name and on its behalf by its duly
authorized representative as of the ___________ day of ___________,
1998.
ATTEST MUNIHOLDINGS CALIFORNIA INSURED FUND V, INC.
By:
------------------------ ----------------------------------
Name: Name:
--------------------------------
Title:
-------------------------------
ATTEST STATE STREET BANK AND TRUST COMPANY
By:
------------------------ ----------------------------------
Name: Marc L. Parsons Ronald E. Logue
Title: Associate Counsel Executive Vice President
<PAGE> 1
Exhibit (k)
REGISTRAR,
TRANSFER AGENCY AND SERVICE AGREEMENT
between
MUNIHOLDINGS CALIFORNIA INSURED
FUND V, INC.
and
STATE STREET BANK AND TRUST COMPANY
closed/trust
2B193
================================================================================
<PAGE> 2
TABLE OF CONTENTS
-----------------
<TABLE>
<S> <C>
ARTICLE 1 TERMS OF APPOINTMENT; DUTIES OF THE BANK 3
ARTICLE 2 FEES AND EXPENSES 5
ARTICLE 3 REPRESENTATIONS AND WARRANTIES OF THE BANK 5
ARTICLE 4 REPRESENTATIONS AND WARRANTIES OF THE FUND 6
ARTICLE 5 DATA ACCESS AND PROPRIETARY INFORMATION 6
ARTICLE 6 INDEMNIFICATION 9
ARTICLE 7 STANDARD OF CARE 10
ARTICLE 8 COVENANTS OF THE FUND AND THE BANK 10
ARTICLE 9 TERMINATION OF AGREEMENT 11
ARTICLE 10 ASSIGNMENT 12
</TABLE>
2
<PAGE> 3
<TABLE>
<S> <C>
ARTICLE 11 AMENDMENT 12
ARTICLE 12 MASSACHUSETTS LAW TO APPLY 12
ARTICLE 13 FORCE MAJEURE 13
ARTICLE 14 CONSEQUENTIAL DAMAGES 13
ARTICLE 15 MERGER OF AGREEMENT 13
ARTICLE 16 SURVIVAL 13
ARTICLE 17 SEVERABILITY 13
ARTICLE 18 COUNTERPARTS 14
</TABLE>
3
<PAGE> 4
REGISTRAR, TRANSFER AGENCY AND SERVICE AGREEMENT
AGREEMENT made as of the ____ day of ___, 1998, by and between
MuniHoldings California Insured Fund V, Inc. a Maryland corporation, having its
principal office and place of business at 800 Scudders Mill Road, Plainsboro, NJ
08536 (the "Fund"), and STATE STREET BANK AND TRUST COMPANY, a Massachusetts
trust company having its principal office and place of business at 225 Franklin
Street, Boston, Massachusetts 02110 (the "Bank").
WHEREAS, the Fund desires to appoint the Bank as its registrar,
transfer agent, dividend disbursing agent and agent in connection with certain
other activities and the Bank desires to accept such appointment;
NOW, THEREFORE, in consideration of the mutual covenants herein
contained, the parties hereto agree as follows:
ARTICLE 1 TERMS OF APPOINTMENT; DUTIES OF THE BANK
1.01 Subject to the terms and conditions set forth in this Agreement, the
Fund hereby employs and appoints the Bank to act as, and the Bank agrees to act
as registrar, transfer agent for the Fund's authorized and issued shares of its
common stock ("Shares"), dividend disbursing agent and agent in connection with
any dividend reinvestment plan as set out in the prospectus of the Fund,
corresponding to the date of this Agreement.
1.02 The Bank agrees that it will perform the following services:
4
<PAGE> 5
(a) In accordance with procedures established from time to time by
agreement between the Fund and the Bank, the Bank shall:
(i) Issue and record the appropriate number of Shares as
authorized and hold such Shares in the appropriate Shareholder
account;
(ii) Effect transfers of Shares by the registered owners
thereof upon receipt of appropriate documentation;
(iii) Prepare and transmit payments for dividends and
distributions declared by the Fund;
(iv) Act as agent for Shareholders pursuant to the dividend
reinvestment and cash purchase plan as amended from time to time in
accordance with the terms of the agreement to be entered into
between the Shareholders and the Bank in substantially the form
attached as Exhibit A hereto;
(v) Issue replacement certificates for those certificates
alleged to have been lost, stolen or destroyed upon receipt by
5
<PAGE> 6
the Bank of indemnification satisfactory to the Bank and protecting
the Bank and the Fund, and the Bank at its option, may issue
replacement certificates in place of mutilated stock certificates
upon presentation thereof and without such indemnity.
(b) In addition to and neither in lieu nor in contravention of the
services set forth in the above paragraph (a), the Bank shall: (i) perform
all of the customary services of a registrar, transfer agent, dividend
disbursing agent and agent of the dividend reinvestment and cash purchase
plan as described in Article 1 consistent with those requirements in
effect as of the date of this Agreement. The detailed definition,
frequency, limitations and associated costs (if any) set out in the
attached fee schedule, include but are not limited to: maintaining all
Shareholder accounts, preparing Shareholder meeting lists, mailing
proxies, and mailing Shareholder reports to current Shareholders,
withholding taxes on U.S. resident and non-resident alien accounts where
applicable, preparing and filing U.S. Treasury Department Forms 1099 and
other appropriate forms required with respect to dividends and
distributions by federal authorities for all registered Shareholders.
(c) The Bank shall provide additional services on behalf of the Fund
(i.e., escheatment services) which may be agreed upon in writing between
the Fund and the Bank.
6
<PAGE> 7
ARTICLE 2 FEES AND EXPENSES
2.01 For the performance by the Bank pursuant to this Agreement, the Fund
agrees to pay the Bank an annual maintenance fee as set out in the initial fee
schedule attached hereto. Such fees and out-of-pocket expenses and advances
identified under Section 2.02 below may be changed from time to time subject to
mutual written agreement between the Fund and the Bank.
2.02 In addition to the fee paid under Section 2.01 above, the Fund agrees
to reimburse the Bank for out-of-pocket expenses, including but not limited to
confirmation production, postage, forms, telephone, microfilm, microfiche,
tabulating proxies, records storage, or advances incurred by the Bank for the
items set out in the fee schedule attached hereto. In addition, any other
expenses incurred by the Bank at the request or with the consent of the Fund,
will be reimbursed by the Fund.
2.03 The Fund agrees to pay all fees and reimbursable expenses within five
days following the receipt of the respective billing notice. Postage and the
cost of materials for mailing of dividends, proxies, Fund reports and other
mailings to all Shareholder accounts shall be advanced to the Bank by the Fund
at least seven (7) days prior to the mailing date of such materials.
ARTICLE 3 REPRESENTATIONS AND WARRANTIES OF THE BANK
7
<PAGE> 8
The Bank represents and warrants to the Fund that:
3.01 It is a trust company duly organized and existing and in good
standing under the laws of the Commonwealth of Massachusetts.
3.02 It is duly qualified to carry on its business in the Commonwealth of
Massachusetts.
3.03 It is empowered under applicable laws and by its Charter and By-Laws
to enter into and perform this Agreement.
3.04 All requisite corporate proceedings have been taken to authorize it
to enter into and perform this Agreement.
3.05 It has and will continue to have access to the necessary facilities,
equipment and personnel to perform its duties and obligations under this
Agreement.
ARTICLE 4 REPRESENTATIONS AND WARRANTIES OF THE FUND
The Fund represents and warrants to the Bank that:
8
<PAGE> 9
4.01 It is a corporation duly organized and existing and in good standing
under the laws of Maryland.
4.02 It is empowered under applicable laws and by its Articles of
Incorporation and By-Laws to enter into and perform this Agreement.
4.03 All corporate proceedings required by said Articles of Incorporation
and By-Laws have been taken to authorize it to enter into and perform this
Agreement.
4.04 It is a closed-end, diversified investment company registered under
the Investment Company Act of 1940, as amended.
4.05 To the extent required by federal securities laws a registration
statement under the Securities Act of 1933, as amended is currently effective
and appropriate state securities law filings have been made with respect to all
Shares of the Fund being offered for sale; information to the contrary will
result in immediate notification to the Bank.
4.06 It shall make all required filings under federal and state securities
laws.
ARTICLE 5 DATA ACCESS AND PROPRIETARY INFORMATION
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5.01 The Fund acknowledges that the data bases, computer programs, screen
formats, report formats, interactive design techniques, and other information
furnished to the Fund by the Bank are provided solely in connection with the
services rendered under this Agreement and constitute copyrighted trade secrets
or proprietary information of substantial value to the Bank. Such databases,
programs, formats, designs, techniques and other information are collectively
referred to below as "Proprietary Information." The Fund agrees that it shall
treat all Proprietary Information as proprietary to the Bank and further agrees
that it shall not divulge any Proprietary Information to any person or
organization except as expressly permitted hereunder. The Fund agrees for itself
and its employees and agents:
(a) to use such programs and databases (i) solely on the Fund
computers, or (ii) solely from equipment at the locations agreed to
between the Fund and the Bank and (iii) in accordance with the Bank's
applicable user documentation;
(b) to refrain from copying or duplicating in any way (other than in
the normal course of performing processing on the Funds' computers) any
part of any Proprietary Information;
(c) to refrain from obtaining unauthorized access to any programs,
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data or other information not owned by the Fund, and if such access is
accidentally obtained, to respect and safeguard the same Proprietary
Information;
(d) to refrain from causing or allowing information transmitted from
the Bank's computer to the Funds' terminal to be retransmitted to any
other computer terminal or other device except as expressly permitted by
the Bank (such permission not to be unreasonably withheld);
(e) that the Fund shall have access only to those authorized
transactions as agreed to between the Fund and the Bank; and
(f) to honor reasonable written requests made by the Bank to protect
at the Bank's expense the rights of the Bank in Proprietary Information at
common law and under applicable statutes.
5.02 If the transactions available to the Fund include the ability to
originate electronic instructions to the Bank in order to (i) effect the
transfer or movement of cash or Shares or (ii) transmit Shareholder information
or other information, then in such event the Bank shall be entitled to rely on
the validity and authenticity of such instruction without undertaking any
further inquiry as long as such instruction is undertaken in conformity with
security procedures established by the Bank from time to time.
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Article 6 Indemnification
6.01 The Bank shall not be responsible for, and the Fund shall indemnify
and hold the Bank harmless from and against, any and all losses, damages, costs,
charges, counsel fees, payments, expenses and liability arising out of or
attributable to:
(a) All actions of the Bank or its agents or subcontractors required
to be taken pursuant to this Agreement, provided that such actions are
taken in good faith and without negligence or willful misconduct.
(b) The Fund's lack of good faith, negligence or willful misconduct
which arise out of the breach of any representation or warranty of the
Fund hereunder.
(c) The reliance on or use by the Bank or its agents or
subcontractors of information, records, documents or services which (i)
are received by the Bank or its agents or subcontractors, and (ii) have
been prepared, maintained or performed by the Fund or any other person or
firm on behalf of the Fund including but not limited to any previous
transfer agent registrar.
(d) The reliance on, or the carrying out by the Bank or its agents
or subcontractors of any instructions or requests of the Fund.
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(e) The offer or sale of Shares in violation of any requirement
under the federal securities laws or regulations or the securities laws or
regulations of any state that such Shares be registered in such state or
in violation of any stop order or other determination or ruling by any
federal agency or any state with respect to the offer or sale of such
Shares in such state.
6.02 At any time the Bank may apply to any officer of the Fund for
instructions, and may consult with legal counsel with respect to any matter
arising in connection with the services to be performed by the Bank under this
Agreement, and the Bank and its agents or subcontractors shall not be liable and
shall be indemnified by the Fund for any action taken or omitted by it in
reliance upon such instructions or upon the opinion of such counsel. The Bank,
its agents and subcontractors shall be protected and indemnified in acting upon
any paper or document furnished by or on behalf of the Fund, reasonably believed
to be genuine and to have been signed by the proper person or persons, or upon
any instruction, information, data, records or documents provided the Bank or
its agents or subcontractors by telephone, in person, machine readable input,
telex, CRT data entry or other similar means authorized by the Fund, and shall
not be held to have notice of any change of authority of any person, until
receipt of written notice thereof from the Fund. The Bank, its agents and
subcontractors shall also be protected and indemnified in recognizing stock
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certificates which are reasonably believed to bear the proper manual or
facsimile signatures of the officers of the Fund, and the proper
countersignature of any former transfer agent or former registrar, or of a
co-transfer agent or co-registrar.
6.03 In order that the indemnification provisions contained in this
Article 6 shall apply, upon the assertion of a claim for which the Fund may be
required to indemnify the Bank, the Bank shall promptly notify the Fund in
writing of such assertion, and shall keep the Fund advised with respect to all
developments concerning such claim. The Fund shall have the option to
participate with the Bank in the defense of such claim or to defend against said
claim in its own name or in the name of the Bank. The Bank shall in no case
confess any claim or make any compromise in any case in which the Fund may be
required to indemnify the Bank except with the Fund's prior written consent.
ARTICLE 7 STANDARD OF CARE
7.01 The Bank shall at all times act in good faith and agrees to use its
best efforts within reasonable limits to insure the accuracy of all services
performed under this Agreement, but assumes no responsibility and shall not be
liable for loss or damage due to errors unless said errors are caused by its
negligence, bad faith, or willful misconduct of that of its employees.
ARTICLE 8 COVENANTS OF THE FUND AND THE BANK
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8.01 The Fund shall promptly furnish to the Bank the following:
(a) A certified copy of the resolution of the Board of Directors of
the Fund authorizing the appointment of the Bank and the execution and
delivery of this Agreement.
(b) A copy of the Articles of Incorporation and By-Laws of the Fund
and all amendments thereto.
8.02 The Bank hereby agrees to establish and maintain facilities and
procedures reasonably acceptable to the Fund for safekeeping of stock
certificates, check forms and facsimile signature imprinting devices, if any;
and for the preparation or use, and for keeping account of, such certificates,
forms and devices.
8.03 The Bank shall keep records relating to the services to be performed
hereunder, in the form and manner as it may deem advisable. To the extent
required by Section 31 of the Investment Company Act of 1940, as amended, and
the Rules thereunder, the Bank agrees that all such records prepared or
maintained by the Bank relating to the services to be performed by the Bank
hereunder are the property of the Fund and will be preserved, maintained and
made available in accordance with such Section and Rules, and will be
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<PAGE> 16
surrendered promptly to the Fund on and in accordance with its request.
8.04 The Bank and the Fund agree that all books, records, information and
data pertaining to the business of the other party which are exchanged or
received pursuant to the negotiation or the carrying out of this Agreement shall
remain confidential, and shall not be voluntarily disclosed to any other person,
except as may be requested by a governmental entity or as may be required by
law.
8.05 In cases of any requests or demands for the inspection of the
Shareholder records of the Fund, the Bank will endeavor to notify the Fund and
to secure instructions from an authorized officer of the Fund as to such
inspection. The Bank reserves the right, however, to exhibit the Shareholder
records to any person whenever it is advised by its counsel that it may be held
liable for the failure to exhibit the Shareholder records to such person.
ARTICLE 9 TERMINATION OF AGREEMENT
9.01 This Agreement may be terminated by either party upon one hundred
twenty (120) days' written notice to the other.
9.02 Should the Fund exercise its right to terminate, all out-of- pocket
expenses associated with the movement of records and material will be
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<PAGE> 17
borne by the Fund. Additionally, the Bank reserves the right to charge for any
other reasonable expenses associated with such termination and/or a charge
equivalent to the average of three (3) months' fees.
ARTICLE 10 ASSIGNMENT
10.01 Except as provided in Section 10.03 below, neither this Agreement
nor any rights or obligations hereunder may be assigned by either party without
the written consent of the other party.
10.02 This Agreement shall inure to the benefit of and be binding upon the
parties and their respective permitted successors and assigns.
10.03 The Bank may, without further consent on the part of the Fund,
subcontract for the performance hereof with (i) Boston EquiServe Limited
Partnership, a Massachusetts limited partnership ("Boston EquiServe"), which is
duly registered as a transfer agent pursuant to Section 17A(c)(2) of the
Securities Exchange Act of 1934 ("Section 17A(c)(2)"), or (ii) a Boston
EquiServe affiliate duly registered as a transfer agent pursuant to Section
17A(c)(2), provided, however, that the Bank shall be as fully responsible to the
Fund for the acts and omissions of any subcontractor as it is for its own acts
and omissions.
ARTICLE 11 AMENDMENT
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11.01 This Agreement may be amended or modified by a written agreement
executed by both parties and authorized or approved by a resolution of the Board
of Directors of the Fund.
ARTICLE 12 MASSACHUSETTS LAW TO APPLY
12.01 This Agreement shall be construed and the provisions thereof
interpreted under and in accordance with the laws of The Commonwealth of
Massachusetts.
ARTICLE 13 FORCE MAJEURE
13.01 In the event either party is unable to perform its obligations under
the terms of this Agreement because of acts of God, strikes, equipment or
transmission failure or damage reasonably beyond its control, or other causes
reasonably beyond its control, such party shall not be liable for damages to the
other for any damages resulting from such failure to perform or otherwise from
such causes.
ARTICLE 14 CONSEQUENTIAL DAMAGES
14.01 Neither party to this Agreement shall be liable to the other
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party for consequential damages under any provision of this Agreement or for any
consequential damages arising out of any act or failure to act hereunder.
ARTICLE 15 MERGER OF AGREEMENT
15.01 This Agreement constitutes the entire agreement between the parties
hereto and supersedes any prior agreement with respect to the subject hereof
whether oral or written.
ARTICLE 16 SURVIVAL
16.01 All provisions regarding indemnification, warranty, liability and
limits thereon, and confidentiality and/or protection of proprietary rights and
trade secrets shall survive the termination of this Agreement.
ARTICLE 17 SEVERABILITY
17.01 If any provision or provisions of this Agreement shall be held to be
invalid, unlawful, or unenforceable, the validity, legality and enforceability
of the remaining provisions shall not in any way be affected or impaired.
ARTICLE 18 COUNTERPARTS
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18.01 This Agreement may be executed by the parties hereto on any number
of counterparts, and all of said counterparts taken together shall be deemed to
constitute one and the same instrument.
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
executed in their names and on their behalf by and through their duly authorized
officers, as of the day and year first above written.
MUNIHOLDINGS CALIFORNIA INSURED FUND V, INC.
BY:__________________________________________
ATTEST:
____________________________________
State Street Bank and Trust Company
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BY:___________________________________________
ATTEST:
____________________________________
21
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Exhibit 99(L)
July 23, 1999
MuniHoldings California Insured Fund V, Inc.
800 Scudders Mill Road
Plainsboro, New Jersey 08536
Ladies and Gentlemen:
This opinion is being furnished in connection with the registration by
MuniHoldings California Insured Fund V, Inc., a Maryland corporation (the
"Fund"), of shares of common stock, 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.
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 Articles of Incorporation
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.
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> 1
EXHIBIT (n)(2)
INDEPENDENT AUDITORS' CONSENT
MuniHoldings California Insured Fund V, Inc.
We consent to the use in Pre-Effective Amendment No. 3 to Registration
Statement No. 333-77531 of our report dated July 19, 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
July 19, 1999
<PAGE> 1
EXHIBIT (P.)
CERTIFICATE OF THE SOLE STOCKHOLDER OF
MUNIHOLDINGS CALIFORNIA INSURED FUND V, INC.
Fund Asset Management, L.P. ("FAM"), the holder of 6,667 shares of common
stock, par value $0.10 per share, of MuniHoldings California Insured Fund V,
Inc. (the "Fund"), a Maryland corporation, 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:
------------------------------
Name: Donald C. Burke
Title: Senior Vice President
Dated: July 23, 1999
